OptionPundit

Category: Options Essentials

  • What is Options Trading? Top 10 Things You Must Know Before Trading Options

    What is Options Trading? Top 10 Things You Must Know Before Trading Options

    Options Trading can be extremely rewarding. However, it is also a fact that majority of Options traders struggle to make money consistently. Before you begin to trade options, it is crucial to understand basic nature of options and how Options are different from other trading instruments e.g. stocks or forex.

    Here is simple, straight forward TOP10 list that might help you in understanding basic nature of options.

    1. Right to BUY or SELL

    Options give you the right to buy or sell an underlying instrument at specific price. Options are available on a variety of different underlying assets including stocks [e.g. Apple (AAPL), Microsoft (MSFT)], futures (e.g. S&P500 futures commonly known as ES_Mini), Commodities (e.g. Crude Oil, Gold, Wheat), Forex (e.g. JPY, CHF, Euro), Bonds (e.g. 30Year, 10 Years) and indices (e.g. S&P500, Nasdaq, Dow Jones). In fact, the list just keeps on growing.

    Once you have identified the desired market or underlying asset to trade, you may simply check out if that underlying asset has options or not.

    2. ONLY Two Types of Options

    There are only two kinds of Options.

    CALL OPTION

    A call option is an agreement that gives the option buyer the right to buy the underlying asset at a specified price within a specific time period.

    PUT OPTION

    A put option is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time frame.

    Bottomline: A Call Option gives you the right to buy the underlying asset and A Put Option gives you the right to sell the underlying asset. Generally speaking, you buy Call Option because you have Bullish Outlook and you buy Put Option when you have bearish outlook.

    Though there are only two types of options, when you factor in other characteristics of options, there are endless trading possibilities.

    3. Each Option has a Symbol

    For instance – Apple is just one stock and its stock symbol is AAPL. However, AAPL may have hundreds of options. So how do you remember? There is proper method for defining symbols. A symbol contains- a) Date of expiration (Year, Month, Date), b) Underlying Asset Symbol, c) Strike Price and d) Option Type i.e. Call or Put.

    An Example – AAPL150821C125 ( Apple Call Option at 125 strike that expires on 21 Aug 2015).

    4. Buying an Option Means, Right

    If you BUY AN OPTION, you are not obligated to buy the underlying instrument; you simply have the right to exercise the option. When you buy a Call Option, you have the right to BUY stocks at your option’s strike price.

    Similarly, when you buy a Put Option, you have the right to SELL stocks at your Option’s price.

    5. Selling an Option Means, Obligation.

    If you SELL a Call Option, you are obligated to deliver the underlying asset at the strike price at which the Call Option was sold if the buyer exercises his or her right to take delivery. If you sell a Put Option, you have to buy the underlying if exercised.

    Generally speaking, if you don’t take any action, your friendly broker will most likely do it for you if your Options are eligible for exercise.

    6.Options are Good only for Specified Time.

    Options are good for a specified period of time after which they expire and the option holder loses the right to buy or sell the underlying instrument at the specified price. This specified period is called “Expiration”.

    Options are available for variety of expiration timings such as weekly, Monthly, Quarterly and much longer durations (known as LEAPs).

    7. The Cost of an Option is Referred to as the Option Premium.

    The price reflects a variety of factors including the option’s volatility, time left until expiration, and the price of the underlying asset. There are several Options Pricing Models that you can use to calculate theoretical Option Price by modeling various parameters.

    There is no fixed price for an Options. It is dynamic and will keep on changing with respect to time to expiration and other variables.

    8. Buy at Your Price, Sell at Your Price

    You can choose any price at which you would like to BUY or SELL underlying instrument. These prices are called Strike Price and Options are available in several Strike Prices at, far or near the current market price of the underlying instrument.

    9. Buying Means, Debit

    Options when BOUGHT are purchased at a DEBIT to the buyer. That is, the money is debited from your brokerage account. It’s exactly like Buying a stock.

    10. Selling Means, Credit

    You can SELL and Option, without owning the shares. Options when SOLD are sold at a CREDIT to the seller. Money is added to the brokerage account. You can’t withdraw this money until the trade has been closed. Usually, this money is used to offset the margin required for selling the options.

    Once you understand the basic differences, key terms of options, don’t jump into trading options yet. Trading options usually requires mindset change and you may want to know the single biggest mistake new option traders make.

    Profitable Trading, OP

  • A Straddle Strangle Swap on Berkshire

    This post will explain what’s a Straddle Strangle Swaps option trading strategy? And also share a trade idea on how to use this strategy on Berkshire Hathaway (BRK.B) to make some money while learning it as well.

    A Straddle Strangle Swaps (SSS) is the sale of a front-month Straddle and the purchase of a back-month Strangle. From the pictorial perspective, it looks like a simple Calendar Spread.

    (For beginners who are wondering what is a Straddle and Strangle- A straddle is long 1 call and long 1 put at the same strike price and expiration and on the same stock. For example, long 1 IBM Mar 120 call and long 1 IBM Mar 120 put ; and a Strangle is long 1 call at a higher strike and long 1 put at a lower strike in the same expiration and on the same stock. For example, long 1 IBM Mar 125 call and long 1 IBM Mar 105 put)

    Straddle Strangle Swap (SSS) is a Market-neutral, defined-risk position that profits from positive time decay (theta) as well as collecting credits from rolling short options forward. Most of the time it is a Theta Positive, Vega positive and Delta neutral. Albeit, depending upon IV skew it can be Vega negative; and as underlying moves higher/lower than the short strike, trade can convert into a directional trade thus delta positive and delta negative.

    [OPNewsletter has outperformed the broader market. Pls read customer reviews or If you would like to sign-up for OPNewsletter directly, pls click here to sign-up for the wait-list (as the subscription is by invitation only)].

    (more…)

  • OPNewsletter Dec +5.3% (Open)

    The December portfolio’s weekly update is now available at the OP Discussion forum (Member’s only section). To access the Subscriber’s Page of the forum, sign on with your own username and password by clicking here. Continue to read full post as  I shall be sharing links to good articles/ resources.

    OPNewsletter Dec 2009 Portfolio
    OPNewsletter Dec 2009 Portfolio

    OPN December portfolio has invested 68.2% of 10K assumption capital per portfolio spread and this is invested in 3 main sub-portfolios. Iron condor sub-portfolio alone is up +10%. I might open one more portfolio in the coming week and then we let it run for the month.

    OPNewsletter has consistently outperformed the broader market. Pls read customer reviews or If you would like to sign-up for OPNewsletter directly, pls click here to sign-up for the wait-list (as the subscription is by invitation only).

    Financial freedom is usually the number one goal that most investors aim for. Some want that freedom as soon as next month or next year, while some work through a very disciplined approach and prepare for long haul. Albeit, talk to any financial planner and he or she will direct you to that “one number” you need your net worth by to retire comfortably and often that number starts with $Million and or above.

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  • Good Chance for the Market Close on High on Expiration Week

    From OP Contributor – Jiayu Chiu

    I have noted that expiration week is the most bullish week in a month. For the past 2 years, there is high percentage of SPX close on high in the expiration week in a month. Let see this month of statistics on how the SPX close :

    Feb 2007 : 2.4 points from high of the month.

    Let look the statistics for the past 16 months :

    From Nov 2005 to Feb 2007 (16 months), there is more than 75% chance that the SPX closes on high on the option expiration date. 10 months closed less than 5 points from the high of the month, 2 months closed between 6-9 points from the high.

    The study starts from the first day of the expiration month, for example in the month of Dec 2006, that was 20 Nov 2006, till the last day of the Dec 2006 trading day, that was 15 Dec 2006. Separately there are 10 months from Nov 2005 to Oct 2006, that the index closed less than 10 points from the high of the month. Just to list the month in details (closing SPX price from the high of the option month):

    1. Nov 2005 : 1.3 point
    2. Dec 2005 : 8.5 points
    3. Feb 2006 : 2.2 points
    4. Mar 2006 : 3.2 points
    5. Apr 2006 : 6.9 points
    6. Aug 2006 : 0 point
    7. Sep 2006 : 5.0 points
    8. Oct 2006 : 4.2 points
    9. Nov 2006 : 2.6 points
    10. Dec 2006 : 4.6 points
    11. Jan 2007 : 4.8 points
    12. Feb 2007 : 2.4 points

    What are the suitable strategies for this observation ? One of them might be to buy a 2 month ATM VIX Put one week on the first monday morning. We all know that VIX generally goes down when the broader market goes up in price. With 2 months ATM VIX Put we do not lose much in time decay. Let take for example this Feb 2007 month, VIX was 11.10 on 9 Feb 2007, the Apr 11 Put was doing around $0.4, the VIX was 10.05 on 16 Feb 2007, the Apr 11 Put closed at around $0.55.

  • Feb 16th is an exciting day

    I mentioned in my past posts about the expiration day opportunities that can be categorized into two types i.e. Directional and Non-directional trades

    I am going to cover non-directional part with respect to pinning of stocks. For the beginners who are wondering what is pinning, it simply means, the tendency of stock’s price to close near the strike price of heavily traded options as the expiration date nears. There are a lot of good studies conducted on why pinning takes place; you may Google “Pinning of stocks” to get more understanding. Here is a brief analysis of Google for the past 5 months and projection for tomorrow’s action.   

    • Sept 15, Pinned ~ $410, Oct 20, Pinned ~ $460
    • Nov 17, Pinned ~ $500, Dec 15, Pinned ~ 480, Jan 19, Pinned ~ 490
    • Feb 16, probably it will be pinned around $460 unless something exciting happens overnight that cause Google to either gap-up or gap down.

    Here is the chart with my comments–  Google Pinning Analysis

    Other observation worth noticing is that $460 is currently a technical support area. It may bounce back from here next week and therefore, in my opinion, there are 2 opportunities 1) pinning and 2) benefit from the stock’s movement from Monday.

    How to play pinning: I experimented this in December and played an Iron fly that generated 29% profit. Check out the details. Also in the same post, there is a chart which shows very clearly that after lunch Google continued to move in horizontal line. You may want to paper trade first to have a feel on how it behaves.

    Adam has identified several candidates XOM (~$75), GE(~$35), MSFT(~30), MO (~85), T(~35), VZ(~35), and add Goog to list (~460). Check out his excellent post.

    Profitable trading,
    OptionPundit

  • Option Strategy Screener

    Here is the strategy screener I was referring to in my earlier post. This screener is an essential part of the OptionPundit’s Toolbox and I encourage beginners to use it to have an understanding of different option trading strategies before diving into option trading world beyond straight calls and puts.

    This screener from option industry council has more than 40 strategies listed and explains it very well. It tabulates whether a particular strategy is suited for bullish, bearish, neutral or sharp move market outlook. Here is the snapshot of the “strategy lists” from the screener Strategy List

    The screener then goes one step further and provides more details of a strategy in an interactive way. Click at any strategy of your choice and it will take you to separate screen that provides details of that strategy with a pictorial view. Here is a snapshot of short iron condor –> ShortCondor Explaination

    Notice the buttons at the top that provide more information when you click at these buttons. For instance, I chose short iron condor strategy and then clicked at description. It precisely described what a short Iron condor is. This screen also shares with you how Greeks and other variables impact short iron condor strategy. At the same page it also lists your maximum loss or profit scenarios. RUT Simulation

    Check out a small button at the bottom “launch interactive analysis”. By clicking at that button, you will be taken to a “position simulator” that has flexibility to let you select options you want to design short iron condor for. There are several input filters that allow you to customize the condor. For instance, I customized it for Russell 2000 (RUT), short 850 call, 760 put and long 860 call and 750 put for March 2007 expiration. Play with the simulator a bit more and find out maximum loss and profit for your trade. BY changing implied volatility, or stock price via bottom toolbars one can visualize how profit/loss curve changes.

    Now let’s talk about cost- If one learns these strategies via “seminars” or so called “secrets of massive wealth, money making in a jiffy”, etc., one might be paying thousands of dollars. Since money is made even by just sharing these basic steps, this free simulator or screener is not widely publicized. OptionPundit is always in search for tools that are available for free and let its reader enjoy the basics of options trading at the minimal cost. Save those valuable dollars for something of higher value which will help you move up in the amazing world of option trading.

    Here is the link to the strategy screener, it’s under “My toolboox” category and is titled “Options Startegy Simulator”.

    Hope you liked it, do let me know your thoughts in the comments section, OptionPundit