This article looks at the same put strike for a long put and also a short put. First, focus will be placed on the long put's Delta. Then the same put strike price that was used for the long will be analyzed from the perspective of the short put.
Delta has multiple levels of meaning. One of the most commonly quoted definitions is that Delta is a measure of the change in an option's premium with respect to a change in the price of the underlying. The Delta of a long call and also of a short put are positively correlated to the movement of the underlying. While in the case of a long put, as well as the short call, the Delta is negatively correlated to the movements of the underlying asset.
Delta could also be an approximate Measure of...
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Articles
The aim of this article is to explain how the option premium of an ITM long call changes as the underlying moves on the price chart. There will be three points in time that we will examine.
We will use DIA, the Dow Jones Industrial Average Exchange Traded Fund, for our example. At the first point in time that we will use, the Dow was trading at 126.50 and a one step in the money long August call was selected.
PART I: Friday close 07/08/2011
On July 8th, after the Dow (and the DIA) had been in a strong uptrend for a number of days, it became evident where the next area of resistance would be – at the 127 level. Figure 1 shows the daily chart of the DIA creating, at that time, a formation that seems like a Bull Flag.
Figure 1: Daily...
There are new options out there called NASDAQ OMX Alpha Indexes Options. This article will explain some of the aspects of this "New Kid on the Block" for options. It is not a recommendation to buy or sell of any of these products. The information presented here is for educational purposes only. The accuracy of what is discussed can be verified on the official NASDAQ website, as well as Investopedia.com.
Prior to explaining what the new NASDAQ OMX Alpha Index options are, we should first be familiar with what the Alpha term actually stands for; so let us define it. According to Investopedia.com, there are two definitions of Alpha. The first dictionary definition states that Alpha is "A measure of performance on a risk-adjusted basis...
Often, tape reading is viewed as something that held value back in the 1990s, yet I would argue that there is still value in it today, especially when it comes to options. This article will walk the readers through the process of discovering a possible trade using tape reading and then follow its evolution chronologically.
Day One: Weekly Options are Listed
Every Thursday morning weekly options are listed on a small number of ETFs (Exchange Traded Funds). On Thursday, 2/24/2011, I was considering placing a trade on the IWM (Russell 2000 tracking ETF). Figure 1 shows three TradeStation windows, the most colorful one being the Options Analysis window. The columns that one needs to focus on are Open Interest, in white, and the Volume for...
In this article, I will go over three possible outcomes for a Bear Call spread at the expiry. Those scenarios involve the price of the underlying closing within the spread, above the sold call, and below the sold call.
Last week's article, "Iron Condor Revisited", had addressed the issue of two vertical credit spreads. Since then, a student whom I shall leave unnamed, has emailed me pleading with me to explain to him a trade in which the student has gotten into without knowing much about spread trading. From the email, it could be inferred that the student has taken a bigger position from what is normal. Again, without disclosing anything more about the student, I will go over the facts of the trade. (I do have the student's consent to...
I have previously alluded to the importance of trading psychology by discussing two types of trading errors: Decision Making Error and Data Error. Some readers have indicated their desire to learn more about it. In this article, I will dive deeper into the topic of option trading and trading psychology.
Trading options and trading psychology are closely interrelated. The goal of this article is to show some of those close connections between the two. Let us start by describing what option trading really is. One of the easiest ways to describe option trading is by simply comparing it to equity trading. Most people are more familiar with equity trading so I will use that as a bench mark. Equity trading involves physically owning a...
In this article we will examine a specific case of a debit and a credit spread in order to point out that there is virtually very little difference between the two.
Instead of attempting to explain the concept by using a fictitious example, the stock XYZ with the one strike price being at this level and the other one at that level, etc, we shall utilize a couple of my recent trades for the same purpose. Again, this scrutiny is for education purposes only and it is not intended to be a recommendation of any kind.
My normal criteria for trading optionable stocks is the liquidity which is evident in the volume of the underlying as well as the high open interest and volume on individual strike prices. The Chevron Corporation has passed...
Today I'd like to talk about a strategy called the Vertical Spread. For those of you who are wondering how the terms Horizontal and Vertical came into common usage, ponder no more. In a typical options chain or montage, the options are typically displayed in the format shown here. Calendar months listed horizontally and strike prices listed vertically!
As I typically like to do, let's start out with a definition.
Definition: A Vertical Spread is an options strategy in which options are bought and an equal number of options of the same type (Puts or Calls) are sold with different strike prices, but with the same expiration date.
Vertical Spreads are directional strategies and are either bullish or bearish. This is what the generic...
I've recently written about the popular strategies of Straddles and Strangles. For the most part, they were discussed from the long side, in other words, buying the Straddle or buying the Strangle. Obviously, there is another side to this story, and that is the short side, selling the Straddle or Strangle.
There were 2 main reasons why I emphasized the long side. The first has to do with the fact that brokerage companies don't just let everyone trade short naked options. Each company has their own set of rules and requirements regarding what they require to allow a customer to trade short options. Factors taken into account can include the customers' length of options trading experience, their income and net worth, and the size of...
I've probably mentioned the term volatility in every article I've written about options trading. Everyone probably has an intuitive feel as to what volatility means, for example looking at the following charts of stocks ABC and XYZ, it's pretty clear which one is more volatile. If you think it's XYZ, you probably should hold off a little before you start trading options (or anything else for that matter.)
So how do we define volatility and how do we measure it? In general terms, volatility is the rate that the price of a security moves up or down. It is measured by the annual standard deviation of the daily price changes in the security. Digging down a little deeper, the standard deviation is calculated by taking the square root of...
A question recently came up about the symbols that represent options and what seems like a relatively boring and mundane topic is actually filled with twists and turns and many surprises. Okay, so it probably won't make you rich knowing more about option symbols than 99 percent of the non-professional options traders out there, but it will keep you from making mistakes when dealing with your broker, and in some circles, can make you a hit at cocktail parties.
The truth of the matter is that the system which has been in place for 25 years (since 1973) has not kept up with available technology and has become extremely unwieldy. In the industry, rumor has it that a particular large brokerage company, whose name I probably shouldn't...
I'll bet you probably never considered how international options trading can be! We know there are American options, which can be exercised at any time from when they are bought until their date of expiration (we call that "early exercise.") There are also European options, which cannot be exercised early, and can only be exercised on their expiration date. Well today we're going to learn about the "Greeks." This term should not be new to anybody who is already trading options. The reason is that they are so important, that unless you have a basic understanding of what they are, and how to use them, you are going to be trading with a serious disadvantage.
So what are these Greeks? Simply put, we can call them risk measurements, (sorry...
Since the introduction of exchange traded options in the 1973, they have become more and more popular. In fact, it seems that almost every month I get an email from the Chicago Board of Options Exchange (CBOE) announcing that a new record number of contracts have traded and showing the month to month and year to year increase in options trading.
What accounts for this increase in options volume? Well, while banks and other institutions have been using exchange traded and over-the-counter options for many years, the general public is beginning to recognize that options don't have to be as risky as their reputation may imply. In fact, they can be used in many conservative ways to hedge a portfolio, provide portfolio insurance, generate a...
Producing a high probability trade forecast is not easy. Just as difficult is determining the best trading strategy and vehicles to capitalize on the forecast. Read on to learn some of my favorites trading strategies.
Let's say you've done your homework. You've identified a pivot point, a futures market direction and have projected a time frame for the move. The only thing missing is the price amplitude. In other words, how big or small will the price move be?
Generally, the magnitude of the move will always be the unknown. With TimeLine forecasts we will always have an idea of the direction and time frame, but it is up to real world commodity market forces to decide how far the move will carry.
The way to handle price uncertainty is...
Virtual Trading (VT) is a general term referring to hypothetical trades made by a trader for either practicing or for evaluation of his/her methodology. You may have also heard the term "Paper Trading" which is usually used interchangeably with VT. In fact, the days prior the rush of personal computers in all aspects of life (trading included) virtual trades were done on paper instead of being done in a real account hence the term "paper trading". Nowadays the astounding massive use of personal computers and the extensive use of internet have made virtual trading possible in an amazingly convenient way. The virtual trader does not have to adjust his notes for corporate actions, dividends and other labor intensive stuff. All these can...
In this article, I will address one of the questions that I have recently been asked. It is on the topic of huge swings in the implied volatility on an individual stock. In order to get to the bottom of the issue under discussion, I have utilized the CBOE's Option Calculator. Here is the question that I was asked:
I own a biotech stock that is currently trading around $50 and I have recently sold some 55 strike covered calls with the expiration next month. The very next day, out of nowhere, positive news came out and the stock jumped $3. However, the value of the option fell by nearly 30%. How can that be?
The simple answer to your question is that the implied volatility decreased, which in turn has caused the premium of your 55 call...
There may be an unlimited number of approaches to the markets and their usefulness may be both obvious and questionable. As mass psychology is a basic engine which drives markets forward, so the analysis is derived from market psychology and as such it may seem more attractive than it actually is. On the other hand sound analytical methods do not get significant attention at times, as they are effective but not necessarily "promising" and give traders the truth, which sometimes may be hard to accept.
In the March 2005 edition of "Futures" magazine the ODI (Option Deviation Index) was presented, which takes measure of market fluctuations based on the entry point (Fig.1). The result is calculated as a percentage of entry value divided...
Part 1
At the end of one my classes at Irvine, an option trader stopped by for some small trading chit-chat. By the look in his eyes, I could tell that he had a large position that was eating away at his sleep as well as his finances. Without disclosing the trader's identity, I would like to describe the situation in which the trader had found himself. He owned 10,000 shares of an unnamed pharmaceutical underlying which, at the time of his entry was trading at $9.95 ($9.95 times 10,000 equals $99,500 in a single trade). Knowing as much as he did about options, he had chosen to sell credit calls on the shares that he owned. As a reminder, each contract controls 100 shares, so if a trader has 10,000 shares (divided by 100) he could sell...
As a trader, one of the key things that I try to consciously do is to cultivate my instincts by talking with other traders and investors as often as possible. It still amazes me how large the divergence of opinion that exists regarding what people believe will unfold as we enter the new millennium. Many very respected names are literally predicting an economic earthquake that will measure a 10 on the Richter scale while others having looked at the exact same research claim that the consequences will be very mild. As a trader I have to evaluate the data and develop a strategy that I feel not only gives me an edge but allows for a great deal of error while still being low risk!
In his book, "Business Without Economists" author William J...
There are an unlimited number of ways to skin a cat and trading is no different. Despite your strategy, risk tolerance or trading capital, having a plan is one of the most important components of achieving success in these treacherous markets. However, perhaps the most important characteristic of a profitable trader is the ability to adapt to ever-changing market conditions. Knowing this, it seems logical to assume that a trading plan should be established but just as rules are meant to be broken, trading plans should be flexible to accommodate altering environments and new events.
The premise of a trading plan is similar in nature to a business plan. It is a relatively detailed outline of the structure of the trade and the...
This week we'll learn about the Straddle's first cousin, the Strangle. Let's start off with a definition.
Definition: A long (short) Strangle is the purchase (sale) of an out of the money (OTM) Put and an OTM Call on the same underlying stock with the same time to expiration. There's also a similar strategy, called a Guts, where both of the options are ITM.
With XYZ stock trading at $50, an example of a long Strangle would be the purchase of the XYZ July 45 Put and the July 55 Call. If the Call is trading for $1.25, the Put for $.90 and we bought 10 Strangles, the total cost (excluding commissions) would be $2,150. Of course, if we sold the Strangles, we would receive a credit for that same amount coming into our account. Like the...
Over the last few months I've discussed a lot of the basics of trading options. It's like building a house; you start with the foundation. As far as actually trading, I've discussed Puts and Calls and a little bit about Covered Calls. Now we're going to start thinking about different types of spread strategies. Why do we want to spread? Several reasons; it reduces the overall cost and limits the risk of a position. At the same time it lowers the breakeven point for the position and allows flexibility to take advantage of different types of market conditions. Of course, like everything else in trading, there is a trade-off. The maximum potential on the upside may be capped, and there will be more commission costs and more bid/ask spreads...
Tomorrow, the 18th April 2008, is the 3rd Friday of the month, commonly referred to as expiration Friday. Coincidentally, this year it almost coincides with the first day of the Jewish holiday of Passover. I therefore find it appropriate to ask "Why is this day different than other days?" (If you don't get the joke, and care to, send me an email.)
The truth is that technically the expiration is on the Saturday following the third Friday, but you can't trade the options after the close on Friday. Also, if you want to exercise an option that is in-the-money (ITM) by less than a nickel, or not exercise an option that is ITM by a nickel or more, you must notify your broker by 5:30 pm (EST) on Friday. Some brokers require this notification...
There are literally hundreds of options strategies, many more if you include the vast array of complex strategy combinations. Why so many? Simple, it s because most options speculators can't figure out price direction. Instead, they rely on complex option strategies and a variety of standard pricing models that don t work and simply add illusion to a constant simple reality of all markets: supply (resistance) and demand (support).
When you filter out illusion and replace it with pure supply and demand analysis in options trading, you not only simplify the useless complexity of options, you discover endless low risk-high reward opportunity based on a set of objective rules. This opportunity is one in which the reality-based options...
How does volatility affect Options trading and is it a good or bad thing?
A little violence is one's life can be very exciting, and profitable. No, I'm not suggesting you go rob your neighborhood liquor store. I'm talking about your trading life. The violence I'm referring to is the up and down fluctuations in the stock market. How severe these fluctuations are is measured by what is called "volatility."
Obviously, when there are dramatic spikes, the volatility can be very high. Conversely, when the stock is moving sideways, and not moving up and down, the volatility is reduced. Remember, earlier we discussed the components of an option price based on the Black Scholes pricing formula. Volatility is one of the ingredients. Basically...
Welcome to the wonderful world of equity options. You may have heard that option trading is high risk, and indeed it is, for much the same reasons that spread betting is high risk. The instruments themselves are derivatives from the cash markets, and are highly geared, but options themselves were originally introduced to the US markets in the mid 1970s as a tool for hedging risk. In other words they were a form of insurance. You paid a premium, a bit like car insurance, which covered you in the case of an accident. In the financial markets you bought some protection in case the market went in the opposite direction. In this article we look at equity options, which are those derived from the cash market share or stock.
In the early...
Ever wondered about Futures Spread Trading? In this article the author looks at the basics and the best way to trade them.
How professional traders optimize profits
Futures spread trading is probably the most profitable, yet safest way to trade futures. Almost every professional trader uses spreads to optimize his profits. Trading spreads offers many advantages which make it the perfect trading instrument, especially for beginners and traders with small accounts (less than $10,000).
The following example of a Soybean-Spread shows the advantages of futures spread trading:
Example: Long May Soybeans (SK3) and Short November Soybeans (SX3)
Four Advantages of Futures Spread Trading
Advantage 1: Easy to trade
Do you see how nicely this...
Having been trading stocks and options in the capital markets professionally over the years, I have seen many ups and downs.
One story told to me by my mentor is still etched in my mind:
"Once, there were two Wall Street stock market multi-millionaires. Both were extremely successful and decided to share their insights with others by selling their stock market forecasts in newsletters. Each charged US$10,000 for their opinions. One trader was so curious to know their views that he spent all of his $20,000 savings to buy both their opinions. His friends were naturally excited about what the two masters had to say about the stock market's direction. When they asked their friend, he was fuming mad. Confused, they asked their friend...
In this article the author gives an example of how to put together all the information learnt in the past articles Covered Calls - Part 1 and Covered Calls - Part 2.
It's time to put it all together - all the stuff you've learned to this point. We're going to go through the process of selecting a position - without adult supervision. We're going to make believe we have an opinion about the direction the market is going. What is this opinion based on? It came via a fortune cookie from last night's Chinese carryout. First it gave you next Saturday night's lottery numbers. Then, it told you that EBAY was going up eight points in the next month.
Wow! What a tip! However, you look at a chart of EBAY and see that it's trading near its...
The second part of the article on Covered Call Writing looks at more detail and gives some examples.
Everybody screws up. It's human nature. I spent the last article explaining what TO do - and what NOT to do - when using the covered call strategy. Did it sink in? I hope so.
Studies have shown that you have to be exposed to something a minimum of seven times before you comprehend it. So, read on. You may think you already understand what I'm about to explain, however, it's more likely (if you're relatively new to options) that you may be a little fuzzy on the subject.
Due to the seeming simplicity of trading covered calls, dozens of books have covered the topic. They devote chapters upon chapters painting blue sky with potential...