Call Option Trading Secrets » Stock Options Trading

Stock Trading Options: Do your research well

admin — Tue, 19 Jan 2010 17:37:33 +0000

Stock options trading can be much profitable in comparison to regular stock trades and investments. While investing, it is always beneficial to have a good amount of knowledge about the type of investment and associated risks. You should be careful about certain things when investing in Options.If you do not have enough information about the Stock Options, it is important that you do some research first. Buy a book or go to the seminars organized by stock trading companies. Technical terms can be a little complicated as there are different types of trading, buying and selling available. Determine the type of Options you want to try first based upon the investment amount and risk factor. Make yourself familiar with terms like calls, puts, long call, short call, long put, short put, long synthetic, short synthetic, call back spread etc.You can always tap into the vast resources available over the Internet and subscribe to the many Stock and Index trading newsletters, join forums and keep yourself informed about latest trading news. You can always take advantage of learning through online trading tutorials. These tutorials have videos and other interactive elements that are quite valuable to everyone who is new to trading in stock options. There are a number of courses available online and offline that provide electronic books, memberships, forums, videos, spreadsheets and other useful material. These courses are designed to teach you how to trade carefully in the Stock Options.This is not all; there are also a number of trading softwares available. These softwares help you simulate and analyze scenarios and have proven to be quite valuable in making informed decisions related to stock trading.Camelot Derivatives is a leading Australia based derivatives dealing company specializing in the trading of international index options and Stock Options Trading. The company provides valuable advice and in-depth analysis to its customers on stock trading.

Options Trading Lesson: The Butterfly

admin — Mon, 18 Jan 2010 05:42:31 +0000

I am sure many of you have heard of a sophisticated sounding strategy called the Butterfly. For some reason, it seems to be the darling strategy of many of those ‘teach-you in five hours’ type option companies. They publicize the ‘mystical magical Butterfly’ and the ’sophisticated Condor’ as if they were going to unlock the options version of Pandora’s box. I guess they feel that, by introducing you to the catchy named strategies, they will grab your attention and thereby give them a chance to promote themselves. From a marketing standpoint, that is not a bad idea.
However, the Butterfly is a ’sophisticated’ only for those that do not know options! If you have done your homework and have learned the option basics properly, then the Butterfly is a simple strategy that is just a combination of an already familiar, basic strategy. Let’s take a closer look and uncover the secrets of the mysterious Butterfly!
Butterfly Construction
The first thing you must understand about the Butterfly is that it is constructed by using either all calls or all puts. The Butterfly is never a combination of the two. (We will talk about an exception called the Iron Butterfly later.)
Whether you choose to use calls or puts, butterflies are always constructed in a ‘1-2-1′ arrangement. For the long Butterfly, you would buy one low strike, sell two medium strikes and buy one high strike with the strike prices equally spaced. The center strike typically matches the current price of the stock.
For example, if the stock is 55 and you decide to create a long Butterfly by using calls, you could buy a 50 call, sell two 55 calls, and buy one 60 call. If you decided to use puts, you could buy a 50 put, sell two 55 puts, and buy one 60 put. The long Butterfly is always long the outer strikes and short the center strike.
You would construct the short Butterfly in the opposite way. The short Butterfly will always be short the outer strikes and long the center strike. For example, to create a short Butterfly, you could sell a 50 call, buy two 55 calls, and sell one 60 call. The short Butterfly trader is simply taking the opposite side of the trade with the long Butterfly trader.
This is not a complicated construction. The trick is to understand that while there are three strikes to a Butterfly, there are four options involved. I know the construction will be hard to associate with long or short in the beginning, so here is a little trick or two to help you remember how to differentiate a long Butterfly from a short Butterfly.
When I think of whether a Butterfly is long or short, I always look at that first strike. If that first strike is long, then it is a long Butterfly. It is as simple as that. Some people find it easier to just focus on the center strike where you have the two-option position. If you are short the center strike, then you are long the Butterfly.
The opposite would be true for short butterflies. These are just a couple of ways that you can determine whether a Butterfly is long or short until you become so familiar that you automatically know which Butterfly is which. Until you get to that point, you will want to use little tricks to remember which one is which. Use whichever is most comfortable but I suggest you focus on only one ‘trick’ and use only it until you become so familiar with butterflies you don’t need it any longer to recognize which one you have. Make your choice and stick with it!
The following chart shows the long and short Butterfly construction:
Notice that the strike prices are equally spaced. This is a necessary aspect of all butterflies. However, while the strikes must be equally spaced, they do not need to be spaced by five dollars as in this example.
We could have spaced them by ten dollars and created a different long Butterfly by purchasing the 45 call, selling two 55 calls, and buying one 65 call. You just have to understand that the strikes must be set up in an equidistant manner and they must be either all calls or all puts in the proper 1-2-1 ratio.
From a terminology standpoint, we call this the 50/55/60 Butterfly or, more simply, the 55 Butterfly taking the lead from the Butterfly’s middle strike.
We add to that term whatever month you are dealing with. If we are referring to the June expiration cycle, it would be called the June 55 Butterfly. If we were in April, it would be called the April 55 Butterfly.

Lessons in Options Trading Strategies – The Lean

admin — Thu, 14 Jan 2010 17:26:01 +0000

Professional traders use the term lean to refer to one’s perception about the directional strength of the stock. When you own a stock and intend to hold it for a period of time, you are aware that you will probably be holding it while it goes up and while it goes down.
This means that at any given moment in time, you might have a different opinion of the potential movement of that stock. Knowing this, there is a way to address your present level of confidence or ‘lean.’ You do this by your choice of which option you sell.
While it is true that the at-the-money option has the most amount of extrinsic value, it might not always be the ideal option to sell in every situation.
For instance, if you feel that the stock itself has a very high chance of producing capital appreciation above the potential amount of premium you could receive from selling an at-the-money call, then sell an out-of-the-money-call so you can allow yourself a little more room to the upside on the stock.
For example, let’s say the stock is trading at $27.00. Normally, you would sell the 27.5 calls at say $1.00. If the stock were to rise quickly and eclipse the $28.50 mark, then with the buy-write strategy, your position would have maxed out at $28.50, and you would have a $1.50 one month gain. Not bad, but if the stock went to $29.50 then you would have missed out on
another $1.00 profit. However, if we had sold the 30 calls for $.30 then we would have another outcome. You bought the stock at $27.00 and sold the 30 calls for $.30 and the stock goes to $29.50.
You would have made $2.50 in capital appreciation and $.30 in option premium for a total of a $2.80 return.
So, if you feel the stock has a real good shot at taking a run up, you can lean your position long by selling an out-of-the-money call.
If you have a more neutral view on your stock you would sell an at-the-money-call in order to receive a bigger premium which allows for greater downside protection if the stock trades down and higher potential profit if the stock becomes stagnant.
This strategy also works on the downside. If, by chance, you feel that the stock may trade down a bit during the life of the option, then you can sell an in-the-money-call. The effect of this would be to provide you with a little extra premium to cover more downside risk.
Remember when you sell an option you seek to capture extrinsic value. An in-the-money option not only has extrinsic value but also some intrinsic value.
When you feel that you want to lean your covered call strategy (buy-write) a little short, choose to sell an in-the-money call so you can also have some intrinsic value to cover your downside.
As an example, say your stock is trading at $29.00 and you feel that your stock may trade down a little but still remain in an uptrend cycle. You don’t want to get rid of the stock but you also don’t want to lose any money so you sell the 27.5 call at $2.00.
The stock starts to trade down and finishes at $26.00. If you had owned the stock naked, then you would have lost three dollars since you owned the stock at $29.00 and it closed at $26.00 on expiration.
However, because you sold the 27.5 calls at $2.00, you would only realize a $1.00 loss in the stock. The premium received will offset the loss due to the fact that you identified and adjusted for a likely move.
As you can see, the buy-write strategy can be altered to fit any directional view you have on your selected stock.
Finally, if you intend to use the buy-write strategy
successfully, you generally need to sell the calls against your stock on a consistent, recurring interval, over a period of time.
This means that you will have to be prepared to ‘roll’ your calls out to the next month come expiration. Sometimes, all you’ll need to do is to sell the next month out call.

The Collar Strategy for Effective Options Trading

admin — Mon, 11 Jan 2010 17:30:18 +0000

Another protective strategy that allows for some upside capital gain while providing maximum down side protection is the collar.
The collar is a combination of the covered call and protective put strategies. The collar uses a long put position in coordination with a short call position along with a long stock position. The ratio is one short call, one long put (not of the same strike) and 100 shares of stock.
As you remember, one contract is equal to 100 shares. The options that we will use to construct this strategy will be out-of-the-money puts and calls.
The object here is to construct a protective put strategy without having to pay for the purchase of the put. We talked about premium in the covered call strategy and how we are better off collecting premiums over a period of time, not paying them out. By selling the call, we collect premium which can be used to offset the capital outlay we incurred for the put purchase.
We said that two of three scenarios in the covered call strategy were positive while the protective put scenario had only one scenario that produced a positive outcome. However, the protective put was the strategy that provided the most downside protection. The challenge was to construct a protective put strategy without paying out money. The solution is the collar strategy.
The collar takes on the characteristics of both the protective put and covered call strategies. Like the covered call, there is an upside cap on profits and like the protective put there is unlimited downside protection.
Ideally, the collar is set up to be an ‘even’ trade meaning you neither receive nor pay out any money. Realistically, depending on the options used, you may have to pay out a small premium or even receive a small premium but the goal of the collar in terms of premium is to be neutral.
As mentioned previously, to construct a collar, just buy one out-of-the-money put and sell one out-of-the-money call per every 100 shares of stock owned.
Obviously, the put and the call must be of differing strikes (it is impossible for a put and a call of identical strike price to both to be out-of-the-money or both to be in-the-money).
For example, with a stock priced at $28.50 a collar may be constructed by the purchase of the December 27.5 puts and the sale of the December 30 calls. Hopefully, the price of the call and put are close enough so that the funds generated by the sale of the call are enough to offset the cost of the put purchase.

Introducing The Amazing Stock Repair Strategy

admin — Mon, 11 Jan 2010 05:28:06 +0000

Introducing the Amazing Stock Repair Strategy. This strategy involves buying one at-the-money call option while simultaneously selling two out-of-the-money call options on the same stock, in the same month.
The construction of this trade is critical. First, you must make sure to purchase exactly the equivalent amount of at-the-money call options as shares of stock you own. Remember, each option contract is worth 100 shares. So if you own 500 shares, then you would purchase 5 at-the-money calls. If you owned 3000 shares then you would purchase 30 at-the-money calls.
Now that you have purchased the correct and exact amount of at-the-money calls, you then must sell exactly twice the amount of out-of-the-money calls. Again, it is imperative that you sell exactly two times the amount of out-of-the-money calls as the amount of at-the-money calls you own.
Looking at the case in which you owned 500 shares and bought 5 at-the-money calls, you would then have to sell 10 out-of-the-money calls to properly construct the Stock Repair Strategy. Likewise, in the case where you owned 3000 shares and bought 30 at-the-money calls, you would then have to sell 60 out-of-the-money calls for proper Stock Repair Strategy construction.
Here’s why. The 500 shares of stock you have, along with the 5 call options you just bought, will result in an even spread trade. The reason this is important is because without owning the equivalent of 10 calls (or 1000 shares of the underlying stock), then the 10 out of the money calls you sell would be considered ‘naked’ and may require an additional margin requirement.
Selling naked calls is considered risky. However, by owning 1000 shares of stock (or 10 call options) at a lower price, your risk is limited because your sold calls are considered ‘covered.’
The chart below shows some examples of the correct Stock Repair Strategy ratios.
The total dollar value of the options’ trade should be neutral or very close to neutral. In this way, you can establish the position without putting out any more money or at least very little.
In some cases, you can even put on this trade for a credit, whereby you can sell the out of the money calls for more than you paid for the at the money calls. This scenario is ideal, because then you also profit from this part of the trade – also known as a credit spread. (Remember, you will be selling the out of the money calls in a 2:1 ratio to the at the money calls you purchase.)
The out of the money calls will invariably be cheaper than the calls you buy, but the 2:1 ratio makes up for the difference in pricing. The easiest way to explain this is by example. Again, we will go back to our XYZ example. You have purchased 500 shares of XYZ for $40.00. The stock then trades down to $30.00 leaving you with a $5,000 loss.
At this point, at $30.00, you would construct the Stock Repair Strategy. (Option prices are for example purposes only.) You would buy 5 February 30 calls for $1.50 and sell 10 February 35 calls for $.75 each. This strategy is known as a 1 by 2 spread.
Now that the position is in place, you are long 500 shares of XYZ, long 5 February 30 calls and short 10 February 35 calls. Just to clarify, if you were long 1000 shares of stock, then you would also be long 10 February 30 calls, and short 20 February 35 calls. Remember, the ratio of stock, to purchased calls, to sold calls is 1:1:2.

Options Buyer Risk & Reward

admin — Sun, 10 Jan 2010 17:34:58 +0000

Like most trades, time spreads have a maximum loss for the buyer. As a buyer, you can only lose what you have spent. If you paid $1.00 for the spread then your maximum potential loss is that $1.00. If you bought the spread for $2.00, then $2.00 is the maximum potential loss.
The buyer of a time spread will be purchasing the out-month option while selling the nearer month option of the same strike in a one-to-one ratio. Since the out-month option will have more time until expiration than the nearer month option, the out-month option will cost more. This means the buyer will be putting out money (debit spread) which makes sense. The buyer can only lose the amount of money they spent to purchase the spread. Thus the buyer’s maximum risk is the cost of the spread.
The buyer can profit in several ways. First and foremost, being a time spread, the buyer can profit by the passage of time. Options are wasting assets. So as the nearer month option decays away more quickly than the outer-month option, the spread widens (increases in value) and the buyer sees a profit.
Second, implied volatility can increase. As implied volatility increases, the out-month option, which the buyer is long, increases in value more quickly (due to its higher vega) than the nearer month option which the buyer is short. This will force the spread to widen or increase in value, which again is profitable for the buyer.
Third, the buyer can make money due to stock price movement. As stated before, a time spread’s value is at its maximum when the stock price and the spreads strike price are identical (at-the-money). You could have an increase in value if you owned an out-of-the-money or in-the-money time spread, and the stock moved either up or down toward your strike. As the stock moves closer to your strike, the spread will expand and increase in value creating a profit for you, the buyer.
The buyer’s risks are obviously the opposite of the rewards. You can not stop or reverse time so the buyer of the spread can never be hurt by time.
Implied volatility, however, can decrease as easily as it can increase. A decrease in implied volatility will decrease the value of the out-month option (which the buyer is long) faster than it will decrease the value of the nearer month option (which the buyer is short) due to the higher vega of the out-month option. This will narrow the spread thereby creating a loss for the buyer.
In the same way that stock movement in the right direction can be profitable for the buyer of a time spread, stock movement in the wrong direction can be costly. As the stock moves away from the spread’s strike, the spread decreases in value. That will create a loss for the buyer of the spread.

Generate Consistent Stock Market Profit Through Credit Spread Writing

admin — Sun, 10 Jan 2010 05:29:32 +0000

Many traders and investors dream about making consistent profit on the stock market. Typically, investors would turn to fundamental analysis for medium to long term capital gains while traders would try to time the market using technical analysis to spot reversals or advantageous entry point and exit with the first sign of trouble. Unfortunately for everyone, the stock market is a zero-sum game. What this means is that for you to profit someone else would have to lose. The market exchanges acts like a distribution center of wealth. Essentially, without knowing, many novice investors and traders are actually trading against the professional and institutional traders. Who do you think will win most of the time? The answer is obvious. Credit Spread is one of the lesser known trading strategies available to the options trader. This strategy is call “credit spread” because you actually collect your target profits upfront or a credit when you enter into a credit spread position. Credit spreads are directional plays – bull or bear. The bull spread is called Bull Put Spread while the bear spread is known as the Bear Call Spread.

The Credit Spread Option Trading Strategy can be constructed to be a low risk investment vehicle. Using this strategy, we are able to use time decay in Options prices to our full benefit. Time decay works towards our advantage the closer it is to expiration. With this in mind, time can very well be our ally in our quest for profit. We just need to know how to use time to help us.

Fact – about 80% of all options expire worthless, it makes sense that serious and long term investor should only be writing credit spreads for a living.

How do we profit from Credit Spread?

Assuming that we are writing a Bull Put Spread:

If the stock moves upwards, we make money. If the stock moves sideways, we make money. If the stock moves lower, but is above the strike price that we sold our puts, we still make money.

I don’t know about you, but any trade that lets you earn a full profit when your stock moves higher, when it moves sideways, or even when it moves lower enhance your winning probability. Credit spread writing is a powerful trading strategy because, if written correctly, it provides room for error and you would still profit even though you are wrong.

The closer it gets to expiration (most of the time 3 rd Saturday of the month), the better it is for us. We make money using the passage of time. Many seasoned credit spread traders like to view the 3rd Saturday of the month as their pay day.

The biggest problem in Stock Options Trading is the race against time. More than 80% of options expire out-of-money or, in simpler terms, expire with no value. If you bought options, this means you would have lost all your money in the trade. So with this fact in mind, use an Options Trading Strategy that would put you on the other side of the table. And that is to use a time profiting trading strategy called Credit Spread.

Time Decay Strategies for Options Trading

admin — Fri, 08 Jan 2010 17:52:30 +0000

Time decay, also known as theta, is defined as the rate by which an options value erodes into expiration. The value of the option over parity to the stock is called extrinsic value.

Since an option is a depreciating asset, meaning it has a limited life, the extrinsic value in the option will wither away daily until expiration. This decay is not a linear function meaning it is not equally distributed between all of the days to expiration.

As the option gets closer to expiration, the daily rate of decay increases and continues to increase daily until expiration of the option. At expiration, all options in the expiration month, calls and puts, in-the-money and out-of-the-money must be completely devoid of extrinsic value as noted in the time value decay charts below.

As more time goes by, the options extrinsic value decreases. Again, it is important to note that the rate of this decrease is not linear, meaning not smooth and even throughout the life of the option contract. An option contract starts feeling the decay curve increasing when the option has about 45 days to expiration. It increases rapidly again at about 30 days out and really starts losing its value in the last two weeks before expiration.

This is like a boulder rolling down a hill. The further it goes down the hill, the more steam it picks up until the hill ends.

By selling the option and owning the stock, the covered call seller captures the extrinsic value in the option by holding the short call until expiration.

As mentioned earlier, an options loss of extrinsic value over its life is called time decay. In the covered call strategy the options time decay works to the sellers advantage in that the more that time goes by, the more the extrinsic value decreases.

Key Point The covered call strategy provides the investor with another opportunity to gain income from a long stock position. The strategy not only produces gains when the stock trades up, but also provides above average gains in a stagnant period, while offsetting losses when the stock declines in price.

We have now seen how a covered call strategy is constructed and how it is supposed to work. Keep in mind that the trade can be entered into in two ways. You can either sell calls against stock you already own (Covered Call) or you can buy stock and sell calls against them at the same time (Buy Write).

Example 1

You own 1000 shares of Oracle at $9.50.

The stock has been stuck around this level for a long time now and you have grown impatient. You finally give in and sell the front month (November for example) at-the-money calls. The at-the-money calls would have a strike price of $10 if the stock was trading at $9.50.

You sell the calls at a $.50 premium per contract which creates a $10.50 breakeven point. Remember, in a buy-write, the breakeven point is the strike price plus the option premium. Lets look at what our returns will be in each of the three scenarios.

The Ultimate Stock Options Trading Strategies

admin — Mon, 04 Jan 2010 17:25:10 +0000

Are you interested in option stock trading? Then you must be interested in option stock trading strategies. To understand stock options better lets see a simple dictionary definition.
Strategy can be defined as a skill in managing or planning, especially by using stratagems. The words managing or planning using stratagems to achieve a particular end or objective is quite useful in our desire to apply this definition to the investment market.
The ability to pick the right stock or group of stocks is vital. Equally vital is the art of making the most possible return on the chosen investment possibility. This is where you need your strategy or game plan. So with the right opportunity but wrong strategy can still lead to risky investment, loss of profits an capital. These underlies the fact the proper knowledge of option stock trading strategies are important.
The desire of the stock investor, his style and depth of research and the personal preference of the stock broker would all contribute to the final selection of stock options would prefer and consider necessary. The process of selection involves the data that are available and preferred by an investor in options stock trading. The sources of data are wide and usually consists of charts, indicators, news, reviews, tips and oscillators.
Each investor in option stocks trading has his own preferred stock choosing process. Each would determine how he undergoes the selection process. Once the selection has been made viable option stock trading strategies would have to be considered and a strategy selected.
A stock option investor has some desired expectation for any opportunity chosen and implemented. A trading strategy that maximally suits the desired expectation should be selected.
Obviously the best strategy would be one that achieves the desired level of returns while still offering the least amount of risk and best protection on investment possible. Every option stock trading opportunity is unique with different variables attached to it and thus would require that each opportunity should have a different strategy that best suits the particular strategy. An obvious popular option stock trading strategy is the selection of stock that is believed to be on the rise, or that is expected to increase in price.
This directional play allows investors to profit as the face value of the stock or portfolio goes up. Each investor should take time to select his stock or trading opportunity and the best available strategy to execute it.

Options Trading Mastery: An Imaginary Spread Scenario

admin — Fri, 01 Jan 2010 17:29:27 +0000

We are going to put together an imaginary spread scenario and set it in real life events. Consider that, in October, you begin to hear about IJK stock. It looks interesting, so you use a variety of sources to learn about it. (News, charts, outside analysts, Internet research, etc.) From your investigations, you decide that this stock is poised for a strong upward move and you would like to take advantage of it. Each share is $50.00 and you question whether you want to put out the capital for enough shares to make the trade worthwhile.
Now is the time to investigate IJK spreads. Since you are bullish on the stock, you look into the bullish plays of the call spreads and the put spreads. You check the pricing of both since you know that implied volatility and time decay affect your purchase and selling price if you decide to sell out the spread before expiration.
Imagine that you set the spread’s maximum potential gain at $10.00 using our formula. Then you decide that you want to buy a call spread, so you buy 10 IJK Nov. 50 calls and sell 10 IJK Nov 60 calls. This is the Nov. 50-60 spread. The spread’s cost is $3.50, which means you pay $3,500 for the trade. This is inexpensive when you consider that 1,000 shares of IJK stock would have cost you $50,000! You will now wait and follow the stock price of IJK. If you hold the position to expiration, you face the following losses or gains.
If the stock does not move up as you expected and stays at $50 or decreases in value, your spread is worthless and you will lose the $3,500 that you paid for the spread. If the stock begins to move up, you will recoup your investment and move into profits. When the stock has moves up to $3.50, you are at the breakeven point. Every money advance after that represents profit.
At any time until expiration, you can sell out of the spread, but what you receive for the price are influenced by implied volatility and time decay. That will change your profit or loss. If you hold the spread until expiration and your bullish lean proves true, your maximum profit on your $3,500 investment is $6,500.
You paid $3,500 for the spread and received $10,000 at expiration with the stock at $60.00. That represents a $6,500 profit, which is a 186% return. If you had invested $50,000 for 1,000 shares of IJK and at expiration sold the stock for $60,000, your profit is $10,000 for a 20% return.
For many investors the reward/risk scenario of the spread is attractive because investors can limit the capital at risk and the time of risk/reward exposure. The spread also offers protection if your lean is bullish or bearish. Finally, the spread has the potential of a large percentage return on investment.