Hello fellow Option Trader:
This is a good article about stock options I thought you might enjoy. The easiest strategy is the calendar spread that I will talk about in detail.
Trading Options by: Alexander Chong
Option is a legal agreement between buyer and seller to buy or sell security at an agreed price in a certain period of time. It is quite similar to insurance that you pay an amount of money in order that your property is protected by the insurance company. The difference between these two is option can be traded whereas, insurance policy cannot be traded. There are two types of option contracts; call options and put options. We buy call option when we expect the security price will go up and buy put option when we expect the security price will go down. We also can sell call option if we expect the security price will go down and vice versa if we sell put option. Usually, option is counted by contract, one contract equivalent to 100 unit options. 1 unit option protects 1 unit share. So, one contract protects 100 unit shares.
Before learning how to trade option, terminologies that you need to know are as follow:
a) Strike price: Strike price is the price that is agreed by both buyer and seller of the option to deal with. That means if the strike price of the call option is 35, seller of this option obligates to sell security at this price to the buyer of this option even though the market price of the security is higher than 35 if the buyer exercises the option. Buyer of this option can buy a security with a price that is lower than the market price. If the current market price is $39, the buyer will earn $4. If the security price is lower than the strike price, buyer will hold the option and leave the option to expire worthless. For put option strike price, buyer of the option has the right to sell the security at the strike price to the seller of the option. That means if the put option strike price is 30, seller of this option obligates to buy the security at this price from the buyer if he or she exercises the option even though the market price is lower than this price. If the market is $25, the option buyer will earn $5. It looks like a lot of transactions have been involved; but actually, seller of the option will not buy a security and sell it to the buyer. The broker firm will do all the transaction but the extra money that has used to buy the security has to be paid by the seller. This means, if the seller loss $4, the buyer will earn $4.
b) Out of the money, in the money and near/at the money option: Option price comprises of time value and intrinsic price.
Time Value + Intrinsic Value = Option Price
Time value is the amount of money that the option worth due to the time the option has until its expiration date. Longer the time the option has until its expiration date, higher the time value of this option. Time value of an option will become zero if the option has expired. Intrinsic value for in the money call option is the difference between current market security price and option strike price. Conversely, in the money put option’s intrinsic value is the difference between option strike price and current market security price. If the current security price is lower than the call option strike price, this option is an out of the money option. It only has time value. Call option with strike price that is a lower than the current market security price is an in the money option. This option has time value and also intrinsic value. Near or at the money option is the option, which strike price is close to the current market security price.
c) Delta value: Delta value shows the amount of the option price will change when the security price changes by $1.00. It is a positive value for call option and negative value for put option. It ranges from 0.1 to 1.0. Delta value for in the money option is more than 0.5 and out of the money option is less than 0.5. Delta value for deep in the money option usually is more than 0.9. If the option delta value is 0.6, meaning that when the security price goes up $1, option price will go up $0.60. If the security price goes up $0.10, the option price will goes up $0.06. Usually, $0.06 will round up to $0.10.
d) Theta value: Theta value is a negative value, which shows the decay of the option time value. Option, which has longer time to expiry, has lower absolute theta value than option, which has shorter time to expiry. High absolute theta value means the option time value decays more than the low absolute theta value option. A theta value of -0.0188 means that the option will lose $0.0188 in its premium after passage of seven days. Options with a low absolute theta value are more preferable for purchase than those with high absolute theta value.
e) Gamma value: Gamma value shows the change of the delta value of an option when the security price increases or decreases. For an example, gamma value of 0.03 indicates that the delta value of this option will increase 0.03 when the security price goes up $1. Option, which has longer time to expiry, has lower value of gamma than option, which has shorter time to expiry. The gamma value also changes significantly when the security price moves near the option strike price.
f) Vega value: Vega value shows the change of the value of option for one percent increase in implied volatility. This value is always positive. Near the money option has higher vega value compared to in the money and out of the money option. Option, which has longer time to expiry, has higher vega value than the option, which has shorter time to expiry. Since vega value measures the sensitivity of the option to the change of the security volatility, higher vega value options are more preferable for purchase than those with low vega value.
g) Implied volatility: Implied volatility is a theoretical value, which is used to represent the volatility of a security price. It is calculated by substituting actual option price, security price, option strike price and the option expiration date into the Black-Scholes equation. Options with a high volatility stocks are cost more than those with low volatility. This is because high volatility stock option has a greater chance to become in the money option before its expiration date. Most purchasers prefer high volatility stock options than the low volatility stock options.
Actually, there are twenty-one option trading strategies, which most of the option investors and traders use in their daily trading. However, I’m only introducing ten strategies as follow:
a) Naked call or put
b) Call or put spread
c) Straddle
d) Strangle
e) Covered call
f) Collar
g) Condor
h) Combo
i) Butterfly spread
j) Calendar spread
Naked call and put meaning buy call and put option only at the strike price, which is close to the market security price. When the security price goes up, the profit is the subtracting of the security price to the strike price if you buy call and the reverse if you buy put.
Call and put spread is established by buying in the money or near the money option and selling out of the money option. When the security price goes up, in the money call option that you buy will generate profit and the out of the money option that you sell will loss money. However, due to the difference of the delta value, when the security price goes up, in the money call option price goes up with a higher rate compared to the out of the money call option. When you deduce the profit from the loss, you still earn money. The purpose of selling the out of the money option is to protect the depreciation of time value of in the money call option, if the security price goes down. However, if the security price continuously goes down, this will cause an unlimited loss. Therefore, stop loss has to be set at certain level. This strategy also has a maximum profit that is when security price has crossed over in the money option strike price.
Straddle can earn money no matter the security price goes up or down. This strategy is established by buying near the money call and put option at the same strike price. The disadvantage of this strategy is the high breakeven level. The sum of the call and put option ask price is the breakeven level of this strategy. You only generate profit when the security price has gone up or down more than the breakeven level. If the security price fluctuates within the upside and downside breakeven level, you still loss money. The money that you loss is due to the depreciation of the option time value. This strategy is usually applied for the security, which has high volatility or before the release of the earning report. The maximum loss of this strategy is the total amount of call and put option price. This strategy can generate unlimited profit at either side of the market direction
Strangle is quite similar to straddle. The difference is strangle is established by buying out of the money call and put option. Because both the options are out of the money option, therefore, both options have different strike. The maximum loss of this strategy is less than the straddle strategy, but difference between the upside and downside breakeven level is slightly higher than the straddle strategy. For this strategy, the upside breakeven is calculated by adding the total call and put option prices to the call option strike price. While, the downside breakeven level is calculated by subtracting the put option strike price with the total call and put option prices. The difference between the strike prices usually is about 2.50 or 5 depending to which stock that you select to buy with this strategy. If the security price fluctuates within the upside and downside breakeven level, you still loss the money due to the loss of the option time value. Application of this strategy is the same as the straddle strategy.
Covered call is established by buying a security at the current market ask price and selling out of the money call option. Selling out of the money option has limited the profit that generated from this strategy. If security price continuously goes down, it will cause an unlimited loss. Therefore, stop loss must be set. When the option has comes to its expiry, if the security price is not moving up significantly, you still earn the total option premium that you have received. If the security price goes up, sure you will earn a limited profit. If the stock price continuously goes down, it will cause an unlimited loss. Therefore, stop loss must be set. Usually, stop loss is set at the security ask price after subtracting by the option bid price. If this security price goes down and passes over the price that you set as stop loss, the loss that is incurred to you is about half of the total option premium that you have received. This is because the delta value of the out of the money call option that you have sold is about 0.4 - 0.5. The out of the money call option strike price must be the closest strike price to the entering security price.
Collar is also known as medium covered call. It is quite similar to covered call strategy. It is only added one more step in order that stop loss is unnecessary to be set in this strategy. This strategy is established by buying a security and near the money put option and following selling an out of the money option. Due to the put option that you have bought, it is unnecessary to set a stop loss because put option will protect the security if the security price goes down. However, out of the money option premium that you have collected has to be used to pay for the put option premium. If the security price goes down, you still loss about half of the total put option premium. This is because out of the money call option premium is less than the near the money put option premium. This strategy is for half or one year long term investment.
Condor strategy has four combinations. Two of them are for stationary market and the other two are for dynamic (volatile) market. Long call and put condor are for stationary market whereas short call and put condor are for dynamic market. The former strategy involves four steps that are buying and selling in the money and out of the money call option with an equivalent amount of contract. With this strategy, profit can be generated as long as the security price does not fluctuate out from the upside and downside breakeven level. Short call and put condor are for dynamic market, which also involves four steps like the long call and put condor strategy. The difference is that in short call and put condor, the strike prices of the options that have bought must be within the strike prices of the options that have sold. For short call and put condor strategy, profit can be generated as long as the security price has fluctuated out of the upside and downside breakeven level. The upside breakeven level is calculated by adding the whole position total pay out or receive to the highest strike price in the strategy. The downside breakeven levels is calculated by subtracting the whole position total pay or receive to the lowest strike price in the strategy.
Combo strategy has two combinations that are bullish and bearish combo. Bullish combo strategy is for bullish market and the bearish combo strategy is for bearish market. This strategy involves two steps that are buying out of the money option and selling in the money option. If the security price goes up more than the higher strike price, profit can be generated. But if the security price goes down lower than the lower strike price, loss is incurred. If the security price fluctuates within the higher and lower strike price, you won’t loss anything. This strategy can earn an unlimited profit but also will cause an unlimited loss depending to the market direction and also which strategy you have used.
Butterfly spread strategy is quite similar to the condor strategy. It has also four combinations that are long at the money call and put butterfly spread and short at the money call and put butterfly spread. Long at the money call and put butterfly spread are for stationary market and short at the money call and put butterfly spread are for volatile market. Steps that involve in long at the money call butterfly spread are buying in the money and out of the money call option and following selling at the money call option. At the money option means the strike price of this option is quite close to the current market security price. Number of contract of at the money call option must double the number of contract of in and out of the money option. Profit can be generated as long as the security price does not move out from the upside and downside breakeven range. The upside breakeven level is calculated by adding the total pay out of this position to the highest strike price. The downside breakeven level is calculated by subtracting the lowest strike price with the total pay out of this position. The short at the money call butterfly spread is established by selling in and out of the money call option and following by buying at the money call option. Number of contract of at the money option must be double the number of contract of in and out of the money option. As long as the security price has move out the upside and downside breakeven range, profit can be generated. This strategy generates limited profit and also cause limited loss if the security price does not go to the right direction.
Calendar spread is also known as horizontal or time spread. This strategy is solely used to earn money from the security, which price trades sideways. There are quite number of stocks have this kind of price trend. This strategy is established by selling at the money call or put option, which has a shorter time to expiry and buying at the money call and put option, which has a longer time to expiry. This strategy merely generates the money from the time value of the option. The option that has shorter time to expiry depreciates the time value faster than the option that has longer time to expiry. Usually, the option that has shorter time to expiry is left to expire worthless. The total money that you receive after closing this position will be more than the total money that you have paid out when opening this position.
With these ten strategies, you can use to earn money from upside and downside market and also the market that trades sideways.
About The Author
Alexander Chong Author of “Workable Option Trading Strategies” http://www.makemoneystocks.com/
Friday, August 22, 2008
Thursday, August 21, 2008
Put Option Review
Hello fellow Option Traders:
PUT OPTION: An option that gives the right to a seller to sell the underlying stock contract at the strike price.
Strike price
As long as the market price is below the option strike price, the put option contract is said to be "in the money". On the expiration date, if the price of the stock is above the strike price, then my put option expires worthless. In the case of put options, it is the market value of the underlying stock minus the strike price. A put option for which the strike price is equal to the stock price is said to be an "at the money" put option. If the strike price is below the stock price, the put option is said to be an "in the money" put option. In answering this question, the first thing to note is that the prices of put options vary depending upon the strike price. The lower the strike price, the more expensive the put option. This makes sense because a put option gives the holder the right to sell the underlying option contract at the strike price. The breakeven is calculated by adding the strike price to the premium of the call option.
The put option price can go to zero as the asset price rises way above the strike price. Don't be tempted by inexpensive put options having a very low strike price. Thus, purchasing a put option requires two immediate decisions: you have to decide on the strike price and the expiration month. If the underlying stock price does not move below the strike price before the option expiration date, the put option will expire worthless.
PUT OPTION: An option that gives the right to a seller to sell the underlying stock contract at the strike price.
Strike price
As long as the market price is below the option strike price, the put option contract is said to be "in the money". On the expiration date, if the price of the stock is above the strike price, then my put option expires worthless. In the case of put options, it is the market value of the underlying stock minus the strike price. A put option for which the strike price is equal to the stock price is said to be an "at the money" put option. If the strike price is below the stock price, the put option is said to be an "in the money" put option. In answering this question, the first thing to note is that the prices of put options vary depending upon the strike price. The lower the strike price, the more expensive the put option. This makes sense because a put option gives the holder the right to sell the underlying option contract at the strike price. The breakeven is calculated by adding the strike price to the premium of the call option.
The put option price can go to zero as the asset price rises way above the strike price. Don't be tempted by inexpensive put options having a very low strike price. Thus, purchasing a put option requires two immediate decisions: you have to decide on the strike price and the expiration month. If the underlying stock price does not move below the strike price before the option expiration date, the put option will expire worthless.
Call Option Review
Hello fellow option traders:
CALL OPTION: An option that gives the right not the obligation to a buyer to buy the underlying stock contract at the strike price.
Strike price
As long as the market price is above the option strike price, the call option contract is said to be "in the money". On the expiration date, if the price of the stock is below the strike price, then the call option expires worthless. In the case of call options, it is the market value of the underlying stock minus the strike price. A call option for which the strike price is equal to the stock price is said to be an "at the money" call option. If the strike price is above the stock price, the call option is said to be an "out of the money" call option. This is because the lowest the call option can go is zero. In answering this question, the first thing to note is that the prices of call options vary depending upon the strike price. The lower the strike price, the more expensive the call option. This makes sense because a call option gives the holder the right to acquire the underlying futures contract at the strike price. The breakeven is calculated by adding the strike price to the premium of the call option.
The call option price can go to zero as the asset price falls way below the strike price. Don't be tempted by inexpensive call options having a very high strike price. Thus, purchasing a call option requires two immediate decisions: you have to decide on the strike price and the expiration month. If the underlying stock price does not move above the strike price before the option expiration date, the call option will expire worthless.
CALL OPTION: An option that gives the right not the obligation to a buyer to buy the underlying stock contract at the strike price.
Strike price
As long as the market price is above the option strike price, the call option contract is said to be "in the money". On the expiration date, if the price of the stock is below the strike price, then the call option expires worthless. In the case of call options, it is the market value of the underlying stock minus the strike price. A call option for which the strike price is equal to the stock price is said to be an "at the money" call option. If the strike price is above the stock price, the call option is said to be an "out of the money" call option. This is because the lowest the call option can go is zero. In answering this question, the first thing to note is that the prices of call options vary depending upon the strike price. The lower the strike price, the more expensive the call option. This makes sense because a call option gives the holder the right to acquire the underlying futures contract at the strike price. The breakeven is calculated by adding the strike price to the premium of the call option.
The call option price can go to zero as the asset price falls way below the strike price. Don't be tempted by inexpensive call options having a very high strike price. Thus, purchasing a call option requires two immediate decisions: you have to decide on the strike price and the expiration month. If the underlying stock price does not move above the strike price before the option expiration date, the call option will expire worthless.
Tuesday, August 19, 2008
New Discount Stock and Stock Options Broker
Hello fellow Option Traders:
Hands down the best stock and stock options discount broker is http://www.optionshouse.com/ These guys have great customer service, if you have a question about stock options they will answer on the first ring. If calling is not for you, e-mail them your question and a response is less than a hour away. Real-time personal support from options experts with the knowledge and experience to understand and solve any problems you might have. Never be a number again. The trading platform is very easy to navigate and color coded. Many of their trading tools have evolved from years of idea generation, testing, and innovation by the professionals. They kept the best, got rid of the rest. Saving the best part for last they have designed their commissions to be simple and clear so that you can focus on the power of your trades. You will never need a calculator to determine your commissions again. Flat rate commissions: $4.95 for stock trades and $9.95 for stock options trades. No minimums, no maximums and no per contract fees. Check these guys out today for state-of-the art trading that won't eat your investment dollars.
Hands down the best stock and stock options discount broker is http://www.optionshouse.com/ These guys have great customer service, if you have a question about stock options they will answer on the first ring. If calling is not for you, e-mail them your question and a response is less than a hour away. Real-time personal support from options experts with the knowledge and experience to understand and solve any problems you might have. Never be a number again. The trading platform is very easy to navigate and color coded. Many of their trading tools have evolved from years of idea generation, testing, and innovation by the professionals. They kept the best, got rid of the rest. Saving the best part for last they have designed their commissions to be simple and clear so that you can focus on the power of your trades. You will never need a calculator to determine your commissions again. Flat rate commissions: $4.95 for stock trades and $9.95 for stock options trades. No minimums, no maximums and no per contract fees. Check these guys out today for state-of-the art trading that won't eat your investment dollars.
Stock Options will trade in pennys
Hello fellow Option Trader:
Stock options trading in penny increments has been around since January 29, 2007. This is helping the individual investor reduce the trading costs known as slippage. An example would be a Citi (C), Inc. September $20 call with the bid/ask at .01/.02 instead of .00/.05 Althought not every option trades in penny increments most Fortune 500 companies and ETF's (Exchange Traded Funds) do. I use the ETF's such as the IWM and QQQQ to create calendar spreads using LEAPS. This way you have many stocks using a broader market instead of one stock with more volitility due to news.
www.equityoptionscherer.blogspot.com
Stock options trading in penny increments has been around since January 29, 2007. This is helping the individual investor reduce the trading costs known as slippage. An example would be a Citi (C), Inc. September $20 call with the bid/ask at .01/.02 instead of .00/.05 Althought not every option trades in penny increments most Fortune 500 companies and ETF's (Exchange Traded Funds) do. I use the ETF's such as the IWM and QQQQ to create calendar spreads using LEAPS. This way you have many stocks using a broader market instead of one stock with more volitility due to news.
www.equityoptionscherer.blogspot.com
Tuesday, August 5, 2008
Equity Options Trading
Hello fellow Option Trader:
Equity Options trading can be very expensive if you don't have the correct information. This blog is about my trails and errors of a novice options trader. I started trading options not knowing anything in June 2001. I only knew that call options make money when the stock goes up and put options make money when the stock goes down. I traded on news about a companys earnings. This was not smart by the end of the year 2001 I lost my entire investment $7,000.
I would like to educate people on equity options and how to trade them and make money when the stock is trading up, down or sideways. I welcome any comments and life experiences. Stay tuned for more posts. www.equityoptionscherer.blogspot.com
Equity Options trading can be very expensive if you don't have the correct information. This blog is about my trails and errors of a novice options trader. I started trading options not knowing anything in June 2001. I only knew that call options make money when the stock goes up and put options make money when the stock goes down. I traded on news about a companys earnings. This was not smart by the end of the year 2001 I lost my entire investment $7,000.
I would like to educate people on equity options and how to trade them and make money when the stock is trading up, down or sideways. I welcome any comments and life experiences. Stay tuned for more posts. www.equityoptionscherer.blogspot.com
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