Option Education

Jim cramer didn't get his wish Oh well

2007-08-05T21:22:00.001-07:00

It was a bad friday the dow finished down 281.42 to end the day at 131,181.91. The Nasdaq finished down 64.73 to end the day at 2511.25. Jim Cramer went on one of his rants for Ben Bernanke to lower interest rates. It looks like he did not get the answer that he wanted to...Oh well

Some changes that I think everyone will like

2007-08-05T19:08:00.000-07:00

I am experimenting with some videos and charts to jazz this up a bit.

When I get the charts up, I think we can do some phenominal trading.

I hope everyone enjoys.

Cheers,

Ben

2007-08-05T19:05:00.001-07:00

Wow the market laid a real stinker today.

2007-07-31T22:02:00.000-07:00

Ok we have been looking at some plays. Now if this market heads into summer mode it could be a bad time to trade.

Let's sell puts on AAPL and GOOG.

Sell the Aug GOOG 500 puts for $4.90
Sell the Aug AAPL 120 puts for $1.35

I tend to think that the market will lay down a little while. I think GOOG will find some support at $500.00. If it breaks $500.00, ouch. We would definately put in stops at $500.00 for this trade.

AAPL will start moving again. I think it is safe at $120.00.

When will GG make it's break. Both GG and gold prices are coiling hard. It has been for a year but it has got to break out. It may not be for months, though.

Everyone have a good night.

RIMM ICE AAPL our observed plays.

2007-07-29T21:20:00.000-07:00

Lets look at our observations. I was out of town for 3 days last week. I wanted to observe the AAPL play as it would have been profitable at that time. The spread on RIMM will is nearly fully profitable. The bid ask spread is high with the big drop so it would be hard to get the fills without legging out. ICE looks like it recieved a lot of theta (time burn). This is in a beutiful position to close. We will be looking at three new plays but keep your eyes on these stocks as it is one of the best ways to learn to play options. We will also discuss in depth the calendar and diagonal spread plays.

AAPL August 135/145 call back spread at a 1:2 ratio.

Short 1 Aug 135 call @ $11.40
Long 2 Aug 145 call @ $5.20
Net cost: $2.30
Cost to close: $1.00

ICE Aug/Sept 140 call calendar.

This looks like:

Short August 140 call at $14.60
Long August 140 call at $19.20
Net cost: $2.60
Premium for closing: $4.60

RIMM: 230/240/250 Aug short put butterfly.

Short 1 Aug 250 put @ $35.30
Long 2 Aug 240 puts @ $26.40
Short 1 Aug 230 put @ $18.30
Premium to open: $1.70
Cost to close: $.80

Observed plays on RIMM, ICE, and AAPL

2007-07-23T22:08:00.000-07:00

The first trades that we will observe are some very risky plays. We are just watching so what the heck.

AAPL has been on a tear. They are announcing earnings on Wednesday. Now I will be the first to say that they are in uncharted territory right now. While I am bullish on AAPL, I would not normally make this bet as high as it is but a back spread will pay dividends if RIMM rises.

A August 135/145 call back spread at a 1:2 ratio.

Short 1 Aug 135 call @ $13.30
Long 2 Aug 145 call @ $7.80
Net cost: $2.30
Maximum loss $12.30
Maximum profit unlimited.
I like the premium vs potential profit. There is enough time to trade out of this position if AAPL decides to hang around the $145.00 range which is the max loss area.

ICE has been dropping lately so let's see if it tests the resistance right above $140.00. This right here is "seat of the pants speculation" but lets try a calendar.
What we are trying to do here is drop the value out of the front month and burn time premium.

The position that we are going to observe is a Aug/Sept 140 call calendar.

This looks like:
Short August 140 call at $19.30
Long August 140 call at $22.90
Net cost: $2.60
Potential profit is $6.00 to $7.00 but it can vary with IV and time left.
Maximum loss is the premium paid or $2.60.

RIMM: RIMM has been going up and it seems as though there is no stopping this stock. At chart tops, RIMM goes into a range and will oscillate in this range. I tend to think that it is very near the top but lets play it both ways and try to lock in some profit. I would not at this point play RIMM either upwards or downwards. I tend to think that would be a mistake.

Lets look at a short put butterfly.

Short 1 Aug 250 put @ $22.90
Long 2 Aug 240 puts @ $15.20
Short 1 Aug 230 put @ $9.20
Premium: $1.70
Maximum risk $10.00-$1.70=$8.30

I don't think that RIMM will stay anywhere near $240.00. It will swing quite a bit.

Everyone have a good night.

A quick link for historical option quotes

2007-07-21T21:24:00.000-07:00

Following is a place that where a person can find historical prices on options:

http://www.prophet.net/quotes/options.jsp.

Take the contract and put a period in front of it and place it in the quote box.

Let's say that you are looking for a historical quote on GOPTU. You would place .GOPTU in the quote and it will give you a historical view of the days prices of the option. This site is free and it doesn't give you anything more than just price.

Everyone have a good evening

Stocks to watch

2007-07-21T17:34:00.000-07:00

I have got the portion of the earnings season that I participate in behind me.

Here are some stocks to watch and some that we will look at for some observational trades:

GOOG
RIMM
BIDU
ICE
CROX
TRLG
GG
ANF
SLW
HLYS
POZN
CAT
OIH
XLB
XLE
XLI
PFE
GT
WFMI
AMZN
DEPO
DNDN
CELG
HPQ
TXN
ADBE
CSCO

Through the next comming weeks we will propose trades on all these stocks. We are going to figure out what we think these stocks will do and propose trades. I will track all trades and we will use our practical knowledge that we have learned so far to see how we should trade these stocks.

I do have many earnings trades to unravel as well as a full options observation on GOOG.

Good trading everyone.

The OE plays

2007-07-21T10:21:00.000-07:00

What happened?

Well we were watching three plays:

GG to $25.00.....Ended Friday at $27.63

NYX to 80.00.....Ended Friday at $78.05

PFE to $25.00....Ended Friday at $24.90

As I had indicated before, GG has always been a very hard pin. I have observed this many times. NYX kept moving down.

Now how did both NYX and PFE fair on Wednesday?

NYX:

1 long July 75 put @ $.10
2 short 80 puts @$.75
1 long July 85 put @ $4.90
Premium for closing: $3.50
Original cost: $1.85

PFE:

1 long 22.5 call @ $2.60
2 short 25 calls @ .25
1 long 27.5 call @ 0
Premium for closing $2.10
Original cost: $1.35

There we have the basic butterfly and one of the mechanics for trading.

GG is a little stinker

2007-07-19T00:15:00.000-07:00

Now everyone can see why I don't like GG around OE. NYX and PFE would be good to close today but I am going to finish the tomorrow. Everyone have a good evenings.

It's GOOG time tomorrow....Are there any good earnings plays

2007-07-18T21:58:00.000-07:00

We should be able to conjure up some fantastic plays right?

Before I answer the question, let's look at some option contracts:

Strike...............July.......Aug.......Sept
530 calls………25.40…34.30……42.00
530 puts ………6.70…13.50……18.50
540 calls………18.90…28.40……36.00
540 puts ………10.20…17.40……22.50
550 calls………13.30…23.10……30.60
550 puts ………14.60…22.10……22.50
560 calls………8.90…18.40……25.60
560 puts ………20.20…27.60……32.20
570 calls………5.80…14.50……21.30
570 puts………27.00…33.60……37.90
580 calls ………3.60…11.30……17.50
580 puts..........34.70..40.40......44.10

Ok I want to say first that there is not a good long option play unless you feel GOOG will move tremendously. Now, GOOG will most likely move around $20.00 or less. There is always an outside chance that GOOG could announce a super fantastic earnings that will be beyond the already fervent expectations. I wouldn't bet on it though.

Ok, what we want to do is sell volatility right. So other than a straight short position what could we do?

I'm glad you asked. Now we tend to get this complex vision in our heads and remember that all we are doing is selling premium.....That's it. All of these contracts will lose IV value through earnings. With a big move, a position could pick up intrinsic value.

How about a July 570/580 bear put (debit) vertical spread? This position would cost $7.70 and would pay $10.00 if GOOG stays below $570.00.

Now why wouldn't we try a Aug 570/580 bear put (debit) vertical spread? There are a couple of reasons. One is the cost would be $6.80. Not that much less than $7.70. The premium spread will not fully widen until Aug OE. This increases the time and this position would have a month of exposure.

I don't like the debit spread because if GOOG goes above 580 the position is 0. Now while I don't think that GOOG will, the payoff is $2.30 against $7.70 risk. I don't like the risk vs reward.

How about an OTM July/August calendar spread?
In this position, the August contract could lose more value the the offset from selling the July contract against the August contract. But lets observe 2:
1) July/August 570 call calendar: This would cost $5.70. If GOOG were to finish 570 or ATM, this position would be a winner.
2) July/August 530 put call calendar: This would cost $6.80.
Most calendars are taking advantage of theta decay and are not good plays on potentially volatile stocks.

If I were to play a calendar, I would go with a August September calendar
A 570 call would cost $5.70 and a 530 put would cost $6.80. These are very technical plays and they assume that the Aug contracts will have far more decay than the September contracts.
A far wrong way move will create a loss. However, the loss will be small as compared to the potential loss with the July/August positions. I actually kind of like these positions but the pay day is not going to be big.

Let's look at a back spread.

First a extremely speculative but high paying position. A 530/560 July call back spread at a 1:2 ratio. This produces a credit of $7.60. The maximum loss would be if GOOG finished at $560 which would render this position at $23.40 in the hole. However with a move to $570.00 this position would be only at a $3.40 loss. So in this position we would be speculating that GOOG would be moving at least $20.00. With a twenty dollar move down, this position would be actually profitable by the credit or $7.60. If there was a big move up (like let's say something like $50.00), this would be at a profit of $47.60.

Now I think everyone is starting to get the gist. All options plays will be expectational and will have to follow a person's convictions. I am not here to give a price point for GOOG but I do want to say that all of these option plays have risk. Earnings plays are blind events.....On some stocks, however, these plays can come with a small risk. In the case of RIMM or DNDN around late April, a person could have made a ton of money with a otm long option position.

If you are so inclined (I as a rule don't trade earnings) to speculate an event, use only a very small portion of your invest able money.

I have many stocks that I observed through earnings so we can categorize plays. Because GOOG has so many strikes in play, I have a large file containing GOOG options and this will base our strategies and we will have a very good handle on earnings plays after all the smoke settles.

I wish everyone success tomorrow. Don't play long July options they are a rip off. If you do play GOOG's earnings just play with a small amount of money that you can afford to lose.

Some OE observations on GG PFE NYX

2007-07-16T21:37:00.000-07:00

I scoured the stock universe and came up with these stocks with unusual option open interest:

GG: (currently at $26.04)
Strike……..Call OI…..Put OI
22.5…………9528……32917
25……………58037…25479
27.5…………16973.…2737

GG is looking like the king daddy of all pins......Look at that OI. There are many betters right around $25.00. GG seems to always be a hard stock to pin but let's see this time. I like the 22.50/25/27.50 put butterfly:

This looks like:
Long 1 July 27.5 put at $1.50
Short 2 July 25 puts at $.10
Long 1 July 22.50 puts at $.05

The cost of this position is $1.35 with a potential of $2.50. I personally get skittish around GG because many sure bets around OE in the past have turned sour.

PFE: (currently at $26.08)
Strike……..Call OI…..Put OI
22.50………103………74……
25……………11,373…22,096……
27.5…………20,225…969………

Will the 25 strike puts get taken out. We shall see. I like this better because PFE has been pinned pretty nicely in the past. PFE also has a slow action and this helps because I usually have to leg into postions to get fills on butterflies.

Lets look at a July 22.5/25/27.50 call butterfly

This looks like:
Long 1 July 22.50 call @ $3.60
Short 2 July 25 calls @ $1.15
Long 1 July 27.5 call @ $.05
Cost: $1.35 and potential of $2.50

NYX: (currently at $82.91)
Strike……..Call OI…..Put OI
75……………6,680……11,263
80……………20,597…8,003
85……………19,402…3,811
90……………10,271…68

Does NYX drop to $80.00 to kill the 80 strike calls. I don't have much conviction in this trade but it does indeed have a very nice OI. NYX has been on a nice trend for the past few days so I think it will be a hard pin. This will be a big pay day if a person where right.

But let's look at a 85/80/75 July put butterfly.

This looks like:
Long 1 July 85 put @ $2.40
Short 2 July 80 puts @ $.30
Long 1 July 75 put @ $.05
Cost $1.85 with a potential of $5.00.

Call me supersitious but I don't like playing OE pins with many earnings on the deck. The key to these positions is to watch closely and moderate loses by legging out if it looks like the stock goes the wrong way. However, this should be an interesting observation. My gut tells me that none of these stocks will get pinned.........So this will most likely mean that everyone will get pinned. (I still have to do a double take on GG).

Everyone have a good evening.

OE trading mechanics

2007-07-15T16:05:00.000-07:00

Now, everyone must be asking why stocks get pinned.

Hey Ben, the stupid MM don't want us to make money!!! The last time I traded options they expired worthless.

Now, I am not going to say that the market isn't manipulated but there is a actually a functional reason that stocks are pinned:

During options expiration week, the poor OCC arbs (I guess they're really not that poor) have to absorb all the contracts that are sold. They have to make the market liquid. When an itm call contract is bought it is paired with a short position so that it is loss less or gain less. If the arbs absorbed a position and the stock moved a great amount of loss could be sustained especially when they are making nickles and dimes on these options. Conversely puts have to be absorbed in a opposite fashion.

A large number in OI will create an opposite pull on a stock. This is how the option market moves the stock.

Now we as traders have to look for some things like:

1) An anomaly in OI

2) A stock that is not on a big trend. A stock that is moving hard will be a hard opposite direction pull.

3) An OI strike that corresponds to 15% (this is my rule) or more of the average daily volume or a total OI of over 50% of daily volume. If there is not much open interest, the OCC will have a hard time pulling a stock across it's volume. Remember to turn open interest into the number of shares that it represents, multiply by 100. So 10K contracts=1M shares of stock.

4) Look for a stock that is near a potential pin. A stock that has to be pulled too far is less likely to be pinned.

5) Look for a stock that is typically pinned. If a stock has a history of ending for instance at a number like $30.15 or $60.22, it is being pinned on a strike. Stocks that have a history are more likely to be pinned.

The bottom line is to find a pin point look at where the stock is and look at open interest and surmise a potential pull on a stock. I will repeat this again....Look for relatively (with respect to the other contracts) large OI strikes.....This is the key for a pin not Max pain (tm).

Now the best way to trade OE is with Delta neutral (or near delta neutral trades) I will explain these in detail later.These are positions that are looking for the stock be in a range. My favorite is a long condor or a long butterfly. There are also a short strangle (getting a little risky), or better yet a Iron condor which is like a hedged both sides short strangle.

Even as I am saying this there will be someone say "Gee willakers, I think I can buy a $.05 option the day before expiration and turn it into a couple of bucks". The previously mentioned methods like butterflies are very good ways of trading OE but for the long option players.....Do not play front month option on OE!!!! Play the option a little in the money. This will save you from flushing your money.

We will look at some OE trades next week and figure out how we can pull some of these trades out of the wood work.

The options expiration trade

2007-07-15T15:54:00.000-07:00

The OE trade. Ah yes the ole pin. With earnings season in full swing, I tend to think that this is not as good a time to trade OE pins but I am certainly not saying that OE trades cannot be made next week. Well what are OE pins?

We all hear alot about Max pain (tm) or pins around Options expiration.There must be many conspiracy theorists right? First of all let's define what Max pain (tm). Max pain (tm) is a point where most posts and calls are out of the money......Translated this is a point where most of the option contracts expire worthless. For those of you who would like to find the max pain (tm)point, here is a link:

http://www.iqauto.com/cgi-bin/pain.pl

Now with that said, I am not a firm and hard believer in Max pain (tm). The point will change with time as a stock rises and falls. This happens as people buy more speculative option positions and some people close out their option positions during and prior to the week of OE. So in a nut shell the point changes with a changing open interest (OI). Basically it starts following the stock.

Now here is where the importance of Max pain (tm) is. If we are sitting a week away from OE, and for instance a stock is at $40.00 and the Max pain (tm) is at $60.00, this should cause us to say, "Hmmmmmm something is fishy in Denmark". This can be both an indicator of sentiment and also an average of where the speculators are betting. This can hold credence in that there is a bet on a move.

Now at this point we have to be sleuths. There can be residual option action....This occurs because maybe there were many bets prior to an event like an earnings. If there is a big rise or fall and then the stock bases at a level, there will be some option contracts that are in the money due to the past event. If there is not a reason for the option contracts to be away from the stock price, then maybe other people are speculating.

The OE trade is a very easy trade in most circumstances. We will look at the mechanics of a OE pin in the next post.

The long call and put condor

2007-07-14T17:34:00.000-07:00

When we hear condor in a options trading context we tend to think of an iron condor. The call and put condor is a very popular options trade and is not an iron condor (This is a combination play with both a call and a put together). This is very much like a butterfly but it extends the profitability range.

Now remember that in a butterfly we look for a stock to stay in a range but we are rewarded if this stock hits an exact point.

For example if we have a long call butterfly, we would have the most profit if the stock ends OE at $50 with the following spread:

Long a 45 strike
Short 2 50 strikes
long a 55 strike

Now a condor (non iron) whether we use a puts or calls will stretch out the range. We have from lower to higher strikes 1 long position.....1 short position at a higher strike.....1 short postion at a higher strike......and 1 long position at the highest strike. So we have a position where we have 2 short strikes surounded by 2 long strikes.

Let's illustrate and example:

First let's look at some July RIMM calls:

180.....$47.60
190.....$37.70
200.....$27.90
210.....$18.20
220.....$9.90
230.....$4.10
240.....$1.40

We will look at a 190/200/210/220 long July call condor.
This looks like:
Long July 190 @ $37.70
Short July 200 @ $27.80
Short July 210 @ $18.20
Long July 220 @ $9.90
This position costs $1.60

If this position is between $200.00 and $210.00 on OE, it is worth $10.00. Now with the butterfly we were looking at a high profit if the stock finishes at one point. Now there is a rationalization that would cause someone to choose a butterfly over a condor and that would be that the condor would typically be more expensive.

This position that I described has a break even point at $218.40 and $191.60. That is almost a $37.00 range. Let's remember that RIMM is currently above the highest strike of the spread so at OE it is worth nothing.

How would we use this spread? We would use it for a time that we would speculate that a stock would be between $200 and $210. Like OE week (I will get into an OE pin post).

This is a cheap play at $1.65 but would be low probability so I am not currently playing this but this is a potential six bagger......Wow!!!!!!! So we are going to observe this play into options expiration which is Friday of next week (Saturday for the proffesionals). Now we can make the spread range much larger but we will get into that in the structuring of trades. We have 3 more strategies to explore before we are done with the basic spreads......Iron condors, short butterflies and condors, and ratio spreads.

I am not going to observe any more OE plays this month because there are many earnings being announced next week so my time will be limited. I will go into further structuring these plays in subsequent posts.

Everyone have a good Saturday

What works through earnings?

2007-07-13T23:11:00.000-07:00

Vertical back spreads were losers. The closer to the money puts gained value and the farther away puts even in the money positions lost money.

The Feb. 490/500/510 short call butterfly spread cost $1.30 to open and $1.35 to close.

The Feb 490/500/510 short put butterfly spread cost $1.40 to open and $1.20 to close.

The Feb 480/490/500/510 short call condor cost $4.50 to open and $3.05 to close. This would be provided that a person got all the fills. This position could be more like break even.

The Feb 520/530 call 470/480 iron condor cost $6.30 to open and $3.90 to close. This is one of the few option plays that actually work well through an earnings event on a high beta stock. We will do a post and get everyone up to spread on iron condors.

Let's look at calendars:

Feb/March 470 put calendar was $4.00 to open $6.60 to close

Feb/March 480 put calendar was $4.40 to open and $7.50 to close

Feb/March 490 put calendar was $4.50 to open and $6.80 to close

Feb/March 500 put calendar was $5.00 to open and $5.60 to close

Feb/March 500 call calendar was $4.00 to open and $7.60 to close

Feb/March 490 call calendar was $6.10 to open and $8.40 to close

Feb/March 480 call calendar was $5.50 to open and $8.70 to close

Feb/March 510 call calendar was $6.00 to open and $5.95 to close

Feb/March 520 call calendar was $5.00 to open and $4.40 to close

There were some very nice plays on calendars which were low loss and low gain. These are very hard to structure and also tough to understand but we will get to calendars and you will have a full understanding. There were some diagonals that performed very well also.

Now we did a back test and ferreted out a couple of good plays. But hey guys we already knew what happened. A person must know that all stocks are not the same. All options are not the same. There are many other times to trade. High beta stocks like GOOG are very hard to invest through an earnings event. There is an easy way to invest through earnings and the concept is simple.....Iron condors. Properly placed iron condors can very effectively take advantage of IV decay through an earnings event. These are very easy to structure......so if you guessed that the next strategy will be an iron condor. The strategy for earnings.

Everyone have a good evening.

Earnings back tested strategies for GOOG iron butterflies

2007-07-13T19:24:00.000-07:00

We just explored iron butterflies as a strategy so let's see how they performed through GOOG's earnings. I didn't look at a short iron butterfly but let's see how it performed. We are looking for a movement based strategy so we are going to turn the butterfly inside out to create a spread that is looking for the stock to move. Following is the first spread:

Long a Feb 500 straddle: Cost to open $37.60. Premium recieved for closing $24.20

Short a Feb 510/490 strangle: Premium for opening $29.10. Cost to close $19.90

This position cost $8.50 to open and recieved $4.30 to close

Now remember on all spreads, time is required to bring the spread to full value.

Let's widden the spread a little:

Long a Feb 500 straddle: Cost to open $37.60. Premium recieved for closing $24.10

Short a Feb 520/480 strangle: Premium to open $22.70. Cost to close $9.10

This position costs $14.90 to open and the position provided $15.00 to close

Wow, a big $.10 profit. Remember, if this position were at OE this would be worth close to $20.00.

Let's widden the spread even further:

Long a Feb 500 straddle: Cost to open $37.60. Premium recieved for closing $24.10

Short a Feb 530/470 strangle: Premium recieved to open $15.40. Cost to close $5.00

This position cost $22.20 to open and a person recieved $19.10 to close.

Well we found that the position where the puts were at the where GOOG ended after earnings.

Let's see what happens when we use a longer term contract.

Let's look at June contracts:

Long a 500 straddle: Cost to open $77.70.Premium to close $68.80

Short a 520/480 strangle: Premium to open $59.10. Cost to close $51.20

This position cost $18.60 to open and the person recieved $17.60 to close.

We can see that the short iron butterfly was not a good earnings play. First remember that the position is not fully valued until OE. A person who initiates these positions will want to equal the amount of the spread with the amount that they expect the stock to move. Now a person also has to look at how much it cost open a position. If the spread is $20.00, we would not want to open a position that costs $17.00 because this will yield very little profit.

Many plays so far through earnings were futile. We will look at some plays that performed well in the next posts.

Earnings back tested strategies straddles and strangles

2007-07-13T19:03:00.000-07:00

The straddle or the strangle is a way of catching a stock going either way. Let's look at how the strategy performed through GOOG's Q4(06) earnings:

I will give the straddle/stgrangle the cost to open and the cost to close the day after earnings:

Feb. contracts (2 weeks to expiration)

500 straddle: $37.60/$24.20

510/490 strangle: $29.10/$19.90

520/480 strangle: $22.70/$9.10

530/470 strangle: $15.40/$5.00

All of these position were stinkers even with a $20.00 move. Maybe this would be better with a longer term option.

March contracts (1-1/2 months to expiration)

500 straddle: $48.60/$37.40
510/490 strangle: $39.60/$28.20
520/480 strangle: $31.10/$20.80
530/470 strangle: $24.50/$14.80

Not too good either. How about a contract with an earnings behind it.

June contracts (4-1/2 months to expiration)

500 straddle: $77.70/$68.80
510/490 strangle: $66.80/$59.80
520/480 strangle: $59.10/$51.20
530/470 strangle: $51.10/$43.30

There was not one winner in the whole bunch. When investing through earnings if a person wants to employ a straddle or a strangle they have to figure that the stock must move by the premium in the front month options. The best way to play a straddle or a strangle is to play a stock with low expectations or premiums. If the stock doesn't move, premium will be lost.

Earnings backtested strategies on GOOG....The covered call and the collar

2007-07-13T18:39:00.000-07:00

The covered call and the collar.

Ok, Ben didn't you know that covered call writing is for sissies?

Actually some of the most sophisticated investors use this method. It is commonly used by mutual funds and large institutions. On the same method there are regular long term investors who are making short term trades stealing a little bit of premium here and a little premium there.

Did you realize that a person who wrote a Feb call at a strike of 500 or less basically lost nothing through earnings. The calls basically covered the drop. They are probably saying nah...nah..nah..nah look at me now.

How much premium did they receive? This is just the difference in the premiums before earnings and after earnings. If they didn't close the position the amount could potentially be higher or lower depending on the movement of the GOOG.

470 $22.00
480 $22.00
490 $19.50
500 $16.90
510 $13.85
520 $10.60
530 $7.70
540 $5.25

Ok, yes the covered call writer has to give up something by writing the call and that is a potential of losing the position to exercise if the stock goes up......They will have to give up their beloved stock.

Why am I not showing March and June contracts? This is actually a specialized one time play and the shorter term contracts have the most premium drop. (This is not to say that a person wouldn't write a longer term call....but that would be beyond the scope of this post) They are long stock but have learned to play covered calls through events like earnings and OE. If the stock makes a large rise, they are hedged against a catastrophic loss by having the shares. You see the person who has 2000 shares and sells the 540 calls will recive $10,500 which makes a nice down payment on a Mercedes SL550. They do this day in day out while the average option buyer is losing money.

How about a collar?

What is a collar? This is selling a call to buy a put. Let's just assume a person buys a Feb 500 (There are many reasons to use back month and further out puts but I would come out with too many different combinations so I'm using the typical strategy) strike put to protect their prized GOOG shares through earnings. The put cost $17.40. How much did this person pay (This is considering this person closed out the call position post earnings) for the 500 strike put which actually locks in the gains at $500.00 until Feb OE.

500 $.50
510 $3.55
520 $6.80
530 $9.70
540 $12.15

Not too bad and this same person can write another call because the position has been closed.

Well we did the covered call and the collar. There is always the risk of giving up the stock and a person who employs these positions must be very adept at rolling positions. If a person is very bullish, they would not want to write near money or ATM calls.....But with typical movements why not take the free premium at a 540 strike and the worst that could happen is a $40.00 rise + premium of the call...That's not bad is it.....Know your expectations before you play. I know if (and that is a big if) Goog rose $100 and person wrote a $540 call, they wouldn't be happy with me.

Back testing option plays on GOOG. The put debit spread

2007-07-13T18:19:00.000-07:00

I posted a table earlier on GOOG through Q1(07) earnings so we can see how options behaved through an earnings event. We are going into another major earnings season next week and boy there are some biggies so let's see if we can learn a little by back testing some plays. GOOG went from $501.50 to 481.50 on this earnings report.

Strike......31st price........today's price

470............$7.30.............$4.60
480...........$10.20............$8.20
490...........$13.50............$13.70
500...........$17.40............$20.90
510...........$22.70............$29.30
520...........$28.60............$38.60
530...........$35.90............$48.83
540...........$43.80............$58.80

The plays:

Buy 500 sell 470 Cost to initiate $10.10 prem to close $16.30
Buy 500 sell 480 Cost to initiate $7.20 prem to close $12.70
Buy 500 sell 490 Cost to initiate $3.90 prem to close $7.20
Buy 510 sell 480 Cost to initiate $12.50 prem to close $21.10
Buy 510 sell 490 Cost to initiate $9.20 prem to close $15.60
Buy 510 sell 500 Cost to initiate $5.30 prem to close $8.40
Buy 520 sell 490 Cost to initiate $15.10 prem to close $24.90
Buy 520 sell 500 Cost to initiate $11.20 prem to close $17.70
Buy 520 sell 510 Cost to initiate $5.90 prem to close $9.30
Buy 530 sell 500 Cost to initiate $18.50 prem to close $27.90
Buy 530 sell 510 Cost to initiate $13.20 prem to close $19.50
Buy 530 sell 520 Cost to initiate $7.30 prem to close $10.20
Buy 540 sell 510 Cost to initiate $21.10 prem to close $29.50
Buy 540 sell 520 Cost to initiate $15.20 prem to close $20.20
Buy 540 sell 530 Cost to initiate $7.90 prem to close $10.00

Every single bear put spread was profitable. Whether the position was initiated itm, otm. Wow pretty neat. We do have to note that these positions had some time to expiration unlike this coming earnings (OE is the day after earnings).

Remember this folks....Debit spreads are not just looking for a directional move but they are looking for decay. Typically theta or time decay. As time goes by, all itm spreads (The stock is under both the bought and sold put strikes) will approach the amount of the spread (the difference between the strikes). So if Goog finished OE at $480 and a person played a 500 bought/480 sold contract, the position would be worth $20.00.

There was a considerable amount of IV decay in the positions which helped the profitability. The put debit spread has to be in the direction of the stock.

The back spread on MICC and CROX

2007-07-10T20:57:00.000-07:00

A little over a week ago, I posted two back spread observations. One on CROX and One on MICC. These two option position couldn't have moved more perfectly to show the point. We will close the positions to see how they performed:

MICC was at: $96.40
CROX was at: $41.84

The initial positions were:

CROX
35/40 July call back spread at a 1:2 ratio
Buy 2 contracts of a 40 strike call at $3.00
Sell 1 contract of a 35 strike call at $7.00
This position produces a credit of $1.00.

MICC
90/100 July call back spread at a 1:2 ratio
Buy 2 July 100 calls for $3.50
Sell a July 95 call for $7.20
Credit is $1.20

CROX:
Sell 2 contracts of a 40 strike call at $8.40
Buy 1 contract of a 35 strike call at $13.30
This position would produce a premium of $3.50
This was started at a credit of $1.00
Total profit $4.50

MICC
Sell 2 July 100 calls for $.75
Buy a July 95 call for $6.40
Cost to close: $4.90
Initial credit: $1.20
Loss: $3.70

Wow what a difference. $4.50 profit on CROX and a $3.70 loss on MICC. The reason for this is that CROX (now at $48.26 moved) and MICC (Now at $95.78 didn't move). Now we spoke about the stock settle between the long and the short strikes. This is not too pretty. One would not normally close out MICC now. The difference in price actually makes a very nice credit spread.......A $4.90 credit with a worse case position worth of -$5.00. Well that is a -$.10 risk. That is a nice play. See how our observation ferreted out a play.

stinker corner

2007-07-10T20:35:00.000-07:00

I am going to start a new post and keep updating it. Stinker corner is for stocks that tank. What happens afterwords will be interesting to see.

DEPO had some dissapointing results on its' phase III trials and the stock dropped $2.93 to $2.00. Ouch!!!!!

We have two stinkers:
MOVI......$.68 after its' drop and now is $.54
DEPO.....$2.00

Everyone have a good evening

There's gold in them thar.......

2007-07-08T22:49:00.000-07:00

...........Gold stocks.

I have been a keen follower of the metals. Major gold stocks have been trading at or near 2 year lows recently. Gold prices have been holding high levels in this period. The long side trade on the gold miners has been a stinker for awhile. There, however, has been much other action in metals market such as:

PD (now part of FCX)
FCX
ATI
TIE
RTI
CRS
AA
AL
X
NUE

To name a few.

Is it golds turn? I would not bet the farm on it.
But you know what.....Many of these gold stocks broke some consolidation levels on Friday. Most gold stocks received a nice boost on Friday.

Here are the major players:

GG
AU
ABX
NEM

The smaller players (I am not including the micro caps) have not fared as poorly but the majority have been in a holding pattern for a year. Here are some more gold stocks:

EGO
HMY
KCG
MDG
GOLD
AUY

Before a you load up on these gold stocks, I would study the charts and do your own research. Could these stocks add some gold to your portfolio?

Or......you know what they say what golds up must gold down.

Everyone have a good evening.

The earnings season picks up

2007-07-08T20:48:00.001-07:00

We are going to be getting into the full thrust of earnings season the week following next.

Following are some companies who are announcing next week:

AA....Mon
INFY....Tues
DNA....Wed
YUM...Wed
FAST...Thur
MAR....Thur
TXI......Thur
GE........Fri

Ok we have already observed the straddle and the strangle through the previous earnings observation. You know what....They actually performed surprisingly well. (RIMM, NKE, and APOG) I will watch some straddles and strangles on these stocks mention but we are going to add some volatility spreads. I know I haven't posted these strategies yet but I will.

What movement specific strategies (Volatility) can we observe:
The short iron butterfly
The short call or put butterfly
The short call or put condor
The backspread
Straight long option positions
Vertical debit spreads
Long stock and option hybrids

Everyone have a good evening.

The call and put butterfly spread

2007-07-08T20:41:00.001-07:00

.......or the non iron butterfly.

In the last post, we saw that a long iron butterfly is a good way to trade a range bound stock.

What are the key differences in a "butterfly" and an "iron butterfly"?

Please note that all butterfly spreads described here are vertical (all in the same month) and are long butterfly positions, and are using July contracts.

1) The butterfly uses either all puts or calls. Where as the iron butterfly uses both puts and calls in the position.

2) The butterfly uses three different contracts and the iron butterfly uses four.

3) The butterfly uses a combination of a debit spread and a credit spread. The iron butterfly uses 2 credit spreads (a put credit and a call credit spread)

Let's look at YHOO and look at an iron butterfly, a put butterfly, and a call butterfly centered at $27.50.

Iron butterfly:

Short a 27.5 put @ $1.10

Long a 25 put @ $.25

Short a 27.5 call @ $.85

long a 30 call @ $.20

Net credit: $1.45

Put butterfly:

Long one 30 put @ $2.90
Short two 27.5 puts @ 1.10
Long one 25 put @ $.25

Net debit: $.95

Call butterfly:

Long one 25 call @ $2.50
Short two 27.5 calls @ $.85
Long one 30 call @ $.20

Net debit: $1.70

Ok, the idea is the same but on the iron butterfly we get to keep the credit if YHOO ends July OE at $27.50. The maximum risk of the iron butterfly is the spread - the credit ($2.50-$1.45)=$1.05.

Now the put butterfly is at a debit of $.95 and the call butterfly is at a debit of $1.70. For both of these spreads, they are worth $2.50 at OE if YHOO finishes at $27.50. Now if YHOO finishes $.50 away from $27.50 ($30.00 or $27.00), then the spread is worth $2.50-$.50=$2.00. It will actually diminish dollar for dollar up to the long strikes. This will not be a negative position to close. The maximum risk on a call or put butterfly is the premium paid.

These butterfly positions mature with time. A centered position is having a debit spread that is going to $2.50 and a credit spread that is going to 0 at OE. The centered iron butterfly has two debit spreads that are going to zero at OE.

That wasn't to hard was it? Actually, I have read some descriptions for butterflies that make them one of the most convoluted difficult positions out there. These are a simple position with a simple mechanic. Us butterfly spread traders are looking for an equity to end at a certain point. ($27.50 in the case of the spreads we mentioned). Even though I am not currently playing YHOO, I like the play (YHOO's earnings announcement keeps me from playing this positions)......So let's observe the three butterflies into YHOO's earnings and to expiration.

There will be plenty more commentary on the butterfly spreads.

How many times can a person lose in a row? (trading options)

2007-07-07T11:00:00.000-07:00

In my formative years learning to trade options, I had made a few good plays just to be bound by a series of bad rotten plays. Yet bad plays just made the matters worse.

I would say to myself that I am going to really nail this one play. After many bad plays in a row, I would ask myself, "How many times can I keep losing?" and after that I would talk to people and say, "A person trading opposite of my trades could make a lot of money......Use my trades as contrary indicators". This whole mentality was a self fulfilling prophecy.

If anyone has been through this scenario, please raise your hands. Even though many will not admit the failures, it is rampant. Go read some of the financial boards and see.

The reason this happens is the luck of one trade gives a view of fantastic returns......Then a person is hooked. That 3 or 4 bagger gives a person a feeling of invincibility. Trying to search for this type of play again, causes a person to gamble.

The crazy world of options portrays sure bets with limit risk and unbound leverage. Taken together, this is a powerful motivator. With everything that we know about the market, we know that there is not anything such as a sure bet......I will get back to this. This limit risk thing is not true and let me explain.

If a person thinks that their position is going to bring them a 20 bagger, how much are they going to place on this play? If you answered everything, you are correct. Ben, there are people who are careful with their trades so this doesn't describe everyone. Oh come now, a person who is shooting for the stars is certainly not being prudent. I know that there are people that will put a little money in for a speculative play but this does not describe the majority of the traders.

It really isn't the option play on a certain stock that causes a person to make a bad play. It is how this person plays the options.......Near month way out of the money options on high beta stocks will be a perennial loser. This is a play that hardly ever pans out. The options lose money every day that transpires. Also putting all the money allocated for trading on one play is bound to make the position go to nothing. When that option position that cost a dollar is now $.60, is the person going to close the position or wish and hope the position is going to go back up? They're going to wish and hope.

This is why the unbound speculative positions seem to fail one after the other. One of the keys to trading is to preserve capital. Yes, everyone will have a losing a trade. The people who brag of trading at a 100% and making 10 bagger after 10 bagger don't exist in the real world. Someone who has a $10,000.00 account could be a billionaire in 5 trades if this was true. 7 trades would make a person the richest person on earth.

Ok, now I am sounding like some arrogant SOB. How can I say this? Well, I once thought the same way.

The key to trading is to manage the risk and look for high probability trades. Understand how options behave and look for the 20%, 10% and yes 5% gains. If a person was able to make 5% per week on all trades, they would have 15 times their original position in a year!!!! (Compounding can work pretty darn well).

I understand that the vast majority of the people will be trading long option positions so in the next few posts let's look for some ways to mitigate risk in these positions. There are some very good ways to make money with long options so let's explore some plays. I will keep posting spread plays, though.....Nobody thought they would get off that easy did they?

Good trading everyone

The first combination spread the iron butterfly

2007-07-06T17:55:00.000-07:00

Ina goda divida baby. Ok you know the song by Iron Butterfly.

Hey Ben, we are here to talk about options not some old washed up group from the sixties.

Your right. We have discussed spreads both vertical credit and debit spreads. We found out that both of these spreads have a directional bias. Well you know what we can profit from stocks that go nowhere.....Really. We will start by combining a bull put spread and a bear call spread. If the inside spread is a straddle, we have an iron butterfly. There are different types of butterfly spreads but this is one of the easiest to understand.

How many times have we heard someone say I'm playing an iron condor? Sounds tough and very impressive.....This guys got to know his stuff. Well before we continue on the lesser known iron butterfly let's define the word "iron". Iron just means that we use both a call and a put spread in the combination. There are butterflies and condors that are all call spreads or all put spreads so not all condor or butterfly spread are iron. Many people associate a condor with an iron condor and a butterfly with a straight butterfly spread so there can be some confusion in the definition.

Let's look at the iron butterfly a couple of ways:

1) Short the inside straddle and long an outside strangle (the long iron butterfly):

A hedged short strangle is what many people consider this.

For example:

Short a 540 GOOG straddle

Long a 530/550 GOOG strangle

OR

Short a 540 call $12.70

Long a 550 call $8.60

Short a 540 put $12.70

Long a 530 put $8.20

2) This is also a vertical call credit spread and a vertical put credit spread. This is a neutral strategy that provides a total credit of $8.60. The maximum loss in this spread is $10.00 (the difference in the long and short strikes) less the credit which is: $8.60

If GOOG, finishes OE at $540 with this spread, then a person pockets $8.60. Not too shabby. In fact pretty darn nice. If this finishes OE at or outside the long strikes, then this position is at a maximum loss of $10.00 - $8.60=$1.40. There is a difference between a long iron butterfly and a long call or put butterfly. A long iron butterfly produces a credit and a long put or call butterfly produces a debit. We will compare and contrast the two in move depth in a future post.

Now this is a neutral strategy right? Yes for the most part. Beautiful plays for OE pins. Maybe there is a stock that is a takeover target and the price does not show the takeover price yet. Good plays?....You bet and I even have some examples that we will follow. Is this always a neutral strategy?......Mostly yes, unless we tweak it a little bit. In the next post I will show how we can bias this strategy. The long iron butterfly is not the only iron butterfly....No, there is also a short iron butterfly (The first of the volatility spreads).

Till next post.....I am going back to my music....Ina goda divida baby.

Hey Ben Turn that crap off.

Everyone have a good Saturday

Sector watch apparel

2007-07-06T11:46:00.000-07:00

When you put on your trendy new clothes and go out on the town you are likely to be involved with one of these companies. Wall street sees many clothes companies as being a fad. Once the companies are established, they become more favored. This can be evidenced by both the PEG and trailing PE's. Take a look at ANF and then take a look a JCG. This gives stocks with tremendous growth like ANF and TRLG a very volatile chart. These have been very good stocks to trade.

TRLG: Trailing PE 13.94
PEG: .70

ANF: Trailing PE 12.36
PEG: .91

AEO: Trailing PE: 12.00
PEG: .86

LIZ: Trailing PE: 16.22
PEG: 1.44

GPS: Trailing PE: 18.82
PEG: 2.09

RL: Trailing PE: 21.19
PEG: 1.67

JCG: Trailing PE: 32.75
PEG: 1.53

When taking a look at stocks, these are very good stocks to research. I like TRLG, and ANF as both fundamental and chart based traders (AEO is in the same catagory but I haven't traded this one). These have been some of my favorate traders in the near past. Take a look at the charts for TRLG and ANF and you will see ups and downs. (these stocks move).

If you are into high beta's or stocks that are currently undervalued against their peers, do a little research on TRLG, ANF, or AEO.

These are great traders.

The next 10 bagger MOVI

2007-07-04T13:06:00.000-07:00

We last looked at small biotech stocks. Why MOVI?

This stock was at $30.00 2 years ago. It was at $6.00 1 year ago. It lost a $1.23 on Tuesday to end at $.66. Ouch!!!!! This stock also has a very high short interest (35% of the float with 9 days to cover) and probably picked up more on Tuesday. Is MOVI going to be bought? Is it going to fugure out a new financing package? Or is it going to pull itself out of its current financial condition?

Well that is the next million dollar question (s). Quite literally. On a $10,000 position, this could potentially earn a person well over a million dollars.

This could not only be the next 10 bagger but maybe the next 100 bagger. How does that sound? January (09) 2.50 calls sell for $.15. A move back up to $15.00 is a hundred bagger.

Now with all this said let's answer the million dollar question. No it is not likely to pull itself in a manner that would make the calls profitable. It may recover a little and through time the position could be at a total loss.

However at the same time there will be many people who run here to potentially flush their whole portfolios away. It's Vegas man. Don't do this....If you want to through a few nickles at it and gamble....Well ok. The reason that these low probability plays are so bad is that many people will put all there money in one position in hopes to make a million. Eventually the high risk play fails and the whole portfolio is lost.

When trading options one must preserve their capital to play another day.

Happy fourth

Let's back test some option strategies. GOOG

2007-07-04T12:33:00.000-07:00

The best ways to look at various strategies is to go back test various strategies. Many people play earnings but as a rule I don't think that this is a good time to trade because the event is unkown and we have no idea of what may actually happen (the event is unkown). A person who observes options will learn more about options than one who doesn't observe. A person who studiously observes options for a year may build a better option knowledge than many of the experienced option traders. A person will not have to pay for a $6000.00 seminar, they will not have to subscribe to a newsletter. A person who can observe will be able to make their own trading decisions based on their own conviction and knowledge of options. This is the way it should be.

Most trades through earnings are directional trades. We are looking for the stock to move. Well in options, there are some technical trades but we are going to have to get everyone up to speed on technical trades before we go through these trades.

I saved in my archives some old trades through earnings. Let's see what we can learn. We will start out with GOOG.

GOOG reported Q4 results on Jan 31 (07)
The closing price the day of earnings: $501.50
The closing price Feb 1: $481.50

Feb calls:

Strike......31st price........Feb 1st price
470...........$39.30.............$17.30
480...........$32.80.............$10.80
490...........$25.70..............$6.20
500...........$20.20..............$3.30
510...........$15.60..............$1.75
520...........$11.50...............$.90
530............$8.10................$.40
540............$5.50................$.25

Feb puts
Strike......31st price........Feb 1st
470............$7.30.............$4.60
480...........$10.20............$8.20
490...........$13.50............$13.70
500...........$17.40............$20.90
510...........$22.70............$29.30
520...........$28.60............$38.60
530...........$35.90............$48.83
540...........$43.80............$58.80

March calls:

Strike......31st price........Feb 1st price
470...........$45.00.............$25.90
480...........$38.30.............$19.50
490...........$31.80.............$14.60
500...........$26.20.............$10.90
510...........$21.60..............$7.70
520...........$16.50..............$5.30
530...........$13.20..............$3.60
540...........$10.00.............$2.40

March puts:

Strike......31st price........Feb 1st price
470...........$11.30.............$11.20
480...........$14.60.............$15.50
490...........$18.00.............$20.50
500...........$22.40.............$26.50
510...........$27.50.............$33.50
520...........$33.60.............$41.20
530...........$39.50.............$50.10
540...........$46.00.............$59.80
June calls:

Strike......31st price........Feb 1st price
470...........$63.00.............$44.40
480...........$55.00.............$39.00
490...........$49.00.............$34.10
500...........$43.80.............$29.10
510...........$38.80.............$25.50
520...........$34.00.............$22.00
530...........$29.10.............$18.30
540...........$25.30.............$15.40

June puts:

Strike......31st price........Feb 1st price
470...........$22.00.............$25.00
480...........$25.10.............$29.20
490...........$28.00.............$34.30
500...........$33.90.............$39.70
510...........$38.30.............$46.30
520...........$43.50.............$51.90
530...........$48.75.............$58.60
540...........$55.50.............$66.00

Commentary will follow. I will post the numbers and we will talk about the potential trades.

Have a very happy fourth

2007-07-03T12:32:00.000-07:00

Everyone be safe and have fun. I would like to take this time to thank everyone who has taken their time to stop by my little piece of cyberspace.

See everyone back trading after the holiday.

Good luck to all

So you want to trade commodities but don't want to trade futures

2007-07-02T17:09:00.001-07:00

How about trading an ETF? These trade just like stocks. Buy and sell at your online broker and yes you can trade options on these.

Power shares has some ETF's that track commodities:
DBA-Agricultural fund
DBB-Base metal fund
DBE-Energy fund
DBO-Oil fund
DBP-Precious metals fund
DBS-Silver fund
DGL-Gold fund

If you don't want to trade a ETF on a commodity, you can trade them on companies that are involved with the commodity:
IYE-I shares Energy
XLB-Material SPDR
XLE-Energy Select SPDR
OIH-Oil service HLDR

Now a person can trade many options on stocks but the ETFs are a good way to get away from single events that move a stock and also these are less volatile and the options aren't as potentially overpriced (IV is lower).

They ETFs aren't just the Q's the DIA's and the SPY.

Dig up the prospectus on these and more ETFs and take a look.

The 10 bagger....The next biotech play

2007-07-02T16:12:00.000-07:00

Option speculators are a risk taking bunch. In my early days, I was in search of the next 10 bagger. The option lottery was the term that was used among my risk taking brethren. I don't have the tolerance for risk that I once had. You want to know the type of stock that will go from sub $10 to $50, $60, or$ 80 in a few years it is the biotech sector.

Just take a look at the heavy hitters 5 years ago to now (All stocks are adjusted for splits):
CELG $3.29 to $57.88
DADE $9.23 to $53.75 (They IPO'd Feb (03)
IMCL $7.34 to $36.70

Looks like I missed out on those plays but who are the future heavy hitters? Well it could be one of these stocks:
SNTS
VIAC
ANSV
DNDN
CEGE
TGEN
AGIX

All are sub $10 dollar stocks and most hover between $2.00 to a little over $5.00.

At least one and maybe a couple in that group will break out and become the next big biotech.

Keep searching for an option play on these stocks and there is a high likelyhood that these stocks will rob a person of all his/her option capital.

............Unless a person is lucky

But with that said it is best to catch these stocks somewhere midway in the trend as opposed to trying to catch them before they break. If anyone remembers DNDN around May, there were people that had made a million dollars on the initial rise and held into the drop just to lose all their capital.

Why would I talk about this? How would I know what it was like to chase the multi-bagger?

I used to be the big gambler and yes I did lose all my capital.....Every single cent.

A word to the wise.......Play safe or be lucky. When I tried to be lucky, I was unlucky......However when I tried to play safe, I had good luck.

Have a happy fourth and I wish you much success in your investments/trades.

The GOOG short term covered call

2007-07-02T15:11:00.000-07:00

Ok, at the beginning we started out with 1000 shares of GOOG at $530.26 and sold 10 contracts of 55o calls for $7.70 and bought it back for $5.00.......We gained $2700.00 from this trade. We then sold 10 contracts of a 540 call for $10.20 and bought it back for $8.40......We gained $1800.00 from this trade. $4500.00 gain to date if we don't count commisions which will be around $80.00.

Now let's do a ratio write this time. Let's write 20 GOOG July 540's @ $9.40. Uh -oh 10 contracts are naked......Not to worry, we will buy 10 contracts of a July 560 call hedge at $3.80.

I am not advocating that people play this way. If they are trading and believe a stock is going down they should sell. This is intended to be the opposite thesis of the call day trader who unless the are very smart typically lose money. Go to the Yahoo finance boards and see for yourself.

If a person is holding long shares of a stock, this can be done profitably and is easier than buying short term option positions for a one or two day trade.

Everyone have a good evening.

Back spreads a look at CROX and MICC

2007-07-02T10:12:00.000-07:00

A back spread is a very nice way to take advantage of a moving stock.

.............But if it settles down and goes range bound watch out!!!!

The back spread is not a good strategy for a stock that doesn't move. A back spread is nothing more than a combination with more long options than short options. The back spread that we will consider is a vertical back spread as follows:

CROX 35/40 July call back spread at a 1:2 ratio
Buy 2 contracts of a 40 strike call at $3.00
Sell 1 contract of a 35 strike call at $7.00
This position produces a credit of $1.00.

CROX is at $41.84 right so both calls are in the money. Let's do the exercise and see what happens at OE:

If CROX goes to $50.00 then the 2 40 strikes will have a value of $10.00 each. The 35 strike will have a value of $15.00 so the total position will be $5.00 positive with a $1.00 credit so the profit will be $6.00. In a back spread as opposed to a debit spread, the position is not capped. Think of it this way: One long strike travels with the short strike and one long strike can gain value with a rise. Now if we look at what happens if CROX settles below the 35 strike, at OE all calls will be worth 0 so the person can collect a credit of $1.00.

Everyone must now think this is a fool proof position with no potential loss. I wouldn't bet on it and here's why. If CROX settles just under the 40 strikes at OE, the 35 strike is worth -$5.00 and the 40 strikes are worth 0 so this position is at a $5.00 loss. In fact this position is lossy all the way up to a $44.00 pps. Would I take the risk. Probably not unless I really though CROX would rise. There are some technical implications on back spread trades (Which we will address in subsequent posts) but we will observe this position for awhile.

How about MICC? If you want to see a volatile stock, this is one. It is currently at $96.40 and this can turn either up or down on a dime. Let's look at a vertical back spread on MICC.

Buy 2 July 100 calls for $3.50
Sell a July 95 call for $7.20
Credit is $1.20
In this position, we will look for MICC to be under $95.00 or $3.80 over 100. As I said before these do not describe the technical implications of this trade. We will only look at directional trading for now.

We have looked at Vertical credit spreads, Vertical debit spreads, and vertical back spreads. To differentiate the 3 let's look at their outlooks.

1) Vertical credit spread is bullish trade with puts and a bearish trade with calls. This is typically a neutral to opposite direction trade.....For example, a person trading a 80/85 vertical call credit spread will be looking for the stock to trade under $80.00. So if the stock is currently at $80.00 a person employing this spread would be neutral to moderately bearish.

2) Vertical debit spread is a bearish trade with puts and a bullish trade with calls. This is typically a directional trade where we would like for the stock to travel in the direction of our position. By the previous example we would desire the stock to be above $85.00. So this position would be moderately bullish.

3) Vertical back spreads aren't discrete like the vertical debit and credit spreads. If played at a credit they can be moderately bearish for a call spread and moderately bullish for a put spread. They are also at the same time very bullish for a call spread and very bearish for a put spread.

We will go into rationalizing plays so we know how to pick plays that are appropriate for the stock that we are playing. We will look at technical implications of the trades. Many people will be fine with the basic vertical plays that they are learning. Before we get into that we will have to finish our vertical strategies. Does anyone know what happens if we combine a vertical debit and vertical credit spread? We have a whole new class of plays that are either bet on a range or bet that the stock stays out of a range. These are butterflies and condors.

GLTA

RIMM the debit spread widdens

2007-07-02T09:02:00.000-07:00

One day is all it took to widden the premium to normal. The rule of thumb is that a person must wait until OE to get value from the spreads. These options were out of whack on Friday so a person could have made some quick money over the weekend.

Let's look at some July RIMM call strikes:

180.......32.10
185.......27.30
190.......23.20
195.......18.80
200.......14.90
210........8.60
220........4.40

Spreads:

185/180.....$4.80
190/185.....$4.10
195/190......$4.40
200/210.....$6.30
220/210......$4.20

Everyone have a good trading day.

CBOE website areas

2007-07-01T21:24:00.000-07:00

I really like the CBOE website. It is free and has many features.

For those of you who would like to learn more about advanced option features, there are video podcasts and video courses from master traders like Dan Sheridan.

Following is the link:

http://www.cboe.com/tradtool/webcast.aspx?channel=986#stream

For people who would like to trade options from a virtual account, there is a virtual trading platform that is free and has the ability to do more advanced option trades like spreads. In my opinion, a person should paper trade options for 6 months before trying any trades. One has to get the feel of options before they understand how they move. Here is the link:

http://www.cboe.com/tradtool/virtualtrade.aspx

Do you want to learn more about trading options on ETF's here is the link:

http://www.cboe.com/Products/OptionsOnETFs.aspx

I will share information on both CBOE and 888options.

The CBOE is the Chicago Board of Options excahnge. Most of the site is free.

Everyone have a good evening.

GL

Disclaimer: I have no affiliation with the CBOE or OCC (888options) and opinions on those sites may not reflect my opinion. They are solely responsible for their own content and views. I recieve no financial payment from either site or organization.

RIMM's straddle/strangle observation

2007-07-01T20:36:00.000-07:00

I was observing some straddle/strangle plays on stocks that announced. RIMM was in a class all by itself so it will have its' own post.

July 165 straddle:
Cost: $15.10
Value at the close of Friday: $36.00

July 155/175 strangle:
Cost: $7.50
Value at the close of Friday: $26.50

Now when a stock moves, the strangle will outperform the straddle. However, if we take a look at the straddle it performed very well. We have seen 3 surprises in this observation:
APOG
NKE
RIMM

We will be observing these stocks next through their earnings:

AA
DNA
YUM
TXI

We will add a dimension by looking at a iron condor. I know we haven't addressed this yet but we will before eanings announcement.

Everyone have a good evening.

The put debit spread trade on BIDU

2007-07-01T16:37:00.000-07:00

Ok, we looked at the vertical call debit spread on RIMM and now we will look at a put debit spread on BIDU (aka vertical bear put spread).

July put contracts for BIDU

185.....$18.00
180.....$13.80
175.....$9.90
170.....$6.80
165.....$4.40

Now let's break it down into the premiums between the spreads.

185/180 $4.20
180/175 $3.90
175/170 $3.10
170/165 $2.40

If we are looking at a 180/175 vertical bear put spread, this position would end OE at $5.00 if BIDU stays under $175.00. The spreads as listed basically show the cost for July BIDU bear put spreads. The possibilities abound and there is money to be made in them thar spreads. We are going to observe both RIMM and BIDU for awhile to see how these contracts fair. I know.......I need to post the rest of our theoretical RIMM, GOOG, FCX option observation. Time consuming is my only defense.

After earnings RIMM trade or learning debit spreads

2007-07-01T15:59:00.000-07:00

What is a debit spread? This is buying and selling an option that creates a debit. This is really just the opposite trade of the vertical credit spread. Instead of recieving a premium for selling a combination we will be paying for the position. This will be a vertical debit spread (aka bull call spread). Same month, but different strikes.

Well let's look at a July 195/190 pair on RIMM. We would sell the 190 and buy the 195 strike July call. The cost would be the difference in current premiums or $3.50. As long as both contracts stay in the money, this combination is worth close to $5.00 at July OE. Pretty nifty isn't it. This close to expriation the premium spread for an in the money debit spread for RIMM should be approaching $4.00 and some change. Money could be made if the spread normalizes. This could happen well ahead of OE but if our trade matures at OE then a $3.50 investment ot make close to $5.00 in 3 weeks isn't too bad.

This position would look like:
Buy the July 190 for $13.60
Sell the July 195 for $10.10

What is the risk Ben? The risk is that RIMM falls and both contracts go out of the money and then this little combination is worth 0 at OE. So this combination has a direction bias but as long as RIMM stays above the long strike or $195.00 this will be worth close to $5.00 at OE.

So what we are doing is capping our gain at five dollars so everyone is probably wondering why in the world is Ben telling us about this debit spread when we could be buying straight long options with no cap. The reason is risk. If we buy a July 200 call, we will pay $7.40 and in the debit spread that we mentioned it is still a winner if RIMM stays above $195.00.

If we are more risk adverse and don't really know what RIMM will do, we can go deeper in the money like 190/185 July bull call spread. Or maybe we want to make more money and believe that RIMM will keep sailing up. We could play a 220/210 bull call spread. If RIMM finishes OE above 220, this position is worth $5.00 at an intial cost of $2.00. Hey not to bad.....This is a two and a half bagger. This would out perform a straight long 200 call at $7.40 if RIMM rose to $220.00.

Ok, thats it. That is the reason that we play spreads.....Right??? Why not just sell naked contracts? Why not just play straddles? Why not just play LEAPS? Why? Why? Why?

In short because, the position is near delta nuetral. I will do a whole post on what delta nuetral trades are, their desirability, and of course when not to use delta nuetral trades.

But first I bet you want to see a put debit spread. I will look at BIDU in the next post.

Dang it missed out on the RIMM trade

2007-07-01T15:49:00.000-07:00

Wow, did RIMM ever move after earnings. Geez, why didn't I have any money in the RIMM trade? Not to fret there are still some opportunities for trades on RIMM.

After a monumental price move such as there was on Friday (For RIMM of course), the option contracts don't have a chance to move to proper levels.

Let's look at some call contracts and price levels for July:
180....$21.70
185....$17.40
190....$13.60
195....$10.10
200....$7.40
210....$3.30
220....$1.30

And now the spreads (the difference between two strikes.
185/180....$4.30
190/185....$3.80
195/190..$3.50
200/195...$2.70
210/200...$4.10
220/210...$2.00

So what do you ask? This actually has some money making opportunities. As time approaches expiration, the difference in the premium for 2 contracts that are in the money will approach $5.00. This isn't always intuitive so let me explain. Let's just assume that OE was on Friday. When the contracts are just about to expire they will carry almost no time value, no implied volatility, and no demand over intrinsic value. Now that I lost everyone, the bottom line is that the option contracts will be worth close to the amount that they are in the money. So a July 190 call contract will be worth near $10.00 at OE when the stock is at $200. A 195 July call contract will be worth near $5.00 at OE with a $200.00 pps. $10.00 - $5.00=$5.00 and 200-195=5. Ok I think everyone is getting the picture.

The strangle/straddle observation

2007-07-01T13:09:00.000-07:00

I promised that we would look at 4 stocks through earnings on Thursday. I observed the option prices on Monday. Following are the stocks:

STZ
Monday close: $23.85
Friday close: $24.28
Cost to initiate a July 22.50 straddle: $2.00
Cost to initiate a July 20/25 strangle: $.55
Value of July straddle on Friday: $2.00
Value of July strangle on Friday: $.40
Cost to initiate a August 22.50 straddle: $2.40
Cost to initiate a August 20/25 strangle: $.80
Value of August straddle at Friday: $2.50
Value of August strangle at Friday: $.70

GIS
Monday close: $58.79
Friday close: $58.42
Cost to initiate a July 60 straddle: $2.20
Cost to initiate a July 55/65 strangle: $.20
Value of July straddle on Friday: $2.20
Value of July strangle on Friday: $.10
Cost to initiate a August 60 straddle: $3.00
Cost to initiate a August 55/65 strangle: $.40
Value of August straddle at Friday: $2.70
Value of August strangle at Friday: $.30

MU

Monday close: $12.65
Friday close: $12.53
Cost to initiate a July 13 straddle: $1.20
Cost to initiate a July 12/14 strangle: $.40
Value of July straddle on Friday: $.90
Value of July strangle on Friday: $.15
Cost to initiate a August 13 straddle: $1.50
Cost to initiate a August 12/14 strangle: $.70
Value of August straddle at Friday: $1.20
Value of August strangle at Friday: $.50

PALM
Monday close: $16.36
Friday close: $16.02
Cost to initiate a July 17.50 straddle: $1.50
Cost to initiate a July 20/15 strangle: $.25
Value of July straddle on Friday: $1.50
Value of July strangle on Friday: $.10
Cost to initiate a August 17.50 straddle: $1.90
Cost to initiate a August 20/15 strangle: $.35
Value of straddle at Friday: $1.80
Value of strangle at Friday: $.30

Now we can see that there was not much movement on any stocks. With the exception of MU, most of the July straddles were pat (no gain no loss). However look at the strangles......The strangles did not perform well. On a percentage basis, however, the August's outperformed the July's. Now there is a reason for this. There is more speculative demand for near month out of the money contracts. This speculative demand diminishes after an earnings event. I spoke about this earlier.

Looking at MU, we see that there were some expectations for it to move. When it didn't move the near month straddles lost a fair amount of value.....But the August straddle held a most of it's value.

I will look at many other stocks through earnings and we will look for ways to figure straddles that are over valued and under valued. We are going to see some high beta stocks. Now when these stocks go through an event flat, watch premiums of options drop substaintially.

So is this a thesis saying that near month strangles never move?

Take a look at RIMM. The most profitable trade would have been a strangle.

I wish everyone success next week.

The last of the straddle strangle observation RHAT

2007-06-28T20:54:00.000-07:00

Well I guess it is RHT now. I will have to get used to the new ticker.

I was looking at a 22.50 straddle which cost $2.90 and it was worth $1.30 after earnings/

The 20/25 strangle cost $1.00 and was worth $.10.

We saw a couple of large movers yesterday in NKE and APOG. The RHT example is atypical of what happens through earnings......Most of the value of the contract was diminished.

We are in earnings season and we will have many different stocks to watch. There will be many rules for options play as we get through a busy season. It looks like there are some stocks starting out with a bang.

Guys do some good trading tomorrow.

GOOG short term covered call trade

2007-06-28T20:41:00.000-07:00

Ok, we got the fill on the Selling the GOOG call. Let's put a buy order in for $8.40. It is nice to trade around the position. Please note: that we could have got different fills and because I can't show this in real time it shows how we trade.

For those who are following this, I am doing a couple of things that most people don't and that is:

1) Set a buy point

2) Set a sell target

I would suggest that people do this with all trades even no option trades.....Many people trade the deer in the head lights way. They wait and see what happens and make a decision afterwords. Buy and sell points always need to be used.

That was my lecture for the night.

Good luck everyone.

Our short term covered call observation

2007-06-28T08:00:00.000-07:00

GOOG is lifting out of the morning doldrums so let's put a sell order in for 540 calls at $10.20. Most people are inclined in a position such as this to sell more calls when the stock is low.

Patience is the key and it is actually a fairly easy strategy.

The 540 calls are currently at $9.60 to $9.80 so let's see if we can get some fills.

Everyone have a good morning.

GL

The first spread the vertical credit spread

2007-06-27T21:38:00.000-07:00

A person named Alfred is taking a look at various option plays and sees a $.20 option that went to $5.00 in one day. Out comes the calculator and he figures that he could have made 25x initial investment with this play. Relaxing back in his chair in a semi dream state....He says to himself....."If I bought $20K of the aforementioned option contracts, I would have $500K right now". Alfred starts seeing these option plays all the time. He says with conviction "I'm going to be rich....real rich....Bill Gates get out of the way...There's a new sheriff in town".

I think everyone knows what happens. Yes sorry to say it.....All the money was lost if Alfred tries to play these highly leveraged positions more than once. (He could be lucky the first time) Let's find a solution to Alfred's conundrum.

Once a person has executed many option plays, the spread is the first advanced play that a person wants to master. The first type of spread that a newbie spread player will master is a credit spread. A credit spread is nothing more than buying and selling an option in a combination in a fashion where it produces a net credit (The sold option is more expensive than the bought option) The type of credit spread we are going to concentrate on now is the vertical credit spread.

Sounds kind of tough doesn't it? Well it's really not. Actually it is easy. A vertical spread is nothing more than a buy/sell (long/short) option position where the options are in the same month. Going up and down the strikes or vertically, makes this a vertical spread…… It’s not that hard to get the idea. There are many types of vertical combinations. Back spreads, ratio'd spreads and more than 2 option positions. We are, however, going to look at the simplest....No ratio's.....no back spreads.....Only two different options. The two constituents of this combination will be a long option position and one will be a short option position.

Let's think of it this way.....You are selling a naked option and buying another for a hedge. (Please note that as we get further along we will give a broader definition) For example: You sell a July 45 CROX call for $1.40 and buy a July 47.50 CROX call for $.70. Now the 45 CROX call is $.70 more than the 47.50 call. So this position produces a $.70 credit. If CROX stays below $45.00, then a person who initiated this position will get to keep the $.70.

But what happens if CROX goes above $45.00? If CROX goes above $45.00, the person will most likely take a loss. However since the person is holding a $47.50 call, the maximum loss will be the spread ($47.50-$45.00=$2.50) less the $.70 premium received=$1.80. Due to this being bearish in nature this is call a bear call spread.

Now the converse is true with a put credit spread. An example would be: You sell a July 42.50 CROX call for $1.90 and buy a July 40 call for $1.00. Your premium (or credit)is $.90 and your maximum risk is $1.60. A person employing this spread would be looking for CROX to stay above $42.50. This is called a bull put spread.

When I gave the definition of the vertical credit spread I indicated that this is like a hedged naked option.This position is somewhat technical.....So in the next post I will give technical aspects of a vertical spread. We will also look in further posts on when to employ these types of spreads and how to play them technically.

Don't worry about the word "technically". This concept on the vertical spread wasn't that hard was it?

NKE and APOG announced AH yesterday and here are the straddles

2007-06-27T18:46:00.000-07:00

We were looking at a 52.50 straddle and a 55/50 strangle on NKE. NKE beat estimates by a penny and the stock is up $4.47.

Following are the prices of the positions at the end of today:

52.50 straddle: $6.05.....The amount paid for the position was $3.00.
55/50 strangle: $3.60....The amount paid for the position was $1.20

APOG announced and EPS of $.40 vs a consensus estimate of $.24. The shares soared today $2.90.

The 25.00 straddle was worth $3.60. The amount to intiate this position on Friday was $2.30.

Looks like a couple of winners today. This is what a person needs to do to make money on strangles/straddle.....Pick stocks that move alot.

Short term GOOG covered call

2007-06-27T08:37:00.001-07:00

We'll it looked like the $5.00 target filled on the 550 call. Well let's put in another sell order for the 550 call at $8.00. We will see if this fills. I don't recemmend that people momo trade covered calls. This is to show how rolling in and out of covered calls can be profitable. This is a simple play and is not a true roll.

I wish everyone success.

GL

Short term trading covered calls

2007-06-26T22:29:00.000-07:00

Huh Ben? I think you are off your rocker right?

Well actually how many of you have bought options on a short term basis to realize a gain in a stock just to find out that they keeep on loosing value. Well if you are long a stock.....Why not try to play the opposite side of the game.

Sell the call and buy it back when it drops. This strategy like everything else has some risk associated with it. However, a person can decrease their exposure and learn about options at the same time. If the stock goes way up the biggest risk is to not be able to hold on to a stock and not participate in the gain.

I would still recommend that if a person beleives a stock is going to go down that they sell their stock. This play can also lock a person into a position where the premium of the call becomes to high to close.

Now I am not a typical covered call writer so let's observe a play. This will be much easier than the other options that we are observing.

Let's say the we own 1000 shares of GOOG which is currently at $530.26. Let's start out by selling 10 contracts of a July 550 strike call for $7.70 or a total of $7700.00 premium. I will trade in and out of this and see what we can do. We will put an order in for a buy to close at $5.00 good for the day.

Everyone have a good evening.

The long term covered call write

2007-06-26T21:44:00.000-07:00

Most of the time Covered calls plays is presented as a single strategy. Well there is actually more than one way to play covered calls. We are going to look at a long term covered call strategy. It is great for people that buy and hold and wish to make a little extra income. Here is the set up://Jane has been holding BA for quite some time.Her outlook for BA is neutral and if she was to give up the stock she wouldn't care.

BA is paying dividends at .35/ share per quarter.
BA is currently trading at $94.98.

Jane decides that she would like a little extra income for BA and believes that the stock is getting near its’ top at $100.00. Jane writes a 100 strike January (08) LEAP with a premium of $11.60. So if Boeing stays flat between now and expiration she will earn 11.60 + .30(3=dividend periods)= $12.50 per share or 13.2% not too bad for 6 months. If the stock goes over $100.00 by expiration then Jane will earn $17.52 total (This includes the gain in the stock) …….That is 18.4% over 6 months. That is nice by all aspects. This is a very conservative strategy and is capable of providing some nice returns. If BA drops, all gains could be negated. I believe that it is better to sell a stock than have it underperforming. Some people don't want to manage their stocks and this would be a good strategy for them provided their currently holding the shares.

The long term covered call with a kick

Yes there is another long term covered call strategy. You could buy a stock with high price LEAPS and use it to pay for the margin. If you did a buy write on DNDN with a $7.50 strike Jan(09) LEAP you would receive a premium of $3.70 per share. DNDN is currently at $6.51. Playing this position this way would allow you to buy 1.57 x the shares without taking on leverage…..Wow!!!! If the stock was to stay flat a person could make a 57% return in 18 months. If the stock rose above $7.50, a person would be able to realize a $5.25 gain or 81% in 18 months. That is fantastic. The problem with these plays is that the stocks that fetch the highest LEAP premiums are unstable.

Now by writing a LEAP out of a fully margined account, a person could theoretically buy an infinite amount of stock. How might you ask? Well a person can use the premium of the call towards margin. Here is an example:

If the person buys 1000 shares of DNDN for $6.51/share the total cost is $6510.00 he could put up $3255.00 and the broker loans the person $3255.00. Well this person writes 10 contracts of a January (09) leap and receives $3.70 x 10 x 100=$3700.00. He just covered the $3255.00 and has $3700.00 to spend again. I think you get the idea. In the real world there are restrictions as to how much a broker can allow a person to play in this scheme. I am not sure what the rule is so I will dig it up and post it.

Now imagine the possibilities. I can hear all the perpetual motion people stirring. I want to mention something.......NEVER TRADE THIS WAY!!! Here is where the problem occurs. When you are buying a stock in a leveraged position, your outlook is short term (maybe no more than a week.....There are some exceptions). By writing a position 15 months out, you have a outlook that is long term. You are in more than 2 x what you could normally afford. If the broker calls, you won’t have the money to cover. Furthermore, a 50% drop in a leveraged position = 0. If a brokerage closes the position, the option position would need to be closed also.....The zero point in this position could very well be the stock dropping 30%-35%. Many brokerages won't allow this (some will) but some people loop into these position by re-buying the stock after they write.

The LEAP covered call writing can be an effective way for a person holding a stock to produce an income if they don't like to manage their portfolio. Everyone that holds stocks should watch and manage their portfolio, however many don't. The leveraged LEAP covered call write can be used effectively by people who choose appropriate leverage levels and understand a stock and its’ option contracts.

Cheers to all investers out there

More companies announcing earnings

2007-06-25T22:56:00.000-07:00

We have some major companies announcing earnings on Thursday of this week. I think it would help us enhance our option knowledge if we could observe the option contracts through earnings.

The companies are:
STZ
GIS
MU
PALM
RIMM

I will start the observation today. I will not do a daily look at the contracts because I just don't have enough time. However, I will look at the contracts after earnings and we can see how they performed.

Successful trading to everyone

The covered call through earnings

2007-06-25T22:21:00.000-07:00

Let's say that a person is long a high beta stock

Earnings season is upon us. How would you like some free money? Well it actually isn't free but let's look at writing covered calls through earnings.

There are a couple of option plays to consider for the person with a level II approval. If your long a stock, sell a covered call that will expire the next day.....Stocks usually don't move as much as people may think through an event like earnings.

Now a person could write a covered call a couple of strikes out of the money just prior to an earnings. Most times this call will lose a lot money through and earnings event. We just talked about volatility crush. The options that are OTM will lose money like crazy after earnings.

Here's the catch......If the stock rises through a couple of strikes to make the call position in the money, then the stock underlying the option will likely be called away. Now many people will ask why I would recommend a strategy that would cause them the risk of losing their beloved stock.

To rise accross a couple of strikes the person would be able to recieve a nice gain and have the premium from writing the call. Most of the time stocks will not rise enough to call the stock away. The person will give up potential gains if the stock rises substantially. But are we here to love a stock or make money. More money will be made in the long run by consistent high probability plays as opposed to the occational big gain.

I don't recemmend this for very low premium stocks and also recemmend that this be done with options that are front month.

This is another observation methodology that we will observe through the earnings season along with our strangle/straddle.

Happy trading

How did our strangle and straddle perform for WAG

2007-06-25T19:47:00.000-07:00

WAG posted earnings today and beat consensus estimates by $.02. Well what happened to the stock?

It dropped $.72.

The 45 straddle which cost $1.75 on Friday was worth $1.60 at today's close.
The 42.50/47.50 strangle which cost $.40 was worth $.25 at today's close.

Many people think that the straddle and strangle are fool proof methods of making money through an earnings event. WAG is about as far from a high beta stock as there is. IV should be low. There was some movement and the premiums dropped.

Everyone have a good night.

Covered calls

2007-06-25T19:44:00.000-07:00

Did we cover all the bases?

Of all strategies, covered call writing is one of the first option plays a person learns. The other is buying puts and calls. Now most people believe that covered call writing is the least risky strategy of all option plays. Furthermore, there are more than one strategy involved with the aforementioned play. I will give a basic definition, describe why covered call writing can be risky, and give a few plays.

A covered call write is very simple......It is selling a call while owning the underlying stock so the writer can deliver if he is assigned. Now a covered call player will either already own the stock or he will buy the stock to write (this is called a buy write). This strategy is employed to collect a premium from writing the call. Here is an example....Tom is holding 200 shares of AAPL and he writes 2 contracts of a July 125 call. He collects a premium of $4.20 x 2(number of contracts) x 100 (an option contract is the price on an option table x 100)=$840.00. Now that is kind of nifty isn't it. $840.00 worth of free money.

........Hey not so fast there Tom

This premium collected is not free. AAPL is currently at $122.34 and let's say that Apple goes up to $145.00. Our friend sold the right to someone to buy his stock for $125.00. Tom will no longer own the stock and didn't have the chance to enjoy the gain. Maybe, though, Tom wanted to just make the premium which was almost 3.43%......Heck, if he were able to do this every month he would double his money in a year if he did this in a fully leveraged position.

Now what do you have to say for yourself, Ben?

The aforementioned scenario is just where the covered call writing became very risky. The one thing that Tom forgot about was that the stock could go down. Now this play is in a whole new ball park. Let's just say that AAPL dropped to $90.00 instead of rising to $145.00.....Our friend Tom just sustained a loss off $32.24(200) - $4.20(2)(100)=$5608.00.....Ouch!!!! Now our friend Tom had already owned AAPL but many people will buy a stock with the sole purpose of writing a call and play this postion fully leveraged. The call premiums are their highest among volatile stocks (the riskiest stocks). If a person wouldn't want to buy a stock alone by itself, they certainly shouldn't buy a stock to write a call. Now to buy a stock in a leveraged position and write a call......Boy o boy that's just plain crazy.

Furthermore a person usually buys a stock so that they can enjoy the stock appreciating.

Now don't get me wrong. I am not bad mouthing covered call writing but I do want to drive the point home that like all option plays covered call writing can be risky. There are a lot of people that write covered calls in a very conservative fashion and do well. I will compose some more covered call strategies in future posts (Long term strategies, Collars (selling a call and buying a put), what contracts to buy, rolling up and down). I will first describe a few strategies that not many people consider.

Here is something interesting and not many people consider this as a strategy why not write short term covered calls.....Trade them around a couple of day period. Trade them through an event like earnings. Instead of being a buyer of the calls a person doing this is the seller and will have time on his/her side. I will post these strategies in the next article.

Straddles and strangles or how to lose twice as much money

2007-06-24T23:14:00.000-07:00

Most people believe that when you play a straddle or a strangle you are essentially creating a risk free option position. Both a straddle and a strangle take advantage of the fact that you don't care if the stock goes up or down but that it moves. The position should, therefore, be profitable if the underlying stock goes up or if it goes down. This is not always the case. But before we get into that lets see exactly what the definitions are:

Straddle: This is buying (you can write a straddle but we won't discuss that in this post) a combination of a call and a put at the same strike price. These are usually bought right near or at money. For example if a stock is at $30.50, a straddle would consist of a $30.00 strike price put and a $30.00 strike price call. The call would be $.50 in the money and the put would be $.50 out of the money.

Strangle: This is buying a combination of a call and a put with different strike prices. These position are typically bought approximately the same amount out of the money. If the put and the call are at a different amount out of the money, this is called a biased position. An example of this would be the same $30.50 stock with a $35.00 call and a 25.00 put. The call would be $4.50 out of the money and the put would be $5.50 out of the money. To bias this on the call side we would buy a $32.50 call and a $25.00 put. The call would then be $2.00 out of the money and the put would be $5.50 out of the money.

The biggest differences between a straddle and a strangle are the cost of the positions and how far the stock needs to move to produce a profit. Because a straddle is at money both the put and the call will be much more expensive than the call and the put in a strangle. If you play either a strangle or a straddle around earnings, you will find that among volatile stocks , the strangle will have to move quite a bit more than the straddle to make the position profitable.Let's look at a example:

WAG (Closed at $44.97) announces Monday and as of Friday:
A 45 straddle costs $1.75
A 47.50/42.50 strangle costs $.40

APOG (closed at $25.15) announces this Tuesday and as of Friday:
A 25 straddle costs $2.30

NKE (closed at 52.50) announces this Tuesday and as of Friday:
A 52.50 straddle costs $3.00
A 55/50 strangle costs $1.20

RHAT (closed at $23.86) announces this Wednesday and as of Friday:
A 22.50 straddle costs $2.90
A 20/25 strangle costs $1.00

Let's see how they do.

With a straddle and a strangle the loss can be doubled because both a put and a call are bought. If a person does not understand how pricing factors govern the profitability of an option combination like a straddle or strangle, they should not be investing through earnings.

There is a time and a place for straddles and strangles like low volatility times. When investing into certain technical patterns such as pennants (draw a line from the tops and the bottoms with the point on the right hand side of the graph), money can be made. As a stock consolidates it becomes less volatile so the premiums will become cheap. In this period money can be made if the stock breaks out in the assumed time frame. There are also stocks that can be invested through earnings and money can be made if a person understands the option contracts underlying the stock that is going to announce.

Paper play is the best way to get a good understanding of options without paying the tuition. I will follow up with some appropriate straddle and strangle plays.

Everyone have a good evening.

Volatility crush

2007-06-24T22:28:00.000-07:00

Volatility crush is where an option contract goes from a high implied volatility (IV) period to a low implied volatility (IV) period. The expectations prior to an event like earnings will cause IV to be high. After earnings, there will be no expectation, thus low (IV).

With many stocks going through earnings (especially high beta stocks like RIMM and BIDU) IV is going to constitute a high percentage of the premium on near month otm contracts. Many of the otm near month contracts will be severely deflated after earnings are announced. Some will be zero.

This is what is called volatility crush. Don't invest with most long option contracts through earnings.

We are entering a new earnings season........Now, many people will be investing in July contracts going into earnings.

Now let's look at a scenario: My name is charlie and I am going to make a killing by buying July 100 calls for $4.85 on WSPH (Waffle Stompers Pancake Houses.....Yes I did make that up). I expect WSPH to make at least a $20.00 jump into earnings it is at $90.00 right now. If WSPH goes to $110.00 after earnings, then it should be worth $15-$20 based on how current contracts are trading. At $20.00 Charlie would make 5x what he invested.

Now, that is a pretty nice gain. Here is the problem though. WSPH announces a blow out quarter and the stock goes up $7.00. Ok the stock went up and the option contracts should go up shouldn't they? Well in this case the option contracts went down to $1.50 and Charlie lost money.

Prior to an event like earnings IV can be sky high. Did anyone notice the IV on DNDN before the May 15th FDA announcement? IV was at 250%. We know what happened there so we wont beat a dead horse but as a rule of thumb imagine the option contract's premium going lower than the theoretical price after an event.

There will be no expectations and no one will be wanting to speculate because they already know what happened. We all have heard the phrase "buy the rumor.....sell the news" This goes double for earnings. It is very hard to make money through events. Most gains are already priced into the contracts.

I will pick some stocks to observe through earnings season and we will watch what happens to the premiums. I am hearing some sighs out there. I know the observation is hard but it is the only way to learn about how options behave.

There are some ways to play through events like earnings but first we need to get everyone up to speed on the observations and knowledge of options.

Happy trading everyone

Friday's option observation

2007-06-24T20:35:00.000-07:00

GOOG:

Close: $524.98

July contracts (calls)

Call strike...Theo price.....Actual price......Vega
480...............$47.34..........$49.20................270
500...............$29.08..........$32.30................4441
520...............$14.52.............$18.90................5754

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
480...............$.85.............$2.20................2780
500...............$1.97............$5.60..............4509
520...............$7.32...........$12.10.............5758

September contracts (calls)

Call strike...Theo price.....Actual price......Vega
480...............$58.29..........$59.50................7324
500...............$38.38..........$44.80................9029
520...............$25.28...........$32.40................1.0199

September contracts (puts)

Put strike...Theo price.....Actual price......Vega
480...............$2.82..........$8.50................7418
500...............$6.65........$13.70................9079
520...............$13.27........$17.10................1.0208

RIMM:

Close: $170.65

July contracts (calls)

Call strike...Theo price.....Actual price......Vega
165...............$8.26..........$11.20................1778
175...............$2.93............$6.00..................1903
185...............$.69............$2.80..................1566

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
165...............$1.91.............$4.90................1781
175...............$6.53.............$9.80................1904
185...............$14.25...........$16.70.............1601

September contracts (calls)

Call strike...Theo price.....Actual price......Vega
165...............$12.32..........$16.60................3217
175...............$7.02..........$11.50................3417
185...............$3.60..........$7.60................3284

September contracts (puts)

Put strike...Theo price.....Actual price......Vega
165...............$4.44..........$9.10................3222
175...............$9.01............$13.90................3416
185...............$15.45............$20.00

FCX:
Close: $82.85

contracts (calls)
Call strike...Theo price.....Actual price......Vega
75...............$8.29......$8.70............0581
85...............$1.98........$2.40..................0910
95...............$.20............$.45...................0439

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
75...............$.43..................$.60...................0526
85.............$4.08...............$4.40.................0908
95...........$12.25............$12.40................0413

August contracts (calls)

call strike...Theo price.....Actual price......Vega
75...............$9.22..........$10.00................0984
85...............$3.26............$4.10..................1298
95...............$.77............$1.40..................0941

August contracts (puts)

Put strike...Theo price.....Actual price......Vega
75...............$1.05................$1.70................0969
85...............$5.00................$5.80................1298
95...............$12.43..............$13.00..............0943

Thursday's option observation

2007-06-24T09:31:00.000-07:00

GOOG:
Close: $514.11

July contracts (calls)Call strike...Theo price.....Actual price......Vega
480...............$36.98..........$39.80................3635
500...............$20.18..........$24.80................5284
520...............$9.44.............$14.70................5871

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
480...............$.75.............$3.70................3676
500...............$3.87............$8.60..............5288
520...............$12.07...........$17.40.............5871

September contracts (calls)

Call strike...Theo price.....Actual price......Vega
480...............$44.62..........$51.20................
500...............$29.91..........$37.80................
520...............$18.43...........$26.70................

September contracts (puts)

Put strike...Theo price.....Actual price......Vega
480...............$3.95..........$10.70................
500...............$8.97........$17.30................
520...............$17.22........$26.20................

RIMM:

Close: $170.96

July contracts (calls)

Call strike...Theo price.....Actual price......Vega
165...............$8.76..........$11.30................17.96
175...............$3.35............$6.10..................1942
185...............$.91............$2.90..................1609

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
165...............$2.07.............$4.80................1802
175...............$6.63.............$9.50................1943
185...............$13.06...........$15.50.............1637

September contracts (calls)

Call strike...Theo price.....Actual price......Vega
165...............$12.95..........$16.90................323
175...............$7.64..........$11.70................344
185...............$4.11..........$7.80................3318

September contracts (puts)

Put strike...Theo price.....Actual price......Vega
165...............$4.73..........$9.00................3234
175...............$9.29............$13.80................3439
185...............$15.62............$19.80

FCX:

Cose: $83.30

contracts (calls)

Call strike...Theo price.....Actual price......Vega
75...............$8.75......$8.90............0512
85...............$2.29........$2.50..................0939
95...............$.27............$.45...................0466

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
75...............$.43..................$.60...................0518
85.............$4.30...............$4.40.................0940
95...........$11.86............$12.30................0548

August contracts (calls)
call strike...Theo price.....Actual price......Vega
75...............$9.68..........$10.20................0950
85...............$3.60............$4.20..................1319
95...............$.93............$1.40..................0968

August contracts (puts)
Put strike...Theo price.....Actual price......Vega
75...............$1.05................$1.70................0964
85...............$4.89................$5.70................1319
95...............$12.13..............$12.90..............1029

Wednesdays observation

2007-06-23T16:43:00.000-07:00

GOOG:

Close: $509.97

July contracts (calls)

Call strike...Theo price.....Actual price......Vega
480...............$33.31..........$36.50................4045
500...............$17.42..........$22.30................5564
520...............$6.96.............$11.90................5854

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
480...............$1.15.............$4.50................4085
500...............$5.17............$10.20..............5572
520...............$14.62...........$20.10.............5860

September contracts (calls)
Call strike...Theo price.....Actual price......Vega
480...............$41.36..........$48.00................8444
500...............$27.28..........$35.20................9794
520...............$16.53...........$24.70................1.032

September contracts (puts)
Put strike...Theo price.....Actual price......Vega
480...............$4.77..........$11.90................8498
500...............$10.41........$18.80................9808
520...............$19.38........$28.50................1.032

RIMM:Close: $168.59

July contracts (calls)
Call strike...Theo price.....Actual price......Vega
165...............$7.05..........$9.80................1880
175...............$2.41............$5.00..................19.02
185...............$.57............$2.20..................1470

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
165...............$2.71.............$5.50................1881
175...............$8.02.............$10.80................1906
185...............$16.13...........$18.10.............1517

September contracts (calls)Call strike...Theo price.....Actual price......Vega
165...............$11.17..........$15.10................3227
175...............$6.29..........$10.20................3410
185...............$3.20..........$6.60................3198

September contracts (puts)Put strike...Theo price.....Actual price......Vega
165...............$5.31..........$9.60................3279
175...............$10.28............$14.60................3411
185...............$17.05............$21.00..................3227

FCX:Cose: $81.38

contracts (calls)Call strike...Theo price.....Actual price......Vega
75...............$7.07......$7.30............0648
85...............$1.56........$1.70..................0869
95...............$.15............$.30...................0351

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
75...............$.73..................$.80...................0636
85.............$5.17...............$5.40.................0876
95...........$13.72............$14.00................0418

August contracts (calls)

call strike...Theo price.....Actual price......Vega
75...............$8.11..........$8.60................1045
85...............$3.20............$2.74..................1271
95...............$.63............$1.00..................0821

August contracts (puts)
Put strike...Theo price.....Actual price......Vega
75...............$1.46................$1.90................1045
85...............$6.00................$6.60................1274
95...............$13.81..............$14.50..............0891

Tuesdays option observation

2007-06-23T16:00:00.000-07:00

GOOG:
Close: $514.31

July contracts (calls)

Call strike...Theo price.....Actual price......Vega
480...............$37.58..........$40.80................396
500...............$21.09..........$25.40................5496
520...............$9.44.............$14.70................607

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
480...............$1.01.............$4.10................3909
500...............$4.43............$9.20..............5483
520...............$12.26...........$18.00.............607

September contracts (calls)

Call strike...Theo price.....Actual price......Vega
480...............$45.53..........$51.90................8277
500...............$31.03..........$38.50................9716
520...............$19.63...........$27.90................1.0427

September contracts (puts)

Put strike...Theo price.....Actual price......Vega
480...............$4.53..........$10.80................8277
500...............$9.75........$17.40................9721
520...............$18.07........$26.40................1.0426

RIMM:

Close: $171.64

July contracts (calls)

Call strike...Theo price.....Actual price......Vega
165...............$8.67..........$11.70................1829
175...............$2.87............$6.20..................2021
185...............$.57............$2.90..................1691

July contracts (puts)

Put strike...Theo price.....Actual price......Vega
165...............$1.26.............$4.20................1827
175...............$5.40.............$8.70................2021
185...............$13.06...........$15.50.............1701

September contracts (calls)
Call strike...Theo price.....Actual price......Vega
165...............$12.08..........$17.20................3246
175...............$6.42..........$11.80................3487
185...............$2.95..........$7.60................3374

September contracts (puts)
Put strike...Theo price.....Actual price......Vega
165...............$3.14..........$8.90................3249
175...............$7.34............$12.90................3487
185...............$13.73............$18.90..................3389

FCX:
Cose: $82.86

contracts (calls)
Call strike...Theo price.....Actual price......Vega
75...............$8.47......$8.80............0610
85...............$2.28........$2.40..................0957
95...............$.30............$.50...................0483

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
75...............$.58..................$.65...................0567
85.............$4.33...............$4.40.................0956
95...........$12.31............$12.50................0482

August contracts (calls)

call strike...Theo price.....Actual price......Vega
75...............$9.46..........$9.90................0991
85...............$3.58............$4.10..................1332
95...............$.97............$.1.40..................0981

August contracts (puts)
Put strike...Theo price.....Actual price......Vega
75...............$1.25................$1.70................1258
85...............$5.28................$5.90................1333
95...............$12.58..............$13.20..............1007

Mondays theoretical option observation

2007-06-18T21:13:00.000-07:00

GOOG:
Close: $515.20
July contracts (calls)
Call strike...Theo price.....Actual price......Vega
480...............$38.29..........$42.00................4032
500...............$21.40..........$27.00................556
520...............$9.38.............$15.80................618

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
480...............$.76.............$4.3................3998
500...............$8.61............$9.30..............555
520...............$11.66...........$18.00.............618

September contracts (calls)
Call strike...Theo price.....Actual price......Vega
480...............$45.68..........$52.60................8266
500...............$30.78..........$39.20................9732
520...............$19.08...........$27.90................1.049

September contracts (puts)

Put strike...Theo price.....Actual price......Vega
480...............$3.71..........$10.70................828
500...............$8.53........$17.10................974
520...............$16.55........$26.00................1.049

RIMM:
Close: $176.05

July contracts (calls)

Call strike...Theo price.....Actual price......Vega
165...............$12.50..........$15.20................1946
175...............$5.28............$8.90..................2087
185...............$2.96............$4.60..................1987

July contracts (puts)Put strike...Theo price.....Actual price......Vega
165...............$.65.............$3.30................1698
175...............$3.38.............$6.90................2087
185...............$9.54...........$12.70.............1994

September contracts (calls)
Call strike...Theo price.....Actual price......Vega
165...............$15.65..........$20.50................3159
175...............$5.61..........$14.50................3529
185...............$4.69..........$9.80................3580

September contracts (puts)
Put strike...Theo price.....Actual price......Vega
165...............$2.27..........$7.20................3160
175...............$5.61............$11.20................3536
185...............$11.03............$16.50..................3583

CROX:

Close: $44.53

July contracts (calls)

Call strike...Theo price.....Actual price......Vega
40...............$4.67..............$5.20................0365
45...............$1.24..............$2.10.................0532
50...............$.14................$.70................0395

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
40...............$.15.................$.75................0375
45...............$1.24................$2.10.............0532
50...............$5.56...............$6.20.............0402

September contracts (calls)Put strike...Theo price.....Actual price......Vega
40...............$5.54...............$7.40................0723
45...............$2.44...............$4.70................0899
50...............$.83...............$2.80................0873

September contracts (puts)Put strike...Theo price.....Actual price......Vega
40...............$.65.................$2.60................0777
45...............$2.48...............$4.80................0899
50.............$5.80...............$7.90................0877

FCX:
Cose: $83.52

contracts (calls)

Call strike...Theo price.....Actual price......Vega
75...............$9.12......$9.30............0626
85...............$2.69........$3.1..................1054
95...............$.42............$.70...................0686

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
75...............$.51..................$.65...................0582
85.............$3.73...............$4.10.................0994
95...........$11.00............$11.30................0626

August contracts (calls)

call strike...Theo price.....Actual price......Vega
75...............$10.09..........$10.50................0987
85...............$4.03............$4.70..................1357
95...............$.42............$.70..................1070

August contracts (puts)
Put strike...Theo price.....Actual price......Vega
75...............$1.21................$1.70................0987
85...............$5.06................$5.90................1357
95...............$12.12..............$13.00..............1112

Theoretical pricing observation

2007-06-18T09:14:00.000-07:00

Let's look at some pricing and we will through in Vega for future post on Vega.

GOOG:
Friday close: $505.89
July contracts (calls)
Call strike...Theo price.....Actual price......Vega
480...............$30.26..........$34.10................4791
500...............$15.44..........$20.70................6141
520...............$6.10.............$11.30................6163

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
480...............$1.83.............$5.70................4806
500...............$6.90............$12.40..............6145
520...............$17.46...........$23.00.............6174

September contracts (calls)
Call strike...Theo price.....Actual price......Vega
480...............$39.00..........$43.50................8914
500...............$24.90..........$33.00................1.014
520...............$14.81...........$22.80................1.0504

September contracts (puts)
Put strike...Theo price.....Actual price......Vega
480...............$5.53..........$13.10................8964
500...............$11.74........$20.50................1.015
520...............$21.35........$30.50................1.051

RIMM:

Friday close: $173.75
July contracts (calls)
Call strike...Theo price.....Actual price......Vega
165...............$10.71..........$13.90................1893
175...............$4.26............$8.10..................2175
185...............$1.14............$4.20..................1983

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
165...............$1.09.............$4.30................1894
175...............$4.58.............$8.40................2175
185...............$21.35...........$30.50.............6174

September contracts (calls)
Call strike...Theo price.....Actual price......Vega
165...............$39.00..........$43.50................8914
175...............$24.90..........$33.00................1.014
185...............$14.81..........$22.80................1.0504

September contracts (puts)

Put strike...Theo price.....Actual price......Vega
165...............$14.01..........$19.00................3021
175...............$7.90............$13.30................3578
185...............$3.99............$8.90..................3553

CROX:

Friday close: $45.58
July contracts (calls)
Call strike...Theo price.....Actual price......Vega
40...............$5.88..............$6.50................0365
45...............$1.98..............$3.10.................056
50...............$.32................$1.30................0508

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
40...............$.09.................$.80................0381
45...............$1.16................$2.40.............056
50...............$4.48...............$5.50.............0509

September contracts (calls)
Put strike...Theo price.....Actual price......Vega
40...............$6.63...............$8.50................0765
45...............$3.20...............$5.60................0921
50...............$1.22...............$3.40................0936

September contracts (puts)
Put strike...Theo price.....Actual price......Vega
40...............$.47.................$2.50................0771
45...............$1.96...............$4.50................0920
50...............$4.91...............$7.40................0939

FCX:

Friday close: $84.42
July contracts (calls)
Call strike...Theo price.....Actual price......Vega
75...............$10.02..........$10.40................0626
85...............$3.29............$3.70..................1054
95...............$.61..............$.90....................0686

July contracts (puts)
Put strike...Theo price.....Actual price......Vega
75...............$.51..................$.65...................0568
85...............$3.73...............$4.10.................1054
95...............$11.00............$11.30................0701

August contracts (calls)
Call strike...Theo price.....Actual price......Vega
75...............$10.93..........$11.40................0882
85...............$4.62............$5.10..................1402
95...............$1.46............$1.70..................1108

August contracts (puts)
Put strike...Theo price.....Actual price......Vega
75...............$1.12................$1.60................0882
85...............$4.71................$5.20................1402
95...............$11.46..............$11.80..............1135

I will comment as this is observed.

Happy trading every one.

Implied volatility and theoretical option price

2007-06-18T08:39:00.000-07:00

Most people who are trying to understand implied volatility (IV) are most likely have a vague idea at this point in time. The problem with trying to understand this monumental concept is that either there is a super easy way of understanding IV or a way that is hard for a Mathematics PHD to understand. A person need not understand the complete calculation of the option pricing model but they do need to have an understanding of what various pricing elements mean their investments/trades.

Theoretical prices are derived by pseudo-(Black and Sholes) pricing models. Yes these are contrived and not able to be calculated by someone who is outside of those making the options market. (A person can use a pricing calculator). So why should we care about theoretical pricing? We can't fully understand it.......Or can we?

Yes, we can actually look at the various elements in the pricing model and get a very keen idea of how the option contract is priced. We can know if the option will go down based on being overpriced or maybe it will go up based on being under priced. Before we go any further let's look at the actual trading price of an option with respect to the theoretical price. One will find that an option contract is most of the time higher than the theoretical price.

Hey Ben, so you are telling me that options are overpriced most of the time. This is more and more confusing all the time.

This really is not as hard to understand if a person is willing to observe the options. A person can go through their option trading life reading and taking recommendations on what others say or they can make their own decisions.

You know what........Most people will not take the time to observe.

Not to worry, I will observe and narrate. This will make it easier. We will watch some equities and look at the performance of the contract based on the theoretical pricing and price movement. I will start from last Friday and will look at ATM contracts and 2 strikes OTM and ITM.

Happy trading everyone

Volatility smile

2007-06-16T08:03:00.000-07:00

When we are writing and chatting online, we see ":)" signifying a smile or happiness. Now this is is this smile is vertical not horizontal....I guess the people who invented our writing syntax forgot about the horizontal parenthesis.

Well lucky for us in options the smile is also vertical. We call this the volatility smile.

Ok, Ben your making this up as your going along. No I am not let's take a look at Vega on CME and I will show you a smile :)....I couldn't resist.

CME May contracts.
At money is $540.
Strike.....Vega
510........(.1712)
520........(.2307)
530........(.2976)
540........(.3138)
550........(.2561)
560........(.1573)
510........(.0822)

If you notice that Vega is the greatest at money and as the contract goes itm and otm, Vega decreases. Hence the volatility smile. If we were graphing this, we would make a smile. This tells a person where volatility is the highest and the lowest. It is greatest at money and as the strikes move either direction (itm or otm), the volatility increases.

Volatility shmolitility. So what, Ben.

This is a very important concept to learn in trading options because this will allow a person to construct their option play by selecting an appropriate strike to play.Incidentally, I don't know whether any one noticed but as options go out to further months, the Vega increased.

Now that I bored everyone to tears with Vega we will move to the next part of implied volatility which is the demand part of the equation. Let's recap: Vega is an important indicator of the price of an option. Vega must be observed. It will be different for each stock. Implied volatility increases as an option goes further in the money or out of the money.Remember Vega isn't a car that was a crappy Chevy made in the 70's. Vega is one of your few friends in understanding options. We will do an extensive observation of option vega's in future posts to rationalize relative values as well as how they correspond to option prices.

Option anatomy.....Vega

2007-06-16T07:48:00.000-07:00

Let's look at some Vega's at money for some different stocks:
Stock......May......June.....Sept......Dec
GOOG.......(.2245)..(.5501)..(1.077)...(1.3827)
CROX.......(.0402)..(.0870)..(.1659)...(.2120)
RIMM.......(.0821)..(.1847)..(.3550)...(.4545)
CME........(.3138)..(.6708)..(1.2792)..(1.6363)

Ok, Ben if Vega measure how much a option will move with a 1% change in volatility. I get that, but CROX just had a big move and a stocks like GOOG has been not doing much lately. Now let me tell you what.... CROX on a percentage basis has moved much more than GOOG. So are you saying that GOOG is a more volatile stock?

Ok we have to look at the price of the stock. GOOG is at $466.84 and CROX is at $70.94. So GOOG has a pps that is 6.58 times that of CROX. Remember that Vega is not a percentage base move....It is a dollar amount move. This is an important concept because higher priced stocks will have higher Vega's. So if CROX were a $466.78 stock it would have a ATM vega for May contracts of .2645.

Vega is very important because it will tell how reactive the stock's option is to movement. In our observation which will come a little later, we will determine high Vega's as well as low Vega's on a comparative basis. We will come to understand a stocks option pricing based on it's vega. This is an observation so it will be a little tedious. I have not seen other people using comparative Vega's but I do and it is helpful because Vega tells us a lot of information about an option contract.

Happy trading everyone

Option anatomy...Implied volatility

2007-06-16T07:08:00.000-07:00

If we break down an option, it will have:
1) An underlying stock
2) Be either a put or a call
3) Will have a strike price
4) Will have a expiration time.

This is the basic structure of an option. I think that we all have a basic understanding of these option principles. We however need to understand how a option moves and if it is priced fairly within our option strategy construct. This brings us to the largest mover of option after price of the underling.

Drum role please.........

Implied volatility (IV).....Why all the ahs (This was not meant to be anticlimactic). This is one of the most misunderstood concepts in options. Even some very experienced option players will not have a full grasp on (IV). Let me put it this way.......If a person does not understand implied volatility, they will lose money on their option plays. A person can easily over pay 2 to 3 times (or more) for an option contract.......What I mean by this is that a person can buy an option contract that will lose even with a major move in the stock. Now option prices are just the cost of an option contract and are traded around demand. A person can learn when an option contract is likely to gain implied volatility or lose implied volatility. There are some option contracts that have implied volatility being 75% of the premium.

Ok, let's go read a book on options.

Go out and read a book on options (or many blogs) that is strategy specific. You will find a "do this" if implied volatility is high and "do that" if implied volatility is low. Folks, there is a problem. Yes there is.......The many different option strategies will perform differently depending on where the are in correlation to the stock.........You know what? A strategy that is supposed to be poor when there is high implied volatility will be different when the play is "at money", "in the money", or "out of the money". A person has to be able to use his/her own discretion not a books to understand the best time to play certain positions. Without a knowledge of the principles that govern the play, a person will not have a base understanding of the play.......So the books reco's are not useful and may cause a person to lose money.

I am repeating myself but...................

The most important concept to understand in options is implied volatility so let's build our option foundation with implied volatility as our base.

What is implied volatility?

It is an expectation of a movement in a stock. So we are looking at something that has not yet happened (or may never happen). Implied volatility comes in 2 parts.Theoretical and actual.

Now theoretical implied volatility is measured from the option Greek "Vega" (Vega is actually not a Greek letter).

Vega by definition is how much the price will change with a 1% change in volatility. The volatility that we are looking at is historical or statistical volatility (This just measures how volatile the stock is). Ok so a vega of .1 says that the option contract will change $.10 if the volatility moves up by 1%. Conversely if the volatility goes down by 1% then the price of the option will go down by $.10.

Ok, Ben now you've done it. Messing with my head again. So you want me to go back and do some sort of stochastic analysis and find out what the Vega is. Hey, forget it pal.

We will not have to understand so much the math that governs Vega as we will understand how to look at Vega's and understand what they are telling us. Vega actually will tell a person a lot about a stock so in the next post we will look at some different stocks and look at the Vega's and see what is being portrayed by ole man Vega.

Option anatomy

2007-06-16T06:43:00.000-07:00

This anatomy lesson has nothing to do with Gray. This has a little more to do with Black and Sholes....But not as much as a person might think. In college there is a course called anatomy and physiology.....This is a first course in understanding the structure and function of the human body.

Don't worry.....This won't be a 3 quarter 5 credit course with a lab....Oh no....This will be much easier.

The problem with option's as an investment instrument is that the explanation of an option leaves most people confused. The most definitive text is "McMillan on Options" by Larry McMillan. (Many other texts which are easier reads will not give a person the meat they need to really understand options)...This text will tell a person most everything they need to know.....But have you read it?....It could be compared to the anatomy and physiology text....Actually maybe a fun course for us EE's (Electromagnetics)......Ok ok...I know.....I know I promised this would be easy.

So let's go back to the basic definition of a call and a put option.

A call is the right to buy a stock at a set price (strike price) for a set period of time.

A put is the right to sell a stock at a set price (strike price) for a set period of time./Pretty easy huh......

Well here is where the tricky part:

There are many different strike prices and many different time frames. Also a person can be the holder of the right or the seller of the right.

There are both books and websites that will point out many different strategies....It is in the "Do this if and do that if" vein....But as we said before all contracts are not created equal. The strike, time, implied volatility, demand, and behavior of the stock will dictate how the option contract will behave.....Cookie cutter plays don't seem to ever behave like they are advertised.

Breaking down the option and having a real understanding will give a person a knowledge that most others don't have........Even a better understanding than many experienced traders. The first foray into options anatomy will be our friend implied volatility. A person cannot be successful in options without an understanding of implied volatility (IV). So your wish is my command.....Implied volatility is the next post.

Happy trading everyone

long options trading part 2

2007-06-15T22:22:00.000-07:00

All option contracts are not created equal............There is a huge difference in longer term option contracts and playing options that are in the money (itm). A person who is long this type of option is going to give up some leverage for a better performing less risky contract.

The type of option a new player should trade is at least 3 months out and at money (ATM) or in the money (ITM). These options are going to have high delta's and behave more like the stock. If the stock goes up the option will go up. Using back month options reduces one of the intricacies that make option trading hard........Not only does the option player have to figure out how the stock is going to move but he has to figure out volatility, theta, etc. This is what makes option trading so hard. So that's it long term deep itm options and a person is on the road to profitable option trading...............Isn't that right?

Actually it couldn't be further from the point. A person must observe option contracts to know how they move. To add to this a person must also keep watching option contracts when they become more experienced because options of different stocks will perform differently. That means paper trading.....I will repeat this many times.

I am not even advocating that a person not trade otm short term contracts. This is a very advanced play. Even more advanced than many spread plays. These contracts will be very dependant on both time and implied volatility......Don't make the mistake of thinking that they aren't.

Understanding options doesn't have to be that tough. The corner stone in basic option play is to have a grounding in the theory that controls the price of an option and some observational experience......You wont have to go to page 631 in the tome (Mcmillan on options) to understand basic options, but I would recommend that anyone who is serious about trading options read either "Mcmillan on options" or "Options as a Strategic investment (Both by Lawerence Mcmillan).

Options can be fun a profitable. But first a person has to understand what type of investment they are getting into before they play. People also have to understand that one stock may have a hundred or more different options available. Because of the variety of the contracts, there are many different option plays available to a person. This will be a very comprehensive blog on options. Here are several free sites by the people who make the options market. (They are very good sites and are a very good starting point for future option traders):

http://www.888options.com/
http://www.cboe.com/

Happy trading everyone

trading long options?

2007-06-15T22:00:00.000-07:00

So.....Why are you long in the mouth?So you have traded stocks with success and you want to make a lot of money trading options. Your favorite stock is about to announce earnings and boy it will go to the moon.Man, look at the money a person could make.....5x, 20x 50x. You plunk down $10k and you watch the earnings.....Hey the earnings are fantastic!!!!! Whoop whoop, I'm gonna buy me that Mercedes S65.....Yea you know the AMG baby!!!!!

Ok, you wake up in the morning and take a look and your stock which goes from $65.00 to $70.00 and your option play goes from $10k to $3.5K. You say to yourself something is going wrong here so I better call my broker. You talk to your broker and he says that is right your account is correct at $3.5k. You get off the phone and say, $%&?@#$@#^ options....I am never going to play options again.....This happens until the next earnings come around and you say "oooo look how much money I could make....Why with this play I could be a millionare"

Does this sound familiar? This happens often. Some people will spend much more money on these plays. The illusion is there from some plays that create such leverage that it tickles our imagination. If one were to play nickle options on DNDN 2 months ago, they could have had a call go from $.05 to over $10.00. That is a 200 bagger!!!! The same $10k investment would have produced a cool clean $2,000,000.00. Not too bad for a couple of days work.

Many people who play options have had a 5x or 10x payday.........That is a pretty gain. The problem is not being able to have gains but to preserve capital. Sequential plays in options can wipe out an account. If a person is looking for large gains, they are typically going to make trades back to back. You know what folks, most long option plays for large gains are low probability plays, and when these bets fail most of the money is lost. In fact many option contracts are held until they go to zero. People who trade conservatively lose their capital through attrition..............bad play after bad play in a row will eventially take care of an account.

Now, I know that many people who are starting in option play will play straight long option positions (buying options). They are cheap (much cheaper than stock). So you might be asking what gives? This is about trading options isn't it.

Well................................................

All options are not created equal.A person who is new to options should understand that buying long option positions can be more risky than any other equity trade. It is sometimes said, "that because an option player has only a fixed amount to lose, the option play is actually a less risky trade than playing a stock".....This just is not so. If this option player is taking every thing he has and plopping it down in one trade, the whole investment can be lost on one trade.

This will be continued in part 2.

Happy trading everyone

Option greeks

2007-06-11T22:19:00.000-07:00

Have you ever bought a call and had the stock go up and the call go down in price? Have you ever held on to an option and had it slowly creep to nothing? Most option players have. The problem is the basic option play seems simple but what happens through time with the contract is hard to understand. Not only do you need to know about the underlying stock of an option, but you also need to know about options by themselves. To understanding calls and puts, one must first understand the pricing factors that govern the movement of its premium.

Our modern understanding of options is described by Black Sholes. Since then many theses and studies have been used to describe pricing behavior. Black Sholes is an equation for option pricing. This model was solved by Fisher Black, Robert Merton, and Myron Sholes in the 1970's. The equation they solved was a risk equation from the late 1800's for insurance. It is a partial differential equation with no equation based solutions. Fisher Black, Robert Merton, and Myron Sholes solved this equation with statistical calculus.....The solution was for European style options and was considered to have some flaws.......However it is considered to be reasonably accurate model for implied volatility of American style options. Following are the Greeks that give us the basis for the pricing of options.

Option Theta
Theta shows how much the value of an option is contracting with time. This is used in time value calculations. Theta by definition is how much the option contract will decrease per day. If an option has a value of $4.50 and a Theta of -.3, then the value of the option with everything else held constant would be $4.20 the next day./Many people don't realize that as time gets really close to expiration the value of the option falls very fast. Theta is not a fixed number. It is dynamic and will change with other factors like implied volatility (IV). Another anomaly in options is that a contract that is far out of the money may go to zero well ahead of options expiration.

Option Delta
Delta shows how much an option contract will move with a given movement in the underlying stock. Call contracts have Deltas that are between 0 and 1. Put contracts have Deltas that are between 0 and -1. If a call option moves up $.30 when the underlying stock moves $1.00 then the call contract would have a Delta of .3. If a put contract moves up $.30 when the stock moves down $1.00, then the put contract would have a Delta of -.3.

Here is how Delta works theoretically (please underline theoretically). If you hold a call contract priced at $5.00 and it has a Delta of .3 and the stock moves up $10.00 the call contract would have a value of $5.00 + .3($10)=$8.00. Now if you hold the same contract and the stock falls $10.00, the call contract would have a value of $5.00 +.3(-$10)=$2.00. The converse is true with a put contract. If a put contract priced at $5.00 has a Delta of -.3 and the stock drops $10, the put would have a value of $5.00 +(-.3)(-$10)=$8.00. Now your getting the idea......It is pretty basic isn't it?

Well, the contracts that we described almost never act this way......In fact you may be holding a call contract that has a Delta of .1 and the stock moves up and the call contract actually drops in price. To make matters even more confusing, the Delta changes incrementally with every movement of the stock. Also other pricing factors like changing implied volatility can contribute to the price anomalies.

Gamma
Gamma describes how the Delta will change with every incremental $1.00 change in the underlying stock. This is an instantaneous point (the derivative of delta). Gamma is the smallest when an option is in the money or far out of the money and is the greatest when an option is near or at money.

We now have all the tools and we can put together perfect option pricing models right?

No......We have put together a set of tools that we can use to figure out high probability plays. Understanding these principles is like taking math in school. Many people wondered why they had to take the classes. Our understanding of math helped us to later understand many other subjects. The aforementioned Greeks are only good for understanding theoretical price movements instead of exact concise movements. Black-Sholes is an imperfect model in itself but it is useful in understanding options.

I also left out the most important concept in options understanding and that is the Vega (Which isn't a Greek letter) and our friend implied volatility. Knowing implied volatility is one of the keys to understanding implied volatility. Please note that these terms described give a theoretical price of an option.

Learning option definitions

2007-05-26T08:57:00.000-07:00

I am starting out my inaugural post with some option definitions. This blog is going to be dedicated to the description of options, how they behave, and strategies. There will be no trading in this blog and I will write another blog that will have a imaginary portfolio that will have option plays that everyone can observe. None of these plays will represent plays that I actually make. I hope that this is a good format to learn.

Here are some basic definitions (repost): Following are some basic option terms. The terminology will help you to understand when you read through literature or read discussions on options.

Contract: A contract is an option on a 100 shares of stock. You can only trade in multiples of 100. Even though options trade in contracts, they are shown and discussed as though they trade on 1 share. i.e.: If an option is shown on a table for $2.30, our minimum trade would be $2.30 x 100= $230.00.

Call: The holder of a call contract has the right to buy the underlying stock for a set price (Strike price) for a set period of time.

Put: The holder of a put contract has the right to sell the underlying stock for a set price (Strike price) for a set period of time.

Write: A person (writer) that writes a call or a put is selling the right to someone else to buy or sell an underlying stock from or to him. The writer is the originator of an option contract.

Expiration: This is when the option contract no longer exists. There are many option contracts that will be available for any one stock. Expirations may exist 1 month out 2 months out and up to a few years out. All expirations are the third Friday in each month (Saturday for professionals). So if we hold an April contract, it will expire in the third week of April.

LEAP: A leap is an option with at least 9 months until expiration.

Intrinsic value: Intrinsic value is the value of the option if we exercised it. If we hold a call that has a strike price of $40.00 and the stock is at $45.00, we would have the right to buy the stock for $40.00. We would be able to buy the stock for $5.00 less than it is worth. The intrinsic value would therefore be $5.00. The converse would be true for a put. If we held a put contract with a strike price of $40.00 and the stock was at $35.00 we would be able to sell the stock for $5.00 more than it is worth.....So this put contract would have an intrinsic value of $5.00.

Time value: The more time the option has until expiration the more expensive the option contract would be. This is one of the factors that determine an option premium. If an option had 9 months until it expired, it would be more expensive than an option that had 1 month to expire. Even if an option contract has no intrinsic value, it will have a value associated with how long it is until the contract expires.

Implied volatility: Implied volatility (IV) is price premium for an option with an expectation that the stock will move in the future. The higher the expectation the higher the IV will be. An option contract will be more expensive the more it is expected to move. This is one of the most important concepts to understand in option trading. I will devote a lot of time to this concept in future posts. If a person doesn't understand this, it is hard for them to trade options.

Delta: An option Delta is how much the option moves when the underlying stock moves. If an option moves $.10 when the underlying moves $1.00 it would have a delta of $.1 The delta can also be negative depending on the contract but we will get into that later. The delta is also dynamic and changes with time.

In the money (itm): An option that is in the money is an option whose strike price is lower than the stock for a call and higher than a stock for a put. With our previous example, the call has a strike price of $40.00 and the stock is at $45.00 so the call would be said to be $5.00 in the money (if the stock where at $50.00, the call would be $10.00 in the money). Likewise, the put has a strike price of $40.00 and the stock was at $35.00 so the put is $5.00 in the money (if the stock where at $30.00 the put would be $10.00 in the money).

Out of the money (OTM): This is how far the option contract is from going in the money. If a call has a strike price of $35.00 and the stock is at $40.00, the call would be said to be $5.00 out of the money. If the put had a strike price of $45.00 and the stock was at $40.00, the put contract would be said to be $5.00 out of the money.

At the money (ATM): If the stock and the strike price of the option are at the same point, it is at the money (at money).

OCC: OCC is the Options Clearing Corporation. When we trade options, the OCC keeps the market liquid so we can buy and sell options like stocks.

Exercise: If we are a holder of an option and we exercise this option, we are using our right as the option holder to either buy or sell the stock. If we have a call option at a strike of $40.00 and we exercise this option, we are making someone sell us the stock for $40.00. If we are a holder of a put contract at a strike price of $40.00 and we exercise this option, we are making someone buy the stock from us at $40.00. We never directly do this with an individual....The OCC does this for us.

Assignment (assigned): If we are the writer of the contract and someone exercises the contract that we sold, they will be making us either sell or buy the stock depending on if the contract is a call or a put. If we wrote a call contract for $40.00 and we are assigned we would have to sell someone the stock for $40.00. If we wrote a put contract with a strike price of $40.00 and we were assigned, we would have to buy from someone the stock for $40.00. As in exercising, assignment would come from the OCC not the individual.