Trading Options Developing a Plan

7/30/2019 Trading Options Developing a Plan

1/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Table of Contents

1. Calls

2. Covered Calls

3. Naked Puts

4. Calculating the yield

5. Puts

6. Selling Naked Calls

7. Credit Spreads

8. Debit Spreads

9. Long Strangles

10. Short Strangles

11. Long Iron Butterfly

Copyright 2000

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/co

5/13/2013


2/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Buying Calls

Success in call buying primarily depends on your ability to

select stocks that will go up in price and to time your selection

fairly well. Most investment strategies are designed to remove

some of the risk and exactness in stock picking, thus allowing

you to have some room for error and still make a profit. But

that doesn't exist with pure play call buying.

Your total investment could be lost in an option play, even if thestock goes up. It has to go up enough and quickly enough to be

profitable. For this reason, one should only use risk money

when buying calls. The potential rewards in buying calls are so

attractive to many investors and speculators that it is the most

used options strategy by the investing public.

The attraction of call buying is the leverage it gives a

speculator. One could potentially realize large percentage

profits from only a modest rise in price by the underlying stock.

And even though they may be large percentage gains, the riskscannot exceed the fixed amount paid for the option originally.

Calls have to be paid in full and cannot be bought on margin.

Nor do they have any margin value nor contribute any equity to

your margin account.

Illustration of how a call purchase might work:

Assume that ABC stock is selling at 48 and the 6-month call,

the July 50, is selling for 3. With an investment of $300, the

call buyer may participate, for 6 months, in a move upward in

the price of the stock. If ABC should rise in price by 10 points

(just over 20%), the July 50 call will be worth at least $800and the call buyer would have a 167% profit on a move in the

stock of just over 20%. This is the leverage that attracts

speculators to calls. At expiration, if ABC is below 50, the

buyer's loss is total, but is limited to his initial investment of

$300, even if the stock declines substantially. Although this risk

is equal to 100% of his investment, the dollar amount is still

small. You should never risk more than 15-20% of your risk

capital in call buying because of the high percentage risks

involved.

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/calls_tu

5/13/2013


3/32

Some investors invest in call options on a very limited basis to

add some upside potential to their portfolio. While investing in

conservative stocks, and covered calls, they invest a small

portion in buying calls on more volatile stocks. The investor will

have a limited dollar risk by owning the option instead of the

stock.

It is very important to understand that the buyer of calls will

only make money if the price of the underlying stock goes up.

Risk/Reward

The cold, hard fact for the call buyer to recognize is that you

will only make money if the stock rises in price. All the analysis

in the world trying to decide which option to buy will not

produce profits if the stock declines. However, this fact shouldn't

dissuade you from making reasonable analyses in your call

buying selections. Further, many times a speculator will pick theright stock, but the wrong option. The stock will go up, but not

enough to be in-the-money, or not soon enough (prior to the

expiration of the option).

Since the only ally the call buyer has is upward movement in

the underlying stock, the selection of the underlying stock is

the most important choice you have to make. Since timing is so

important too, technical analysis and current news, are more

reliable indicators than fundamentals. You must be bullish on

the stock to consider purchasing calls. Only after the stock has

been selected can you begin to consider other important

factors, such as strike price and expiration months.

The purchase of an out-of-the-money call has both greater

potential gains and risk than does an in-the-money call. Many

call buyers will only buy out-of-the-money calls simply becausethey are cheaper. But the dollar amount should never be the

deciding factor for which option to buy. If your funds are so low

that you can only afford to buy out of the money calls, then you

should not be investing in calls. The risks are too great. If a

stock advances substantially, the out of the money calls will

provide the best returns, but if it only advances moderately,

then the in the money will perform better.

Example: Assume ABC stock is at 60, the December 55 calls areat 5 and the Dec 65 calls are 2. If the stock moves up to 63

relatively slowly, the Dec 65 (out of the money) calls may

actually experience a loss, even if the call has not yet expired.

But the Dec 55 (in the money) calls will definitely have a profit

because the call will sell for at least 8 points since that's its

intrinsic value. So percentage-wise, an in the money call will

have a better return if the stock moves modestly, while an out

of the money call will have a better return if the stock moves

up a great deal.


5/13/2013


4/32

An in the money call clearly has less risk.

Timing is also a critical element. If you're relatively certain thestock will move up in the near future, then a short-term option

offers the best deal. You won't be paying as much in

time-premium. But if you're uncertain about the timing, then a

farther out option is the better strategy.

Strategies Long Call

Component Buy call

Potential profitWhen the stock price is above thebreak-even point

Unlimited, equals to the prevailingstock price minus break-evenpoint

Maximum loss Total premium paid

Time value

impactNegative

Break-even Strike price plus premium paid

Example:

Component Buy ABC June $200 Call

Net Premium Pay $20

Break-even $200+$20=$220

Profit when Stock price is above $220

Potential Prof it Stock price - $220Potential Loss $20

Time Value Impact Negative

Copyright 2000


5/13/2013


5/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Covered Calls

The primary objective of the covered call writer is increased

income through stock ownership. Coupled with that is the desire

to minimize inherent risks of the market.

There are various strategies for covered call writers. Some

strategies could satisfy the most conservative investor whileothers would challenge the most aggressive. We offer this

tutorial to teach some of the strategies that are relativelyunknown by the vast number of covered call writers. We do not

contend that this is an all-inclusive authority on the subject, but a

brief tutorial only.

All covered calls involve selling an option on a stock that you

currently own. But there are two broad terms that "categorize"

your position: In-The-Money and Out-Of-The-Money. If you own a

stock that is trading at 19 and sell the 20 call, then the option is

deemed "out of the money". There is no intrinsic value in the

option. The only value it has is time value. If you sold a 15 callon the 19 stock that you own, then the option is said to be "in the

money". It is in the money by 4 dollars. The option of course

would be worth more than 4, depending on the amount of time

left before expiration.

Typically, writing a covered call by selling an out-of-the-money

option offers the highest returns, while writing a covered call with

in-the-money strikes offer the highest degree of safety. The

deeper in the money the safer. There are also combination

strategies to maintain a high degree of safety, and obtain higher

yields as well.

Out of the Money

Example: ABC stock is selling for 22 1/2 and the January 25 call

is selling for 1. If you were to buy the stock for 22 1/2 then sell

the $25 option you would receive the premium for the option and

have the potential capital appreciation in the stock, up to the

strike price of 25. So you could earn 3 1/2 points on this trade. If

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/cc_tu

5/13/2013


6/32

you purchased one round lot (100 shares) and sold one contract

your return would be $350. Now if you maximized your leverage

and purchased the stock using 50% margin, you would purchase

the stock for $1125. So the gain of $350 on an $1125 investment

equals 31.1% return. That is assuming the stock price rises to at

least 25 and you're called out. Any gain above the strike price

doesn't benefit you, but the holder of the option.

If the stock price remains flat until expiration and you aren't

called out, you still earn the option premium of one dollar. So a

$100 return on an $1125 investment equals 8.8%, even if the

stock price doesn't move. At the expiration you can then sell

another option or sell the stock and look for another one.

But wait! What if the stock price falls? That's always the risk, isn't

it? But even then, the price could drop to 21 1/2 and you'd still

break even. You gained the $1 premium for the option. It is this

principle that makes covered calls safer than most investments.

But what if the stock price falls below the break-even point,

you're doomed right? Not necessarily. There are some protectiveactions you can take. The simplest thing to do is close out the

position. This should be your action if you think the price will

continue to decline. Bite the bullet, pull the trigger, move on.

Another action you could take is roll down. When the underlying

stock drops in price, buy back the original call -- it will certainly

be less than you sold it for since the underlying stock has

declined -- then sell a call with a lower strike price. This could

give you some more downside protection and might turn the deal

into a profit.

Example: If you bought ABC stock for 25 1/2 and sold the May 25

call at 3, you would have maximum profit potential at expirationof 2 1/2 points. Your downside protection is 3 points, down to a

price of 22 1/2. If the stock price drops to 22 1/2 the May 25 call

might be selling for 1/2, and the May 22 1/2 call might be around

2. At this point, you'd be 2 1/2 points below the strike price and

have a 1/2 point unrealized loss. If the stock should continue to

fall from this level, you could have a greater loss at expiration.

What to do? Here's one salvage technique. You could buy back the

original call for 1/2 (you sold it for 3, remember), then sell the 22

1/2 call for 2. Now your downside breakeven point is 21 since you

rolled down.

Further if the stock remained unchanged (exactly at 22 1/2) untilexpiration you would make an additional $150. If you had not

rolled down, and ABC remained at 22 1/2, the most you could

have made would be the remaining 1/2 from the May 25 call. So

rolling down gives you a little more downside protection and

might produce additional income if the stock price firms.

The only time it doesn't pay to roll down is when the stock

reverses and begins to climb. There just is no way around the

equation: lower risk = lower potential return, higher risk =

higher potential return.


5/13/2013


7/32


8/32

can fall 2 1/2 points and the trade still work out as planned. You

will be called away and you've earned the premium. If the stock is

at-the-money and you're not called out, then you can sell the

stock or do another covered write.

Your breakeven point is 18 1/2 which means the stock would have

to fall nearly 20% for this to turn into a losing trade. The

downside to in-the-money covered calls is that you don't benefit

from any upside potential of the stock. But in a flat market, or

even a bearish market, there is great comfort in those

in-the-money covered calls. Great comfort. Many investors

reconcile themselves that they are after 8-15% per month and

want safety first. They never concern themselves with the rising

price of a stock. They simply want to get called out of their

position and look for another trade that will earn them another

8-10% in a month or so, and they consistently have yields of

100% per year.

StrategiesCovered Call WritingLong Stock + Short Call

Component Buy stock and sell at-the-money call

Potential Prof itWhen stock price is abovebreak-even point

Limited to premium received

Maximum LossWhen stock price is belowbreak-even point

Substantial, equals to break-evenpoint minus stock price

Time Value Impact Positive

Break-even Strike price minus premium received

The combined position is a synthetic shortput. Compared with holding stock only, loss

would be reduced by the amount of

premium received when the stock price

drops. But profit is limited to premium

received.


5/13/2013


9/32

Example:

ComponentBuy ABC stock at $200 and sell ABC Jan$200 Call, receive $15

Net Premium Receive $15

Break-even $200-$15=$185


Potential Prof it $15

Potential Loss $185 - stock price

Time Value

ImpactPositive

Copyright 2000


5/13/2013


10/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Naked Puts

Selling puts is a bullish or neutral strategy where profits are

earned by receiving premium for the put option. It's frequently

used instead of a covered call.

Not everyone can sell naked puts. First your broker is going to

want to know if you have any experience with options, and he's

going to require a certain amount of cash or equities in youraccount, and that amount can vary from broker to broker.

This review is not intended as an in depth study on the subject,

but as a brief review. If you have an interest in selling naked

puts, I suggest you first begin by studying the subject. Don't

just dive in. There are many good books available on the

subject.

Let's work through an example. On Sep 18th Compaq

Computer closed at 30 5/8. The Oct 35 Put closed at 4 5/8. Ifyou're bullish on this stock you could do several things. But

we'll discuss a bullish position by selling puts. If you thought

the stock would reach or go beyond 35, you'd sell the Oct 35Put.

Once your brokerage account is set up and funded, you would

call your broker (or do it online), place an order to sell the Oct

35 Put. This is a "Sell to Open" order. You are selling something

to open a position. If you sold 10 contracts, $4,625.00 would

be deposited into your account the next day. This will show up

as a short position on your statement from your broker.

Now, if the stock has risen above the 35 strike price on

expiration day, the option expires worthless and the entire

$4625 is yours to keep (less commissions of course.) But you

don't have to wait until expiration date to do something with it.

If you sold options at 4 5/8 and the stock price jumped very

quickly such that the option price has now fallen to 1 or 1 1/2,

you can buy them back and close out the position. Your profit is

the difference in what you sold them for and what you had to

pay to buy them back to close the position. Frequently, options

are sold many times prior to expiration date.

What happens if the price of the stock drops after the position

is opened? First, if you're the seller of the puts, and you

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/naked_puts_tu

5/13/2013


11/32

haven't closed out the position on expiration day, the stock can

be put to you. That means you have to buy the stock at the

strike price. If you sold the Oct 35 Put and the price of the

stock fell to 29, you'd have to buy the stock for 35. Of course,

the cost of the stock would be offset with the premium you

received in the first place.

You could choose to buy the put back just before expiration so

that the stock would not be put to you. The Put price would be6, and maybe a little change, since the put is 6 dollars in the

money, right at expiration. You sold the puts for 4 5/8, had to

buy them back for 6, so you have a loss of 1 3/8, right? Well

that's right if you leave it there, but a salvage technique is to

buy the put back for six, then immediately sell the next month

put at the same strike price. You'd sell the November 30 put for

6 dollars (the intrinsic value) plus you'd get additional premium

for the time-value. So the put might sell for 8 dollars. Now

you've got another month for the stock price to rise. If it rises

above 35, at expiration the option would expire worthless and

the premium is completely yours to keep. This cycle could go

on many times.

Selling puts can be very profitable, but like all option trading

there is risk. It is possible to sell a put, and the stock price fall

to zero. Your liability would be the entire strike price. Now let's

be real, how many stocks really fall to zero? Not many, but it

can happen. So when choosing the stocks on which to sell puts,

use the same care that you would if you were buying call

options.

Strategies Short Put

Component Sell put

Potential profitWhen the stock price is abovethe break-even point

Limited to the premium received

Maximum lossSubstantial, equals to break-even

point minus stock price

Time value

impactPositive

Break-even Strike price minus premium received

Example:


5/13/2013


12/32

Component Sell ABC Feb $200 Put


Break-even $200-$20=$180


Potential Profit $20Potential Loss $180 - stock price

Time Value

ImpactPositive

Copyright 2000


5/13/2013


13/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Calculating the Yield

Unlike many investments where the yields are simple and

concrete, yields from Naked Puts can be more difficult to figure,

and will vary from broker to broker, depending on his margin

requirements. The yields listed in our Naked Puts section are

calculated on a 30%+ margin requirement. Many brokers'

margin requirements are less than that, so your yields could be

even greater that listed.

Ameritrade is one of the large online brokers and in their

MARGIN ACCOUNT HANDBOOK margin requirements are

spelled out as follows:

"The writing of uncovered puts and calls requires an initial

deposit and maintenance of 100% of the current market value

of the contract plus 30% of the underlying stock value less the

out-of-the-money amount, if any, to a minimum of the option

market value plus 10% of the underlying stock value."

This rather complicated formula really isnt that difficult to

understand. Basically, your broker will require 30% of the stockprice plus the cost of the option to sell a put that is at the

money. If the option is out of the money, then theyll give you

credit for the out of the money portion. Armed with that info

we can calculate what the yield would be if we were to sell

various options.

Example: Lets say that ABC stock is selling at 42. Its the

end of July and the August 40 Put is selling for 1 7/8. If we

wanted to sell the Aug 40 Put, our broker would require on

deposit the following funds: 30% of the stock price (which

equals $12.60) plus the cost of the option ($1.88), minus the

out of the money amount ($2.00) -- 12.60 + 1.88 2.00 =12.48 Since one option is for 100 shares of the underlying

stock, then 12.48 * 100 = $1,248. Your broker will require

$1,248 cash or equities in your account to sell 1 Jan 40 Put

option. The premium youd receive is 1 7/8 * 100 = $188. To

figure your yield divide $188 by $1248, and you get 15%. So

as long as the stock price remains above 40, youd keep the

entire premium and earn 15% in one month. This is a very

lucrative from of trading. When you compare it to buying

options, it can be safer as well. The stock would have to drop

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/put_

5/13/2013


14/32

below 40 for your yield to be less than 15%, and could drop all

the way to 38 1/8 and youd still break even (commissions not

included).

Copyright 2000

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/put_

5/13/2013


15/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Buying Puts

Success in put buying primarily depends on your ability to

select stocks that will go down in price and to time your

selection fairly well. Most investment strategies are designed to

remove some of the risk and exactness in stock picking, thus

allowing you to have some room for error and still make a

profit. But that doesn't exist with pure play put buying.

Your total investment could be lost in an option play. It has togo down enough and quickly enough to be profitable. For this

reason, one should only use risk money when buying puts. The

potential rewards in buying puts are very attractive.

Illustration of how a put purchase might work:

Assume that ABC stock is selling at 52 and the 6-month put,

the July 50, is selling for 3. With an investment of $300, the

put buyer may participate, for 6 months, in a move downward

in the price of the stock. If ABC should drop in price by 10points (just over 20%), the July 50 put will be worth at least

$800 and the put buyer would have a 167% profit on a move in

the stock of just over 20%. This is the leverage that attracts

speculators to options. At expiration, if ABC is above 50, the

buyer's loss is total, but is limited to his initial investment of

$300, even if the stock rises substantially. Although this risk is

equal to 100% of his investment, the dollar amount is still

small. You should never risk more than 15-20% of your risk

capital in call puts because of the high percentage risks

involved.

It is very important to understand that the buyer of puts willonly make money if the price of the underlying stock goes

down.

Strategies Long Put

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/puts_tu

5/13/2013


16/32

Component Buy put

Potential p rofitWhen the stock price is below thebreak-even point

Limited to break-even pointminus stock price


Time value

impactNegative

Break-even Strike price minus premium paid

Component Buy ABC Mar $200 Put

Net Premium Pay $20

Break-even $200-$20=$180

Profit when Stock price is below $180

Potential Prof it $180 - stock price

Potential Loss $20

Time Value

ImpactNegative

Copyright 2000

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/puts_tu

5/13/2013


17/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Selling Calls

Selling calls is a bearish or neutral strategy where profits are

earned by receiving premium for the call option.

Not everyone can sell naked calls, nor should they. The risk

potential is unlimited. Your broker is going to want to know if

you have any experience with options, and he's going to

require a certain amount of cash or equities in your account,and that amount can vary from broker to broker.

Let's work through an example. Suppose XYZ stock is at 40.

The Oct 40 call is at 3 1/2. If you're bearish on this stock you

could do several things, but let's assume that you are an

experienced trader and understand the risk involved and prefer

to sell premium, that is, sell a call option for a given amount of

money in hopes that the option will expire worthless and you

get to keep the money you took in.

Once your brokerage account is set up and funded, you would

call your broker (or do it online), place an order to sell the Oct

40 Call. This is a "Sell to Open" order. You are sellingsomething to open a position. If you sold 10 contracts,

$3,500.00 would be deposited into your account the next day.

This will show up as a short position on your statement from

your broker.

Now, if the stock falls below the 40 strike price on expiration

day, the option expires worthless and the entire $3500 is yours

to keep (less commissions of course.) But you don't have to

wait until expiration date to do something with it. If you sold

options at 3 1/2 and the stock price fell quickly, the option

price would fall quickly too. You could buy it back and close out

the position for a quick profit. Your profit is the difference inwhat you sold them for and what you had to pay to buy them

back to close the position. Frequently, options are sold many

times prior to expiration date.

What happens if the price of the stock goes up after the

position is opened? First, if you're the seller of the calls, and

you haven't closed out the position on expiration day, the stock

can be called from you. That means you have to buy the stock

at the current market price and sell it for the strike price. This

is where the unlimited risk comes in. If you sold the Oct 40 Call

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/naked_calls_tu

5/13/2013


18/32

and the price of the stock went up to 45, you'd have to buy the

stock for 45 and it would called from you at 40, causing you a

loss of 5 points. Of course, the cost of the stock would be offset

with the premium you received in the first place, so you loss

would actually be 1 1/2 points.

You could choose to buy the call back just before expiration so

that the stock would not be called from you. The Call price

would be 5, and maybe a little change, since the call is 5dollars in the money, right at expiration. You sold the calls for 3

1/2, had to buy them back for 5, so you have a loss of 1 1/2.

Selling calls can be very profitable, but it is very risky. Only the

well capitalized and experienced traders should participate in

these types of trades.

Strategies Short Call

Component Sell call

Potential prof itWhen the stock price is belowthe break-even point

Limited to the premiumreceived

Maximum lossUnlimited, equals to stock priceminus break-even point

Time valueimpact

Positive

Break-even Strike price plus premium received

Component Sell ABC Sep $200 Call


Break-even $200+$25=$225



Potential Loss Stock price - $225

Time Value Impact Positive

Copyright 2000

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/naked_calls_tu

5/13/2013


19/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Credit Spreads

(Bull Put Spreads, Bear Call Spreads)

A credit spread is one in which you sell an option and buy a lower priceoption, thus generating a net credit to your account. Credit spreads canbe bearish or bullish.

If you're bullish one strategy might be to sell a bull put spread. Assumethe stock is at 62. If you think the stock will go higher, you could sell the60 put, say for 4 and buy the 55 put maybe for 2 1/2. So you'd take in$400 for sell the 60 strike and you'd have to pay $250 for the 55. Yournet credit would be $150, or 1 1/2 points.

Your margin requirement is $500. That's the difference in the strike prices.That's the absolute most that you can lose on the trade. If your brokerrequires more than $500 to execute a 5-point spread, fire him! Your totalrisk would be $500. No one should require more than that. Further, if youraccount is set up to buy options at all, you should be able to openspreads without filling out any other forms or anything else. So you canparticipate in selling of puts without selling naked puts.

Now, what can happen in this trade? First, if the stock goes higher or atleast remains above 60 on expiration date, then both puts will expireworthless and the $150 credit you received is yours to keep. There'snothing to do, no need to call your broker or anything else. They'll justexpire and the money stays in your account.

How much would you have made? You would have made $150 on a $500investment. What?!!! Yep, your broker requires $500 in your account tocollect $150. Do the math --- $150 divided by $500 = 30%. Thirtypercent for about a month's trade. Do you see how selling puts andspreads can be lucrative? Many traders prefer selling puts to writingcovered calls. I do both.

Now I have left out one thing... the commissions. And yes, you will becharged 2 commissions. One for selling the put, and one for buying theother put. So you do have to consider commissions in here. If you weretrading just one option, then the commissions might cut in to your profitsso much that it's not worth it. But if you were selling 10 then you can seehow it gets better. You'd collect $1500 on a $5000 cash requirement inyour account. Now commissions don't take such a bite.

Now the down side... Let's say the stock tumbles.... going down, dropsbelow 60, keeps dropping, goes to 50, keeps going, drops all the way to

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/credit_spread_tu

5/13/2013


20/32

zero. What happens? You close out the trade. The 60 Put that you sold isbiting you in the butt, but the 55 is your salvation. Whatever you have topay to buy back the 60, is offset by the 55 Put, less the 5 point spread.So your total loss can only be 5 points, even if the stock goes to zero.

If this is all new to you, then paper trade some spreads and get the feelfor it. If you trade online, the first time you execute a spread, call yourbroker on the phone and get him to open the trades for you. You want to

make sure that you open and close both sides of the trade at the sametime. Otherwise, you could get caught "naked".

Strategies Bull Put Spread

Component Buy lower strike price put, sell higherstrike price put of the same month

Potential profit

When the stock price is above thebreak-even point

Limited to the net premiumreceived

Maximum loss Limited to the difference between thetwo strike prices minus the netpremium received

Time value impact Neutral

Break-even Higher strike price minus net premium

received

As different from a Bull Call Spread

which would result in net premium paid, a

Bull Put Spread would result in net

premium received, as the premium for the

lower strike price put is lower than that

of the higher strike price put.

Example:

ComponentBuy ABC May $180 Put, pay $10, andsell ABC May $210 Put, receive $30

Net Premium Receive $30-$10=$20

Break-even $210-$20=$190




5/13/2013


21/32

Potential Loss ($210-$180)-$20=$10

Time Value

ImpactNeutral

Bear Call Spread:

StrategiesBear Call Spread

ComponentSell lower strike price call, buy higherstrike price call of the same month

Potential profitWhen the stock price is below

the break-even point

Limited to the net premiumreceived

Maximum lossThe difference between the two strikeprices minus the net premium received

Time value impactNeutral

Break-even

Lower strike price plus net premiumreceived

As different from a Bear Put Spread

which would result in net premium paid,

a Bear Call Spread results in net

premium received, as the premium for

the lower strike price call is higher than

that of the higher strike price call.

Example:

ComponentSell ABC Jan $190 Call, receive $30,and buy ABC Jan $220 Call, pay $10

Net Premium Receive $30-$10=$20

Break-even $190+$20=$210


Potential Profit $20


5/13/2013


22/32

Potential Loss ($220-$190)-$20=$10

Time Value

ImpactNeutral

Copyright 2000


5/13/2013


23/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Debit Spreads

(Bull Call Spreads, Bear Put Spreads)

A debit spread is one in which you buy an option and then sell a lowerpriced option, thus generating a net debit to your account. Debit spreadscan be bearish or bullish.

Strategies Bull Call Spread

Component Buy lower strike price call, sell higherstrike price call of the same month

Potential profitWhen the stock price is above thebreak-even point

Limited to the differencebetween the two strike pricesminus the net premium paid

Maximum loss Net premium paid

Time value impact Neutral

Break-even Lower strike price plus net premiumpaid

As different from a Bull Put Spread

which would result in net premium

received, a Bull Call Spread would resultin net premium paid, as the premium for

the lower strike price call is higher than

that of the higher strike price call.

Example:

ComponentBuy ABC May $190 Call, pay $30, andsell ABC May $220 Call, receive $10

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/debit_spread_tu

5/13/2013


24/32

Net Premium Pay $30-$10=$20

Break-even $190+$20=$210


Potential Prof it ($220-$190)-$20=$10

Potential Loss $20

Time ValueImpact

Neutral

Strategies Bear Put Spread

Component Sell lower strike price put, buy higher

strike price put of the same monthPotential p rofit

When the stock price is belowthe break-even point

Limited to the differencebetween the two strike pricesminus the net premium paid

Maximum loss Net premium paid

Time value

impact NeutralBreak-even Higher strike price minus net

premium paid

As different from a Bear Call Spread

which would result in net premium

received, a Bear Put Spread results in

net premium paid, as the premium for

the lower strike price put is lower than

that of the higher strike price put.

Example:

ComponentSell ABC Mar $180 Put, receive $10and buy ABC Mar $210 Put, pay $30

Net Premium Pay $30-$10=$20

Break-even $210-$20=$190


Potential Prof it ($210-$180)-$20=$10


5/13/2013


25/32

Potential Loss $20

Time Value

ImpactNeutral

Copyright 2000


5/13/2013


26/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Long Strangle

A Long Strangle is used when an large move is anticipated in a stockprice, but it's unknown as to which direction the stock might move. It'soften used around earnings announcements. Traders think that if acompany beats their earnings expectations the stock will rocket upward,but if the miss the number then it will really take a hit and drop drastically.

Strategies Long Strangle

Component Buy lower strike price put, buy higherstrike price call of the same month

Potential profitWhen the stock price is belowthe lower break-even point,substantial and equals to lowerbreak-even point minus stockprice

When stock price is above theupper break-even point,unlimited and equals to stockprice minus upper break-evenpoint


Time valueimpact

Negative

Break-evenThe lower break-even pointequals to lower st rike price

minus total premium paid

The upper break-even pointequals to higher strike price plustotal premium paid

Compared with Long Straddle, Long

Strangle is less expensive to establish but

requires higher market volatility to be

profitable.

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/long_strangle_tu

5/13/2013


27/32


28/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Short Strangle

A Short Strangle is used when a stock is expected to remain flat.Traders will sell both a put and a call for the purpose of collectingpremiums.

Strategies Short Strangle

Component Sell lower str ike price put , sell higherstrike price call of the same month

Potential profitWhen the stock price is betweenthe upper and lower break-evenpoints

Limited to total premium received

Maximum lossWhen the stock price is below thelower break-even point,

substantial and equals to lowerbreak-even point minus stock

price

When stock price is above theupper break-even point, unlimitedand equals to stock price minusupper break-even point

Time valueimpact

Positive

Break-even

The lower break-even pointequals to lower strike price minustotal premium received

The upper break-even pointequals to higher strike price plus

total premium received

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/short_strangle_tu

5/13/2013


29/32

Compared with Short Straddle, Short

Strangle has less premium receivable but

requires higher market volatility to result in

a loss.

Example:

Component Sell ABC Jun $180 Put , receive $5, andsell ABC Jun $200 Call, receive $10

Net Premium Receive $5+$10=$15

Break-evenLower: $180-$15=$165

Upper: $200+$15=$215

Profit when Stock price is between $165 and $215

Potential Prof it $15Potential Loss

When the stock price is below

$165, $165 - stock price

When the stock price is above$215, stock pr ice - $215

Time ValueImpact

Positive

Copyright 2000

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/short_strangle_tu

5/13/2013


30/32

Home

Advertise

About Us

SPONSORS

Stricknet.com

Option

Money

Long Iron Butterfly

A favorite strategy among professional option traders, the long ironbutterfly has the best chances of success in most markets. This strategysounds quite complicated but it's really very simple once you let it soak in.It's sometimes referred to as the "secret weapon of option traders".

A long iron butterfly trade makes 3 assumptions:

1. Stocks mostly trade within a range.2. Option sellers usually make more money than option buyers.3. Selling naked options is too risky.

If those 3 things are mostly true, then the iron butterfly trade. SupposeABC stock trading around 50 per share. Maybe it drops to the 42-43range sometimes and goes as high as 56-57. So it usually tradesbetween 40-60. Lots of stocks trade in a range like that. One thing wecould do to play this stock is sell the naked put with a strike of 40. Right?If the stock remains above 40 on expiration day, the put expires and wekeep the premium.

Another thing we could do is sell a naked call. Maybe sell the 60 strike.

Then if the stock doesn't go over 60, the option expires worthless and wekeep the premium.

Well, why not do both? We could sell the put and the option. As long asthe stock closes between 40 and 60 then both options expire worthlessand we keep all the premium. That's a naked strangle.

If we take it one step further we can set up a long iron butterfly and nothave the awful risk of having naked options as a liability.

We could sell the 40 put, then buy the 35 put for insurance against amarket collapse. Our risk could be no more than 5 points. Essentially wehave have sold a bull put spread. At the same time, we sell the 60 call

and buy a 65 call, thus setting up a bear call spread, and again minimizingour risk since we are not now in a naked option position.

Did that soak in? Let me summarize.... If you think a stock will tradewithin a range, you can sell out of the money options, both puts and calls,and collect the premiums. But instead of selling them naked, you do it inthe form of a spread to eliminate most of the risks.

If you think a stock will stay around 80, then you sell the 70 put (then buythe 65) and simultaneously sell the 90 call (and buy the 95). You're sellinga spread on each side of the stock price. Even if the stock goes against

ng Options - Developing A Plan http://www.graymetalbox.com/tutorial/butterfly_tu

5/13/2013


31/32

you, it can't go against you in both directions. This is why professionalslove this strategy. If the stock goes down the put spread may hurt you,but the call spread will be a success. The stock is either down or up. Itcan't be both. So even if you take a loss on one side of the trade, theprofit from the other side will help offset that.

Strategies Long Iron Butterfly

Component Sell out of the money bull put spread,sell out of the money bear call spread.Both spreads expiring the same month.

Potential profitWhen the stock price is betweenthe short put and the short call.

Maximum lossWhen the stock price is below thelower st rike of the put spread, or

when the stock price is higherthan the higher strike price of thecall spread.

Limited to t he point spread of justone of the spreads.

Time valueimpact

Positive

Break-evenThe lower break-even pointequals to the short put strike

price minus total premiumreceived

The upper break-even point

equals to t he short call strikeprice minus total premiumreceived

Compared with Short Strangle, the Long

Iron Butterfly does not sell naked options.

One sells the strangle, but buys farther out

of the money options for protection.

Example:

Component Sell ABC Jun $60 Put, receive $4, andbuy ABC Jun $55 Put, pay $2 1/2 for acredit of 1 1/2


5/13/2013


32/32

Sell ABC Jun $75 Call, receive $5, andbuy ABC Jun $80 Call, pay $3 1/2 for a

net credit of 1 1/2

Net credits = 3 points

Net Premium Receive $1.5 +$1.5=$3.0

Break-evenLower: $60-$3=$57

Upper: $75+$3=$78

Profit when Stock price is between $60 and $75


Potential LossWhen the stock price is below$60

When the stock price is above$75

Time ValueImpact

Positive

Copyright 2000


Trading Options Developing a Plan

Documents

Transcript of Trading Options Developing a Plan