Options Strategies & Discussions 02 (Oct 09 - Dec 18)

Re: Options Strategies and Discussions (Nov 09 to Mar 10)

Postby iam802 » Mon Nov 23, 2009 10:33 pm

K,

How would you have done it? What will be your choice and why? :)
1. Always wait for the setup. NO SETUP; NO TRADE

2. The trend will END but I don't know WHEN.

TA and Options stuffs on InvestIdeas:
The Ichimoku Thread | Option Strategies Thread | Japanese Candlesticks Thread
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Re: Options Strategies and Discussions (Nov 09 to Mar 10)

Postby kennynah » Mon Nov 23, 2009 11:52 pm

Supposing V has an equal chance of moving up or down,

a) which of the 2 options would you choose to establish and why?
b) you are indifferent as to which option to choose why?
c) establish both and why?


hi 802 :

i probably wont go for c), since i expect V to move away from $80, I dont want a 0 delta position.

i will likely choose one directional bias. if i were to simply indulge in stock position, i would be indifferent as to whether I Long V or Short V, although, due to margining, I might just choose to Long V stock.

but when it comes to options, i will choose to Short 80 Put instead of Short 80 Call. the primary reason has to do with Vega.

recall, that both Short 80 Call and Put will yield the same -ve Vegas (-0.09). i prefer to Short V 80 Put instead of Short V 80 Call.

reasoning :
if V price drops, chances are good that the IV will rise. when IV rises, a -ve Vega will cause this option value to lose value (eg. IV up 5% => 5 x 100 x -0.09 = $45 losses due to -ve Vegas). so, even when a Short V 80 Call is supposed to be a profitable proposition when V's price drops, in reality, -ve Vegas can cause havoc...

if V price increases, chances are good that IV of V options will drop. when IV drops, a -ve Vega will cause this option value to GAIN value (eg. IV drops 5% => -5 x 100 x -0.09 = $45 profits due to -ve vegas)

do i make sense ??? hope so ;)
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Re: Options Strategies and Discussions (Nov 09 to Mar 10)

Postby kennynah » Tue Nov 24, 2009 2:24 pm

actually 802 setup a great opportunity to speak about an Option concept and strategy called

Delta-Neutral Trading


If you follow the discussion a couple of posts above, you will see that Selling a Strangle, such as Short V 80Call and Short V 80Put in our example, results in 0 (zero) Delta. Recall, that value of options with a 0 Delta position will not be affected by underlying price movement.

Perhaps by relating options to stocks, Delta can be better explained...

Long 100 shares of V = 100 Deltas
1 contract of Long V 80 Call (this is ATM Call) = 100 x 0.5 = 50 Deltas (1 option contract = 100 shares)
=> 2 contracts of Long V 80 Call = 50 x 2 = 100 Deltas

Therefore, Long 100 shares of V = 2 contracts of Long V 80 Call

(sidetrack : 100shares of V @ $80 = $8000 of capital. 2 contracts of V 80 Call will cost only a few hundred. such is the leverage nature of options)

802 is correct to suggest that if we Short 80 Call/Put, yielding a 0 Delta, which means that however V price swings, we just milk the Theta dry (read : profit from premium decay)... this is the intention !!!

Although such Short Strangles have 0 Delta, it doesn't mean that this Delta will stay totally unchanged. Given sufficient movement in V's price, this Delta will become more +ve or -ve; the reason? Gamma. This old faithful Gamma is at -0.14

Delta-Neutral trading is the process of ensuring that the overall option position is immune to price swing in either direction. It aims to profit from either Theta or/and Vega movement....

I'll leave it as such for now...and open this for further discussion...
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Re: Options Strategies and Discussions (Nov 09 to Mar 10)

Postby kennynah » Sat Nov 28, 2009 4:27 pm

just like school classes, too much of theory can be boring. we have spent some time theoretically discussing Option Greeks. unless, we begin to utilize such knowledge, it will remain unprofitable.

so, i thought we take a short break from this usual approach of explaining Greeks and put them to practical use.

give me a moment while i search for a underlying where options can be used for potential profits in the next 2-3 weeks.
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Re: Options Strategies and Discussions (Nov 09 to Mar 10)

Postby kennynah » Sat Nov 28, 2009 6:01 pm

TLT - iShares Trust Barclay's 20 Plus Yr Treasury


Remember that Option Trading is no more different than stock trading, in that one needs to first formulate an trade opinion, as part of an overall trading plan.

In this example, using TA, I see a possible bullish setup at this juncture. Obviously, one can include FA into consideration or use both TA and FA to decide if TLT will move up, down or sideways in the next 3 weeks.

As my trade opinion is that TLT will move higher than current price, I need to adopt appropriate Option Strategies that can offer an acceptable potential profits for some known associated risks of this position.

Note that Historical Volatility for TLT is now ~13%. It is at the low end of its HV. Option chain of Dec09 TLT also shows a similar Implied Volatility.

This is one possible setup employing ONE contract size :

Long TLT Dec 96 Call and pay a premium of $1.25 (known risk).

Short TLT Dec 96/94 Put and receive a premium of $0.67.


This entire position requires a capital outlay of $58 ($125 - $67) + commissions + $133 ($200 - $67) of margin requirement.

The maximum loss of this trade = $258 ($58 paid for this position + maximum loss of the $2 wide Short Put spread)

The maximum profit is unlimited !

GREEKS for this trade :

Delta = + 77.05
Gamma = + 11.45
Theta = - 1.40
Vega = + 7.09

Clearly, this is a +ve Delta setup, a Bullish position, which reflects the bullish opinion. If TLT moves up by $1, this position makes ~$77 and loses the same if TLT drops by $1. Of the remaining GREEKS, Gamma is the next most significant risk factor. It will fluctuate Delta more or less by ~15%; ie. quite quickly with TLT's price swings.
A short note on Implied Volatility. As TLT is now trading with HV of only 13%, TLT options are also relatively cheaper now than when TLT was at 36% volatility. Remember that option values are positively correlated to Implied Volatility. The lower the IV, the cheaper the option. It is unwise to buy options when IV is very high, such as those just before an earnings report.

The main reason that this delta is large is because of the choice of ITM 96 Call. Since TLT is currently at $96.40, this ITM 96Call has a delta of +0.54. The Short 96Put is also very near ATM and so yields another +0.47 deltas. Both these options combine to form ~ +1.00 delta.

You should realize now that Long 96Call + Short 96Put = a synthetic Long TLT stock !! You paid $58 capital to establish a position that almost mimics a Long TLT stock position, which otherwise would have cost $9,640 to buy the 100 shares.

This is the power of option leverage. But it is not free. There are trade offs.

a) this option expires in 20 days
b) $1 move in TLT yields ~$77 vs $100 if 100 shares of TLT was bought
c) this overall option position has a maximum risk of $258 ($200 + $58) vs maximum losses of $9640 if TLT stock price drops to $0. of cos, we dont expect this to happen. but even if TLT drops off $10, the losses would be $1000 if 100 TLT shares were purchased. in other words, the downside losses can be very damaging. but using this option position, the losses is capped at $258.

If you believe that TLT will move significantly to the upside within the next 3 weeks, then consider establishing this position, instead of outlaying $9640 to buy 100 shares of TLT when all you need is $258 to put on this option trade.

(this discussion does not constitute a recommendation to trade!!!)
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Re: Options Strategies and Discussions (Nov 09 to Mar 10)

Postby kennynah » Sat Nov 28, 2009 11:44 pm

GS - Goldman Sachs

As I looked at GS chart, I cant resist wanting to go bearish on this stock.

GS is currently trading at $164.16 and has a current Historical Volatility of ~33%.

Using options, I can construct a bearish play, like so :


Long GS Dec09 165 Put and pay $5.60
Short GS Dec09 170/175 Call and receive $1.14


This position will cost a trader $446 and require a margin of $386.

The maximum losses is $946
, if at option expiration, GS trades above $175; ie. GS goes past the Long 175Call option. If this happens, all of the premium paid, $446, for Long 165Put will be lost. The Short 170/175 Call spread will cost $500. Hence, the total damage = $946.

This position has unlimited profits
. Although it is enticing to add a "unlimited" profit potential position, the trader must have a reasonable chance of it actually happening. In this case, we need to know how much GS price needs to weaken in order to make enough profits to justify the potential max loss of $946 !

To be able to achieve ~$950 of profits, GS must trade at $151 in 20 days time. GS must drop by some 8% from its current ~$164 price tag. Is this reasonable expectation? Let's get scientific about it.

Take a look at GS Option chain appended below. It shows that 150Put has a -0.14 delta. Ignore the -ve polarity. This is telling us that there's roughly 14% chance of GS price settling at or below $151 at expiration. Restating, GS has ~86% of staying above $151 in 20 trading days. Delta is a trader's rough gauge of an option expiring In-The-Money.

A more scientific way is to actually calculate the de-annualized Implied Volatility. Right now, averaged ATM option is showing about 31% annual IV. To calculate the potential move of GS price in 20 days, do this :

square root (20/365) x 31% = +/- 7%

There's a 68% chance of GS price fluctuating 7% up or down within 20 days. This makes GS price having a 2/3 chance of trading between $152.60 and $175.65. Now, this position makes ~$950 if GS price trades at $151 at expiration day. This calculation suggests that this is outside the 2/3 chance; ie. this trader has only 1/3 chance of making $950 or more but yet has 2/3 chance of losing $946.

Now, it is apparent that the risk/reward is not so enticing anymore.

Thus, as much as this trader likes to establish a bearish position on GS using options, current option chains do not offer the trader any meaningful way of doing so. It would be wise to find another trade.

I like to hear your additional comments on this trade analysis
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Re: Options Strategies and Discussions 2 (Nov 09 to Mar 10)

Postby kennynah » Wed Dec 23, 2009 12:23 pm

but alas...i didn't establish the above trade....if i had, it would have been a winner...on both counts...

Long GS Dec09 165 Put and pay $5.60 >>>> GS did lose value to a low of ~$161 on 17Dec09
Short GS Dec09 170/175 Call and receive $1.14 >>> this option expired worthless on 18Dec09, thus I keep all of $1.14 premium

but this is only how it looks like on the surface....

QUIZ :

In reality, how much profit did I make if I held 100 shares GS and 1 contract of that Short Call spread until option expiration last Friday, 18Dec09?
Last edited by kennynah on Wed Dec 23, 2009 12:47 pm, edited 2 times in total.
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Re: Options Strategies and Discussions 2 (Nov 09 to Mar 10)

Postby kennynah » Wed Dec 23, 2009 12:46 pm

Covered Call

We all know that the term, Covered Call, implies a position consisting of Stocks and Short Call options...

example: 100 shares of AAPL (Apple) at $196.40 and 1 contract of Short AAPL Jan $210 Call (whose premium today stands at $2.15)...

The 2 primary reasons for having such a WRITE Buy are :

a) Income generation from the premium collected for selling the Short Call option
b) Cushioning price decline

this position roughly requires a capital outlay of $19,425 (100 x $196.40 - 100 x $2.15)...

Max Profits = $1575 (trust me here)
Max Losses = $19,425 (if AAPL bankrupts and price zooms to Geeloh)


now...consider the following alternative :

naked 4 x Short AAPL Jan 195 Put ...whose premium is currently $350 per contract

this position requires margin of ~ $15,600 to be set aside

a) Max Profits = $1400 ( 300 x $3.50)
b) Max Losses = $78, 000 (400 x $195) >> (if AAPL bankrupts and price zooms to Geeloh)


now, if AAPL does indeed collapse and stock value goes to $0... i guess, i would throw in the towel and admit, i am not cut out for this business... ie, this scenario is remote...not impossible...but very slim chance...

this said, look at the 2 trades... would you not say, they are about similar.... they both have limited profit potential and very large potential losses..


QUIZ :

so, why would anyone be interested to purchase Covered Call vs Naked Short Put, given that they 2 are synthetically similar (they are...trust me)....

assumption : NOT a dividend paying Stock...
Last edited by kennynah on Wed Dec 23, 2009 1:23 pm, edited 2 times in total.
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Re: Options Strategies and Discussions 2 (Nov 09 to Mar 10)

Postby kennynah » Wed Dec 23, 2009 1:19 pm

Bull Call Spread

We know that a Bull Call spread is a bullish position, with limited profit potential and losses. It this sense, credit Call spreads are limited risks positions...

A Bull Call spread consists of Long Call and Short Call of a higher Strike price.

Let's take AAPL as a case study....with AAPL price trading at ~$196

Some traders like to establish

A) Long 200 Call + Short 220 Call and pay $5.41 premium
vs
B) Long 180 Call + Short 200 Call and pay $15.38 premium

P/L for A)
Max Profit = $14.59 ( $20 - $5.41)
Max Losses = $5.41

P/L for B)
Max Profit = $4.62
Max Losses = $15.38

A) has a lot of profit potential and losses are much lesser, when compared to B). Moreover, it costs less to establish A) than B).

QUIZ :

Which of the 2 positions is a better trade, if indeed there's any difference, given the following Greeks:

GREEKS of A)
Delta +43
Gamma +1.5
Theta -7
Vega -11.6

GREEKS of B)
Delta +37
Gamma -1.7
Theta +4.9 >> most are mistaken that Bullish option positions will always yield -ve theta.. clearly not true
Vega - 11
Last edited by kennynah on Wed Dec 23, 2009 1:38 pm, edited 2 times in total.
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Re: Options Strategies and Discussions (Nov 09 to Mar 10)

Postby kennynah » Wed Dec 23, 2009 1:27 pm

this trade below....is a loser !!!

this is a great example of how options can lose money... and also that TA is not always accurate !!

however, if i had simply traded the underlying, perhaps the losses would have been more... risks is not automatically capped with Long or Short stock positions... but with appropriate Options strategies, risks can be mitigated...and in this example, the losses was capped at $258... not a penny more...hence one of the most significant advantages of trading Options (NOT Asian Warrants!!!)

***************************************************************
kennynah wrote:TLT - iShares Trust Barclay's 20 Plus Yr Treasury


Remember that Option Trading is no more different than stock trading, in that one needs to first formulate an trade opinion, as part of an overall trading plan.

In this example, using TA, I see a possible bullish setup at this juncture. Obviously, one can include FA into consideration or use both TA and FA to decide if TLT will move up, down or sideways in the next 3 weeks.

As my trade opinion is that TLT will move higher than current price, I need to adopt appropriate Option Strategies that can offer an acceptable potential profits for some known associated risks of this position.

Note that Historical Volatility for TLT is now ~13%. It is at the low end of its HV. Option chain of Dec09 TLT also shows a similar Implied Volatility.

This is one possible setup employing ONE contract size :

Long TLT Dec 96 Call and pay a premium of $1.25 (known risk).

Short TLT Dec 96/94 Put and receive a premium of $0.67.


This entire position requires a capital outlay of $58 ($125 - $67) + commissions + $133 ($200 - $67) of margin requirement.

The maximum loss of this trade = $258 ($58 paid for this position + maximum loss of the $2 wide Short Put spread)

The maximum profit is unlimited !
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