Options strategies

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Article #1

This page was created to give prospective members a better feel for the option trades we make. What strategy we choose depends on what the market is doing. If the market is flat and not moving much we do certain types of trades more, and if the market is flying in one direction either up or down, we concentrate more on other types of trades.

Volatility is an option trader’s friend and nemesis. High volatility is great because it raises the prices of all options. As sellers, this means options are pricier and the seller gets paid more when he sells them than under normal conditions. But high volatility can also hurt us because the market can move quickly.

Here are the option trading strategies we use and a short description of them.

The credit spread is one of our favorite option strategies. This is a trade which results in a credit (money given to you at the beginning of the trade). It consists of two different options (legs).

You buy an out of the money option at a certain strike price and then you sell an out of the money option at a different strike price of the same month.

For example, if ABC stock is selling at . You sell the January Call option for . Then you buy the January Call option for .50. You get a credit of 50 cents. As long as ABC stays below at expiration you get to keep the credit. As time goes on the options will decay in value. This strategy allows you to win if ABC goes down, stays where it is, or goes up until .50. You start to lose money above .50.

Since each option is for 100 shares, the maximum potential gain on the above trade would be . (50 cents x 100 shares). The maximum loss would be 0. (Difference in strikes minus the credit: 80-75-.5) The return on investment would be 11.11% I like to place credit spread close to expiration so this return for would for a one or two month time frame.

So even though you have to pay for the second option, it is a conservative strategy to employ it.

You can also do credit spreads with Put options if you think a stock is going up.

Which option strike you decide to sell depends on how aggressive you want to be. Our style is conservative so we choose options that have a very low probability of expiring with any value. If you use this strategy with At the Money or In the Money options you can make a lot more money, but have a higher risk of loss.

Another of our favorite option strategies is the Iron Condor.

If the stock threatens to break our range, we have to adjust our range by adjusting the trade to account for the movement.

If you subscribe to my Free Options Course, I will show you exactly how we put on an Iron Condor trade, a real trade that we did, and the adjustments that we made to the trade when it got into trouble.

The butterfly is a neutral position that is a combination of a bull spread and a bear spread.

Let’s look at an example using calls.

Results of butterfly spread at expiration

Price at Expiration

July 50 Profit

July 60 Profit

July 70 profit

Total Profit

40

-1200

1200

-300

-300

50

-1200

1200

-300

-300

53

-900

1200

-300

0

56

-600

1200

-300

300

60

-200

1200

-300

700

64

200

400

-300

300

67

500

-200

-300

0

70

800

-800

-300

-300

80

1800

-2800

700

-300

As you can see our breakeven points are 53 and 67. As long as ABC stays between those strikes the trade will be a winner.

So for example, you buy 100 shares of ABC at 100 and you sell the 100 Call for 2.00. At expiration if ABC is above 100, your call will be exercised and they will take your 100 shares. But you get to keep the 2.00.

Writing calls against stock you already own and want to keep long term is a neat way to make some extra money for holding the stock.

Where you can get into trouble is when the stock drops in price. If you want to hold it, do so. But if you were in for a quick trade, you are in trouble. If that is a risk, you can do a covered call that is already in the money. So buy ABC at 100 and sell the 90 Call.

We do not use this technique much. But it comes in handy in times of very high volatility. When volatility is high, options are more expensive and so the premiums we get by selling options are larger than normal. We can use covered calls to take advantage of this volatility.

Here’s a real trade that we did on November 26, 2008.

I chose to illustrate the trade with 200 shares, but members are free to trade as much or as little as they want.

In this trade we paid each for 200 shares = ,400. We then got a credit of 2 for selling 2 calls that were set to expire in 25 days on December 20. Notice that we sold In the Money Calls. So if C is above on expiration day we will get called and our stock will be taken away from us which results in a maximum gain.

We stand to make 31 cents per share or max. That is a 6.6% return in only 25 days. If you use margin the return is 13.2%.

On expiration day C was at 7.02. Our stock got called away and we made the max on the trade..

The Calendar (AKA: Time Spread) is a spread that is a relatively cheap trade but has a large profit potential. It is created by selling one option and buying a more distant option with the same strike price. When we use it as a neutral trade, we benefit from the time decay because the near term option will decay and lose value faster than the farther out option that we bought. When enough decay has occurred we exit the trade.

The risk in a Calendar is the debit required to put on the trade.

Double Diagonal Option Trading Strategy

A Double Diagonal is two diagonals, Puts and Calls put together. First, let’s discuss the regular diagonal trade. The diagonal spread is created by buying a longer term call at a higher strike price and selling a near term call at a lower strike price.

So if ABC was at 100, we would sell the January 110 Call and Buy the February 120 Call. In this case we want ABC to stay below 100 at expiration in January.

This gives us a range of 110-90 that ABC can play in. If it stays in that range we make our max profit. If it gets out, we need to make adjustments. The Double Diagonal is a good trade because with adjustments you can still win even if the stock goes well out of the range.

Source: https://optiongenius.com/option-trading-strategies/



Article #2

Options Trading Strategies: Buying Call Options

HOW TO TRADE OPTIONS:
– What Are Options?
– What Are Options Contracts?
– Price of Options
– How to Read Options Symbols
– How to Price Options
– How to Read Options Quotes
– Understanding Options Risk
– Common Mistakes to Avoid
– Options Trading Strategies
– Choosing an Options Broker

A call option gives you the right, but not the obligation, to buy the stock (or “call” it away from its owner) at the option’s strike price for a set period of time (until your options will expire and are no longer valid).

Typically, the main reason for buying a call option is because you believe the underlying stock will appreciate before expiration to more than the strike price plus the premium you paid for the option. The goal is to be able to turn around and sell the call at a higher price than what you paid for it.

The maximum amount you can lose with a long call is the initial cost of the trade (the premium paid), plus commissions, but the upside potential is unlimited. However, because options are a wasting asset, time will work against you. So be sure to give yourself enough time to be right.

Options Trading Strategies: Buying Put Options

Investors occasionally want to capture profits on the down side, and buying put options is a great way to do so. This strategy allows you to capture profits from a down move the same way you capture money on calls from an up move. Many people also use this strategy for hedges on stocks they already own if they expect some short-term downside in the shares.

When you purchase a put option, it gives you the right (but, not the obligation) to sell (or “put” to someone else) a stock at the specified price for a set time period (when your options will expire and no longer be valid).

For many traders, buying puts on stocks they believe are headed lower can carry less risk than shorting the stock and can also provide greater liquidity and leverage. Many stocks that are expected to decline are heavily shorted. Because of this, it’s difficult to borrow the shares (especially on a short-them basis).

On the other hand, buying a put is generally easier and doesn’t require you to borrow anything. If the stock moves against you and heads higher, your loss is limited to the premium paid if you buy a put. If you’re short the stock, your loss is potentially unlimited as the stock rallies. Gains for a put option are theoretically unlimited down to the zero mark if the underlying stock loses ground.

Options Trading Strategies:  Covered Calls

Covered calls are often one of the first option strategies an investor will try when first getting started with options. Typically, investor will already own shares of the underlying stock and will sell an out-of-the-money call to collect premium. The investor collects a premium for selling the call and is protected (or “covered”) in case the option is called away because the shares are available to be delivered if needed, without an additional cash outlay.

One main reason investors employ this strategy is to generate additional income on the position with the hope that the option expires worthless (i.e., does not become in-the-money by expiration). In this scenario, the investor keeps both the credit collected and the shares of the underlying. Another reason is to “lock in” some existing gains

The maximum potential gain for a covered call is the difference between the purchased stock price and the call strike price plus any credit collected for selling the call. The best-case scenario for a covered call is for the stock to finish right at the sold call strike. The maximum loss, should the stock experience a plunge all the way to zero, is the purchase price of the strike minus the call premium collected. Of course, if an investor saw his stock spiraling toward zero, he would probably opt to close the position long before this time.

Options Trading Strategies:  Cash-Secured Puts

A cash-secured put strategy consists of a sold put option, typically one that is out-of-the-money (that is, the strike price is below the current stock price). The “cash-secured” part is a safety net for the investor and his broker, as enough cash is kept on hand to buy the shares in case of assignment.

Investors will often sell puts and secure them with cash when they have a moderately bullish outlook on a stock. Rather than buy the stock outright, they sell the put and collect a small premium while “waiting” for that stock to decline to a more palatable buy-in point.

If we exclude the possibility of acquiring the stock, the maximum profit is the premium collected for selling the put. The maximum loss is unlimited down to zero (which is why many brokers make you earmark cash for the purpose of buying the stock if it’s “put” to you). Breakeven for a short put strategy is the strike price of the sold put less the premium paid.

Options Trading Strategies:  Credit Spreads

Option spreads are another way relatively novice options traders can begin to explore this new family of derivatives. The most basic credit and debit spreads combine two puts or calls to yield a net credit (or debit) and create a strategy that offers both limited reward and limited risk. There are four types of basic spreads: credit spreads (bear call spreads and bull put spreads) and debit spreads (bull call spreads and bear put spreads). As their names imply, credit spreads are opened when the trader sells a spread and collects a credit; debit spreads are created when an investor buys a spread, paying a debit to do so.

In all of the types of spreads below, the options purchased/sold are on the same underlying security and in the same expiration month.

Bear Call Spreads

A bear call spread consists of one sold call and a further-from-the-money call that is purchased. Because the sold call is more expensive than the purchased, the trader collects an initial premium when the trade is executed and then hopes to keep some (if not all) of this credit when the options expire. A bear call spread may also be referred to as a short call spread or a vertical call credit spread.

The risk/reward profile of the strategy can vary depending on the “moneyness” of the options selected (whether they are already out-of-the-money when the trade is executed or in-the-money, requiring a sharper downside move in the underlying). Out-of-the-money options will naturally be cheaper, and therefore the initial credit collected will be smaller. Traders accept this smaller premium in exchange for lower risk, as out-of-the-money options are more likely to expire worthless.

Maximum loss, should the underlying stock be trading above the long call strike, is the difference in strike prices less the premium paid. For example, if a trader sells a .50 call and buys a call, collecting a credit of 90 cents, the maximum loss on a move above is .60. The maximum potential profit is limited to the credit collected if the stock is trading below the short call strike at expiration. Breakeven is the strike of the purchased put plus the net credit collected (in the above example, .90).

Bull Put Spreads

These are a moderately bullish to neutral strategy for which the seller collects premium, a credit, when opening the trade. Typically speaking, and depending on whether the spread traded is in-, at-, or out-of-the-money, a bull put spread seller wants the stock to hold its current level (or advance modestly). Because a credit is collected at the time of the trade’s inception, the ideal scenario is for both puts to expire worthless. For this to happen, the stock must be trading above the higher strike price at expiration.

Unlike a more aggressive bullish play (such as a long call), gains are limited to the credit collected. But risk is also capped at a set amount, no matter what happens to the underlying stock. Maximum loss is just the difference in strike prices less the initial credit. Breakeven is the higher strike price less this credit.

While traders are not going to collect 300% returns through credit spreads, they can be one way for traders to steadily collect modest credits. This is especially true when volatility levels are high and options can be sold for a reasonable premium.

Options Trading Strategies: Debit Spreads

Bull Call Spreads

The strategy is more conservative than a straight long call purchase, as the sold higher-strike call helps offset both the cost and the risk of the purchased lower-strike call.

A bull call spread’s maximum risk is simply the debit paid at the time of the trade (plus commissions). The maximum loss is endured if the shares are trading below the long call strike, at which point, both options expire worthless. Maximum potential profit for a bull call spread is the difference between strike prices less the debit paid. Breakeven is the long strike plus the debit paid. Above this level, the spread begins to earn money.

Bear Put Spreads

Investors employ this options strategy by buying one put and simultaneously selling another lower-strike put, paying a debit for the transaction. An investor might use this strategy if he expects moderate downside in the underlying stock but wants to offset the cost of a long put.

Maximum loss — suffered if the underlying stock is trading above the long put strike at expiration — is limited to the debit paid. The maximum potential profit is capped at the difference between the sold and purchased strike prices less this premium (and is achieved if the underlying is trading south of the short put). Breakeven is the strike of the purchased put minus the net debit paid.

Source: http://investorplace.com/2012/04/options-trading-strategies/



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