Archive for October, 2009

How To Use Options Credit Spreads To Make Profit

Posted by admin on October 29th, 2009

The first thing you want to do is check the overall trend of the S&P index. If it is trending down use a Bear Call Spread. If it is trending up use a Bull Put Spread. There are a number of ways you can do to determine the trend of the market. One simple way is to use the 50 day moving average. If the market is above 50 day moving average the market is considered to be in an uptrend, below it the market is in a downtrend. There are also things like moving average crossovers and or the close above the highest high of the last three trading weeks or a close below the lowest low of the last 3 trading weeks.

You then want to find a stock that is trending the same way as the index. So again if the index is bullish you want to find a stock that is going up, if the index is bearish find a stock that is falling.

You then want to find a support or resistance level on the stock or exchange traded fund (ETF). You can use bollinger bands, the 50 day moving average or pivot points for this.

After that check the stocks fundamentals. One good way of doing this is using Investors Business Daily. Using their website all you have to do is type in the ticker symbol and it gives you a letter grade for the stock you are looking at. Obviously if you are bullish on a stock you want it to have a grade of A or better. If you are bearish on a stock it should have a C or lower. The website will also give you information on things like earnings per share, relative strength of the stock and institutional accumulation. All important things for determining a stocks fundamental strength.

Finally you want to purchase the credit spread. In the case of a bull put spread sell a put at the money and buy a put two or three strike prices below. So let’s say the Nasdaq Stock ETF is selling at $29.00 and it’s January. You can sell a February $29.00 Put for $1.60 and buy a February Put for .90 bringing in a total of $70 per contract (.70 x 100) If the stock closes above $29.00 at options expiration in February (3rd Friday of the month)then you will keep the full credit. If it ends at $28.30 ($29.00-.70) you will break even. If it ends at $27.00 or below you will lose $130 per contract ($29.00-$27.00)-.70.Depending on the number of contracts that you use you can easily earn anywhere between 1-10% a month using this method. The beauty of it is that as it gets closer to the expiration date the options will begin to lose value, which is what you want to happen. Because once they go to 0 you don’t have to do anything, but keep the money that you’ve already collected.

1. There are a couple of key points to remember about using this technique.
2. Always use good money management.
3. Don’t expose more than 6% of your portfolio at one time.Don’t trade before earnings or other announcements come out.
4. Don’t take more than a 2 to 1 risk to reward ratio. In other words if you’re risking $2 you should be making at least $1. I usually like more of a 1 to 1 risk to reward ratio if I can get it.

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Basic Options Trading Mistake You Should Avoid

Posted by admin on October 24th, 2009

 

 

 

While in stock trading the most normally practiced tactic is to buy low and sell high – the trader relies on the increase in value of the stock, so the proficiencyl involved basically comes down to forecasting the change in stock prices and timing the market accordingly. Options trading is distinctive from this more extensively understood practice of stock trading.

 Even comparatively simple call options can have minor variations that establish whether you win or lose by purchasing a specific option. With options trading, it is not possibly to be as simple but more complex than stock trading.

The call option shares some of the features involved in stock trading and therefore is probably the most uncomplicated, most understood and known type of option. For instance when you buy a call option you are purchasing the right to buy a block of stock at a certain price some time before a set point in time – usually two or three months down the road.

This strategy is considered a bullish strategy and it is correspondent to buying low and selling high. That is because your ability to make money on the deal is founded entirely on the increase in price of the underlying stock.

When you purchase what is called an “out of the money” call, you are purchasing the right to buy a certain stock within a defined period of time. There is only one reason for you to buy such an option is because you expect the underlying stock price to increase higher  than the strike price. These options are comparatively cheap to buy, and that is why they are so appealing to new traders without much experience.

For example, say you notice a stock currently selling at $75, and you believe (you think) the value of that stock will increase considerably over the next two or three months. Say you expect it might go as high as $92.

Based on that speculation you might purchase an option to buy that stock at a strike price of $80 some time in the next two months. When you do that, it is called buying an OTM (out of the money) option because the strike price is higher than the prevailing market value of the stock.

This is a comparatively conservative approach to go about trading options because the sum of money you can lose is limited to the premium you pay for contract. If the contract cost you only $1 per share and you bought a block of 100 shares, then your total disbursement would only be $100. This is a somewhat small amount equated to what you see as possibly large profits if the stock price should go as high as you expect it might.

If it should go to $85 a share within your contract period you could exercise your option and buy it for just $1. That would be a profit of $5 per share minus the $1 premium you paid for the contract. That sounds fairly painless because your risk is minimal – just $1 per share.

But there is a reason this kind of contract is cheap and that is because the chance that the stock will behave as you anticipate is relatively low. After all, these are seasoned options traders setting these probabilities and the chances are very good they know at least as much as you do about the future movement of stock prices.

So while your expected losses are comparatively low, your chance of making any good earnings is also relatively low. Not only does the stock price have to increase you hope, but equitable as important, it has to do it within the time frame stipulated in your contract. Timing is much more important in options trading than it is in stock trading.

As an alternative strategy it is suggested your attempt selling an OTM call (rather than buying one) on a stock you already own. In other words, it is advised that you reverse this and play the very odds that work against the buyer of an OTM call.

This is called a “covered call”. It is covered because you already own the stock. What you are saying is that you are prepared to sell the stock at the strike price – even if it is lower than the then-current market price – in exchange for a premium up front.

If the stock actually goes up higher than the strike price, you will still have made a profit on the sale – just not as much as you would have if you were not holding the contract. Plus you will already have the premium price in your pocket.

If the stock does not go up and the option is not exercised, you simply keep the premium. In that case the premium is pure profit. And if the stock starts going south and you decide you want out you can just buy back the option and sell the stock.

As you can see, this is a more imaginative approach which is also less speculative. It allows you to profit from the miscalculations of others while risking very little yourself. At the same time it gives you a better opportunity to learn how the options market works so you can move on to even more sophisticated strategies.

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Covered Calls, A Godsend in a Flat or Falling Stock Market

Posted by admin on October 22nd, 2009

It is amazing to me that not many retail investors understand the concept of generating cash flow from their stock positions. When I tell people that I utilize covered calls to generate extra income, hedge my stock positions, and set strict sell disciplines they look at me like I am crazy. I was introduced to the concept from a stockbroker, Scott Masse, who runs Masse Wealth Management, in Smithfield, RI. Scott is also the owner of a few bars and one night over a few diet cocktails, ie. barcadi and diet cola, he explained the concept to me. The idea of writing covered calls is the only option strategy that you can employ at most of the major brokerage firms for your IRA investments. The reason is that writing covered calls is a very conservative strategy relative to other option strategies.

The strategy is very similiar to selling an option on a piece of real estate. For example, I’ll give you $10,000 now, if you allow me to buy your property 6 months from now at a set price. If I choose not to exercise my option, you keep the money and we go our seperate ways.

With a stock, if I buy 1,000 shares of ABC OIL at $10 and the stock goes to $11 in the following month. I can sell someone the “right” or option to buy the stock from me six months from now at $12.50. For that right or option, the option buyer has to give me some consideration, similiar to the above real estate example, let’s assume it is .50 per share or $500.

The $500 is immediately deposited into my brokerage account, but an option position also shows up on my statement. I can not sell the stock prior to 6 months unless I buy back the option in the open market. The option price can fluctuate from day to day, therefore, I typically hold my stocks until expiration.

Six months from now, two things can happen. One, the stock goes above $12.50 and the person “calls” me out of the position, which I am more than happy to do since I bought it at ten. Second, the stock has declined below $12.50 and the option holder is holding on to a worthless option. The option holder would not “call” the stock from me at $12.5 when he or she might be able to buy it in the open market at $11.50.

I then start the process all over again and write the calls again.

Let’s examine what I accomplished with this strategy: 1. I hedged my position by 5% or $500 2. I set a strict sell price that I was willing to let the shares gor for, $12.50 3. I generated income that I could enjoy or reinvest.

I can not tell you how happy this strategy has made me since the crash of 2000-2001. The strategy has helped me keep my head above water in this depressing market.

A good friend of mine is a computer programmer. He also shares a passion for covered call writing and has written a program that is in beta testing. I am his BETA Dummy. So far, the program has saved me countless hours of research and has narrowed my focus to a short list of 5-10 natural resource stocks to add to my portfolio quarterly. In future articles, I’ll discuss some of my picks and income generated from the covered call strategy, plus provide a link to the option software.

As a reminder, make sure you “know what you own” and consult with a tax professional or adviser before investing your hard earned money!

 

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Profit In Any Market Conditions Using Options Trading

Posted by admin on October 18th, 2009

Trading options opens the door for all stock market traders to profit under any kind of market conditions. If traders are able to profit only when stock price move up, then you will find it a tough task to ever have any sustainable success, much less become a stock market millionaire.

 

With option trading, it is possible and easy to collect profit whether stocks move up, down or sideways. If the ability to trade all kinds of market conditions is the doorway to becoming a stock market millionaire, then option trading would be the very key.

 

 

Simple Option Strategies for Down Markets:

 

Buy Put Option – Instead of shorting stocks and risking a margin call, you could simply buy a put option. Buying a put option is exactly the same as buying call options except that you profit when the stock goes down instead of up.Sell Naked Call Option – Instead of buying put options, you could sell short call options thereby pocketing the entire amount you made on selling the put options if the stock should go down.

 

Bear Put Spread – A bear put spread consists of buying put options at the money and selling short out of the money put options of the same month. The benefit of this strategy is that you profit when the stock goes down and profit also when the stock stays sideways!

 

Simple Option Strategies for UP or DOWN Markets Straddle – A straddle consist of buying a call option and a put option at the same strike price on the same stock. This strategy allows you to profit whether the stock moves up or down and is excellent when you are certain that a stock will move greatly soon but isn’t sure which direction that may be.Strangle – Similar concept to a straddle but buys out of the money call option and put option instead of at the money ones in order to reduce the cost of the position.

 

Covered Call – is a simple option tactic for sideways market. If you are holding on to a stock that is moving sideways, you could collect “rental” out of it by selling the call option of that stock month after month and pocket the whole amount of the sale should the stock remain sideways.

 

Short Straddle – In a Straddle, you would sell short instead of buying call options and put options as explained before. In this way, you create an option position which profits when the stock remains sideways.

 

Are you amazed now at how easy it is to profit in any kind of market conditions by option trading? These are only very few of the many more option trading strategies that you can use to your specific portfolio needs.

 

Simple Option Strategies for Up Markets:

 

Buy Call Option – You could buy the same number of equivalent stocks for a fraction of the price using call options and profit when the stock goes up. If the stock should crash, you will lose only the small amount you put towards buying the option instead of the whole amount that you would have put towards buying the stock itself.

 

Sell Naked Put Option – You could sell short put options instead of buying call options, thereby pocketing the entire amount you made on selling the put options if the stock should go up.

 

Bull Call Spread – A bull call spread consists of buying call options at the money and selling short out of the money call options of the same month. The benefit of this strategy is that you profit when the stock goes up and profit also when the stock stays sideways!

 

 

 

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How Investment Options Works For The Buyer

Posted by admin on October 16th, 2009

A call investment option is a financial contract involving two parties, the buyer and the seller of this type of investment option. Often it is simply labeled a “call”. The buyer of the option has the right but not the obligation to buy a settled quantity of a particular commodity or financial instrument from the seller of the option at a certain time for a certain price. The seller is obligated to sell the commodity or financial instrument if the buyer should decide to buy. For getting this right the buyer pays a premium.

As the buyer of a call investment option wants the price of the underlying instrument to rise in the future; the seller either expects that it will not, or is willing to give up some of the upside profit from a price rise in return for the premium plus retaining the opportunity to make a gain up to the strike price.

Call investment options are most profitable for the buyer when the underlying instrument is going up, making the price of the underlying instrument nearer to the strike price. When the prices of the underlying instrument surpass the strike price, the option is said to be in the money.

The initial transaction in this situation – buying/selling a call option – is not the supplying of a physical or financial asset – the underlying instrument. Instead it is the granting of the right to buy the underlying asset, in exchange for the investment option price or premium.

Precise specifications may differ depending on option style. A European call investment option allows the holder to exercise, to buy, the option only on the delivery date. An American call option allows exercise at any time during the life of the option.

Call investment options can be purchased on many financial instruments other than stock in a corporation. Investment Options can be purchased on interest rates as well as on physical assets such as gold or crude oil. A call option should not be confused with a stock option. A stock option is the option to buy stock in a particular company. And it is a right issued by a corporation to a particular person, normally an employee, to purchase treasury stock. When a stock option is exercised, new shares are issued. When a call option is exercised, if it involves shares, the shares are merely being transferred from one owner to another. Nor is stock investment options traded on the open market

 

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Binary Option Trading – How it is performed?

Posted by admin on October 13th, 2009

Binary option trading is based on the concept of that each trade has only one of two possibilites. It changes from broker to broker but the basic idea is the same. By rapidly turning over binary option trading calls and puts – either hourly or daily. Day traders find their investments making money on consistent basis – and profiting huge sums as a result.

 

High Yields Attract Investors to Binary Option Trading
Yields on the rapid turning trades range from sixty percent to in some cases seventy five percent. It is literally impossible to compute the compounding rates of return on some of these investments because the yields are so high. Here’s an example of how a trade payout might look.

What would happen though if the position expired out of the money? This is where brokers can vary significantly. Sometimes an investor can unload an out of the money put or call prior to expiration – but some brokers operate differently. An unsuccessful trade might pay $30 (15% of the original $200 investment at expiration) on some particular securities. In other cases a trader might not be able to move his or her position at all. The bottom line is that it is difficult to get out of an out of the money trade.

 

A Binary Options Strategy
One possible way to reduce the possibility of getting wiped out while using all or nothing binary option trading contracts is by pairing up an in the money call (for example) with an at the money put. This can create a nested position where the trader makes money if the spot price at expiration is between the two strike prices.

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Understanding and Trading Put Options

Posted by admin on October 12th, 2009

 

Put options are a misunderstood investment tool but once understood by an individual investor it can be a very versatile investment tool.  Put options can be used to protect your portfolio, and they can help you pick up huge profits by controlling the stock of a company during a price decline and profiting from the decline. Plus, put options offer strictly limited risk. If an option trade goes the wrong way, you won’t lose more than your initial investment plus commissions.

So what are put options?  Put options are a type of investment that gives you the right to buy an underlying security at a higher  price for a specified amount of time and if that security falls lower you can purchase the shares at that price and then sell it to the issuer of that put option at a higher price and keep the difference as your profit.

In other words, put options give you the right to bet on the price decline of a stock, but you are limited to that bet for a certain period – usually from 1 month to as long as 3 years depending on the option selected.

For example, you believe that the SPX, the S & P 500 index, is very overbought and that if the Federal Reserve raises interest rates that it will cause the SPX to sell off and decline.

You then look up the strike prices on the SPX options for the current month because the Fed (Federal Reserve) will make its decision in a week so there is no need to look at buying puts several months out. The SPX has a current price of 1310 so you decide to purchase the ATM (at-the-money) SPX 1310 options for the current month at $11 (which is $1100; $11 premium x 100 = $1100 cost per option).

The Fed raises interest rates as you expected and over the next 8 days has a massive sell off and declines over 60 SPX points to a price level at 1250.

Your SPX option rises in value from $11 to $47 for a profit of $36 ($3600) which translates into a return of 327%!

Another advantage to investing in options is that you can never lose more than you invest in an option. If the trade doesn’t go your way, you only lose the amount you paid for the option and any commissions related to the trade.  If the SPX had continued to rally from the example above then the most you would have lost is your original investment of $1100.  Also, you could have sold your position for a smaller loss instead of holding it for the duration.

Put options are another tool in your trading arsenal that offer large rewards but limit your risk.  While there are other factors to consider such as timing, understanding volatility, etc. it can be well worth the effort to understand how put options can help maximize your returns.

 

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Systems On Option Trading Explained

Posted by admin on October 10th, 2009

Stock option trading has always given the traders additional work of not just predicting correctly the security’s price. They also must choose the best option for trading strategies. But most stock traders incorrectly figure they can easily make the change from stocks to options.

In order to make systems on option trading an on-going basis, the trader needs to fully understand the major differences between the stock and the option trading.

With the options buying, time is the enemy. If each day passes without enormous changes, the value of the premium time will decline. In order to solve it, the value of the time premium should be declining more rapidly as the option reaches its expiration. The significant factor that option traders need to evaluate is the amount of time that is probable for a move in the stock to take place. Buying close to a stock’s low may be supportive as a strategy, but if the trader is obliged to wait too long in an options position, the loss of time could more than devastate a reasonable gain in the original stock.

Most of the options analysts will inform traders to focus on the volatility assumption within the different options pricing model, for the reason that is the only aspect the standard options model assumes to be indefinite. The reason behind this is the Efficient Market Theory notion that stock prices cannot be predicted in the future. There are a lot of times traders that are way too positive in the scenarios they input, and a way to restrain this is by applying one of the following two tactics: The traders who want to make use of more conservative tactics can either choose to buy one strike further in-the-money or they can buy the next expiration month further out than they think they will be needing.

Understanding all the commodity features and other option contracts is very important before investing into those kinds of contracts. You ought to know in advance the rules so that you can guesstimate whether you are competent of handling your obligations.

The option trading systems and the futures which have been explained are inherently risky and very intricate. The investors need to recognize that this alternative does not pertain to all of them. In the case of investing, you need to know from the start how much you can lose and earnestly evaluate if you can afford to lose it in the analysis of your financial resources and the investment goals. You need to share your different conclusions with a broker in order to discuss if your decisions are sound and wise. If you think that you are most capable, willing, qualified and you have all the reasons to invest in the option trading and the futures, you also need to settle on the extent to which you wish to proceed, trusting your own intuition after consulting with a broker.

 

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Managing Option Directional Trades

Posted by admin on October 8th, 2009

Options provide great position management and risk control potential when using them to trade the market directionally. This goes beyond the simple fact that a long position in a call or put option has an absolute maximum risk equal to the cost of the option (plus commissions, of course). That, in and of itself, is a very useful thing. What this article discusses, however, are a couple of handy little things one can do while holding an option position to maximize the return and keep the risk well constrained.

Roll Up/Down

Most traders are familiar with the concept of a trailing stop whereby one moves their protective exit as the market moves in favor of the trade. This is used to lock in profits. The same thing can be accomplished when one is trading options rather than the underlying. This is done by rolling one’s position up or down strike prices depending on whether the trade is a long using calls or short employing put options.

Here’s a recent example from the author’s own trading.

A long position in Seagate Technology (STX) was initiated when the stock was trading at around 21.50 using the March 22.50 call options. They were purchased for $0.80. The market rallied over the next few weeks, eventually moving up above $24. At that point, a roll-up was executed by selling the March 22.50 calls at $2.60 and purchasing the March 25 calls at $1.40. This action served two purposes. The first is that it took $1.20 off the table, reducing the portfolio exposure and freeing up cash for use elsewhere. It also locked in a profit of $0.40 ($2.60 sales price minus the $0.80 purchase price for the 22.50 calls minus the $1.40 purchase price for the new 25 calls). At the same time, it had no effect on the remaining upside potential for the trade. The two strikes would probably profit about the same from any further appreciation in the price of STX shares.

If the portfolio exposure was deemed acceptable at $2.60, an alternate course of action would have been to sell the March 22.50 calls and not take any money out, but rather roll it all in to the March 25 calls. For example, if the position was 10 options, selling the 22.50s would net $2600. That cash could have been used to purchase 18 of the 25 calls ($2600/$140 = 18.57). By doing so, one actually increases the upside potential for the trade substantially. Of course, the full position is at risk, meaning one could theoretically lose the whole $2600 invested, which is more than could have been lost when the trade was first initiated.

Roll Forward

One of the issues with options is the limited duration they provide for holding trades. If one is an intermediate to longer-term trader, this can be an important hurdle. That said, however, in a manner similar to the roll up/down, if one wants to extend the holding period of a position it can be done by rolling forward the expiration month.

Continuing with the STX example, we can look at rolling forward. That would be accomplished by going from the March contract to the June one. As of this writing, the March 25s are trading at $2.40 and the June 25s are at $3.60. There’s the rub, though. Because of the longer time to expiration, the June contract is priced significantly higher. That is why a roll forward is often best accomplished with a roll up/down.

Consider the earlier roll-up in STX from the 22.50 call to the 25 call. If we were still in the former, and wanted to both roll forward and up, we could jump to the June 25 call. The current price on the 22.50 option is $4.10. With the June 25 at $3.60, we could accomplish both the roll up and roll forward and take $0.50 off the table. That is not quite as much as we accomplished with the roll up, but it does extend the time we could hold the position by three months. Whether that is worth the trade-off depends on the anticipated holding period for the trade.

The rolling of strike prices and expiration is something easily accomplished. The transaction costs for options trades have come down substantially for the individual trader in recent years. That opens up a great many possibilities for playing the market directionally and managing positions efficiently.

 

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Option Trading – Thinking “Outside The Box”

Posted by admin on October 6th, 2009

Wouldn’t it be great if we could buy an option with five months left until expiration and sell an option with 2 months left until expiration for the same price? You couldn’t lose. Well we can’t . I love options spreads so much I realized something very important. We can buy a spread that has a lot of time value left at almost the same price as we can sell one with less time value left. The reason really opened my eyes and gave me new insight into options. Here is what I came to realize.

I started comparing how expensive options were in relation to the other strike prices in the same month and to the other months. I wanted to know based on the price per day which options were more expensive.

The first 1 or 2 option months, as everyone knows loses time value quickly. The at the money strike prices are very expensive compared to the out of the money strike prices. Since there is not that much time left, how much can they charge for an out of the money option? Not much.

The next several months, the opposite is true. Compared to each other, the strikes that are closer to the money are cheaper in terms of price per day than the options further out of the money. Let me explain it another way using the S&P market.

6 days left at the money option cost 12 points
6 days left out of the money option cost 2 points

70 days left at the money option cost 43 points
70 days left out of the money option cost 29 points

There is more than 10X the time left but the 70 day at the money option (43 points) is only less than 4X the price than the 6 day at the money option (12 points).

The 70 day out of the money option (29 points) is almost 15X the cost of the 6 day out of the money option (2 points) but only has 10X the time value. We will buy the cheaper per day options and sell the more expensive per day ones.

Sell 6 day at the money and sell 70 day out of the money. Buy 6 day out of the money and buy 70 day at the money. This will be done for a 4 point debit. We are now buying a spread that has 10X more time value than the one we are selling and are only paying 4 points for it.

When the 6 day options expire we can sell the next month to take in more premium, still keeping the 70 day option spread.

What goes up, must come down! We have all heard this before in reference to the laws of Gravity. We have laws in the commodity markets as well. What comes down, must go up! The greatest traders of our time like Warren Buffet know this. He is perhaps the greatest Stock trader ever. He had never traded commodities until a few years ago. He bought silver in the futures market. When the market went even lower he bought more.

The “smart money”, commercials will not be scared into selling when a market they have purchased drops even further. They know better than anyone that a commodity has real value and will always be worth something.

There is a famous book, “You Can’t Lose Trading Commodities”. The author buys commodities and then just waits for the market to go higher. He would purchase more as the market fell.

You need a big bankroll for this. Personally I know corn won’t go to $1.00 but what if it did? I want to minimize the risk in case I want to end the trade.

I started trading the Soy Complex this way several years ago. Not with options. Strictly futures. I bought what was similar to a crush spread. I increased the contracts as the market went against me until the spread rebounded a little. Since I increased the contracts I didn’t need the market to come back to where I started. It only had to rebound to the next level.

Black Jack players did this until Casinos caught on and put limits on bets. It is a known fact that futures traders make good gamblers and professional gamblers make good futures traders. I am against gambling but even gambling done with a system is not really gambling.

These card players would bet something like this: $5 lose, $10 lose, $20 lose, $40 lose, $80 win. The losses add up to $75. They would win $80, so the profit is $5. Not a lot, but they would do this all day. Black Jack is just under 50% probability for the player.

The problem is there is a slight chance that you could lose 40 times in a row. Now with Commodities we have a 50% probability and we won’t lose 50 times in a row because the market can’t go below zero.

Now before I go any further, I need to tell you that I am not recommending you double down on your trades. What you can find are markets that are near their lows where you can do a small scale trade. Spreads offer even better opportunities. They have a closer range (high to low).

By now you can see we only use this to go long a market since we can never be sure how much a market can go higher. First we need to find a market that is low already so we won’t have to wait that long and also so there will be less capital needed.

I prefer to trade this using options. There are many ways to do this. You could buy an option in a market like soybeans and choose how many cents the market will drop before you buy more. The problem is, an option is a wasting asset. The Theta (time decay) would cause you to lose money.

I use spreads so I am not paying for time decay. I will probably sell more Theta than I buy, so if the market does nothing I will make money just on time decay.

 

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