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THE COLLAR TRADE:
Cap risk and lock in profits
• TRADING MARKET NEWS WITH STRADDLES • OPTION TRADING AND SENTIMENT
• MERC LISTS NEW E-MINI STOCK INDEX
and currency options
• OPTION BASICS:
Pricing, volatility, and strategy fundamentals
• NEW PRODUCTS, WEB SITES, SOFTWARE,
Contributors . . . . . . . . . . . . . . . . . . . . . . . .4 Editor’s Note . . . . . . . . . . . . . . . . . . . . . . .6 Options News
By Carlise Peterson CME launches new stock index and currency options . . . . . . . . . . . . . . . . . .8 The Chicago Mercantile Exchange expands its offerings of stock index and currency options with Russell 2000, Euro FX, and yen contracts. Fraud down under . . . . . . . . . . . . . . . . . . . . .9 An Australian bank head pleads guilty to fraudulent foreign exchange option trades that caused $282 million in losses to customers.
Software review . . . . . . . . . . . . . . . . . .10
OptionVue 5 (Standard version) By David Bukey
Options and sentiment analysis . . . . . . . .26 Learn how sentiment indicators reveal the mood of the market and improve the odds of successful options trading. By Bernie Schaeffer and Jon Lewis
Hedging risk with collar trades . . . . . . . . .14 Learn how to create collar trades, which provide protection and flexibility to long positions without adding to costs. By Jim Graham Event-driven straddle trades . . . . . . . . . . .18 Larry McMillan lays out the criteria for long straddle trades that can successfully capitalize on market events. By Lawrence G. McMillan
Options 101 . . . . . . . . . . . . . . . . . . . . . . . . .30 Learn the basics about option pricing, trading, and volatility. By Options Trader staff
Options Resources . . . . . . . . . . . . . . . .38
Software, Web sites, and new products.
Key concepts and definitions . . . . .40 Options Calendar/Events . . . . . . . . . .41
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April 2005 • OPTIONS TRADER
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Jim Graham is the product manager of OptionVue Systems, where he works to develop and enhance the company’s OptionVue 5 options analysis software. Previously, he worked in the securities and commodities division of First Chicago Capital Markets, helping broker-dealers, hedge funds, and other securities firms meet their financing and settlement needs. Graham spent four years in the United States Marine Corps, with a specialty in computer operations, and earned his B.A. in economics from Lake Forest College. Lawrence McMillan is the author of the best-selling books Options as a Strategic Investment and McMillan On Options. He is publisher of the Daily Volume Alert service and The Option Strategist newsletters, as well as all market commentaries found at his site, www.optionstrategist.com. Bernie Schaeffer, author of The Option Advisor: Wealth-Building Techniques Using Equity & Index Options, founded the Option Advisor newsletter in 1981. Timer Digest has ranked Schaeffer as a top market timer since 1984 and the Market Technician’s Association presented him with the 1997 “Best of the Best” award for his work in the field of sentiment analysis. His Web site, SchaeffersResearch.com, has been recognized as a “Forbes Favorite” and by Barron’s as a “first stop” for options traders. Jon Lewis is managing editor for Schaeffer’s Investment Research and directs the activities of the company’s editorial department. He is responsible for most of the written work supporting Schaeffer’s newsletters, alert services and SchaeffersResearch.com. He is the editor of the Option Advisor and is the senior editor of the firm’s primary education product, 10 Days to Successful Options Trading. In addition, Lewis has written numerous articles on options and sentiment analysis for Schaeffer’s clients, the print media and SchaeffersResearch.com.
Volume 1, Issue 1. Options Trader is published monthly by TechInfo, Inc., 150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright © 2005 TechInfo, Inc. All rights reserved. Information in this publication may not be stored or reproduced in any form without written permission from the publisher. The information in Options Trader magazine is intended for educational purposes only. It is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. Traders are advised to do their own research and testing to determine the validity of a trading idea. Trading and investing carry a high level of risk. Past performance does not guarantee future results.
April 2005 • OPTIONS TRADER
this issue also includes an excellent primer on options in the Options Basics section. But mostly. because even many relatively experienced stock and futures traders have only a passing familiarity with options. Options can be a daunting subject for a few reasons — arcane terminology and some occassionally complex math. Mark Etzkorn. to name a couple. In the meantime. We want Options Trader to help remedy that situation. software and other resources. let us know what kind of topics interest you most so we can provide the kind of magazine working traders can actually use from month to month. Options Trader will introduce additional features (including analysis of options systems) and expand its range of new articles. along with coverage of Web sites. the first monthly magazine for options traders in the stock and futures markets. Also. we’ll feature articles for new options traders every month. In addition to an extended article by Larry McMillan (adapted from two articles he wrote for Active Trader maga- Options can be a daunting subject for a few reasons — arcane terminology and complex mathematical pricing models. Each issue will include market and industry news along with different trading strategies and analysis articles that demystify options and allow you to experiment and learn before you risk money in the market. confusion about options stems from a lack of plain-language. Editor-in-chief 6 April 2005 • OPTIONS TRADER . And our news section reviews a few recently launched futures options contracts that might interest you. zine) about trading straddles in conjunction with market news. commonsense sources of information about these instruments. We hope you will stay with us as we grow. as well as a new article by Jim Graham on the collar trade. to name a couple.EDITOR’S NOTE Exploring trading options W elcome to the inaugural issue of Options Trader. Over the next several months.
The current CME Globex electronic fee waiver for the CME’s E-mini S&P 500 and E-mini NASDAQ-100 options on futures contracts will also be extended to E-mini Russell 2000 options.m. CME’s Chief Executive Officer. Feb. CME now offers options on three of our most actively traded futures contracts: E-mini S&P 500. for serial expirations.233 contracts.005 (e. Exercise price interval: $. “As the E-mini Russell 2000 is one of our most successful E-mini products. – 4 p. CME will select seven firms to commit to provide continuous. CME will offer connectivity to a select group of automated market makers for the options.OPTIONS NEWS CME launches new stock index and currency options he Chicago Mercantile Exchange (CME) launched options on E-mini Russell 2000 futures contracts.000 Euro. Last trading day: March quarterly and serial options: The second Thursday preceding the third Wednesday of the contract month at the normal Regular Trading Hours (RTH) closing time of 2 p.00).m. Contract months: Two quarterly expiration months and two serial expiration months. transparent and competitive markets for the exchange’s E-mini Russell 2000 equity options traded on CME Globex. T E-mini Russell 2000 options contract specifications Contract size: One E-mini Russell 2000 Index futures contract. Trading floor hours: 7:20 a. on its electronic CME Globex platform in April. Minimum tick: $.m.g. – 3:15 p. The E-mini Russell 2000 futures have become one of the most active stock index contracts in the world. the smaller-sized. Globex trading hours: 5 p. a capitalization-weighted index of approximately 2.121.00045 or less.. CT. Contract months: Four quarterly expiration months and two serial expiration months.m. small-capitalization U. with European-style expiration. Monday – Friday. 13.” says Craig Donohue. CT on Sunday.m. – 2 p. E-mini NASDAQ-100 and E-mini Russell 2000.310. E-mini Russell 2000 options were listed for trading at 5 p.m.05 index points ($5.25) for option prices of $.000 actively traded. FX (EUR) and Japanese yen (JPY) options contracts. European-style options can be exercised only on expiration day. electronically traded version of the CME’s Russell 2000 contract.00005 ($6.” To help ensure liquidity in this new market.305. CME’s E-mini Russell 2000 options are based on the Russell 2000 Index.m.m.000 contracts with total 2004 volume at 17.10 index points ($10.m.) Euro and yen options set for April launch The Merc will also launch new Euro 8 April 2005 • OPTIONS TRADER .. and 3:30 p.m. 2005. Exercise price interval: 5 index points.m.50).00). stocks. 8:30 a. offering options on the Emini was the next logical step. start up on Sunday at 5 p. etc.0001 per Euro ($12. CT on CME Globex and in the open outcry market on Euro FX option contract specifications Contract size: One Euro FX futures contract for 125.m. – 4:30 p. a half tick is . $. for quarterly expirations. Globex trading hours: 5 p.S. Last trading day: Third Friday of contract month. Monday – Friday.m. while American-style options can be exercised any time up to expiration. For the fourth quarter 2004. $1. 3:15 p.m. “With this upcoming product launch. Weekly options: At the normal RTH closing time of 2 p. (CT) on any Thursday of the contract month that is not the termination of a quarterly or serial European-style option. average daily volume for E-mini Russell 2000 futures was approximately 67. Minimum tick: . with average daily volume up 344 percent in 2004. The new electronically traded FX options contracts will be available nearly 24 hours a day and will trade alongside the open-outcry markets. The CME already offers these contracts with American-style expiration through open outcry and during a limited CME Globex trading period. CT the following day. (CT). $1. Similar to its FX futures. The European-style options on these two futures contracts will be listed on April 3 at 5 p.m.
pleaded guilty to three charges of making false foreign exchange trades that led to losses of A$360 million (U. Australia’s biggest bank. and Vince Ficarra for unauthorized trading at the Melbourne-based bank. Duffy was required to surrender his passport and will appear in the County Court for a plea hearing June 14.000 for Duffy to A$120. According to the Australian Securities & Investments Commission. Weekly options: At the normal RTH closing time of 2 p.757 in 2004 and 31. One of the charges related to currency trades worth A$145 million. plus one charge each under the Crimes Act of obtaining financial advantage by deception to secure personal bonuses. The maximum penalty for each offense is five years in jail. Monday – Friday. Offering the choice of European-style expiration.000 for Ficarra.m.m.” according to a report by PricewaterhouseCoopers.). Later.50). ing day and exercise. The fallout reached the bank’s boardroom. 9 .0000045 or less. Contract months: Four quarterly expiration months and two serial expiration months. and Ficarra face 19 such charges under the Corporations Act. Bullen.2 trillion in notional value. between October 2003 and January 2004. Duffy pleaded guilty to charges under the Corporations Act of using his position dishonestly to make 12 false foreign exchange trades. Fraud down under Aussie bank traders convicted of faking trades to protect their bonuses. allows our investors flexibility in determining investment strategies and also provides alternative tools that are more in line with the OTC market. Luke Duffy. Globex trading hours: 5 p. our total FX volume grew more than 50 percent. Minimum tick: $.” CME’s Euro FX and Japanese yen futures and options contracts are among the exchange’s most actively traded FX contracts.000 ¥. “Last year.April 4 at 7:20 a. which last year traded $6. Last trading day: March quarterly and serial options: The second Thursday preceding the third Wednesday of the contract month at the normal Regular Trading Hours (RTH) closing time of 2 p. The CME will continue to offer American-style options on both Euro FX and Japanese yen futures contracts. Their supervisor and three other executives were also dismissed.500. $. he former head of National Australia Bank Ltd. $282 million).S. as well as American-style expiration. dollar would rise in value against the Australian and New Zealand OPTIONS TRADER • April 2005 T currencies in the final quarter of 2003. Average daily volume in Euro futures and options was 86. they processed false spot foreign-exchange and false currency-options transactions to hide losses. Except for the termination-of-trad- Japanese yen option contract specifications Contract size: One Japanese yen futures contract for 12.0000005 per Japanese yen ($6. The four were fired after the losses were discovered in January 2004 by a junior trader. etc. Gray.00005 (e.m.m. are a rapidly growing part of the overall FX market. – 4 p.070 in Japanese yen futures and options. $.g. A total of 20 criminal charges each were set against currency options dealers David Bullen.000001 per Japanese yen ($12. CT.00975. CT on any Thursday of the contract month that is not the termination of a quarterly or serial European-style option. all contract terms specified are the same as for CME’s American-style FX options. which they called “smoothing. Exercise price interval: $. with Frank Cicutto resigning as chief executive and Charles Allen quitting as chairman..S.00965.00970.” says Rick Sears. $.m. Trading floor hours: 7:20 a. $. The losses were hid to protect annual bonuses. The traders first hid losses by shifting profits and losses from one day to another. Gianni Gray. CT. – 2 p. In October 2003. Managing Director of CME Foreign Exchange. “CME FX futures and options. CT the following day.m. the traders discovered the bank had stopped checking internal options transactions. and our electronic volume was up 128 percent from the prior year. which ranged from A$265. the four hid losses after incorrectly betting the U.25) for option prices of $.m.’s currency options trading desk.
Suite C-10 Libertyville. However. and all current strike prices and expiration months (including LEAPs) can be downloaded. Minimum Windows 95. Milwaukee Ave. Internet access. daily point and percentage change. volume. including its scanning and account-tracking ability. delayed — $49.400 stocks. commodity and currency). build trading strategies based on them and evaluate each scenario’s profitability. AT Financial.) 10 OptionVue’s Background Data Base (BDB). futures (financial. as well as a categoApril 2005 • OPTIONS TRADER . lets you search for assets with low or high volatilities relative to their historical levels. (Monthly vendor fees also apply. traders looking for detailed price charts might be disappointed. margin requirements.50. Additional features sold separately — $400 each: Portfolio Manager. Data: 20-min. daily high. 1 GHz processor requirements: (recommended). Company: OptionVue Systems International Inc. and constant elasticity of volatility (CEV) factors — vital statistics that OptionVue needs to project option values and perform accurately. Who it’s for: Options traders. daily low. Thompson One or BullSignal. You can retrieve prices manually or set DataVue to update every 10 minutes.. BackTrader. Continuous Data Interface. dividends and interest rates. which the program uses when projecting option values. per year — $500. EOD — $27. OptionVue 5 can then recommend specific option trade combinations and track performance. and futures). while traders new to options won’t be overwhelmed with unnecessary details. and several features. This review describes the standard version of OptionVue 5. No intraday stock charts and limited set of technical indicators.com Phone: (800) 733-6610 Address: 1117 S. What it is: Options analysis program that provides updated options data. standard or professional. IL 60048-9860 Price: Standard — $995.695. Real-time users must pay a one-time $400 fee to access one of six continuous data feeds: IDC eSignal. The program also has several tools that identify underlying assets whose options characteristics fit a variety of trading strategies. Upside: Long list of clever analysis features. Background Data Base subscription for one year: weekly — $650. IDC Comstock satellite. Value Sheets (to print the Matrix — $195).0 or later. The program isn’t cheap. indices. 128 MB RAM memory. Up to six years of historical daily price and volume data is available. which is updated each Saturday morning. 2000 or XP. Service bundles of these features are available at various prices on the Web site. which provides data from the Australian Stock Exchange. OptionVue’s quote window can hold hundreds of underlying asset prices with more than a dozen columns of market data. Skill level: Intermediate to advanced option traders. Although a BDB subscription is optional. Data OptionVue’s DataVue subscription service provides 20minute delayed and historical prices on more than 2. Features Quote display. each asset file contains current strike and expiration information. 98. 60 MB of hard disk space.SOFTWARE REVIEW OptionVue 5 (Standard version) SOFTWARE SUMMARY REVIEWED BY DAVID BUKEY Program: OptionVue 5 O ptionVue 5 is an options analysis package that allows option traders of most skill levels to view all options across asset types (stocks. Also. monthly — $300. Downside: Cost. exchange traded and time) for selected indices.optionvue. plots an option strategy’s performance and suggests specific trades based on user-defined criteria. Professional — $1. are sold as separate packages (see “Software Summary” for price details). 800x600 resolution monitor. which gives options experts great flexibility. indices. stocks and futures. bonds and their options. PC Quote/Hyperfeed. Customizable tools and variables (including its volatility pricing models). NT 4. OptionVue also imports and exports ASCII price files. Figure 1 shows relevant price information (last price. Thirty-day trail — $49. the professional edition offers more detailed reports and manual volatility modeling. Web site: www. OpScan per month — $49. nearly every feature can be modified.
margin requirements. Also..80 and $36.. cash flow.Although the trade is currently below the breakeven line. You can “paper” trade the underlying asset. the second column shows each option’s market implied volatility (MIV). Most chart features can be easily edited. These statistracts in both columns. OptionVue will summa.g. Matrix. If there are shares or con. OptionVue’s graphic analysis window displays its top section.220 on expiration day. which consists of four main sections: actuals. options and summary statistics (e.certain stock price intervals (horizontal lines). open interest. 12 OPTIONS TRADER • April 2005 11 .the trade and also view performance (y-axis) by yield. ry labeled “strategy candidates. you can change the Matrix’s format and dis. Each asset has its own Matrix. However. After you propose a trade in the Figure 2 shows the Matrix of the Nasdaq 100 index-tracking stock (QQQ) and lists the underlying stock price in the Matrix. In-the-money (ITM). overvalued and option Greeks. Graphic analysis. your shares roll over into lower section lists the trade’s profit or loss and its Greeks at the “existing positions” column. change from initial value or option price. nearly 30 of these statistics appear in a separate window. condors. OptionVue can plot options positions the same way. current value and “Greeks”).” Instruments can be easily added or deleted and you can also create original categories. or underlying assets.will return up to $1. The figure’s portfolio manager. or as many as five performance lines based on either user-defined dates or implied volatility changes. it tive) in the third “Trade” column. you can choose how to analyze them. butterflies and each asset or option. You can change each column’s width and select among 15 additional headings. You can modify the size of mid-point between its bid and ask prices. trade statistics. Here. It distinguishes between potential trades and existing positions and can on three dates: current (dotted line). but The options section lets you track proposed and existing change if other lines are highlighted. expiration (solid brown analyze their trade details separately or combined. implied volatility. or build ume.20. Double-clicking on an asset in the quote window brings up its “Matrix” — a list of options at every strike price and expiration month. buy or sell a single call or put. and the lower summary section calculates the figure’s today’s date and several future dates (e. At this point.g. tion on any asset or option. the nearest option expiration date and the date half-way to it). if you double-click straddles. This short straddle will profit on expiration day if QQQ’s Once you execute these trades and click the “convert trades” button. you can test any trade scenario involving options and their underlying Source: OptionVue 5 assets. depending on where QQQ trades at that point. collars.FIGURE 1 — QUOTE DISPLAY All of OptionVue’s features are easy to format. stocks and futures as well as two option-strategy candidates. at-the-money (ATM) and profit profile according to price changes in the underlying out-of-the-money (OTM) options appear in the center sec. futures (if applicable). annualplay up to six columns and three rows of detailed informa. rize trade statistics in the lower section. volcontinued on p. In the Matrix. The program shows each trade’s gain or loss based on tion. such as bid and ask price. If you line) and the midpoint between both dates (dashed line).or more sophisticated combinations such as covered calls. theoretical price. enter the number of shares to buy (positive) or sell (nega. the program tracks them here and in the closing price is between $33.asset. percent under. This quote screen shows various indices. credit or debit spreads.ized yield. tics are based on the current date (in late September). Figure 3 shows the profit profile of a QQQ short straddle The Matrix resembles a spreadsheet.
For each underlying asset. and it’s easy to distribute individual trades among them. and six years. and total gains and losses. However. given OptionVue’s sole focus on option strategies. You apply the following criteria to up to six years of asset data: greatest dollar volume of options traded. which can lead to more accurate results. and highest or lowest current percentile (IV or SV). OptionVue’s BDB survey searches nearly 2. highest and lowest SV or IV. which allows you to select a specific area of a price chart to predict upcoming price moves. OptionVue’s volatility charts plot six years of daily implied (IV) and statistical (historical) volatilities (SV) 12 for each underlying asset — invaluable information for options traders. Analyzing multiple scenarios is easy and extremely helpful. OptionVue’s reports are quite extensive and cover five topics: a list of open positions. Portfolio manager. dividends. Each chart also lists average SV and IV levels over several intervals: three. The program plots underlying assets in daily. four-and-ahalf. Navigation within the report tool is easy because OptionVue organizes each area into separate tabs and you can switch to a different account at any point.SOFTWARE SCREENING continued FIGURE 2 — THE MATRIX The Matrix is OptionVue’s central feature and shows options prices (including LEAPS) and implied volatilities for each underlying asset. The chart window’s most useful feature is its target box. Source: OptionVue 5 The “Details” button on the lower right is a great feature that breaks down the trade into individual components and calculates its performance (including commissions) and daily time decay. April 2005 • OPTIONS TRADER . and you can add 10 indicators including a moving average of put/call volumes. In the status window. There is no limit to the number of accounts you can track. six and 10 weeks. individual gains and losses (realized and unrealized). underlying asset prices and volatility changes. margin requirements. you can view account values. summarize account values and evaluate account performance.000 volatility charts in its Background Data Base to find up to 50 underlying assets with unusually high or low statistical and implied volatility — ideal candidates for non-directional trading strategies. as well as 18 months. you can superimpose different performance charts into the current one to determine which is more profitable. OptionVue copies the box’s target price and date ranges into its TradeFinder scanning tool to find specific option strategies that profit when the underlying asset moves in that direction Volatility charts. so serious technicians and intraday traders should rely on other software to plot tick-bytick price moves and create original indicators. track open positions. Users can also overlay asset prices in these charts. highest and lowest IV/SV ratio. it moves from the Matrix to the transaction log. performance analysis. OptionVue’s price charts aren’t as detailed as its performance charts. Modeling. weekly or monthly bars. and transfers and taxes. buying power. As with all of OptionVue’s features. and three. Once you execute a trade. It’s easy to see how trade parameters shift across different dates. OptionVue’s three portfolio manager tools (Transaction log. This figure shows a short straddle that consists of at-the-money October QQQ options. delta and theta. Scanning tools Background Data Base (BDB) Survey. portfolio beta. but the variable method measures the individual IVs of each option. The program can calculate options prices using two volatility models: uniform and variable. the uniform method uses an overall average of all options’ implied volatilities. where you can edit its details. you can include slippage and commissions. interest. You can propose trades here and evaluate their characteristics. If you are evaluating more than one trade. Status and Reports) conveniently convert trades from the Matrix. its charting features are more than adequate. Price charts.
Both intermediate and serious option traders should appreciate its analytical power. Default formulas have titles such as “breakouts to the upside. The results are sorted by the difference between implied and statistical volatility (i. at expiration (solid line) and the midpoint (dashed line). TradeFinder. The “pick” line scans for assets that have current statistical volatility of 30 percent or less and current call implied volatility that is 10 percent above that value. straddles. or right-click on one or more rows to add them to any section of your quote window.. you specify one or more option strategies among 25 different types including long and short underlying positions. the TradeFinder tool can find specific option trades with the highest expected returns or largest probability of profit. assets with expensive options appear first). Also. it requires the five-day average volume of all of that asset’s options to be more than 200. and OptionVue always lists each asset with its daily options volume. which shifts the entire program back to a specific hour or date and lets you paper trade with historical data. Each scan is based on formula language that isn’t hard to learn. OpScan. which represent the profitability of a QQQ short straddle today (dotted line). The final line shows each asset’s overall implied and statistical volatility as well as the IV of its calls alone.CIV edited or created from scratch. You can build original formulas or use 12 predefined ones. 13 OTIONS TRADER • April 2005 . Up to 12 of OpScan’s predefined formulas can be copied. The top 50 suggested trades can be sorted by predicted profit.SV. volume and open interest. which gives you more flexibility. collars and butterflies. Conclusion OptionVue has an extensive list of analysis tools. but these are minor complaints. Survey results can be sorted by these categories.e.” “fat call premiums on quiet stocks” and “undervalued options based on recent market implied volatility. TradeFinder Source: OptionVue 5 looks for trade opportunities based on either underlying price movement or changes in implied volatility. Other features OptionVue offers other valuable features such as the BackTrader. and you can immediately analyze each trade in the Matrix or in a performance chart. Simply highlight a row and click the Matrix or chart buttons. strangles. This figure shows three lines. Also. Title: Pick: Sort: Show: Fat call premiums on quiet stocks SV<=30 AND CIV>SV+10 AND ATVOL(5)>200 IV-SV iIV. minimum or maximum option prices. vertical credit and debit spreads. but the program’s flexibility is its best feature. in between or above given prices at a future date. The OpScan service uses a simple formula language to explore OptionVue’s own servers via the Internet and find assets and options that have unique trade characteristics. Though OpScan is similar to the BDB survey. you can write custom formulas from more than 70 criteria here.FIGURE 3 — PROFIT ANALYSIS OptionVue plots each strategy’s projected profit or loss based on upcoming expiration dates or expected changes in implied volatility. If you have a list of assets with options that seem attractive. TABLE 1 — OPSCAN FORMULA EXAMPLE The OpScan scanning tool retrieves attractive underlying assets and options from the company’s servers. Digging into the details of these assets is easy. and current statistical and implied volatilities with relevant percentile rankings. Once you select a number of assets to explore and set the price and date targets for each. long or short options. OptionVue will only show trades that meet your criteria in terms of investment amount. The program is expensive and its stock charting features could be expanded.” Table 1 shows the main sections of an OpScan formula. the probability calculator tells you the likelihood of an underlying asset ending below.
it was not long ago that FIGURE 1 — A COSTLESS COLLAR so many people saw the value of their This collar trade. But you cannot lose any more than that April 2005 • OPTIONS TRADER . This has insurance policy. you can adjust the strategy’s components to unexpected moves in the underlying instrument to help maximize a trade’s potential profSource: OptionVue 5 Option Analysis Software (www. and you buy a put option with a $45 strike price.000 and caps potential gains at $3. Similar to an Exchange’s volatility index (VIX). Individual stocks can be hurt by company or industry specific news even when the overall market is rising. This strategy allows you to either limit a trade’s risk or protect unrealized gains. That’s why it is important to consider a trading plan that incorporates hedging techniques to limit the damage from sudden price drops. 14 Suppose you have 100 shares of stock valued at $50. Also. If the stock drops. costs the same as buying the underlying shares.optionvue. the put’s premium. excessive losses from unexpected price drops or to protect as measured by the Chicago Board Options unrealized gains in a stock without selling it. plus the put option’s cost. it protects you against losses for a fee — led to a certain amount of complacency among investors. The most commonly used option hedge is the purchase of a put option to protect a long stock position. who seem to have a short memory span. O Hedging with protective puts A hedge is a transaction that reduces the risk of an existing position. built around 100 shares of Google (GOOG) purchased at stocks plummet when the tech bubble $185. you bear the first five dollars of losses.OPTIONS STRATEGIES Hedging risk with collar trades Collar trades can help reduce the risk of a stock or futures position — and lock in gains without wiping out additional profits.com) it. After all. BY JIM GRAHAM Buying a protective put is the easiest way to prevent ver the past year. The collar trade is a hedging technique that consists of buying the underlying stock or futures contract while simultaneously buying puts and selling calls with the same expiration date.500. stock market volatility has been very low by historical standards. but it limits risk to burst. $2.
2007. The collar trade helps you work around the expense of providing continuous downside protection.00 on March 2. Since the options were essentially “free.90. You can even create a “costless” collar. While you can use options from any expiration month to construct a collar. (Figure 1’s diagonal line — $165 to $220 — is identical to the potential profit or loss of owning 100 shares of the underlying stock. This is the “floor” established by the collar. both the call and put option must have the same expiration date.) If GOOG drops below $165 by the expiration date. Costless collar example Let’s look at a collar trade example in which we don’t own the underlying stock. First. 16 15 . 2005 and the options’ Jan. Finally. To create a costless collar you need to look at the price of the various call and put options and then construct the trade so the premium you receive from selling the calls completely pays for the puts’ purchase. However. oil prices have increased by about $10 a barrel since the beginning of 2005.500 — the same as if you simply bought 100 shares of GOOG.500 ($220 .700 ($185 . you would lose $3. if the stock dropped 20 percent to $148. minus the put premium paid. no matter how high the stock price goes. 2006’s 220 call premium offsets the cost of buying the January 2006 165 put.$185 = $35 *100 shares) for those 325 days. Figure 1 shows the collar’s potential profit or loss based on Google’s stock price. 2005. 2006 expiration date. and buy the same-month 165 put. Several things could happen to Google between March 2. but you are perfectly insured below $45.$165 = $20 * 100 shares) no matter how low the stock price drops. 2006 options so that a stock sale won’t occur until the next calendar year. If the stock finishes above $45 at the option’s expiration date. For instance.00 and sold the same-month 125 call for $4. Collar trades lock you into a protected price band. on March 2. its price could remain between $165 and $220. the put expires worthless. you could have purchased the January 2006 105 put for $7. if Google rises above $220 by expiration. On March 2. the options cost nothing because the Jan. It is a very popular strategy among institutional investors. Collar that trade A collar is a hedge that confines your risk to a particular price range. sell the January 2006 220 call. which represents an unrealized gain of $25 per share. which means you would not pay capitalgains tax until April 15. but are interested in buying it. The collar trade is perfect for protecting this type of gain without having to actually sell the stock. the collar trade can’t lose more than $2. and your shares will be assigned at $220 to the call option buyer no matter how high GOOG climbs. Here.” you end up no better or worse off than if you had simply bought the stock. Assume you correctly anticipated oil prices would continue to rise and bought 100 shares of Conoco Phillips (COP) at $84 on Jan. you could construct a collar using Jan. In addition to providing low-cost protection. Collars let you lock in a trade’s profit now. an 18.$148 = $37 * 100 shares). and it can also help you defer capital gains taxes. For example. most investors will simply stop buying puts. if the stock is trading below $45 a share at expiration. This strategy’s advantage is that if the stock price goes up. which is a collar that requires no additional capital. To create the collar. they also reduce potential profits. Over a long bull market. you will gain $3. first buy a put option for every 100 shares of stock to protect against a price drop.92-percent return. both the bid price of the January 2006 220 call and the ask price of the January 2006 165 put were $15. This can be especially useful for stocks you want to sell that have substantial gains. you keep all the gains. Then. OPTIONS TRADER • April 2005 Protecting unrealized profits The collar strategy can also be used to protect unrealized gains. Google (GOOG) traded at $185. When a stock goes up and the puts expire worthless. but you do not actually sell the stock until the options expire. 3. while protective puts reduce potential losses. To construct a collar around a stock position. continued on p. For example. At that point. but you can always use this technique to at least minimize the trade’s capital requirements. However. and you only held the underlying stock. The strategy costs just $18. In this case. This may not be possible for every stock. This cost discourages many traders from buying puts on a consistent basis. traders start to complain about the put premiums’ expense. buy 100 shares of GOOG. To lock in this gain. COP traded at $109.000 ($185 . 21. both options will expire worthless. but you forfeit any profits above the call’s strike price. You are insured if the stock falls below the put’s strike price. And losses would continue to mount with every additional price drop.amount no matter how far the stock price drops below $45. a collar can be used to lock in unrealized profits without actually selling any shares. the gain from the put will equal any loss incurred on the stock below that level. and you own 100 shares of Google. sell one call option for every 100 shares to help pay for the puts. However.
collar? Just lock in the trade’s unrealized profits. and still allowed $16 of upside potential per share (i. you will receive a $50 dividend each quarter profit if it heads back up. you’ve locked Source: OptionVue 5 Option Analysis Software (www. your gain would be $4.100 ($125 .950. $3.$84 = $21 * 100 shares). In fact. appreciates.950.950.. One your stock will be assigned to the call option’s owner. Although this collar trade cost $300 more than owning COP stock outright. if the stock price ends up between $105 and $125 at expiration. the short call drops in value as the long put outcome of $1. buy Subtracting the cost of the $300 collar leaves a profit of back the short call.stock) and take your gain or loss.950 (barring a decrease about the same. Figures 1 and 2 show only what would happen if you placed It is also possible to increase your potential return by pura collar and then waited until expiration.100 profit ($105 . you borrowing the remainder from your brokerage firm. and then put a (Selling the January 2006 125 call requires you to sell 100 new collar on using an at-the-money put and an out-of-theshares of Conoco Phillips stock at $125.$400). Therefore. see “Options and dividends. This would lock in some profit while giving you more Flexibility upside potential if the stock fell back. If the stock price falls dramatically. The result will look similar to the Conoco bought COP at $84. Margin allows you to trade stock is likely to move (up or down) substantially over the securities by putting up only part of the purchase price and next nine months. You can always close the entire position (including the Let’s break down these totals to see exactly how to calcu. this core positions. option’s prices and strategies.OPTIONS STRATEGIES continued FIGURE 2 — LOCKING IN PROFITS Collar trades guarantee you’ll capture unrealized gains without sacrificing too much upside potential. It makes sense to make this type of adjustin the dividend).) Because you money call. This insurance cost only $300. Again. it delivers a minimum $1. that protection caps your profit at are not necessarily forced to stay in the position. The difference is dividends. Because you own the under.” What if the underlying stock takes off while you are in a If COP trades above $125 during this nine-month period.500 (including dividends). you’ll get three payments much (if any) additional capital because the cost of the put between March 2004 and the options’ January 2006 expiration and the premium you receive from the call should again be date for a guaranteed total profit of $1. Figure 2 shows the resulting position’s potential profit and loss based on COP’s stock price. equals a $2. plus commissions. But the underlying chasing the stock on margin. while allowing room for COP to increase further (up to $125). and then place a new collar on the stock. We structured this trade to provide maximum downside protection (down to $105). subtract the $300 cost of the collar Another possibility is to buy additional in-the-money and then add $150 in dividends — a total profit of $3. The long 105 ments you can make to increase the collar’s overall profput option guarantees a minimum selling price at its strike itability. $125 projected price . approach is to sell the put. For details about how dividends affect ment anytime the stock price has dropped roughly 20 percent. there are several ways to trade around your price. But after placing this trade.and worst-case scenarios.optionvue. But there are often adjustlate Figure 2’s best.$84 = Phillips example (Figure 2).sell-offs at the current price while still allowing additional lying stock.e. $41 * 100 shares).50 per share. However.$109 current price). sell the long put.50 * 100 shares).950. Because this is not a costless collar. $1. and since you bought Conoco Phillips at $84.com) in a gain of at least $1.800. buy back the call.950 profit while allowing a maximum gain of $3. Yet this is $150 less than Figure 1’s worst-possible In this case. or the net difference in price between the options ($700 . you will make $300 less than if you simply held the stock. For 16 April 2005 • OPTIONS TRADER . Note this is not a “costless” collar like the previous example. This adjustment should not require ($0. puts (one for every 100 shares of stock) against the collar. Conoco Phillips pays a quarThe new collar will then protect the stock against further terly dividend of $0. When large stock price moves occur.
4. When a strategy includes a long position in the underlying stock (e.ivolatility. Managing your positions Current low-volatility market conditions are a great time to adjust your portfolio and improve your risk profile.250.Options and dividends D ividends need to be considered when entering any trade involving a stock. you must typically deposit 50 percent of the trade’s cost (i.” Active Trader.g. If you own stock. the dividends you will receive over the life of the trade will affect your probable gain and loss.92 percent.com/calc/. 2-to-1 leverage).htm Allison Ellis Ad sales West Coast and Southwest aellis@activetradermag. or index options.com (312) 775-5421 HIT YOUR MARK! Related reading box “Putting volatility to work.500 and had a maximum potential profit of $3. The collar trade’s advantage is that it works well in all kinds of markets. Traders also need to understand how dividends affect option prices.e. The stock price will also drop by the dividend amount on its “ex-dividend date. To calculate the fair value of various types of options using several variables (including dividend yield). Dividends impact a stock’s price. “Technical Tool Insight: Volatility Index (VIX). April 2001 VIX for beginners: an analysis of the CBOE volatility index (VIX). you’re entitled to receive any dividends paid. You can purchase and download past Active Trader articles at www.62 percent of capital instead of the original 10. which doubles the collar’s potential return (in percentage terms) to 37. look for ways to hedge your downside risk. If you choose to use margin to purchase the stock.. you need to pay dividends to the lender.com (312) 377-9435 OTIONS TRADER • April 2005 17 . which impacts your decisions and could cause you to enter a trade that might not have been a good idea after all. and it’s easy to adjust as market conditions change.” or the first day the security trades without its dividend (i.com (626) 497-9195 Mark Seger Account Executive mseger@activetradermag. which in turn influences option prices. For example. In Figure 1. a covered call or collar trade). If the bulk of your portfolio consists of individual stocks.activetradermag. and if you’re selling short. High-cash dividends imply lower call premiums and higher put premiums. 100 shares of Google cost $18.” Active Trader. you only need $9. stock options. using margin also means that your potential losses also double. option prices anticipate dividend payments in the weeks (and months) before they are announced..500 — a possible return of 18. if you don’t take this step when entering trades that include a long stock position. However. It is a low-cost way to provide downside protection. you’ll substantially underestimate potential profits.com/purchase_articles.81 percent. For example. Advertise in Active Trader and Currency Trader Magazines Contact Bob Dorman Ad sales East Coast and Midwest bdorman@activetradermag. stocks.000 loss actually represents 21. Not including dividends when analyzing a potential option trade may make an option seem up to 15 percent undervalued at times. While the stock drops by the dividend amount in a single adjustment. For information on the author see p. for example.e. if Google trades no higher than $166 at expiration. you must own it before this date to receive the dividend). This also applies to trades that involve options on stock indices. the collar’s $2.. Questions or comments? Click here. The expected dividends to be paid by all the stocks in an index (adjusted for each stock’s weight in the index) need to be taken into account when calculating the fair value of index options. visit www. protect existing gains. April 2001 How to make practical use of volatility in your trading.84 percent if the underlying hits or exceeds the call’s $220 strike price.
OPTIONS STRATEGIES Event-driven straddle trades Options can allow you to profit whether the market goes up or down. The following discussion outlines a set of criteria for taking advantage of potentially significant stock moves triggered by these kinds of events and illustrates the results by walking through trade examples. justifying the expense. either up or down. while the option buyer is willing to pay more because of the potential for a price gap. the premium you pay is expensive relative to just buying one or the other outright. and the number of times they occurred. and this category appeared only eight times per year. Circumstances that can have a dramatic impact on the price of a stock include the results of a Food and Drug Administration (FDA) hearing. but the approach won’t do you much good if you pick the wrong options under the wrong circumstances. straddle premiums seem ridiculously expensive. It is rare for a stock’s options to get extremely expensive for at least four consecutive days prior to an earnings announcement. The option writer demands more for an option because of the increased level of uncertainty in these situations. by the underlying instrument. Because a decision from the FDA or a categories of market-moving events that drove the high implied volatility levels. no one can predict the direction the stock will move — up or down. To determine whether a straddle was a good opportunity. and for which the ex-dividend date (the date at which the stock price is lowered to TABLE 1 — WHAT’S THE BUZZ A number of events triggered high implied volatility in options from January 1997 to February 1998. Reactions to FDA rulings are generally about 2. Table 1 shows the different “Stock splits” refers to stocks that have already announced their splits.com Number of cases 12 8 1 9 13 5 Events that drive volatility Option premiums often rise before FDA 18 April 2005 • OPTIONS TRADER . jury can’t be known in advance. a lawsuit verdict or — to a lesser degree — a potentially volatile earnings announcement. 1997.5 times as big as those from earnings announcements. The underlying market has to move a considerable distance — and quickly — to generate a profit. McMILLAN uying an option straddle is the simultaneous purchase of a call and a put with the same strike price and expiration month. This ability to profit regardless of market direction is a major reason many traders are attracted to long straddles. The next step was to identify stocks that appeared on that report four or more consecutive days. according to their appearance in the High Implied Volatility section of the Daily Volume Alert report (www. In some situations going long a straddle is appropriate. BY LAWRENCE G. 1. 1998. we reviewed stocks whose options were trading at extremely high implied volatility levels from Jan. but the opposite side of this coin is that the underlying stock will often move a great deal. to Feb.optionstrategist. There were 48 such situations. Traders use this option strategy to take advantage of sudden price moves. 1. such as before a major event that could dramatically move the underlying instrument. B hearings or lawsuit verdicts because option traders believe the news will make the stock gap in price. because you are purchasing both a call and a put. Here are some ideas to help you put on trades that have a better chance of succeeding when news moves the market.optionstrategist. In many cases.com). Reason for high volatility FDA hearings Earnings announcements FTC decisions Stock splits Takeover rumors Unknown reason Source: www. However.
20 OPTIONS TRADER • April 2005 19 .63 -5 Finally.44 -69 announcements.81 -7 ing” column is the price at which the ATIS 13. We were interested only in those situations for which there was a publicly known date when information will be released that could drive the underlying stock. such items are takeover rumors.75 -3. Keep in mind the stock had to have extremely expenEarnings category: sive options for at least four days prior to the known date of the QNTM 36. However. continued on p.44 -0.25 -43 Federal Trade Commission (FTC) AIMM 4. the option volume in these Average: 11% cases did not provide any reliable * Move continued for another day or two clues. the MACR 9.88 -8.25 -61 shows the actual moves that IPIC 19. but at the time there was no identifiable source for the rumor. ORG 22. large dayAPCC 23.88 +5 announcement is due.38 +12* If the market is open when the GDT 60. we will compute the initial straddle price four days after the implied volatility registered extremely high levels. Furthermore.13 -5. category: This narrowed the list to FDA and REGN 10.75 +0. This eliminated “unknown” and takeover rumors. Stock splits also were discarded because in these cases the options were expensive only because the TABLE 2 — REACTING TO THE NEWS market makers raised their offers in This list of reactions to news events the face of increased demand from reveals FDA/FTC rulings have much people trading the “split phenomemore impact on the market than earnnon” (the supposed tendency for ings announcements.50 -11* large move in either direction. the Symbol Stock Price Net high implied volatility is not prereopening change percent dicting a volatile stock movement FDA/FTC per se.50 +4 stock reopened. there were situations for which this date was not available. reflect the split) is approaching.88 +2.56 -15.38 -12. although no major ones occurred during the test period. as no one knew the news in Source: www. Table 2 LIPO 9. and the “Stock reopenCEPH 10.25 +9 announcement. atthe-money straddles.63 -4. Clearly. stocks to rally after stock splits).25 -7.06 +2.88 +13 one were able to guess the direction TCNL 22. CORR 12.00 -35 fit the study parameters.50 -24 times as big as those from earnings Average: 27% announcements.com advance. Twenty-one cases CEPH 13.00 -7.56 -2.optionstrategist. “Unknown” refers to situations in which the options became expensive and then returned to a lower implied volatility without a news item to account for the temporary rise.00 0 the stock was going to move after TSA 17.63 +14 Table 2 shows the reactions to CYTC 23.00 -17* fact the options were so expensive indicates there was a possibility of a JBIL 59. and earnings announcements.00 +4. Stock FDA/FTC category: REGN AIMM CEPH LIPO IPIC PLC CORR GDT CEPH ATIS ORG CYTC ODP Earnings category: QNTM APCC ORCL TCNL TSA MACR JBIL BJS Implied volatility Before After Gain/ loss 121 145 144 113 129 151 163 62 141 159 145 99 106 92 141 88 85 69 110 70 52 90 55 80 64 73 143% 72 26 87 -41 111 -26 -2 -15* -60 -40 -6 -4 Average: +19% 78 115 75 70 89 98 113 46 56 86 40 51 70 73 76 41 Average: -18 -45 -11 -43 -20 12* -22* -10 -20% * Move continued for another day or two Source: www. In all likelihood.31 -9. Although we have stressed it was necessary the date of a pronouncement be publicly known.88 +20 FDA rulings are generally about 2.88 +1.75 +10 occurred when the anticipated PLC 13.TABLE 3 — STRADDLE PERFORMANCE The long straddles triggered by FDA/FTC announcements performed much better than those based on earnings announcements.13 0. BJS 71. Lawsuits would normally be included.13 -48 announcement eventually occurred.5 ODP 17.88 -17 trading profits would be available if ORCL 41.00 -14 the announcement.38 +3.com Straddle performance In analyzing how a straddle performed in each of these situations we will consider only the near-term.38 +3.25 +1. trading is suspended.63 -3.optionstrategist.
g. If you know why volatility is high (e. and consider selling them in advance of earnings announcements uations in which a considerable amount of time elapsed between the fourth day of high volatility and the day before the FDA announcement. Hence. earnings situations or stock splits. proceed. CORR -26 same GDT CEPH ATIS ORG ODP Average: 2 -15 -60 -40 34 29% slightly better same same same somewhat improved Enhancements One way to improve profits would be to wait until the day before the FDA hearing to buy the straddle. They should be bought only in anticipation of FDA or FTC hearings. 4. everyone knew the FTC was reviewing the Office Depot (ODP) merger. This way. resulting in a potentially large loss. Table 3 shows the option market did a pretty good job of predicting how far Traders should buy straddles before FDA or FTC events. As a there was a considerable delay between the result. the general level of implied volatility after the stock made its gap move (“Implied Volatility After”) and the net gain or loss from buying the straddle.optionstrategist. options traders often pay fourth day of high implied volatility and the too much for straddles in actual FDA/FTC announcement. no matter what the FDA decides. In such cases. see if the date of the event can be determined with certainty. the stock will move away from the straddle’s strike price.com 20 . If you do not know why implied volatility is high. advance of earnings announcements. Don’t buy straddles on takeover rumors. If the date is definite.” Table 3 shows the implied volatility of the options on the dates the straddles were initially bought (“Implied Volatility Before”). but in general there was still room for the long straddle to make money in the FDA/FTC category. Stock Net Results Regarding companies await(Straddle bought straddle ing the results from FDA hearon last day) buy profit ings. CEPH 104 much the FDA often surprises everyimproved one and the stocks move (norLIPO 157 much mally. A better approach is to wait until the day before the FDA announcement and buy an atthe-money straddle. but no one knew the exact day on which the ruling would be handed down — only that it would be within the “next few days. To buy straddles on stocks prior to FDA/FTC hearings or jury verdicts in lawsuits: 1. more or less consecutively. it is possible for the stock to rise or fall during this period. Once the reason for the high volatility is validated. lawsuit verdicts or similar events. and consider selling them in advance of earnings announcements (“consider” because commissions work against the straddle seller. Recall that the results in Table 3 assumed the straddle was bought after implied volatility had been extremely high four consecutive days. Hence. traders take positions FDA/FTC based on the analysts’ projecCategory: tions for what they expect to REGN 143% same happen.OPTIONS STRATEGIES continued For example. Table 4 lists those sit- Source: www. 2. owning straddles is profitable PLC 58 worse going into an FDA ruling. only to move back to where it was on the day you bought the straddle. traders would actually make money by writing (selling) the straddles. it is generally apparent that traders should buy straddles before FDA or FTC events. However. an FDA hearing is imminent). As far as earnings go. there is often an overly optimistic “whisTABLE 4 — THE WAITING GAME per” number that circulates This table shows straddle performance when among aggressive traders. do not buy a straddle yet — wait for a reason to become evident. 3. fall) far more than anticiimproved pated as traders liquidate on IPIC -41 same the disappointment. Here are some guidelines for trading straddles immediately before a news announcement. too. wait until the day before the event and buy straddles. and don’t leave much room for profit). Wait for implied volatility to be extremely high for four days. In the earnings category..If you can’t determine April 2005 • OPTIONS TRADER these stocks would move. and those are often AIMM 72 same positive projections. A quarter point was deducted for slippage and commissions.
the straddle had been trading at approximately 9. • Get your free 2. In this case. If you had purchased the straddles in the morning. daily 30 the date with certainty. 9. All you can do is determine that the options have gotten very expensive. which shows that a price trend is not a reliable predictor of the outcome of this kind of event. Waiting until the last possible minute to buy the straddle minimizes time decay during the trade and increases OPTIONS TRADER • April 2005 10 April May June July August Source: MetaStock Professional (www. the OCT 17. Using the trade rules. a research paper concerning UTHR was posted on the FDA Web site. the stock fell more than 60 percent. 22 www. the straddle would be far too bearish. written by one of the advisors to the committee that was going to rule the next day.5 straddle was trading at 6. In this case.com) the odds of still holding the straddle when the news is announced.FIGURE 1 — FDA REJECTION When the FDA did not approve Liposome’s drug application. If the FDA meeting drags on.5 straddle the appropriate strike. the stock collapsed from 25 to 9. It’s important to remember that no one knows what the FDA will decide. Liposome Technology (LIPO). An FDA meeting was scheduled for July of that year. Prior to the announcement. 2001 (Figure 3). in which case the event-driven long straddle strategy is appropriate. In this case. and not nearly neutral enough to profit from an up move in the stock.week trial to our daily trade recommendations. The stock dropped nearly $10 after the news.50. it is not efficient to buy the OCT 25 straddle several weeks ahead of time. the stock had been rising. so the 16-point drop in the stock price resulted in a substantial profit.63. the strategy is to buy the shortest-term straddle that makes sense in a given trade situation. • We provide an outstanding combination of service and market insight.metastock. including trades that did not work out as planned. trading in the stock could be halted for a day or two. United Therapeutics (UTHR) announced it would be appearing at an important FDA hearing on Aug. The next two examples show that sometimes other events can get in the way of the one you’re trying to trade. and implied volatility expanded as the announcement approached. When the FDA rejected the company’s drug application. only to find the stock trading at 20 or lower on the day of the FDA meeting. Figure 2 shows the same stock in September 1999. 8. The stock was trading around 12. 5. The paper continued on p. you were in for a wild ride. buy the straddles on the fourth day of high volatility. you would buy straddles on Aug. • Call today and get your commission rate quote! 800-273-4899 / 312-663-7887 21 . 20 15 Trade examples Figure 1 shows Liposome Technology (LIPO) in the summer of 1997. during the previous month. This would have produced a substantial profit for a long straddle position. advantagetraders. 16 was the day before expiration. In that case.Exit immediately after announcement is made. so do not look for guidance in a stock’s price action leading up to an announcement. which means you would buy the October at-the-money straddle. As explained last month.com A division of Man Financial • Come get the advantage only institutional customers are accustomed to. making the AUG 12. the 25 This month’s article includes examples of the event-driven straddle approach. Sept. Late in the trading day. In this case.
For example. UTHR stock plummeted to 8.5 13.5 14. Sept. despite the seemingly overpriced nature of the options at such times.5 15. The next day. And although naked call sellers would have come out OK in the MATX situation.5 11.0 12. there is no way a covered writer would have been protected down to a price of 1.5 straddles.0 11. Avoid selling options — covered or otherwise — in these situations. the company’s drug was approved. At the time.OPTION STRATEGIES continued FIGURE 2 — BUYING THE RIGHT STRADDLE Although Liposome again tanked after a negative encounter with the FDA. As a result.0 15.0 10. On Aug.metastock.5 12. 10. traders who bought their straddles too soon would not have reaped the full benefits of the trade.5 9. When the stock finally reopened — after the trading interruption following the terrorist attacks — it did so at 1! The long straddle strategy was still sound (the straddles cost less than 6. What appeared to be a perfect straddle trade turned into a loser. . a negative opinion paper was released by an FDA researcher and posted on the FDA Web site. 7.com) essentially said the drug being reviewed did not work and should not be approved. even April 2005 • OPTIONS TRADER 18 25 2 9 July 16 23 30 6 13 August 20 27 Source: MetaStock Professional (www. There was no trading in MATX that day or the next — which was the day of the hearing itself. 2001. 9. Many a covered writer has been buried when the underlying stock plummets after a negative FDA announcement. Matrix Pharmaceuticals (MATX) had announced an FDA hearing for Sept.5 strike price. Liposome Technology (LIPO). even if you execute the trade correctly (waiting until the day before the announcement.0 9. setting up a straddle purchase on the preceding trading day — Friday. UTHR reopened at 14 the next day.metastock.com) FIGURE 3 — BAD NEWS BECOMES GOOD NEWS…AND A BAD TRADE A negative report on the FDA Web site sent United Therapeutics tumbling. they will not when market-moving news is positive.5 16. Not covered It is not a good idea to put on covered writes or other option selling strategies in advance of FDA announcements (or similar chaotic events). Naked put sellers would have suffered the same fate. however. United Therapeutics (UTHR). Another example further illustrates how the current era of instantaneous and far-reaching communications can impact any trade. daily 30 25 20 15 10 July August September October November Source: MetaStock Professional (www. Perhaps the lesson to learn here is that.75 in the last few minutes of trading on Aug. 8. however.0 13. but the implementation became a little more difficult because of the release of information on Web sites in advance of the hearings. the stock was trading near 7 (Figure 4). before the stock opened for trading on Friday.5 10.0 14. the straddle purchase was not profitable because the stock wound up just slightly above the 12. so we were preparing to buy the September 7. in this case). in the MATX situation. However.5 4 10 24 September it doesn’t guarantee a winning trade. daily 17.0 8.0 16. the FDA committee met (trading in the stock was halted all day) and approved the appli22 cation.5).
metastock. On the other hand. 11 hammered Matrix Pharmaceuticals. during October the underlying market was behaving much as an individual stock does prior to an important event: trading in a range — despite the very high VIX readings. shown in Figure 5. 24 23 . making it more difficult to execute straddle trades. 11 terrorist attacks. The broad market Because market indices are collections of stocks. even though index options might be expensive. the constant scary stories on TV about anthrax. there appeared to be potential for a sharp upside price move as well. The math can’t accurately estimate the scope of the chaos that will follow the event. Thus.20. One such opportunity developed in the aftermath of the Sept. That the broader market was relatively unchanged while the OPTIONS TRADER • April 2005 Source: MetaStock Professional (www. At this point. Matrix Pharmaceuticals (MATX). The DJX is oneone hundredth of the Dow Jones Industrial Average (Figure 6). the unknown variable in this scenario was the timing of the event. reflecting the market’s deeply oversold state. daily 12 11 10 9 8 7 6 5 4 3 2 1 0 23 30 6 August 13 20 27 4 10 24 September 1 8 October 15 22 29 though such strategies seemingly appear to be mathematically attractive. During mid- October. as reflected in very high readings in the CBOE volatility index (VIX). Moreover. However. 11 attacks. The Internet has made it easier to quickly disseminate information that can affect stocks. any dramatic news affecting one company is unlikely to make the event-driven straddle strategy a worthwhile approach for trading index options. Everyone was concerned about the possibility of more terrorist strikes. which would very likely produce a sharp. terrorists attacks and the seemingly growing worldwide unrest over the bombing of Afghanistan. However. This is akin to the event-driven straddle buy setup for individual stocks. we would need a move of 620 points in the big continued on p. This created an opportunity to execute an event-driven straddle trade on index options. daily 60 55 50 45 40 35 30 25 20 23 30 6 13 August 20 27 4 10 24 September 1 8 October 15 22 29 Source: MetaStock Professional (www. Option implied volatility increased dramatically. the DJX was near 94. and the NOV 94 straddle was selling for approximately 6.metastock. Implied volatility had risen in anticipation of another chaotic event taking place and stayed high during October. downward gap in the stock market.com) VIX was high offered the opportunity to execute an event-driven straddle buy in index options for those who expected a big movement.com) FIGURE 5 — HIGH VOLATILITY The CBOE Volatility Index (VIX) reached extremely high levels in the days following the Sept. nearly all put/call indicators at the time were giving buy signals. CBOE Volatility Index (VIX). it was important to evaluate what the Dow Jones (DJX) straddle might be worth for the November expiration.FIGURE 4 — TOO MUCH INFORMATION A negative report on the FDA Web site and the terrorist attacks of Sept. the market’s potential for extreme movement is great. so to profit from a long straddle.
optionstrategist. This was one of the most difficult times in history to predict volatility because of the potential for chaos. However. the 10-day historical volatility of the DJX at the time was 18 percent — something fairly in-line with the long-term history of the broad market.64. 18 was to buy DJX NOV 92 calls (DJVKN) at 3. at option expiration. which was more than the cost of the straddle. which uses a mathematical technique called Monte Carlo theory to predict the probability of a stock hitting a target (or targets) at any time during the life of the trade. Considering the results from Table 5. Dow Jones Industrials (DJX). the 20day historical volatility was 30 percent. The probabilities were derived using www. daily index prior to expiration. if we use the lowest estimate of volatility (18 percent) there is a 58 percent chance that the Dow can move 620 points either up or down at some time prior to November expiration. Both of these probabilities are quite high. For example.com’s Probability Calculator 2000. For more information on the author see p. Questions or comments? Click here. then determine if they are trying to adjust for the outcome of a government hearing or a lawsuit. there is a 92percent chance the Dow will move 620 points. A version of this article previously appeared in Active Trader magazine. What was the probability of the Dow being able to move 620 points between mid-October and the November expiration? Any probability estimate is very dependent on what volatility we expect the Dow Jones index to have during the life of the option.metastock. However. it’s more reliable to have these probabilities relate more to a real-world environment. DIFFERENT PROBABILITY Volatility 18% 25% 30% Estimate of hitting breakeven 58% 82% 92% Source: Probability Calculator 2000 (www.com) below a target price at the end of a study period — say.10 and buy the DJX NOV 92 puts (DJVWN) at 3.optionstrategist. Hence. Careful analysis and conservative interpretation of the guidelines at the beginning of this article (and in last month’s article) will help you focus on the best trade setups. At that time the DJX was 91. the probabilities are shown in Table 5. Most free online calculators allow you to estimate the probability that a stock will be above or 100 95 90 85 80 10 24 September 1 8 15 October 22 29 5 12 19 November Source: MetaStock Professional (www. Figure 6 shows that the DJX rose to almost 100 by expiration — a move of more than 8 points (equivalent to a move of more than 800 points by the index itself). this was something of an event-driven straddle buy in the broad market because — as is the case with individual stocks — the options were seemingly expensive but in reality failed to account for the full effect of the chaos potential of the underlying market. A sector to watch Because event-driven straddle trading works best in FDA. 4. increasing activity in the biotech sector should lead to many more opportunities for these trades. The position on Oct. April 2005 • OPTIONS TRADER 24 .and FTC-related situations.OPTION STRATEGIES continued FIGURE 6 — DOW JONES INDEX OPTIONS The price of the Dow Jones index options moved more than 8 points from October to November — a substantial move that resulted in a successful trade for straddle buyers. Which volatility measure should be used in trying to estimate the probability of the DJX being able to move 620 points over the course of one month? Although there is no definitive answer. However.40. as the Monte Carlo simulation does. Watch for options that are overly expensive. if we used the highest volatility estimate of 30 percent (which would probably not occur unless chaotic events took place on either the upside or the downside). because this longer time frame contained some of the chaotic trading days following the terrorist attacks.com) TABLE 5 — DIFFERENT VOLATILITY.
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These are good reflective tools.The underlying stock must move in the predicted direction. short interest.The move must be sufficiently large to overcome the option’s time premium. however. You can beat time decay only if the underlying stock moves quickly in the proper direction. 26 even if they are “option wizards. Most stock pickers tend to use some combination of fundamental technical analysis to predict future price movement. 2. and the option open interest configuration: Find out what these “sentiment” tools represent and how you can trade with them. That’s the foundation for a profitable optionbuying program. successful options trading does not result primarily from your knowledge of options or options strategies. the option will expire before the move unfolds. BY BERNIE SCHAEFFER AND JON LEWIS S hort-term option buying can be lucrative. option trading will only magnify this inadequacy. In other words.OPTIONS STRATEGIES Options and sentiment analysis Put/call ratios. they still achieve substantial gains because their winning trades take in far more dollars per trade than their losing trades give up. The challenge is to pick stocks that meet the previously outlined conditions. price-to-earnings ratios.This move in the predicted direction must occur quickly. The need for speed There are three conditions the underlying stock must satisfy for an option buyer to achieve a substantially profitable option trade: 1. otherwise. 3. Accordingly. but there is a reality that all option traders must face: You will have losing trades. speed allows the leverage of the options you buy to overwhelm their inherent time decay. but they are not very helpful in forecasting short-term stock prices. However. successful options buyers almost always have more losing trades than profitable ones. magnitude and speed of the underlying stock. the key factor is your ability to correctly forecast the direction. something that is critical for the time frames in which option traders operate. Contrary to what you might think. Generally speaking. it is imperative that winning trades yield substantial profits for a trader to be successful. dividend yields and other well-known fundamental indicators are not particularly useful for short-term options trading. While such knowledge is necessary for successful trading. In fact. April 2005 • OPTIONS TRADER . Poor stock-pickers will never profitably trade options.” In fact. Option buying is a constant battle between the leverage that options pro- vide and the time decay that will inevitably occur.
If expectations for a stock are relatively low. Expectations are critical because a stock’s price represents traders’ and investors’ perceptions of reality — and these perceptions are often excellent contrary indicators. and give a good indication which way the underlying position will move. low put/call ratios indicate a point at which there is so much optimism that very little money is left to push the stock or index higher. magnitude and speed of the underlying stock. Once a trend reaches the magazine-cover level of awareness. it is almost certainly at its peak. High put/call ratios often indicate excessive pessimism and. Quite simply. We’ll take an in-depth look at a few of the most useful. as the price adjusts itself lower from its unrealistic heights to better match reality. However. which can enhance the reliability of technical and fundamental signals. as the “last to know” in the investing public finally gets the word. For that reason. Option open interest is a highly effective means of measuring investor optimism and pessimism. Another factor is the short-interest ratio. Low ratios (around 2. they don’t provide a clue about the magnitude or speed of the move. It can provide you with a tremendous edge in evaluating the price movement of individual stocks and the market as a whole.e. Technical charts are useful for identifying trends and support and resistance level to one that reflects the real world. Cover stories are most effective as contrarian indicators when several publications have a similar theme with similar concluding remarks. as skeptical investors wait on the sidelines. their confluence does not ensure future strength. Magazine covers. This excess demand drives the price even higher. because negative sentiment in the context of strong price action often implies a resumption of the prevailing trend. When open interest data is displayed in the form of put/call ratios. high expectations usually mean that most of the sideline money has already been committed to a stock. which is the number of shorted shares divided by the stock’s average daily volume. Higher ratios (6. as the stock price will rise from an artificially low OPTIONS TRADER • April 2005 Sentiment tool kit There are a number of tools traders can use to gauge investor sentiment. increasing short interest indicates the general outlook for the company is negative.0 or lower) suggest the shorts could be covered in just a few days and would not likely impact a stock’s price move. and when a business story is featured on the cover of a general news magazine (e. focus on the front three months of continued on p. In fact. Put/call ratios. large amounts of money on the sidelines. A stock needs a catalyst to give it the necessary boost to power higher following an earnings report or quickly decline following an encounter with overhead resistance. Conversely. Time. Short interest. low expectations translate into potential buying power. it is most useful for gauging whether a stock is poised for a rally or vulnerable to a sell-off. they are a direct indication of how much buying or selling is going on at a precise moment). It’s important to note that contrarian views of public sentiment often prove to be more reliable than those of institutional sentiment. The covers of business magazines are often amazingly accurate contrary indicators. sentiment analysis — the study of the beliefs and convictions of traders and investors — is often the most important factor in stock selection.0 or greater) could result in a short-covering rally if the stock continues to gain ground. Open interest represents the number of open contracts on an option at the end of each day..Although technical analysis is certainly not a fail-safe method for predicting price movement. 28 27 . there is a good chance of a rally. Put another way. the trend is very likely at or near its peak. On the other hand. it has an advantage: Price and volume patterns are grounded in the “real world“ of how investors are currently viewing a stock or market (i. Buyers are now scarce and selling will dominate on any perceived negative news. Newsweek) the contrarian implications are even stronger. Short interest measures how many shares of a particular stock were sold short during a specific period of time.) Monitoring a stock’s monthly short interest provides an idea of the public’s level of pessimism toward the stock. allowing the short seller to buy the stock back at a lower price. profit-takers. This additional ingredient is investor expectation. In most instances. levels. (A short-selling strategy is profitable when the price of the stock declines. ready to bolster a stock’s appreciation by buying up the supply from The key to successful option trading is not knowledge of options or option strategies. resulting in a price decline. thus. high expectations can ultimately put downward pressure on a stock. it’s the ability to correctly forecast the direction. Magazine covers work as contrary indicators for a simple reason: A trend will be featured on a magazine cover only when it has been in place long enough to become widely known and almost universally accepted. Conversely.. The option-buying edge Although strong fundamentals and technicals are usually necessary for a stock to move higher. This pessimism is bullish for the stock if it is in an uptrend.g. when a magazine cover features a stock or an investment trend (either bullish or bearish).
00 20. those who sold these options to specu28 become a very significant factor as the options approach expiration. From a longer-term perspective. Ratios that are among the highest of the past year suggest a relatively extreme level of negative sentiment. Oct. something most companies wouldn’t (or couldn’t) do. the company had made an impressive showing in the second quarter of 2001. let’s take a look at an early October 2001 call option trade in Krispy Kreme Doughnuts (KKD). From a fundamental perspective. which had turned back a rally in late August (see Figure 1). Apr. Nov. which is where the retail speculators tend to gravitate. In addition. Option open interest configuration. Comparing a stock’s ratio to its previous ratios is an “apples to apples” gauge that provides a more accurate picture of sentiment. and was supported on an even longer-term basis by its 10-month MA (inset). Another way to use open interest is to examine the “open interest configuration” of the underlying stock. which is the number of open puts or calls at its various option strike prices. Trading with sentiment To see how sentiment indicators combine with technicals and fundamen- with profits soaring 65 percent from the same quarter a year earlier. A high level of call open interest identifies a potential point of extreme market optimism that usually coincides with a drop in buying strength. which usually coincides with a lack of selling strength. the stock had rallied (and closed) above the 10-week moving average (MA). It can provide a tremendous edge in evaluating the price movement of individual stocks and the market as a whole. the stock was bouncing off the support of its rising 10-month MA (see inset on Figure 1). Moreover. weekly Monthly 40. call sellers can tals. KKD reaffirmed earnings guidance for the rest of the year. It can be analyzed by plotting a chart with adjacent call and put bars representing the open interest at every strike price (typically for front-month options). By comparing the current put/call ratio to previous readings for that stock.00 25. Krispy Kreme Doughnuts. A high level of put open interest reflects a level of extreme pessimism toward the stock. Sentiment analysis — the study of the beliefs and convictions of investors — is one of the most important factor in stock selection. Also. KKD’s solid fundamentals were backed by strong technical signals: The stock had rallied above the 10-week moving average (MA).00 2001 Feb. and they must eventually buy these shorts back. Mar. This approach is effective in determining possible resistance and support levels.00 20. Sept.00 30. Inc.00 25.OPTIONS STRATEGIES continued FIGURE 1 — TECHNICAL FACTORS options data. KKD hadn’t closed above its 10-week MA since mid-July. In early October. (KKD).00 40. In fact. especially at strike prices with the highest open interest for the month. Each stock’s put/call ratio behaves differently and has its own particular timing implications.00 35. May June July Aug. This is extremely important because absolute readings can vary substantially from stock to stock. On the technical front.00 30. because they generally own stock they can sell to create overhead resistance. you can accurately gauge relative levels of investor optimism and pessimism. The opposite is true for a ratio that is among the lowest of the past year. April 2005 • OPTIONS TRADER . The opposite applies to puts. which can have bullish implications for a stock with strong fundamentals and technicals.00 35. Source: TradeStation Platform by TradeStation lative investors may buy the underlying stock to balance their bearish positions. These long positions will ultimately be sold when the options expire or the call buyers unwind their positions. This suggests it will take less selling to change the stock’s direction. Comparing ratios also allows you to see if current readings are among the highest or lowest readings of the past year. Put sellers may short the stock to balance their bullish position.
Incorporating these tools will allow you to take advantage of opportunities the crowd has not yet discovered. investor sentiment was clearly entrenched in the pessimistic camp.00 200. KKD’s short-interest ratio was just under eight.500 4. Also. 505. because there would likely be many skeptical investors waiting to jump on the bandwagon if the stock continued its renewed ascent. reducing the impact of time erosion. see p. This concentration of puts set up the possibility of optionrelated downside support at that level. the broader market.500 3. investors had been adding puts at the 30 strike. KKD’s weekly relative strength vs. which made the stock vulnerable to a short-covering rally. calls outnumber puts.000 4. though. The stock ended up making a major run over the subsequent week. a large stock move was needed to produce a substantial return on the $1. the stock overcame the level with the greatest call open interest and the potential resistance that such high levels often provide. or bets the stock would decline in value.500 1. For most stocks.000 500 0 Call Put 22. a long position in the November 35 call was established.500 2. FIGURE 3 — OPEN INTEREST CONFIGURATION KKD’s open interest configuration (the number of open puts or calls at its various option strike prices) rounded out a bullish scenario. because the stock’s move was: in the right direction. This sets up an ideal bullish scenario. Jan. was KKD’s relative strength vs. the call’s strike price was more than four points above the stock price). This was only possible. the stock’s open interest configuration added to the bullish picture (see Figure 3). 2001 April July Oct. meaning that puts and calls were about equal among options expiring within the next three months. By moving above 30. This created the possibility of option-related downside support at that level. For more information on the authors.00. so this ratio suggested a relatively high preference for puts. My sentiments exactly Combining sentiment indicators with technical and fundamental tools provides an extra edge in gauging expec- Questions or comments? Click here.10 option premium.000 1.00 250.5 25 30 Strike price 35 40 Source: Schaeffer's Daily Sentiment ing a profit of 140 percent on the call option position from a 16. making it the level for peak put open interest in the October option series.00 350. The stock’s weekly relative strength vs. though.e. it raced above 35 in just four days. of sufficient magnitude. Analyzing option data revealed the stock’s put/call ratio was hovering around 1. making it the level for peak put open interest in the October series. In fact. 5.000 2.5 percent move in the underlying stock. A version of this article previously appeared in Active Trader magazine. In fact. Investors also had been adding puts at the 30 strike. Furthermore.FIGURE 2 — RELATIVE STRENGTH Perhaps the strongest technical case. The number of shorted shares stood at more than 8 million.98 July 2000 Source: ILX Systems Oct. the stock had outperformed the S&P by more than 250 percent since its IPO in April 2000.000 3.. Despite these factors. the S&P 500 (SPX) had just made a higher high after a pullback in a powerful uptrend (see Figure 2). Finally.47 450.00 150. By moving above 30. Because this option was more than four points out of the money (i.00 300. tations of market participants and selecting profitable option trades. With the stock at 30. the S&P 500 (SPX) shows it had just made a higher high after a pullback in a powerful uptrend. 4. the stock overcame the level with the greatest call open interest (and the potential resistance such high levels often provide). 29 .00 99.62.00 400. which represented more than 15 percent of the shares outstanding. producOPTIONS TRADER • April 2005 KKD had dramatically outperformed the S&P since its IPO in April 2000. and occurred quickly.
let’s consider some possible rationales for the participants in our hypothetical real estate scenario. and the writer keeps the money (and can turn around and sell or option the script to someone else). futures and other financial markets operate on the same principles. Because he’s not required to purchase the property — he simply has the right to do so while the option is in effect — his risk is limited to what he pays for the option.000 for an option on his script. a common practice in real estate is to buy an option on a piece of property: You give the property owner some money. if he bought the property outright and real estate values plummeted. but learning a few basic concepts will remove much of the mystery and BY OPTIONS TRADER STAFF intimidation. It’s called buying an option. and sell those. By purchasing an option on a stock.000 an acre during that period. Options on stocks. Here’s what you need to know to get started in the world of puts and calls. you can acquire the right to buy or sell that stock at 30 a specific price for a certain period of time. the option buyer has effectively doubled his money (less what April 2005 • OPTIONS TRADER . In the movie business. This concept is just as much a part of the real estate and movie industries as it is the financial markets. For example.OPTIONS BASICS Options can seem complex. you could buy an option that would give you the right to buy Oracle (ORCL) at $30 any time in the next three months. or perhaps pay more money to the screenwriter to extend the length of the option). say. he’d be left holding the bag. he also stands to make a handsome profit if the property value increases during his option holding period. and he agrees to give you the opportunity to buy the property from him for an agreed upon price any time in. why would someone interested in a property buy an option for the right to purchase it in the future. If the stock rises during that period. In return for his investment. Why options? To get an idea of why and how to use options. A studio might pay a screenwriter $50. Again. locking up the rights to it for a certain period of time — the screenwriter cannot sell the script (or sell another option on it) to another studio who might be interested in making a movie out of it during this period. First. they lose their rights to the screenplay. studios routinely buy options on hot screenplays or books for possible development into feature films. instead of simply buying the property outright? One motivation for the option buyer might be limited risk. and the value of the real estate jumped to $10. if the studio that bought the option does nothing in the allotted time period (that is. By comparison. the next six months. if he wishes).000 an acre any time in the next six months. If you don’t buy the property within that time period. I t is a concept as old as free markets: You can pay for the right to buy or sell something at a fixed price for a certain period of time. For example. you could profit two ways: You could sell the option (which would have increased in value because of the rally) to someone else. For example. they don’t purchase the script outright. if the option buyer bought an option that gave him the right to purchase the property for $5. or exchange it for shares of ORCL priced at $30. you no longer have any claim on the property and the current owner gets to keep the money you gave him (and sell the land to someone else.
you are buying the right to purchase 300 shares of the stock in question.5625 continued on p. but was in no rush to do so. it’s unlikely the option buyer Calls and puts There are two types of options: calls and puts.) A put option gives the buyer the right (but not the obligation) to sell the underlying stock at the strike price until expiration. FIGURE 2 Underlying Stock DELL Expiration Month May Strike (Exercise) Price 20 Type Price (Premium) 2 . Learning to trade options begins with understanding the basic definitions of these tools and the aspects of price behavior that affect how they trade. OPTIONS TRADER • April 2005 $425 for this option.) These characteristics attract stock and futures traders to these instruments. and the property value rises. a premium of 4 . in effect. selling the option is a way to create some cash flow that will offset the depreciation of his property. which in the case of May 2001 stock options is May 18. his only risk is that. 32 Put 31 . Also. he is obligated to sell the property at $5. In short. the major advantages of options are limited risk (in some. if the property value suddenly increases.25 Call Figure 1 shows the different elements of an option. First. but because his eventual plan is to sell anyway. If you buy three call options. in terms of establishing trades that can profit in different circumstances or market environments.000 per acre on the open market. FIGURE 1 Underlying stock DELL Expiration month May Strike (exercise) price 20 Type Price (premium) 4 . The price of the option is referred to as the premium.000 an acre on the open market. if $5. in terms of establishing trades that can profit in different circumstances or market environments.25). he may have to sell his property at a price below its open-market value. which may or may not happen). In that case.000 per acre. A call option gives the buyer the right (but not the obligation) to buy the underlying stock at a specific price (the strike or exercise price) until the designated expiration date of the option. 10. He could buy the property for $5. and the owner will get to keep the money he collected for selling the option. Buying this option would give you the right to purchase 100 shares of Dell (the underlying stock) at 20 (the strike price) until expiration. However. but not all cases) and flexibility. If he does.5625 ($256.he paid for the option). Here are two versions of what things might look like from the option seller’s viewpoint. he has a chance to make some extra money by selling the option to the option buyer. this last point is moot. (Premiums for options on futures are generally quoted in terms unique to the specific underlying futures contract. the strike price and expiration month are the same as the call example. so you would pay The major advantages of options are limited risk (in some. In this case. the property owner might not be particularly interested in selling his property.25 would translate to a price of $450.000 an acre to the option buyer (if the option buyer chooses to make the actual purchase. but the premium is 2 . Figure 2 (below) shows the elements of a Dell put option trading on Jan. and so on. Second.25. but not all cases) and flexibility.000 an acre and turn around and immediately sell it for $10. However. if the current owner of the property was already planning on selling the land. will want to use his option rights to buy it at $5. but he might think its value may drop in the near future. The example shows a Dell (DELL) May 20 call option trading at a premium of 4. However.000 per acre represents a significant profit over what he initially paid for the property. The following discussion is given in terms of stock options. (This aspect will be discussed in greater detail in the sections on options strategies. options can be cheaper to trade (because of more favorable margins in some cases) than outright stock or futures positions. A standard option represents 100 shares of common stock. he runs the risk of having to sell his land. Each point of a stock option’s premium represents $100 (because each option contract represents 100 shares of stock). the concepts apply equally (except where noted) to futures options. if the property owner is wrong. If the property drops to $3. he’s locked in what he considers to be an acceptable profit (even though it might not be as big as it could have been).
by selling a call option. in the form of risk. In the latter case. Option contract months for futures will vary from market to market. The profit potential is theoretically unlimited (for calls). The next section will explain some of the risks of selling options. strike price and option type. This money is the option writer’s to keep. as previously described. If the writer does not own the stock.com Figure 3 shows a typical quote screen with option “chains” (industry-speak for “lists of option price quotes”) for DELL call options. buying a put is a way to go short the underlying stock without actually selling it. limiting the put side of the equation. because there is no limit to how high a stock can rise. A seller of the same option might have established his or her position assuming the stock price would drop.” An ORCL put option expiring in June with a strike price of 25 would be a “ORCL June 25 put. Selling calls and puts outright (referred to as naked options because these trades are not covered by a position in April 2005 • OPTIONS TRADER . Similarly. the risk on a long option position is limited to the premium you paid for it. Stock options are listed in contracts that expire each month. April options expire on the third Friday of April. (Stocks can only drop to zero. who must sell you the stock at the option’s exercise price. the writer assumes the obligation of having to sell the underlying stock to an option buyer who exercises his option. regardless of what happens to the option price or the underlying market. You do so by notifying your broker you 32 wish to exercise your option (you will pay an extra exercise fee for this. For example. this revenue comes with a price tag of its own. option buyers pay the premium for this combination of profit potential and limited risk. However. or exercise it and establish a long position at 20 in a stock now trading $10 higher. Options are typically described in terms of their underlying market. Because you are not obligated to buy or sell stock when you buy a call or put option.) Accordingly. The DELL call option expiring in May with a strike price of 20 would commonly be referred to as a “DELL May 20 call. you can buy or sell options that expire in any month.OPTIONS BASICS continued FIGURE 3 — OPTIONS QUOTE SCREEN A typical option quote display. The underlying stock represented by the option is then assigned to a seller of the same option (not necessarily the same person you executed the option trade with — the process is more random). You must exercise an option before expiration day. The writer makes money by collecting the premium the option buyer pays. which (for stock options) is the third Friday of the month for each option contract month. and so on. In short. The act of translating a long option position into a stock position is called exercise. Note the difference in premium (time value) between options with the same strike prices but difference expiration months. Assume the stock has rallied to 30 two weeks later.” Buying a call is a way to go long the underlying stock without actually purchasing it. Exercise Options can be bought and sold to profit from their price fluctuations (like any other trading instrument) or exchanged for stock to profit in the underlying market. he or she would have to buy the required number of shares in the open market at 30 and sell them to the option holder at 20. the option writer will be forced (if assigned) to sell the stock at 20 when it is trading at 30. Source: QCharts by Quote. in which case it would be unlikely option holders would exercise their options because they would be paying more for the stock than the current market price. The option buyer may want to sell his option for a profit. option writers assume the risk of unprofitable stock assignment in return for receiving premium. on top of your brokerage commission). Say a trader bought the DELL May 20 call option in Figure 1 when Dell was trading around 19. assuming the stock would rise significantly by expiration day. taking a 10-point loss. contract (expiration) month. a put seller runs the risk of having to buy stock at a loss if assigned when a put buyer exercises his option. The risks for a person who sells an option (referred to as an option writer) are reversed from those of an option buyer.
Because the stock could be immediately sold in the open market at 50. would you rather try to predict whether it would reach that level in the next 24 hours or the next 24 days? For example. A call option with a strike price of 60 has zero intrinsic value if the underlying is trading at 50. An option with a delta of .. in practice. one with a strike price of 40 and another with a strike price of 30. the greater the option’s value. gamma is highest for ATM options and lowest for deep ITM and OTM options. the option with a strike price of 30 should command a higher price for its larger “built-in” profit.e. the average close-to-close move over the last 20 days used in this example is a measure of the underlying stock’s volatility. (By the way. if you calculated the average close-to-close move in a particular stock over the past 20 days and found it was three points. If you had to make a prediction OPTIONS TRADER • April 2005 ∆ΓΡΘΚ∆ΓΡΘΚ whether a stock would close above or below a certain price level.. the dividend factor is irrelevant. but you may have to factor in storage costs for the commodity in question. Say a stock is trading at 50 and you are looking at two call options with the same expiration date.e. How options are priced A stock option’s price is influenced by six factors: the underlying price of the stock. the intrinsic value of all other options is zero. 34 33 . Gamma is the change in delta relative to a change in the underlying market. Only ITM options have intrinsic value. you would probably say it would not.00 would move 1 point for every 1-point move in the underlying stock. dividends (if any) and the prevailing interest rate. In terms of the relationship between strike price and underlying price. (For options on commodity futures. you would be much less confident continued on p. Delta is the change in an option’s value relative to a change in the price of the underlying market. which will be discussed shortly. Unlike delta. the owner of the first option would make a profit of 20 points if he exercised his option (not taking into account commissions or the premium paid for the option) while the owner of the second option would make only 10 points. the stock could potentially move much more over this period than it could in a day. OTM options are calls with strike prices above the current underlying price and puts with strike prices below the current underlying price. ATM options are calls and puts with strike price equal to (or. Accordingly. Rho is the change in option price relative to the change in the interest rate (i.) Now assume you are trying to determine whether a stock will close x points away from the current close three months from now.the underlying market) is the same as having a short or long position. how sensitive the option is to volatility). The next component of an option’s price. respectively. the time (days) until expiration. volatility. at-the-money (ATM) and out-of-the money (OTM). the strike (exercise) price. time until expiration. an option with a delta of 1. because the stock’s typical price behavior suggests it will only move three points from today to tomorrow. Theta is relatively larger for OTM than ITM options.50 (50 percent) would move a half-point for every 1-point move in the underlying stock. Theta represents the rate at which an option decays each day (the rate of time decay). The minimum value of any ITM option is its intrinsic value. ∆ΓΡΘΚ∆ΓΡΘΚ The “Greeks” Option “Greeks” are measures of how an option behaves in relation to shifts in its underlying market and the interaction of different option-pricing components. and increases as the option gets closer to maturity (i. The option with the strike price of 30 should be trading at a higher price than the option with the strike price of 40 because the former option could be exercised for stock at a price of 30 while the latter option could only be exercised for stock at 40. Without going through the entire analytical process again. In this example. and your bet was to determine whether the stock would close tomorrow more than 10 points away from today’s close. the first option has an intrinsic value of 20 and the second has an intrinsic value of 10. in the underlying market. nearly equal to) the current underlying price. Vega is how much an option’s price changes per a 1-percent change in volatility (i. how sensitive the option is to interest rates).) The relationship between the price of the underlying stock and the strike price is the easiest part of option pricing to understand. This is a function of the unpredictability of the future. options fall into three categories: in-the-money (ITM).e. Delta varies between 0 and 1. two things are apparent: First. its expiration date). second. ITM options are calls with strike prices below the current underlying price and puts with strike prices above the current underlying price. The more time left until an option expires (referred to as its time value). The difference between an option’s strike price and the price of its underlying stock is called intrinsic value. which is highest for deep ITM options. also is a straightforward concept.
different expiration month. and the lower the value of put options. the difference in time value between the May and August expirations is one point. The more dividends a stock will generate over the lifetime of an option. or just above.”and “Indicator Insight.e. allowing you to keep the premium. volatility is the most variable.) Similarly. The higher the volatility (i. In this case. the best-known of which are the Black-Scholes.” The position is most profitable if the stock expires at. the more uncertainty in the market.. Figure 3 provides a clear example of time value: The May 25 call is trading at 2. same strike price. and the most important to understand. Black-76 and Binomial models.” Dividends and interest rates are the final option-price components. Of all the option price components. and the most important to understand. the better the chance the stock will trade favorably to the option holder. Or. Profit Long stock Long call spread Price of stock Covered call write Price of stock Short call Loss Short call Loss predicting where the stock is likely to close three months from now because of the inability to know all the possible events that could affect the stock between now and then. Another way to look at volatility and time value is the higher the volatility and the further away from expiration. the higher the prevailing interest Of all the option price components. and the higher the premiums options sellers will demand for the risk they assume. the option seller will demand a higher compensation. dividends are irrelevant to commodity futures options. Accordingly. all other conditions being equal. the price of an option can vary significantly at a given moment from its theoretical value. Trading strategies Options can perform many functions.OPTIONS BASICS continued FIGURE 5 — COVERED CALL WRITE FIGURE 4 — LONG CALL SPREAD The long call spread consists of long and short call options at different strike prices. the less uncertainty there is in the market and the lower option premiums will be. volatility is the most variable. Option values can be calculated using any number of option pricing models. An option’s value also fluctuates with the level of volatility in the market at a given time. 34 rate. However. It’s a limited-risk. the August 25 call is trading at 3 . For this higher likelihood of success for the holder. it is covered in greater detail in other articles in this issue. but they all essentially factor in the option price components outlined in this section and produce a theoretical price for an option. An investor long a stock could buy a put option as a hedge against a price drop. see “Putting volatility to work. Same stock. limited-potential strategy designed to profit from an up move in the underlying stock Profit Long call Selling call options against a long stock position is called a “covered write. the higher call premiums will be.5. the strike price of the options. the more price movement). and the lower put premiums will be. the time value of an option disappears at an accelerated rate with the passing of time (a process known as time decay — see Theta in “The ‘Greeks’“). The lower the volatility. One of the advantages of selling options is that time decay works in your favor. Such models are computationally intensive. a trader with a long stock position could sell calls against April 2005 • OPTIONS TRADER . (As mentioned.5. the greater the value of the call options on that stock. For an in-depth discussion of the role of volatility in option pricing and trading. because markets are made up of human beings driven by fear and greed. Because this uncertainty decreases as expiration approaches.
volatility-based option trade is the straddle. not just whether a stock or future goes up or down. In short..e. We’ll look at a few option strategies. consider a stock trading at 50 with ATM June (i. good example of this approach is covered call writing (selling OTM calls against a long stock position). or buy a put (or sell a call) to profit from a down move. FIGURE 6 — LONG STRADDLE Purchasing calls and puts with identical strike prices and expiration dates allows you to profit from a large move — in either direction — in the underlying stock. OPTIONS TRADER • April 2005 35 . In practice. using options is a more sophisticated process than these approaches suggest. A long call spread consists of simultaneously buying a call option with a lower strike price and selling another call option with a higher strike price. Covered calls profit most if the stock ends up just higher than the strike price of the call (in this case 60).e. and in the case of short options. An example of a long call spread would be. Such strategies are volatility-based. buying a 50 call for 6 . the position profits when the underlying stock moves enough in either direction to overcome the premium paid for the options.5 points. The tough part is determining which particular call to buy. in this case 60. Above that price. from a decrease in volatility (which will deflate option values). you could sell a call with a strike price of 60. the put spread (“bear spread”). They seek to profit. including one that consists of more than one option and offers a more favorable trade. with a long stock position at 50. A long put spread is a bearish trade in which you would buy one put with a higher strike price and sell another put with a lower strike price. The trade’s maximum profit occurs when the underlying stock price is the same as the higher strike price. The classic non-directional. it’s easy to determine that buying a call will allow you to participate in an up move. Figure 5 shows the profit profile for a covered call write at expiration. The strategy’s risk is limited to the difference between premium paid and premium received.5 (which. These trades should be executed in stocks on which you are neutral to mildly bullish. in the case of long-option strategies. While we will just scratch the surface here. 36 Combining options and the underlying instrument Combining the reward-risk characteristics of options and their underlying stocks is another way to construct flexible option strategies. The flexibility factor One of the strengths of options is that you can build “nondirectional” strategies that can profit regardless of the direction of the underlying market. Option spreads are like having a designer suit tailored to your specifications. They do this because they can construct trades with very specific reward-risk characteristics that can profit from a wide range of market situations (i. If you buy the straddle — that is. simultaneously purchase the June 50 call and put for a total cost of 11. Two of the most basic option spreads are the call spread (“bull spread”) and its opposite.75 — the stock must move 11 . A trader could buy a call (or sell a put) to take part in an expected up move. The goal of this trade is to profit on the long call from an up move in the underlying stock while limiting risk with the sale of the short call option (although this short option will limit your profit potential as well). from an increase in volatility (which will inflate option values). with strike prices of 50) calls trading at 6 . by the way.75 points (plus what you paid in continued on p. If the stock rallies too strongly — significantly above the strike price — you’ll lose money on your options. with the underlying stock trading at 50. implies a slight bullish bias in the stock since the call and put should theoretically have the same value in a completely neutral market environment). or whether to consider an alternate strategy. There is no limit to the downside risk for this position. Figure 4 is a diagram of the profit-loss profile of a long call spread. but how much it moves in either direction). For example. Profit Long put Long call A Price of stock Loss Long straddle Option spreads: Customized trading Professional option traders create option “spreads” — combinations of long and short options — far more often than they buy or sell options outright.his stock to generate additional income. Outright option positions are like buying a suit off the rack. For example.5 and selling a 60 call at 3.25 and ATM puts trading at 5 .. It consists of buying a call and a put with identical strike prices and expiration dates. these examples will give you an idea of the possibilities available to option traders and the considerations that go into establishing an option trade. additional gains in the value of the long call option are offset by losses in the short option. in this case 3 . show how they illustrate the concepts outlined earlier and how they are typically used in the market. but because of the premium received for the call option the stock needs to decline by at least that amount before the position starts to lose money.
they want to own low-volatility options and sell high-volatility options. Who are they selling them too? The public. The importance of volatility cannot be stressed enough. are ways to play breakouts in situations when you’re unsure which way the market will break out. you could purchase more calls than puts — say. you’ll lose money on the put and make money on the call. A version of this article previously appeared in Active Trader magazine. or sell options with 36 In this regard. To come out ahead. ed drop in volatility (a “short-volatility” trade). because options commissions are more expensive than straight stock commissions. which in turn means the options have greater potential to increase in value if and when the underlying market moves. If the stock goes up. not just straddles. Remember. Limited risk is always accompanied by limited profitability. which would mean the options are a good buy relative to other options. Another layer of flexibility can be added by selecting options that are in the money or out of the money by varying degrees. the importance of volatility cannot be stressed enough. Understanding this aspect of price behavior is the key to buying inexpensive options and selling expensive ones — the real edge in trading options. and then profit as volatility returns to more normal levels and the options drop in value. As mentioned. In return for this risk. Build on the basics. to generate a profit. such as butterfly spreads. because lower volatility means cheaper option premiums. a stock in a very tight trading range would have low volatility. The more calls you buy relative to puts. They use combinations of options (spreads) and stock-option mixtures to construct either directional or non-directional strategies. On a practical note. This is not exhortation for retail traders (especially beginners) to exclusively sell options — there are risks to doing so — but this reality should provide some food for thought. you get the premium. vice versa if the stock drops. You also could use options with different expiration dates. In this case you would want to sell identical calls and puts when volatility is exceptionally high. Options trading is not rocket science (even rocket science isn’t rocket science if you can get someone to explain it to you in plain language). collecting the accordingly inflated premiums. of course. Questions or comments? Click here. especially short-term traders. the greater the bull bias in the position. are impractical for most off-floor retail traders. For example. three calls for every two puts — to take advantage of an up move. there’s a dirty little secret in options trading: Professional option traders sell options more often than they buy them. This is only one example of the flexibility options provide. Straddles. The reward-risk profile of this trade is exactly the opposite of the long straddle: Your return is limited. Despite what some people may want you to believe. up or down. the joy of collecting premium comes with unavoidable risk. The nuances you can add to a trade are virtually limitless. appreciate the subtleties The topics presented here have been simplified to make them more accessible. In short. executing many well-known multi-option strategies. Figure 6 shows the profit-loss profile of a long straddle The key to this kind of strategy is to buy “low-volatility” options. most successful options professionals do not simply buy calls when they think a market is going up or buy puts when they think a market is going down. As long as the market doesn’t move (in either direction) enough to erase your total collected premium.OPTIONS BASICS continued commissions). which might make options on it a good candidate for this kind of trade. whose predisposition is always to buy first. the more you will profit. The closer it stays to the strike price. Similarly. Understanding this aspect of price behavior is the key to buying inexpensive options and selling expensive ones. you have to understand its subtleties as well as its hard-nosed realities — and that takes time. For example. Your risk is limited to what you paid for the options. Selling a straddle is a technique to capitalize on an expect- a great deal of time value and buy options with less time value. but your risk is not. option traders will try to identify the “best” options for this kind of “long-volatility” trade by calculating the volatility (perhaps both the implied and historical volatility) and determining whether it is exceptionally low. In practice. to put time decay on their side. but it is multi-layered and nuanced. April 2005 • OPTIONS TRADER . Such techniques allow you to tailor strategies with highly defined risk characteristics that can capitalize on various market conditions or forecasts. then. Using such “ratios” is a common technique for adding flexibility and directional bias to all kinds of options spreads. keying their strategies to the relative volatility levels in the market at a given time. you’ll profit. if you see evidence of a slight upside bias in the underlying market. You would reverse the ratio to give the position a greater downside bias. there is no free lunch in the markets.
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options exchanges to providing volume statis. One of its most popular educational tools is a CD-ROM called The Options Investigator. The Position Simulator.poweropt. The program is a combination of text and multimedia. Test your Options IQ. While the searches require the user to have a working knowledge of options. THE OPTIONS INVESTIGATOR However. PowerOptions also features more than 20 “reports. One of the site’s features is the SmartSearchXL. has plenty of basic features (options chains. through its Web site (www. as it covers everything from the difference between a put and a call to how to place an order. The search engine has almost three dozen different parameters. Depending on the strategy. Strategy Basics. the latter three won’t make any sense without the first. The subscription-based site. Principal Factors Affecting Price. the OIC also is an educator.888options. The screen is separated into three windows. PowerOptions POWEROPTIONS T raders trying to find options suitable for a specific strategy might find help at PowerOptions (www.com) and other endeavors.” where pre-configured scans search for things such as stocks trading for less than $25 a share that are in an uptrend with at-the-money options available.com). Placing an Order. The Tutorial is broken down into seven main sections — Options Basics. and Live Seminars. etc. list of new 52-week highs/lows. the site also includes some very simple features. To a beginner.S. which 38 April 2005 • OPTIONS TRADER . It can be ordered free of charge through the OIC Web site. users can change the pre-set parameters chosen by PowerOptions.OPTIONS RESOURCES The Options Investigator T he Options Industry Council (OIC) performs and Options Strategies. or naked calls that are at least 10 percent out of the money and in a downtrend. which offers a 14-day free trial. Introduction to Premium. The Strategy Explorer. Again. One is the Strategy Search Summary. but it also has search capabilities and other tools.window features the information (audio of the text is also tics and other data to the media. The largest many functions. ranging from option volume to stock price to implied volatility to delta to P/E ratio. so it’s best to start with The Tutorial. The “home page” has four sections — The Tutorials. which allows users to find strategies as simple as covered calls or as complex as iron butterflies. PowerOptions has pre-selected values for certain criteria. The Investigator is designed for beginners. although all can be changed by the user. and it’s presented in a straightforward fashion.) and a helpful education section. from lobbying for the U.
Also. the upper left window features charts. the seminar section takes you to the OIC Web site. credits. he outlines positive and negative aspects of common index and equity options strategies. and the date you expect the stock to reach your target price. Another simple tool is the Optimized Long Option Finder. Depending on the strategy. The Stock Repair Strategy allows users to enter a stock and view a list of options that can help recoup some of the money lost on the stock. David Lerman covers how to analyze and incorporate volatility in at least four forms — historical. The Explorer and the Simulator allow you to test different strategies. your fee will be waived for the next month. and most finish with a quiz to make sure you’ve grasped what you’ve read. etc. No single “page” provides too much information. volatility. • The Ten Most Powerful Option Trading Secrets By Bernie Schaeffer Marketplace Books. While a repair is not always available. The right side of the screen has a toolbar. you can print out any page. and a virtual “notepad” that allows you to jot down thoughts and other observations. where upcoming free seminars are listed. 2005 www. data is given for various statistics such as downside protection. more advanced information). and the site says if you don’t make at least five times the monthly subscription fee trading options. and buying put options as well as call options. He details how to go against the crowd and explains why he opposes some popular options trading strategies. when one is. etc.com DVD.com DVD. Each section features several sub-sections. 102 minutes $99. An appendix includes a 13-page glossary and a summary table listing important aspects of the book’s strategies. Some topics include time decay. and synthetic. which makes it easy to read and provides impetus to continue to the next section. implied. the site provides a detailed explanation. And. when you enter a stock symbol. if you wish. graphics. and the lower left window has the table of contents. or more information. returns all the possibilities for covered calls. and tips on mitigating loss for 60 options strategies. breakeven price. Three subscription levels are available. and PowerOptions will produce a list of options suitable for buying.95/month to $79. leveraged.95 This reference book features stepby-step instructions. forecast and future. this is one tool even knowledgeable options traders can use. • The Bible of Options Strategies: The Definitive Guide for Practical Trading Strategies By Guy Cohen Financial Times Prentice Hall. with instant links to a glossary. 2005 Paperback.traderslibrary.00 This DVD presentation is designed to teach options traders how to profit from volatility instead of falling victim to it. trading options based on more than a high or low volatility. and volatility percentile rankings.traderslibrary.00 Schaeffer presents 10 “secrets” of his contrarian trading style in this DVD presentation. A similar tool — the OneStrike — allows you to enter a stock symbol and search for a specific strategy. Enter a symbol and. the amount you are going to invest. 108 minutes $99. advantages. a resource section (which provides numerous links to additional. 2005 www. Exploiting Volatility: Mastering Equity and Index Options By David Lerman Marketplace Books.70/month. ranging from $9. 39 OPTIONS TRADER • April 2005 . disadvantages vs. Cohen divides the approaches into five categories: income. The Options Investigator is a simple — and free — program that provides a good place to start. depending on what is being discussed. An options literacy quiz is offered as well. Trading tactics Schaeffer proposes include using time stops rather than price stops to limit losses. spreads. And. 255 pages $49. sideways market. as long as the original price of the stock is not too far from the current price. The information is quite detailed. the expected price of the stock. delta.available). straddles. For those looking to cut their teeth in the options market.
time value decreases at an accelerated rate. The higher the implied volatility. Put option: An option that gives the owner the right. but not the obligation. the higher the option premium. American style: An option that can be exercised at any time until expiration.com (626) 497-9195 Mark Seger Account Executive mseger@activetradermag. . Three good tools for targeting customers . deep in-the-money option or deep out-of-the money option): Call options with strike price that are very far above the current price of the underlying asset and put options with strike prices that are very far below the current price of the underlying asset.” Volatility: The level of price movement in a market. but not the obligation.g.KEY CONCEPTS AND DEFINITIONS Options glossary Call option: An option that gives the owner the right. — CONTACT — Bob Dorman Ad sales East Coast and Midwest bdorman@activetradermag. the past 20 days. Intrinsic value: The difference between the strike price of an in-the-money option and the underlying asset price.com (312) 775-5421 40 Allison Ellis Ad sales West Coast and Southwest aellis@activetradermag. Expiration: The last day on which an option can be exercised and exchanged for the underlying instrument (usually the last trading day or one day after). Strike (“exercise”) price: The price at which an underlying stock is exchanged upon exercise of an option.g. As expiration approaches.. a phenomenon known as “time decay. not before. Historical volatility measures of the price fluctuations (usually calculated as the standard deviation of closing prices) over a certain time period — e. Deep (e. Out of the money (OTM): A call option with a strike price above the price of the underlying instrument or a put option with a strike price below the underlying instrument’s price. to buy a stock (or futures contract) at a fixed price. to sell a stock (or futures contract) at a fixed price.. . Premium: The price of an option. Implied volatility is the current market estimate of future volatility as reflected in the level of option premiums. A call option with a strike price of 22 has 2 points of intrinsic value if the underlying market is trading at 24. Exercise: To exchange an option for the underlying instrument. Time value: The amount of an option’s value that is a function of the time remaining until expiration.com (312) 377-9435 April 2005 • OPTIONS TRADER . European style: An option that can only be exercised at expiration. At the money (ATM): An option whose strike price is identical (or very close) to the current underlying stock (or futures) price. In the money (ITM): A call option with a strike price below the price of the underlying instrument or a put option with a strike price above the underlying instrument’s price.
cme. May corn. soybean. Event: CME Options Online Seminar — Part One: The Basics. May crude oil options (NYMEX). Finance IQ's First European Managed Futures Conference will focus on the risks and opportunities available when utilizing managed futures in your portfolio. 3:30 p. April 27. Date: May 9-12 Location: Paris & Bally's Resorts. rice.com • Event: First Annual European Managed Futures Conference 2005. Brazil For more information: www.S. April 2005 • CURRENCY TRADER • Event: The 17th Annual Las Vegas Money Show.m. There is no cost to attend. and gold options (NYMEX) 27 28 LTD: April feeder cattle options (CME). as well as schedules for OIC’s Covered Calls and Directional Strategies seminars.4:30 p. oats.22 Location: The Selfridge Hotel.m. April CME U. and soybean products options (CBOT) 23 25 26 LTD: May natural gas. April Nasdaq options (CME). Options Trader is not responsible for the accuracy of calendar dates beyond press time. May aluminum. Date: June 23-24 Location: Sofitel Hotel.expotrader.com.888options. Date: July 13-16 Location: Hyatt Regency Chicago For more information: http://www. CT For more information: Log on to www. April Dow Jones options (CBOT).com • Event: The Options Industry Council is conducting a handful of options seminars across the country this winter. April ethanol futures (NYBOT) 9 11 12 13 14 LTD: April lean hog options (CME) 15 LTD: All April equity options. silver. For more information: Log on to www.tradersexpo. Speakers include John Bollinger. May orange juice options (NYBOT). May cotton options (NYBOT). April S&P options (CME). and Frank Tirado.co.uk/GB-2440/ediary • Event: Expo Trader Brazil International Asset Managers and Traders Conference. wheat. London For more information: www.com for an updated listing of seminar locations.m. .intershow.br/ • Event: The Traders Expo Chicago.OPTIONS EXPIRATION CALENDAR GLOBAL ECONOMIC CALENDAR & EVENTS Monday Tuesday Wednesday Thursday Friday APRIL MONTH Saturday 1 LTD: May cocoa options (NYBOT).iqpc. April Goldman Sachs Commodity Index options (CME) 18 19 20 LTD: May platinum options (NYMEX) 21 22 LTD: May T-bond options (CBOT).m. Larry Williams.com or call1-800970-4355 41 . Date: April 21 . They are taught by exchange professionals in a classroom-style format and run from 6 p. April live cattle options (CME) 2 4 5 6 7 8 LTD: April currencies options (CME). Las Vegas For more information: Log on to www. April 26 and Part Two. April milk and nonfat dry milk options (CME) 29 LTD: May lumber options (CME) 30 The information on this page is subject to change. May sugar and coffee options (NYBOT). Part 2: Trading Strategies Presenter: Dan Gramza Date: Part One. copper. gasoline and heating oil options (NYMEX). dollar index options (CME). Rio de Janeiro. to 9 p.
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