Options Framework - Module 1 Black & White (Three Charts Per Page)

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Candlestick Secrets for Profiting in Options Seminar
The Foundation of Options
Option Essentials for “Candlestick Secrets

for Profiting in Options” seminar

• The 8 major benefits of options
• Review of option essentials
• Buying In, At and Out of the Money Strikes
• Implied Volatility
• Four ways to decrease impact of Implied Volatility
• OTM and ITM – Pros/Cons of each
• Time value decay
• Advantages and disadvantages of short term expirations
• Advantages and disadvantages of longer term expirations
• The Greeks- basic definitions
• Bull call (debit) and bull put (credit) spreads
- how they work, best strikes, when to use, cautions
• Bear put (debit) and bear call (credit) spreads
- how they work, best strikes, when to use, cautions
• Volatility Skew
• When to buy options outright instead of spreads
• Long outright option strategies for higher confidence
• Long outright option strategies for lower confidence 1
The Benefits
of Options
As per non-disclosure agreement, you are legally bound not to share this information including handouts
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Leverage
Buy at 144.50
Sell at 151.50
% gain on stock = 4.8%
$700
Buy ATM 145 call

14 days expiration
@ 3.25
Sell to close call 11 days later

for 6.60 with mkt @ 151 ½
% gain on options =103%
$335
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3
Risk Control
Welcome
back from
a hard day
at work
4
REDUCE RISK
Target Poor risk/reward with

outright, but options gives
us a way to trade this
Risk
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Portfolio Protection
“Being able to employ some defensive timing

measures REALLY reduces my anxiety”
Time to hedge
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Benefit
Trade high
price
markets
Take advantage of bear moves
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Benefit
Improves
Market
Adaptability
ADAPT TO NEW MARKET CONDITIONS
Bearish change of polarity, so

may want to short. But if gets above here
becomes bullish crack and snap.
The correct option trade set up (to be
discussed later) gives you the potential to
flip from bearish to bullish
9
Flexibility with stops
Buy here stop on close Intraday

under rising window fake out
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Benefit
Income
Producing
Strategies
Benefit
Can profit in
any market
condition
Call or Put
• Calls are options to buy a security.

– The buyer obtains the right (but not the
obligation) to purchase the underlying security.
• Puts are options to sell a security.

– The buyer obtains the right (but not the
obligation) to sell the underlying security.
Examples
XYZ January 70 Call at $3.10
ABC February 35 Put at $1.20
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Premium
• The price of the option.

• Paid by buyer; received by seller.
• The price is multiplied by the number of shares the
contract represents, generally 100 shares.
– $3.10 option costs 100 x 3.10 or $310
– $1.20 option costs 100 x 1.20 or $120
Exercise & Assignment Defined
Exercise:
• to invoke the right contained in an option
contract
Assignment:
• to be required to fulfill the obligation
Strike Price
• The pre-determined
Examples
price at which the XYZ January 70 Call at
underlying asset will $3.10. Strike price is 70
be bought or sold ABC February 35 Put at
should the option be $1.20. Strike price is 35
exercised.
In the listed options marketplace the strike prices are
standardized.
– Stocks priced between 0-25 intervals of 2 1/2
– Stocks priced between 25 - 200 intervals of 5
– Stocks priced greater than 200 intervals of 10
Note: In high volume markets – like SPY and MSFT- can be $1, or
GOOG can be $5
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Four Basic Trades
CALL PUT
Buyer Right to Right to

(long) buy sell
Seller Obligation Obligation

(short) to sell to buy
Examples
XYZ January 70 Call at $3.10: Call buyer can buy XYZ (up to
expiration date) for $70. And call seller must sell to him at that price.
ABC February 35 Put at $1.20 (Put buyer can sell XYZ (up to
expiration date ) for $35. And put seller must buy it from him
at that price.
I’m Long or Short, What Now?
• Sell to close or buy to close 69.4%
• Exercise or accept assignment 11.6%

– Shares are exchanged at the
predetermined price
• Let expiration (worthless) 19%
– If long, lost what was paid

– If short, gained the maximum
Source:
possible Option Clearing
Corporation
* Calendar year 2008
In, At, or Out of the Money
The relationship between the

strike price and underlying
security’s price determines if
call or put option is In, At, or
Out of the Money
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At-the-money
For calls and puts: When the price

of the underlying security or index is
equal (or close) to the strike price
In-the-money
For calls: a call option is in-the-money if the

strike price is less than the current price of the
underlying security or index.
Example: underlying@40, 35 strike
For puts: a put option is in-the-money if the

strike price is greater than the current price of
the underlying security or index.
Out-of-the-money
For calls: a call option is out-of-the-money

if the strike price is greater than the price of
the underlying security or index.
For puts: a put option is out-of-the money

if the strike price is less than the price of the
underlying security or index.
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In- At- or Out-of-the-money?
Market = 99 Market at 99
Call strike = 100 Put option at 100
a) ITM a) ITM
b) OTM b) OTM
c) ATM c) ATM
23
Intrinsic Value and Time Value
Intrinsic value: the amount, if any, by which

an option contract is in-the-money. By
definition, at- and out-of-the- money options do
not have intrinsic value.
Time Value: the portion of an option's total

premium that exceeds its intrinsic value, if it
has any. By definition, the premium of at- and
out-of-the-money options is entirely time value.
24
Calls
Market at $49
Is it In-At
Strike Time or Out of
Price Intrinsic Value Premium the
Money?
$48.00 3.77
$49.00 3.15
$50.00 2.75
$52.50 1.76
$55.00 1.17
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Calls
Market at $49
In-At or
Strike Time Out of
Price Intrinsic Value Premium the
Money
$48.00 1.00 2.77 3.77 ITM
$49.00 0 3.15 3.15 ATM
$50.00 0 2.75 2.75 OTM
$52.50 0 1.76 1.76 OTM
$55.00 0 1.17 1.17 OTM
Puts
Market at $49
Is it In-At
or Out of
Strike Time the
Price Intrinsic Value Premium Money?
$48.00 2.55
$49.00 3.01
$50.00 3.62
$52.50 5.20
$55.00 7.05
Puts
Market at $49
In-At or
Out of
Strike Time the
Price Intrinsic Value Premium Money
$48.00 0 2.55 2.55 OTM
$49.00 0 3.01 3.01 ATM
$50.00 $1 2.62 3.62 ITM
$52.50 $3.50 1.70 5.20 ITM
$55.00 $6.00 1.05 7.05 ITM
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Major Components of Option’s Price (Premium)
• Price of Underlying Security

• Expiration: The date on which the contract
expirations. The option holder must elect to
exercise the option or allow it to expiration
worthless.
• Strike Price
• Implied Volatility
• Short term interest rates/dividend
Implied Volatility (IV)

Implied volatility is the volatility as implied by the
market price of the security's options. In other
words, implied volatility is the market's opinion of
the volatility of the option's underlying security and is
determined using the following information:
• The price of the underlying security
• The market price of the option
• The strike price of the option
• The expiration date of the option
• The interest rate and dividend yield
If put in all of these and see what price is- only variable is IV
so what would IV have to be to be at the current.
Gauging Implied Volatility
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Decreasing IV Exposure
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S&P
VIX
34
Decreasing IV Exposure
Time decay
Time decay (or time "erosion") is the

decrease, of an option premium's time value
due to the passage of time. The rate of this
decay increases as expiration approaches.
At expiration a call or put is worth only its
intrinsic value, if it has any.
“With long options timing is everything

since time is working against you.”
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OTM: Pros/Cons
Benefits
• Highest leverage - best % gains if right
• Tighter spreads than ITM
• More liquidity than ITM
• For the same $ amount can buy more of
them compared to ATM or ITM
Note: Delta is the amount a theoretical option's price will change for a
corresponding one-unit (point) change in the price of the underlying security
Disadvantages
• Most sensitive to time decay
• More susceptible to IV crunch
• Lower probability of success
In-The-Money: Pros/Cons
Benefits
• Slower time decay – “I buy in the money options.
This way I pay mostly for intrinsic value while giving
the trade enough time to work.”
• Less susceptible to volatility crunch – “When overall
market IV is lower I trade ATM (or one strike ITM),
but when IV is higher I will do deeper ITM”
• Higher probability of success
• Can do trades with normally poor risk/reward
• Less leverage helps if market goes against you
Disadvantages
• High Cost
• Less leverage hurts if market goes in your favor
At-The-Money: Pros/Cons
Benefits
• Close to 50% delta means your position will pick up
delta faster for your position and slower against your
position (after about a point move). Will detail more in
Trade Management section
• Medium cost compared to ITM
• Tighter spreads than ITM
• More liquidity than ITM
Disadvantages
• Highest time premium
• High time decay
• Strongly affected by IV changes
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Advantages of Short Term Expirations
Low Cost
Lower cost means you can buy a lot of them
with the allocated money for the trade due
relative to time premium paid.
Explosive
If OTM or ATM option becomes ITM before
the expiration the price of the option will most
likely move close one to one with the
movement of the underlying.
Disadvantages of Short Term Expirations
Rapid time decay.

If the option has time value, for every day that
the underlying doesn't reach the strike in the
time frame, the time value will decay at a rapid
rate
Susceptible to volatility crunch

If implied volatility (IV) decreases before the
underlying reaches the strike, the option price
will decline. If beyond the strike IV can’t touch
intrinsic value.
Advantages of Longer Term Expirations
Slower time decay.
For every day that the underlying doesn't

reach the strike in the time frame, the
time value will decay, but at a less rapid
% rate then near-term
More time for the trade to work
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Disadvantages of Longer Term Expirations
High Cost
Higher time value means you can
not buy as many options as you
can with the shorter term
expirations (lower time value).
Slower price swings

The delta doesn’t get to 1 as
quickly as would be with the near
term option.
Basic Greek
• Delta – The amount a theoretical option's price will change
for a corresponding one-unit (point) change in the price of
the underlying security. ATM delta usually 50%
• Gamma - The amount a theoretical option's delta will
change for a corresponding one-unit (point) change in the
price of the underlying security.
• Vega – The amount a theoretical option's price will change
for a corresponding one-unit (percentage-point) change in
the implied volatility of the option contract.
• Rho- The amount a theoretical option's price will change for
a corresponding one-unit (percentage-point) change in the
interest rate used to price the option contract
• Theta – The amount a theoretical option's price will change
for a corresponding one-unit (day) change in the days to
expiration of the option contract.

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www.fttuts.

Option Essentials for “Candlestick Secrets

The Foundation of Options

Buy ATM 145 call

Sell to close call 11 days later

Target Poor risk/reward with

“Being able to employ some defensive timing

Take advantage of bear moves

ADAPT TO NEW MARKET CONDITIONS

Bearish change of polarity, so

Flexibility with stops

Buy here stop on close Intraday

• Calls are options to buy a security.

• Puts are options to sell a security.

• The price of the option.

Exercise & Assignment Defined

Four Basic Trades

Buyer Right to Right to

Seller Obligation Obligation

I’m Long or Short, What Now?

• Sell to close or buy to close 69.4%

• Exercise or accept assignment 11.6%

– If long, lost what was paid

In, At, or Out of the Money

The relationship between the

For calls and puts: When the price

For calls: a call option is in-the-money if the

For puts: a put option is in-the-money if the

Example: underlying@40, 45 strike

For calls: a call option is out-of-the-money

For puts: a put option is out-of-the money

In- At- or Out-of-the-money?

Intrinsic Value and Time Value

Intrinsic value: the amount, if any, by which

Time Value: the portion of an option's total

Major Components of Option’s Price (Premium)

• Price of Underlying Security

Implied Volatility (IV)

Gauging Implied Volatility

Gauging Implied Volatility

Gauging Implied Volatility

Time decay (or time "erosion") is the

“With long options timing is everything

Advantages of Short Term Expirations

Disadvantages of Short Term Expirations

Rapid time decay.

Susceptible to volatility crunch

Advantages of Longer Term Expirations

Slower time decay.

For every day that the underlying doesn't

Disadvantages of Longer Term Expirations

Slower price swings

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