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By Jeff Fischer From Motley Fool President, Scott Schedler
Dear Fellow Investor, You're in a very fortunate position... The market of the last year or two is creating some unique opportunities. That's why I've arranged for Jeff Fischer (the expert behind our two premium trading services, Motley Fool Options and Motley Fool Pro) to reveal to you some of his most powerful, and widely useful, options trading strategies in this special "Options Edge" handbook. Jeff Fischer is a long-time Fool who co-managed the original Rule Breaker portfolio from 1994 to 2003 with Motley Fool co-Founder David Gardner. Together they helped investors earn more than 20% per year. More recently, Jeff began focusing on options to take advantage of moments of unprecedented volatility. And of his last 42 trades -- 39 have generated serious profits. That's a staggering 93% rate of success. And what's truly exciting are the profits that are still to come! With access to all of The Motley Fool's resources -- all the research and coverage from our newsletter team, and all the community intelligence of CAPS -- Jeff is prepared to zero in on short-term price moves and leverage his considerable trading expertise. And this special "Options Edge" handbook is a perfect primer if you, too, are interested in building wealth in up, down, and even flat markets. Inside you'll discover the tools to profit more substantially, and more assuredly, than at any point in recent history! It's all part of The Motley Fool's ongoing commitment to empowering you, the individual investor. Kindest regards, Motley Fool options wiz, Jeff Fischer -- an extraordinary trader with a documented 93% success rate -- leads two exclusive groups committed to achieving bigger returns in up, down, and sideways-moving markets:
Scott Schedler President, The Motley Fool
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Motley Fool Options, our dedicated options service, has been piling up profits and dazzling members... Motley Fool Pro, our slightly more sophisticated trading service, employs options, ETFs, and other advanced hedging strategies to help members achieve their financial dreams...
And because we're committed to maximizing the profit potential and experience for our premium members -- Motley Fool Options and Motley Fool Pro are by invitation only... So if you're interested in learning more about Motley Fool Options, or slightly more advanced Motley Fool Pro, simply click the button below. We will notify you the moment either service begins accepting new members.
Click Here It's Free!
Options are ideal for generating income, protecting profits, and most importantly, earning outsized gains! They can generate returns in flat markets, cushion the blow of down markets, and be outstanding performers in decent markets. So basically, whatever your investment goals, options can be a powerful addition to your portfolio. And it's important for you to know that I advocate trading options as an investor, not as a speculator. In other words, every option trade we make should be based on thorough analysis of the underlying stock and its value. That way, the option is simply a way to leverage what we know about a stock.
What Are Options?
Stock options formally debuted on the Chicago Board Options Exchange in 1973, although option contracts (the right to buy or sell something in the future) have been around for thousands of years. Applied to stocks, an option gives the holder the right, but not the obligation, to buy or sell an underlying stock at a set price (the strike price) by a set date (the expiration date). The option contract allows you to profit if a stock moves in your favor before the contract expires. Not all stocks have options -- only those with enough interest and volume. There are only two types of options: calls and puts. A call appreciates when the underlying stock rises, so you buy a call if you are bullish on that company. A put appreciates when a stock declines. You buy a put if you believe a stock will fall or to hedge a stock that you already own. One way to remember this is: "call up" and "put down"... By the way, there's an Options Glossary in the back of this handbook for you to use at any point! Next, let's walk through the most common options trades: buying calls, buying puts, selling covered calls, and selling puts. Motley Fool options wiz, Jeff Fischer -- an extraordinary trader with a documented 93% success rate -- leads two exclusive groups committed to achieving bigger returns in up, down, and sideways-moving markets:
When you believe a stock will rise significantly Buy Calls over time and you want to leverage your returns or minimize capital at risk
To short a position or to hedge or protect a current long holding
Sell Covered Calls (sell to open)
To earn income on shares you already own while waiting for your desired sell price
Sell Puts (sell to open)
To get paid while waiting for a lower share price (your desired buy price) on a stock you would be happy to buy
Investors often buy call options rather than buying a stock outright to
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Motley Fool Options, our dedicated options service, has been piling up profits and dazzling members...
"84% gain in 3 weeks..." I closed my NVDA covered call option at a 84% gain in 3 weeks!!! I would never ever thought about using options in my years of investing if it wasn't for Jeff and Jim. Thanks guys. -- S.S. Melrose Park, IL "Add to my education and wealth building...." "I've been able to add options to my toolbox. I have seen the potential options can add to your portfolio and know this service will add to my education and wealth building. -- D. Heredia, Keller, TX
Motley Fool Pro, our slightly more sophisticated trading service, employs options, ETFs, and other advanced hedging strategies to help members achieve their financial dreams...
"Incredible" "My average investment return per month is 11%, which will bring my annual to 132%. Wow! That is incredible! Am I missing something or can this be true?" -- A. Ward in Brighton, Michigan "In for the long haul..." "I will be in for the long haul with this philosophy!!!! I wish I had been 'playing the FOOL' since 1995, but just since February 2009 it has been extra fine. Rock on!" -- G. Seibert, Marietta, Georgia And because we're committed to maximizing the profit potential and experience for our premium members -- Motley Fool Options is by invitation only...
simply click the button below. you'd only be up 18.many shares of stock without putting a lot of capital at risk. It's a way to take more meaningful positions in stocks I believe in -. Selling Covered Calls Now our overview moves from the act of buying options to. your risk is again limited to the amount that you invest in stark comparison to traditional short selling.though hopefully you sold them at some point along the way to recoup part of your investment.www//:ptth So if you're interested in learning more about Motley Fool Options. since a stock can easily work against you in a set amount of time and make your call worthless. Buy put options when you believe that the underlying stock will decline in value. When you do so. we aim to buy longer-term calls in positions in which we have high confidence and that have near-term catalysts. The market offers $30 call options on the stock that expire in 18 months for $1. I almost always buy puts rather than short something outright to limit my risk. Of course.5%. one that you don't want to sell yet for any number of reasons. You've made 100% in a few months. In fact.50 per share. your options will increase in value. will cost you $1.v?mth. or even entire sectors! With put buying..llAtnirP/10/rfs/05/srettelswen/moc. Buying Puts Next up. causing you to lose your option money and miss the stock's eventual rebound. the puts will increase in value. "Covered" simply means that we own the underlying stock at the same time. As with any investment. so your options expire worthless -. representing 1.. Where real opportunity can be lost is when your timing is wrong.loof. instead. an investor can control -and benefit from -. When you make the right call. there is a flip side. smoothing out returns. They're generally used to generate income on stock positions while waiting for a higher share price at which to sell the stock. Any qualified investor can "sell to open" an option contract. Suppose the stock recovers all the way to $32 after a few months.without risking mounds of capital. enhancing your possible returns while limiting your potential losses to only what you invest (which is usually a much smaller amount than a stock purchase would be). Imagine that a stock that you know well has been hit hard and now trades at $27 per share. Writing covered calls is one of the most conservative options strategies available. When a stock being protected -. Ouch! Aside from betting against a position with puts. Because each option contract represents 100 shares of stock. you'll enjoy higher returns than you would have if you had used that money to buy the actual shares. Therefore. Thus. it's below $20. as the contract writer. You believe the shares will rebound in the coming months or year. I tend to buy puts on stocks that I believe are due to decline over the coming months or even years. you get paid. where your potential losses are unlimited. most retirement accounts allow you to write covered calls. Let's look at an example. instead. This option contract gives you. Your options might expire before the stock rebounds. This is useful if you lack capital or just don't feel like risking it all in a stock. 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. I like to buy longer-term call options on well-valued stocks that I believe will pay off handsomely over the coming months or years. If you had simply bought the stock. the right to buy 1. too. Buying puts is an excellent tool for betting against highly priced or troubled stocks. Your option's value would likely at least double to $3 or higher per contract. you should only invest what you can afford to lose. its owner.in this way declines for a while. you can also buy puts to protect an important position in our portfolio. Suppose your stock continues its decline to the abyss.looF 32 fo 3 Click Here It's Free! . or slightly more advanced Motley Fool Pro.500 plus commissions. the antithesis to call options: puts. You may also use puts to hedge long positions that you own.000 shares of the stock at $30 any time before expiration. selling them to others.or hedged -. . If your stock starts to rise again.000 shares of the stock.obtain leverage and potentially increase returns several-fold. Call options work as "controlled" leverage. Even 18 months later. or to short sectors and indexes in a small portion of your portfolio. We will notify you the moment either service begins accepting new members. All cash generated from your option selling is paid immediately and is yours to keep. 10 contracts. you don't pay the premium.
when you can. Tread carefully here so you don't get sold out at too low a price. blue-chip stock. you should use them only on stocks you know well.buying a stock just to write calls on it. The other risk is that a stock may fall sharply after hovering around your desired sell price for a while. and you're not worried about it declining too much in the meantime. month after month. Approximately 80% to 90% of options are not exercised until expiration. If the stock does not exceed $60 by your option's expiration. You believe a stock you own is going to stagnate for a while. and then kick back and wait. You could even set up some covered call-only positions -. but you think it is fairly valued around $60 and you would be happy to sell at that price. Write calls to make the stagnation more profitable. so the call writer has to be prepared to deliver the shares at any moment.llAtnirP/10/rfs/05/srettelswen/moc. when you can. but they can be exercised early. You believe a stock you own is going to stagnate for a while. and you get paid up front to do so. Write calls to make the stagnation more profitable. but you don't want to sell it right now.. If the stock is above $60 by expiration and you haven't closed out your call option contract.looF 32 fo 4 When to write Covered calls . So you sold your shares at the price you wanted to and received some extra cash for doing so. and you're not worried about it declining too much in the meantime. Rinse and repeat. write covered calls when: You would sell a stock that you own at a higher price. month after month. Write calls at your desired sell price. forcing you to wait longer for your sell price.loof. collect the dough. You want to cushion a stock that is in decline.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. When you write covered calls. It's trading at $56. but you don't want to sell it right now. Your actual proceeds on the sale would include the option premium you were paid. Even though covered calls are low risk. but that you're not ready to sell yet. You would sell a stock that you own at a higher price. That's pretty sweet.000 shares of a stable. Rinse and repeat. So. but that you're not ready to sell yet. You want to cushion a stock that is in decline.lost potential if a stock price rises. .. This is the biggest downside to covered calls -. you'd sell your stock at $60 via the options.v?mth. Write calls at your desired sell price. You could then write more calls if you wanted to. So you write $60 call options on the stock expiring a few months ahead. you must be prepared to give up your shares at the strike price. Suppose you own 1. you'd still have to sell at $60.Here's an example of a covered call. Tread carefully here so you don't get sold out at too low a price. and then kick back and wait. collect the dough. you keep your shares and you've made money on the call options. That means that if the $56 stock in the example above suddenly soars to $70.
is that a stock falls sharply and you're stuck owning it.also referred to as selling naked puts -. not before.looF 32 fo 5 . In many cases. Let's turn to an example: A top-rated stock we found on Motley Fool CAPS and researched thoroughly is trading at $39.. Put options are an excellent way to potentially buy a stock at your desired. but I'd prefer to snag them at lower prices. and can try again..www//:ptth Put Option The right. You can write puts as you wait to average in at lower prices. but not obligation. we most likely would not have had the shares sold to us during this brief decline because about 80% of options are exercised only at expiration. We "sell to open" the put contracts and get paid $3 per share to make the trade. We didn't get to buy the stock at the price we wanted. and we still have hope. We didn't have the heart to close our losing option position. assuming that we would have bought the stock outright when it hit our $35 buy price. Scenario 4: The company's CEO flees to Bermuda and the stock is only at $16 by our option's expiration. Selling puts -. You won't actually need to use margin -. Let's review.v?mth. as with all options. you must maintain the cash or margin (for us it's always cash and we recommend you follow that rule. but then climb back above $35 by expiration.is a favorite strategy of mine to seed a portfolio. puts appreciate as the stock falls (remember: "put down") 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. lower share price and get paid an option premium while waiting for that price.. our broker would automatically buy the stock for our account. but not obligation. At all times. too) to buy shares if they are put to you. or you keep writing puts if the situation merits it. The other risk. In this situation. Either you eventually get to buy the stock at your desired price via the puts. You should sell puts on it at lower strike prices. Call Option The right. The $35 put options expiring four months out are paying $3 per share. This is the worst-case scenario -.but we did get paid the premium. above your desired buy price. and we'll have missed our buy price and the stock's rebound -. have ample buying power (cash. That can quickly wipe out a portfolio. The biggest risk with selling puts.we're down 50% to start. The risks of writing puts include the fact that the stock could soar away without you. You should most often sell puts when a stock you follow closely and want to own is.. of course. but at least we made money on the options we sold. prices that you believe are great levels at which to buy.even lower than our $35 desired buy price! Scenario 3: The stock may tank to $29 soon after we sell the puts. to sell a stock at a set price (the strike price). is when investors rely on margin instead of cash. Writing puts on stocks you know well and want to own at lower prices can be an excellent tool for income and for securing lower buy prices.llAtnirP/10/rfs/05/srettelswen/moc. but you must be prepared to buy the stock should it fall below your strike price. the options we sold would expire. Scenario 2: The stock could fall below $35 by expiration. But we own the stock now and can hope it rebounds. whether it arrives or not. This is a great tool for allocation and averaging into a position. it's better to just buy a great stock once you've found it. A few things could happen here. There may be plenty of stocks that I'd like to buy at the start. giving us a potential net purchase price of $32 before commissions. so we wait and the shares are "put" to our account at $35 (minus our option premium) upon expiration. So we won't own the shares. you must have a margin account. to buy a stock Option buyer at a set price (the strike price). giving us a start price of $32 before commissions -. calls appreciate as the stock rises (remember: "call up") . as we had considered.Selling Puts Note: to sell puts. and have full options permission from your broker.loof. Scenario 1: The stock could stay above our $35 strike price. we would be down even more than we would be with this strategy.but you must be margin-approved. but our analysis suggests that we shouldn't buy it above $35. at least. Of course. alas.which entails high risk -. In this case. in our margin-free strategy). It's important that you only write puts on stocks that you understand well and will be happy and ready to buy at the prices you're targeting. You may also sell puts when a stock you already hold a partial position in is above the price where you'd like to buy more.
your start price is actually $21. You're paid $300 (minus commissions) up front.meaning you'll earn income on your puts when they expire. strategy. The stock increased from $20 to $25.. Verify that the option premium payment makes the trade worthwhile. but if it does. ample buying power) in your account to buy a minimum of 100 shares of Kinetic. you often won't get to buy the stock.50. you'd be happy to buy.llAtnirP/10/rfs/05/srettelswen/moc. Brokers allow put writing on margin. so you're not as anxious to buy it.loof. Let's say the puts pay you $1. and you write two contracts representing 200 shares of Kinetic. . Put writing is a bullish. must have the buying power at the ready (preferably in cash) in case the stock declines Believes the underlying stock will fall If the stock falls. Rather than just sit and wait.www//:ptth The obligation to buy a stock at the strike price. and you'll potentially get that lower buy price. that's "sell to open") the $22. must hold the stock in the account. Put writers do not collect dividends paid by the underlying stock.. If Kinetic Concepts ends this time period above $22. You don't believe a stock will drop to your buy price.Option writer (or seller) The obligation to sell a stock at the strike price. however. Before placing this trade. or at least neutral.50. meaning your strike price is below the stock's current share price. Let's use an example: Assume you're bullish on the health-care company. When you write in-the-money puts. the guidelines in our table don't apply. you'll just get option income. That's why we sometimes write puts on stocks in which we already own partial positions. And now you wait (cue the Jeopardy theme). Remember. Kinetic Concepts (NYSE: KCI). This is called a "covered" position. you can write (remember.50 strike price put options. Vary the expiration dates among your individual option holdings so they don't all fall in the same month -. keeping the premium paid for keeping the premium received for writing the option 8 Tips for Writing (or Selling) Puts Always choose a strike price at which you'd be happy to buy the stock. Nice! Now you own shares at an attractive start price and can wait for appreciation.this staggers your risk.v?mth. is ready to sell shares at writing the option the strike price.50 per share. your options simply expire. This strategy also increases the odds that you get to buy the stock. Never overextend yourself by writing too many puts.50 puts that expire in a few months. Including the option premium you received. Focus on strong businesses that you'd be excited to own for the long term. Write "out-of-the-money" puts. the puts you wrote will be exercised. When you write a put. and you're on the hook to buy 200 shares of Kinetic at a strike price of $22. 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. for experienced investors. . You'll get paid while you wait. You can then write $22.looF 32 fo 6 When to write puts You're ready and willing to buy a stock at a lower price and You don't believe the stock will soar away from you in the meantime (otherwise you'd just buy the stock). If the shares fell to $22 or so. is ready to buy it at the strike price. you're saying you believe the underlying stock will eventually increase in price (hopefully after you've bought shares). You can then write new puts if you'd like. or You just want to make income writing puts. you'd still be happy to buy it. or at least hold steady -. You may write "in-the-money" puts with strike prices above the current share price when you're especially bullish on a stock and want to capture more upside potential with its options. If Kinetic dips below $22. make sure you have the cash (or. Option buyer Believes the underlying stock will rise Option writer (or seller) If the stock rises. but we write puts when we have the cash to buy the stock.50 at the option's expiration. and you keep the $300.
50 by the time your option expires. In this case.and at a price you like. You don't believe a stock will drop to your buy price.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc.you would need to buy back your puts ("buy to close") early -. and you will have missed your buy price. Now what do you do? It might be a tough call. you won't get the shares.looF 32 fo 7 . you keep the $1. Of course. you write puts when: You're ready and willing to buy a stock at a lower price and You don't believe the stock will soar away from you in the meantime (otherwise you'd just buy the stock). . or You just want to make income writing puts. You miss out on a $5 stock gain for only a $1.So. Because almost all options are exercised only at expiration. and you still don't own shares. If Kinetic fell to $17. Fools. but instead jumps to $30 over the next few months.and at a large loss. That's beautiful. So. but then climb back to $25 just as your puts hit their expiration date. you'd still be happy to buy it. whenever you write puts.loof. be confident that you want to own the stock for the long haul. What Can Go Wrong? Sounds perfect. your options would be far underwater. Kinetic could also drop to $22 soon after you write your puts. In this case.. At least you're getting a much lower start price than if you had simply bought the stock outright at $25 on day one. But if you no longer wanted to own Kinetic even at $17 -. But every investing strategy has some risk. assume Kinetic Concepts doesn't fall below $22. doesn't it? You're paid to potentially buy a stock you wanted to buy anyway -. you must be ready to just buy the stock at your net price of $21 and hope for a rebound.say there's a fundamental change in the business -. but what if you miss your buy price again? There's also the scenario that the stock drops and doesn't come back up for a long time.50 gain in the put options.50 option premium and can write new puts. but if it does.llAtnirP/10/rfs/05/srettelswen/moc.v?mth..
we're bidding at $2. and sideways-moving markets: 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc.50 January options. Seibert.llAtnirP/10/rfs/05/srettelswen/moc. has been piling up profits and dazzling members. Heredia. At least 7% to 10% of your Option premium payment strike price. These numbers are great. ideally. don't write puts when you believe a stock is greatly undervalued and about to take off -just buy the stock. ideally. Melrose Park. On Nov. In general. IL "Add to my education and wealth building. -. employs options. "Incredible" "My average investment return per month is 11%. Jeff Fischer -..G. The $22.30 -.20 on a $22. Rock on!" -.. TX Motley Fool Pro.20 per share. I have seen the potential options can add to your portfolio and know this service will add to my education and wealth building. Weigh both the risk of waiting to buy the stock instead of buying today (missing potential upside) and the risk if the stock falls sharply.16.D. our slightly more sophisticated trading service. 2008. and other advanced hedging strategies to help members achieve their financial dreams. calculate whether the options are paying you enough to make the risks worthwhile. which expire in just two months.www//:ptth Motley Fool options wiz. -.. Target time frame until option expiration No more than 9 months. Trade's break-even price (your strike price At least 14% to 17% below minus the option premium paid to you) current stock price.. down.7% of your potential purchase price ($2.." "I will be in for the long haul with this philosophy!!!! I wish I had been 'playing the FOOL' since 1995. The strike price of $22.S. Marietta. our dedicated options service.20 per share in two months. Write puts when you believe a stock is a good buy at a certain price yet is unlikely to leave you in the dust if you don't buy it anytime soon. For the above figures... especially for an inexpensive-looking stock and options that expire in less than three months." I closed my NVDA covered call option at a 84% gain in 3 weeks!!! I would never ever thought about using options in my years of investing if it wasn't for Jeff and Jim.) At least 4% to 5% of your strike price. Michigan "In for the long haul.loof. (This is also your return on the cash you'll be keeping aside for the possible stock buy... which will bring my annual to 132%. or nearly 10% on the cash you have set aside for this trade. "84% gain in 3 weeks.A. Keller. You want a large enough cushion on your puts to ensure a much better valuation on the stock you'll potentially buy. Kinetic Concepts was trading at $24. 11. Your breakeven price if you get the shares is just $20." "I've been able to add options to my toolbox.6% below the stock's current price of $24. .Make Put Writing Worthwhile When you like a stock enough to want to own it.35 per share -. you want enough payment from the options to make the trade worth your wait. 3 months or less. Even if you didn't get the shares at expiration. Once you've identified a put contender. Thanks guys. At the same time.50 was 7. Strike price should be at least 4% below current stock price. and the option premiums paid a solid 9..S. Georgia And because we're committed to maximizing the profit potential and experience for our . At least 8% to 9% below current stock price. Now let's apply these guidelines to a real-life scenario.looF 32 fo 8 Motley Fool Options.but let's say you preferred to buy in the low $20s. be as certain as possible that it's a good strategy to write puts rather than just buying the shares outright.. The table below shows what to generally seek on options expiring in four months or longer versus those that expire in a few months: Fact or to Consider Options Expiring in 4 Months or More Options Expiring in 3 Months or Less Strike price should be at Strike price least 7% below current stock price.an extraordinary trader with a documented 93% success rate -.6% below the current share price.35. 6 months or less.. but just since February 2009 it has been extra fine. Wow! That is incredible! Am I missing something or can this be true?" -.leads two exclusive groups committed to achieving bigger returns in up. ETFs. you would have earned $2..50 strike price). Ward in Brighton.v?mth.
or on stocks that won't likely decline (but you'd happily own if they did) to generate income. You can also choose to close your put-writing strategy early to write new puts that expire in a later month. you only need to own the underlying stock). We will notify you the moment either service begins accepting new members.000 before you can sell put options. Simply say. you'll earn strong higher returns on your money. If you really want to own a stock. When writing any options. As your account grows over time. please. We suggest starting with the more practical (and less expensive) strategies of buying calls.. your assets.looF 32 fo 9 Click Here It's Free! Bottom Line Target healthy businesses with attractively valued stocks. you should have a higher account balance and you'll need a margin account as well.or write -. With most brokers. If you're not ready or able to sell puts yet. say $5. .loof. typically. and a bit more. though. It can take a week or longer to get approved.put-writing.000 in your account. resulting in a gain or loss dependent upon what you were paid for the puts at the start. So if you're interested in learning more about Motley Fool Options. In most cases. . whether it generates income or you end up buying the stock. just a few hundred dollars. for any reason. buying options is not unlike buying stocks. though. whether it generates income or you end up buying the stock. or if you've made most of your potential profit on the options. buy at least some shares outright. if you want more time for your strategy to play out. You can buy options with cash or partly on margin. and your put writing strategy should leave you happy. buy at least some shares outright. or if you simply want to be paid more now for keeping the strategy in place. Write puts on stocks you'd like to own at cheaper prices.options. a brokerage firm will require about $25.." To later close the position. Typically. but margin is certainly not recommended." Just make sure you can find attractive new puts to write before closing your old ones. paying you a higher option premium.Closing Early and Rolling Forward If you no longer want to potentially buy the underlying stock. buying puts. Meanwhile.000 or $10." You'll need to answer questions about your investing experience. If you really want to own a stock. specifically -requires ample buying power in your account.which would mean our analysis was mistaken from the beginning or something drastically changed at the company.000. If you plan to follow along with our options trades. You might do this if you've made most of the money you can possibly earn on the trade (about 85% is our guideline). we suggest have at least $10. If the stock rises. you can buy options even if you have very little money. Just "buy to close" the puts you sold earlier.www//:ptth premium members -. This is called "rolling forward. To sell -. you would use "buy to close. However.. "I'd like to apply for full options trading permission." Writing options -. the brokerage terminology used to start the position is "sell to open.Motley Fool Options is by invitation only. The advantage of buying an option contract or two is that you can "control" many shares of the underlying stock for. to make options worthwhile after spreads and commissions. less if you wish to sell covered calls (there. Write puts on stocks you'd like to own at cheaper prices. and your put writing strategy should leave you happy. we won't close a put early at a loss unless we're certain that we don't want to own the underlying stock anymore -. simply click the button below. that's perfectly fine. Broker Requirements Applying for options trading permission with your broker involves filling out a form that they'll give you when you ask. Bottom Line Target healthy businesses with attractively valued stocks. you can try out more involved options strategies. or slightly more advanced Motley Fool Pro. you'll pay the going market price. or writing covered calls. you'll want to apply for full permission right away.v?mth. or on stocks that won't likely decline (but you'd happily own if they did) to generate income. 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc.llAtnirP/10/rfs/05/srettelswen/moc. Be sure to review your cash and margin buying power before writing a put option.. you can close your puts early. It's probably the strategy you should consider last if you're new to options.
starting from the beginning. when it comes to equities. you are obligated to either deliver the shares (in the case of a call) or buy shares (in the case of a put). A put option goes up in value when the underlying equity or exchange-traded fund declines in price. and you need to pay out $2. you can protect your portfolio by purchasing put options. it's called a costless collar. However. Don't sell calls on stocks you're not willing to sell or that you believe are grossly underpriced. This allows you to choose more advantageous strike prices and be paid more for the calls. In times of uncertainty. So when you buy a put. After all. In this guide. If shares of Emerging Markets exceed $24 by your call option's . But when you buy options. leverage.v?mth. you may be reluctant to sell even if you see storm clouds on the economy's horizon.Protective Collars As you move deeper into the world of option strategies. without needing to get the underlying stock involved unless you want to. when you buy them. For example. Using this strategy. For a costless collar. and selling the calls to pay for them means your net cost for the strategy is only $0.a.often with little downside risk and at little to no cost to you.10 per contract.not selling them. you're using options as a strategy on their own..your insurance -. In other words. Also. Purchasing options -. you still see risk to the downside. it can be expensive -.or sharply -. Let's say (using real-life quotes available as I write this) that the $19 strike price put options expiring in seven months can be purchased for $2. The real cost of implementing a protective collar is limited upside. That's right. you want to buy puts and sell ("write") calls to pay for them.that's cheap insurance. Let's explain how collars work.30 to buy the puts).10 for selling the calls. and the puts gain value. assume Emerging Markets is trading at $21.loof. They can also be a prudent way to protect your gains on stocks that have recently leaped in price. Insure Your Positions by Buying Puts As a long-term investor who remains committed to your core holdings. the $24 strike price call options can be sold for $2. You want to protect your investment against a large decline. you'll begin to find creative ways to protect. you buy your puts -. So if you buy puts on a stock you own. Now let's explain buying puts. The position you're protecting usually needs to decline soon -. or hedge your portfolio -. The puts will protect you from a meaningful decline in the ETF's price. often without any out-of-pocket expenses. you're paid $2. thus saving yourself the cost of the puts.with funds you receive from the concurrent sale of call options.or even Long-Term Equity Anticipation Securities (a. Sell Calls Assume you own shares of Vanguard Emerging Markets (NYSE: VWO). specifically. life is full of ups and downs. You believe emerging markets will reward investors in the long run. Nice -. Protective collars are useful in bear markets or when you're uncertain about a stock's valuation risk. A put gives its owner the right to sell the underlying investment at a minimum set price (the strike price) by a set date (the option's expiration date) no matter how far it falls.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. You can "cover" all or some of your shares. Buy puts and sell calls with the same expiration date but different strike prices (the most attractive available). you'll learn how to use options to protect an existing investment from downside. Protective collars can be used to shield against downside risk in rocky markets or to safeguard gains when you're not ready to sell -.llAtnirP/10/rfs/05/srettelswen/moc. you'll simply sell those puts later for a profit and still keep your shares of the underlying stock (assuming you want to). When you sell options.but would willingly sell at slightly higher prices. The Costless Collar: Buy Puts. But in the intermediate term..30 per contract. nearing your estimate of fair value.20 per share plus commissions (remember.and when it's free to you. and you can't simply disengage when the going gets tough. you're not under any obligation regarding shares of the underlying investment.for puts to pay off handsomely.k. Typically seek to use options that expire in six months or more -. LEAPS) that expire in 18 months or more. buying puts to protect your key holdings makes plenty of sense. just in case. you're basically buying insurance for your investment. This is called a protective collar -. However.looF 32 fo 01 Collar Cheat Sheet .and who wants to shell out piles of cash for insurance policies that will one day expire? Enter the costless collar.
you can keep holding your shares to await eventual gains. but reluctant to pony up the cash to buy it today? A synthetic long may be just the ticket. or (3) the stock stagnates. you can sell $25 strike price covered calls for $4 per contract. Meanwhile. finally ending with little or no value. your upside potential is unlimited. This option strategy works nearly the same as owning the underlying stock outright -. and allow you to ride out a rough market with more confidence. you believe that the underlying stock is going to appreciate considerably over the life of your option. sometimes to a much greater degree. Looking at the options that expire in 10 months. you buy a call option and concurrently sell a put option on the same underlying stock or exchange-traded fund. If the stock does not appreciate.. Remember the three possible outcomes with a synthetic long: (1) the stock increases and both your options make money. you'll set up a synthetic long on a stock if you foresee a strong catalyst for appreciation in the next 18 months or so. and the calls you sold will expire. The synthetic long allows for the best of both worlds: On the options you buy in this strategy. however.50 strike price puts for only $2 per contract. Let's see an example. This type of strategy combines the best of both worlds: Limited downside and unlimited upside. and expect a catalyst over the next 18 months or so. Buy Calls. A true synthetic long uses the same strike price and expiration date for both calls and puts.as opposed to selling (or writing) them -. if you use income from a put sale to buy your calls. help hedge your portfolio. in which case both your options may simply expire. Your full position is protected against a sharp decline. Synthetic Longs Are you confident about a stock. For a true synthetic long. Sell Puts To initiate a synthetic long. you can buy the $17. and you could lose your whole investment. The puts will provide a profit. you should use the longest-dated LEAPs (Long-Term Equity Anticipation Securities) you can find so you'll have the largest window of time to be proven correct. protect a holding. This makes the synthetic long an especially attractive trade for bullish investors. but they're useful in situations that merit protection.loof. the calls and puts will have the same expiration date and strike price. although there are attractive variations that you'll discover below. but you only need to sell three calls to pay for it -. your options gain value along with it. Usually. Assume you own 600 shares of Kinetic Concepts (NYSE: KCI). on the options you sell. This is exactly what you do to set up a synthetic long position. bought at $21. When you buy a call. you discovered that when you buy options -. .. rather than getting the underlying equity involved (unless it's to your benefit). and half of your shares still have unlimited upside potential since you didn't sell calls on them. though. and you're back where you started.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc.llAtnirP/10/rfs/05/srettelswen/moc. You must be ready to buy the underlying stock if it falls below your put option's strike price. your calls will move toward expiration with less and less value. As the stock price goes up. you'll be glad you set up the collar. They're not for everyday use. (2) the stock decreases enough that you're obligated to buy it via your put options. This potential loss is much easier to stomach. refrain from initiating short-term synthetic longs that expire in nine months or less. You need to be correct by the expiration date or the option won't maintain value. at least somewhat bullish on the market overall. Typically.you aim to profit from the option itself. This means you can protect all 600 shares by buying six puts. you'll miss any upside above that price and need to sell your shares at $24.v?mth. With the proceeds. That is always the risk of buying options.expiration. Earlier.looF 32 fo 11 Synthetic Longs at a Glance Synthetic longs are best when you're bullish on a strong business.except you don't need to pay up front. But if the ETF's price declines over the next few months. If it does. The Bottom Line Collars can smooth returns. the call usually gains value dramatically.and you still pay nothing out of pocket. Too There is a way to insure your investment and maintain unlimited upside potential on at least some of your shares. Insure Your Positions and Keep Upside. you . the worst-case scenario is that you end up buying the underlying stock at a price of your choosing.
and you can then hold the shares and hope for a recovery. but ideally it bought you shares of a good company. If Autodesk appreciates to. If Autodesk declines. The net cost is the same -. you'll use synthetic longs to profit from the options themselves over the course of your investing thesis -. consider taking your profit on the calls. both your calls and puts will start to show gains in your portfolio.30." however. On the flip side. In this case. your put options are on the path to expire for the full cash payment. This is the only number you'll ultimately care about if your trade is underwater. your net start price on Autodesk will be about $12. $20 by sometime in 2010. your call options will slowly lose value.you should start to consider taking your profit in your call options (unless you prefer to exercise them in order to own the stock at your call's strike price). so you'd like to set up a synthetic long position to benefit. With the shares trading around $12.. .30 per share -.www//:ptth can "split the strikes.50 per share. Splitting the Strikes Setting up a synthetic long with identical put and call strike prices near a stock's current share price is the norm (because you're looking to approximate a stock purchase today). With that income. your calls will gain 100% to 200%. but you use different strike prices. you don't need to buy it until it is $10 or lower. around 18 months. The Bottom Line When you're bullish on a stock and want to invest without spending capital today. When to Close a Synthetic Long If all goes well. if Autodesk begins to appreciate. at which point -.loof.50 calls) by January 2011 for your call options to appreciate meaningfully or at all.30 to set up your synthetic long..llAtnirP/10/rfs/05/srettelswen/moc. On the flipside.50 call options on Autodesk for $3.80 per contract. and your net start price will be $10.v?mth.50 calls from the first example) for about $2. and shares drift lower to $10 or $11 for the next year or longer. depending on your preference. Using a synthetic long option strategy on a dividend-paying stock does not entitle you to the dividend payment. Given that you paid a net $0.based on the valuation of the stock and the amount of time left in your options -. At the same time. you can then buy the January 2011 $15 call options (instead of the $12. you still use calls and puts that expire during the same month. For more downside protection.50. to set up a more defensive or aggressive synthetic long.looF 32 fo 21 . setting up a synthetic long position is a sensible alternative. let's say you decide to write the January 2011 $10 put options instead of the $12. and concurrently sell (or write) the January 2011 $12. 2009). with unlimited upside on the call options -.or it nets you shares of a stock that you should be happy to buy at a lower price.but you have more downside protection when you split the strike this way.80. 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. Once your thesis has largely played out and you've earned money on your calls. you'll be ready to buy the shares and hold them. let's suppose Autodesk continues to suffer from soft sales. The $10 puts pay you $2. Usually.50 puts.50 put options for $3.Bullish on Autodesk? Go Synthetic Long! Suppose you have a bullish long-term stance on 3-D software leader Autodesk (Nasdaq: ADSK). you may consider "splitting the strikes" as you set up a synthetic long. Using Autodesk as the example. in effect mirroring the stock or even outperforming it. use the underlying stock's valuation and your option's approaching expiration date as guides. You're ready to buy Autodesk at a net $12. Only rarely will you exercise the calls and turn them into a stock position if the options are successful. you could have bought the January 2011 $12.30 per share. The strategy can reward you with handsome profits on two options at once.just $0.50.typically.80 per share. too. say. Your synthetic long didn't make you any money. Once you make these trades. when the position works against you and you need more time for your thesis to materialize.50 (as of March 13. the underlying shares will appreciate for you well before your options near expiration. You believe the business will be on the upswing again within 18 months. In that case. but it may not be the most comfortable choice for you. Your net cash outlay is just $0. and your puts will be well on their way to becoming a 100% cash gain. What do you sacrifice? You now need Autodesk to appreciate by a greater degree (compared to buying the $12.80 per share. and your put options put you on the hook to buy shares at $12.
That means.llAtnirP/10/rfs/05/srettelswen/moc. Consider synthetic shorts on indexes (like SPY) as a portfolio hedge. It's rare that an option is exercised early. Use the same expiration date for both the call and put. But your potential profits are hefty.so this is a risky strategy. there's a way to use options to mimic shorting a stock -. you sell a call option and simultaneously buy a put option. Splitting the Strikes . "split the strikes" and use a higher call strike price. the greater your potential loss.. Second. but -. in this case you do not own the underlying stock. forcing you to buy the stock and deliver it sooner than you wanted.especially when you don't own the underlying shares -. you sell a naked call and buy a put option simultaneously. You're now effectively short Goldman Sachs -. and you would either need to take your lumps and close them or wait and hope for Goldman to fall. and those broker requirements will be updated daily if the stock increases against your position.shorts usually involve a narrow time frame. To take on less risk. In the ideal situation for you. This results in a $2 per share credit to you. Choosing options that are as close to Goldman's current share price as possible. Borrowing shares to short is difficult. Your thesis has played out. The terrifying outcome (here's that risk you read about) would be if Goldman soared.you need to be aware that it could happen.Synthetic Shorts Feeling bearish? If you're looking to profit when stock prices slip. Use LEAPs so you have more time to be proven right. For a straight synthetic short.profitably while you can.. Because you have naked calls. Your options would show large losses.selling naked calls is risky! The higher the stock goes.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc.v?mth. To get a handle on how this strategy works. Be careful -. and you should close your position -. and then deliver the shares at $180 per share for an instant loss -. you don't need to cover any dividend payments yourself. by their expiration you'll be required to buy Goldman stock at the going market price if it sits above $180 per share. and you believe there's profit to be had by shorting it over the next few months (remember. You also need to maintain enough buying power to cover your naked call obligations. it's a "naked" call. unlike when you short a stock outright. the stocks you want to short most are the most difficult to obtain for a traditional short sale. Sell a Naked Call. Finally. the one that is as close to the current share price as possible. you don't need to borrow shares of a stock to short it when using options -. using the same strike price and expiration date for each. and the strategy provides advantages when compared to traditional shorting. let's say you want to bet against one of Warren Buffett's recent investments. the amount of money you need to risk up front is typically much smaller with a synthetic short. First. . Unlike a covered call strategy. just as when you short a stock outright.looF 32 fo 31 Synthetic Shorts Synopsis To replicate shorting a stock with options.which you don't want to cover yourself -. shorting usually involves a narrow time frame).but with distinct advantages.often. Third. you want to use LEAP options so you have more time to be correct if need be. For less risk shorting with options. Another risk with an underwater call option is that it could be exercised early. and the stock pays nearly a 1% dividend -. To set up this "synthetic short" position. your potential losses are unlimited with synthetic shorts -.both options -.just as if you'd shorted the stock outright.and Buffett (how do you even sleep at night?). you simultaneously sell the January 2011 $180 calls (which will pay you $30 each) and buy the January 2011 $180 puts (which will cost you $28). Once you have your desired profit.loof. let's run an example. close the options -. given the leverage provided by options. Buy a Put Brave soul that you are. both opening and closing a synthetic short can be done quickly. while the traditional shorting method sometimes involves a lot of waiting. you sell a call and buy a put with the same strike price. so when you sell (or write) the call. Volatile Goldman Sachs (NYSE: GS) has jumped to over $180 per share. Goldman declines 20% or more over the next few months and pushes both your calls and puts toward sizable profits. Although your shorting thesis only covers a few months.so a synthetic short is your best route. simply buy puts and forego writing naked calls.
assume you sell the January 2011 $195 calls on Goldman for $24 each and buy the $165 puts for $24 each. Use the same expiration date for the options you buy and sell. and you're still effectively short Goldman. Not interested in averaging down or holding for the long haul. The lower strike on the put does make it more difficult to ultimately profit from the stock's decline. but with less risk. Using a margin-approved account and can write call options. price above the current share price. the advantages of the strategy over straight shorting should earn it a rightful place in your tool box. This guide will teach you how to use options to exit laggard positions at breakeven. a reality check: Stock repair does not protect you from additional downside in the shares you already own -. So. so a Foolish investor should only "go short" carefully and in special situations. but you use different strike prices. . few growth prospects. Just Buy the Puts Remember. Stock Repair Sell (write) two call options at a strike At some point. The "stock repair" option strategy not only recoups your initial investment. while synthetic shorts are as risky as selling short outright and shouldn't be taken lightly. You'll likely prefer to short companies with high debt. The strategy can. it's still attractive. and if you're wrong on the trade. rather than using the $180 strike price.. most or all of that money will be lost.loof. every investor gets stuck hanging onto a stock that has declined 20% or so and never seems to recover. so your risk is known.v?mth.If this example sounds too risky. But first. a low Motley Fool CAPS score.llAtnirP/10/rfs/05/srettelswen/moc. You won't have to worry about the potentially unlimited losses that a naked call entails. weak or no profits. for every 100 shares of a losing stock you (woefully) own: Buy one call option at a strike price below the current share price. stronger buys. For example. but frees up your cash for new.. however. To do this. you can add a little breathing room to your synthetic short by "splitting the strikes" (you discovered this earlier as well). Sure. use options that expire in 90 days or less. you still sell your naked calls and buy your puts with the same expiration date. The Bottom Line Despite the recent rout. the market's long-term trend remains up. Typically. . the $165 put will move nearly as much as the $180 put when Goldman declines. and inflated valuations. an index doesn't present as much upside risk as an individual company. In closing. This gives you a sleep-aiding 15% window before your naked call's strike price is hit. But that's the most you can lose with a put purchase. you can also invest against a stock by simply buying put options on it and foregoing selling naked calls to finance your put purchase. but in the short term. lower your cost basis in your losing stock and allow you to exit the position at breakeven without introducing any additional risk.nor does it offer you a profit above your break-even price.looF 32 fo 41 Who Should Use Stock Repair To Set It Up To set up a stock repair. companies come and go every year. Someone who is: Down 15% to 25% on a stock and willing to forego profits to sell at breakeven.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. Business is Darwinian by nature. and synthetic shorts provide a way to invest against the losers. Naturally. you need to come up with all the money to buy the puts yourself. A synthetic short is also well-suited for shorting a market index to hedge your portfolio.
v?mth. Rock on!" -.50 You make $2. Wow! That is incredible! Am I missing something or can this be true?" -. and your options cancel each other out. "84% gain in 3 weeks.loof. while the second call you sell is covered by the new call you just bought.. the stock repair strategy has three possible results: (1) no change at all if the stock doesn't move or declines. so your cost basis in the stock is now $35. Marietta.an extraordinary trader with a documented 93% success rate -.bingo! Your $30 call is now worth $5 per share. I have seen the potential options can add to your portfolio and know this service will add to my education and wealth building. Melrose Park. Seibert. you purchase a $30 call option for $2. Ticks up a few dollars -. you've effectively lowered your stock's cost basis to $37. and $40 you can still sell your stock at breakeven. Recovers to $35 -.50 Sell two $35 call options for $2. employs options.. Catapults beyond All of your positions still cancel each other out. bought at $40. you'd simply sell. the strategy does not bring new risk to your stock -. (2) a lower cost basis if the stock ticks up. Keller. To start. our slightly more sophisticated trading service.Motley Fool .www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc.. TX Motley Fool Pro.. Declines or holds All the options expire." "I've been able to add options to my toolbox." I closed my NVDA covered call option at a 84% gain in 3 weeks!!! I would never ever thought about using options in my years of investing if it wasn't for Jeff and Jim. You then sell two $35 call options for $1.50.Setting It Up These option trades result in minimal or no cash outlay for you because the call you buy is paid for by the two calls you sell..llAtnirP/10/rfs/05/srettelswen/moc. and sideways-moving markets: If the $30 Stock. It seems your best move to get to breakeven is to initiate a stock repair strategy. -.looF 32 fo 51 Motley Fool Options.S. ETFs. Then.. At the same time. The calls you wrote expire. Michigan "In for the long haul. As you can see.. Your option trades have paid for themselves.. You can sell or close all positions and break even (commissions aside).. Georgia And because we're committed to maximizing the profit potential and experience for our premium members -. Heredia. You can try again. Plus.. Got that? Let's turn to an example to show how it works. Jeff Fischer -.D. You're down 25%.S.. You've foregone a profit in the stock. You are breakeven on the stock. Soars to $40 No problem. and don't want to hold your shares any longer.say. you don't believe there's high risk left in the stock -..50 per share on your $30 call option (because you bought it for $0 net cost) and by selling the call for the gain.G. down. You can use the strategy again. "Incredible" "My average investment return per month is 11%. and other advanced hedging strategies to help members achieve their financial dreams.50 total income Here are your possible outcomes: Motley Fool options wiz. You can close everything and move on. has been piling up profits and dazzling members. to $32. Your positions look like this: Original stock. IL "Add to my education and wealth building." "I will be in for the long haul with this philosophy!!!! I wish I had been 'playing the FOOL' since 1995. but just since February 2009 it has been extra fine. our dedicated options service.A.. or (3) a break-even sale if the stock cooperates even .25 each.leads two exclusive groups committed to achieving bigger returns in up. though.. lack hope for the stock's recovery. Ward in Brighton. all profit.. -.. Thanks guys..50 that expires in 60 days. and the first call option you sell (or write) is covered by the 100 shares of stock you already own.otherwise. nothing changes (you just steady at $30 lost on commissions).your options are neutral and covered: They largely cancel each other out. which will bring my annual to 132%. is now $30 Buy one $30 call option costing $2. Repair That Dog! Assume you purchased 100 shares of a stock at $40 per share. and it now trades at $30.
You want to leverage potential returns when the underlying investment moves meaningfully in either direction. You must be happy to just breakeven and confident the stock won't fall sharply while you wait. We will notify you the moment either service begins accepting new members. but you don't know which way. Choosing Your Strike Prices In general. you've paid two option premiums. an acquisition is pending. the options would eventually expire with little or no value. let's go over what can go right or wrong. The clock also plays a large role. this strategy works best when you're down about 20% on a stock.llAtnirP/10/rfs/05/srettelswen/moc. if you bought 100 shares of a stock at $50 that is now $40..in this case. So if you're interested in learning more about Motley Fool Options. so the value of the options you're buying will increase. Buying a call and a put. But what if you set up a stock repair trade only to change your mind and turn bullish on your stock again? The situation is salvageable.. And. splitting the two.looF 32 fo 61 Click Here It's Free! Why Buy A Straddle? You believe a stock or index will move dramatically. so you .or turn at any moment. The Bottom Line on Stock Repair When you're down a reasonable amount on a lagging stock and simply want out at breakeven. when you buy a straddle. and you write your two other call options at the midway point between the current share price and your stock's start price. Here are the basics: You buy ("buy to open") an equal number of calls and puts on the underlying stock or index (usually you'll do this as a stand-alone strategy. it's called a "straddle" because your calls and puts sit symmetrically on either side of the same strike price -. In fact.but you didn't know which direction it would go? Maybe a big earnings announcement is looming. this strategy positions you to make money as long as the underlying stock is especially volatile in one direction. However.while expiring in the same month. How The Strategy Works Now let's "straddle up" and see how the strategy works.halfway. unsure what to do. but (unless you close the options early) it does limit your upside to your break-even price. This makes buying a straddle attractive as a bullish or bearish strategy. setting up a stock repair strategy may help you meet your goal more quickly.. if the stock stays tightly range-bound. buying a straddle can be superior to shorting a high-flying stock outright. your profit potential is unlimited -. moving at least (as a general guideline) 10% to 30% in the coming weeks or few months. Whether bearish or bullish.loof.but also profit if it finally flames out. On the plus side.the more the underlying stock moves in one direction. In that case. you can close all of your option trades at or near breakeven (they'll largely cancel each other out) and continue to hold the stock. 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. at about the current share price). Most investors would sit on their hands. you can lose your whole investment -. The strategy does not increase or decrease your risk in owning the stock. and with each passing week . but limit your risk. to repair it. on the same stock. or slightly more advanced Motley Fool Pro. Let's say your stock returns to $40 on good news. since you'll profit even if it keeps rising -. while risking only the small cost of a few options. You buy your lower-priced call options at a strike price that is about 20% below your stock's start price (or. as with any option you buy (as opposed to writing options). You believe volatility will increase in general. The strategy works because you gain a much larger profit on one side of your straddle than you lose on the other (more on that later). and you wish to keep owning it. in another example. or a stock has recently soared and could keep going -. Pros and Cons Before you walk you through an example. the more you can profit on that side of your trade.www//:ptth Options is by invitation only.. to answer your burning question. simply click the button below. you'd buy one $40 call and write two $45 calls. you can set yourself up to profit whether the stock goes up or down. So. But if you buy an option straddle. Buying Straddles Have you ever thought a stock was about to make a significant move -.v?mth. as the biggest drag on a straddle purchase is the time value erosion of the options.
Your profit in this case. both options will steadily lose value if the stock isn't making a move one way or another. and usually you'll choose an expiration up to four months ahead if you expect volatility soon.65 each and the October $17. you may slowly lose extra value in your options.close your existing puts and buy puts at that next-higher strike price to increase your profit potential.65 each. also for $1. and the fact the stock could easily swing the other way again.llAtnirP/10/rfs/05/srettelswen/moc. you'll make more money on one side of your options than you'll lose on the other. in one direction or another. 2009..65 each. Finally. Inversely. up from $1. but will cost more up front.www//:ptth won't own the underlying stock).50 puts for $1.50 in July. and Autodesk stays within a few dollars of $17.50 the next month. While increasing the total cost of your strategy. There are two ways to potentially boost your profits while being defensive: If the price of the underlying stock increases to the next higher strike price (compared to the strike price you used to set up the trade). Say management saw business improving. your up-front investment is $990. However. if you buy three contracts of each. these follow-up moves increase your chance for higher profits on any subsequent stock move. Closing a Straddle If your original thesis holds true and a stock makes a big move. you may want to -.50 for a few months? You're losing money on both the calls and puts in this case. your options will steadily lose value. while the puts are worth very little -.30 ($330) -. and you might want to close them ("sell to close") early to get some capital back -. or six months or more if you want more time. This is called "rolling down" the calls. your puts are worth more than $5 each and your calls have little value. What if your thesis is wrong.their value erodes unless the stock's volatility increases. Your calls are now worth at least $5 each.unless you believe volatility will increase significantly and soon. If you believe volatility is subsiding. If your strategy isn't working in time. With shares at $17.50. Your combined cost per contract is $3. though -. The strike prices of the calls and puts should be the closest available to the current price of the underlying stock or index (also called "at the money"). If the underlying stock doesn't make a significant move in either direction. buying the October $17.loof. 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. consider closing ("sell to close") both of your positions at the same time to lock in your profit. if the underlying stock declines to the next lower strike price. you may want to close both positions early to recoup some capital and rethink your strategy. You won't have much value left on that side anyway.you're losing money on them. and if the stock reverses. A Straddle in Action Let's use a real world example. option premium costs. Having more time for the strategy to work can be an advantage. depending on the company's outlook in its next quarterly report.reacting to every zig and zag in the stock can be a detriment when you consider the commissions. your $990 investment is worth more than $1. The expiration month on the calls and puts should be the same. Your calls and puts serve to hedge each other in the early going. a gain of more than 50%. Suppose you believe the stock will move aggressively. If you wait until expiration. Taking Follow-Up Action Straddles can benefit from more active management once the position is in place.500. though.looF 32 fo 71 . Plus. you may regain some . if Autodesk's guidance is weak and the stock falls to $12. you could have set up a straddle that expires in three months. you should consider selling your calls and buying new calls at that next-lower strike price. is 50%. This is called "rolling up" the puts. if you earn a quick profit on one side of your straddle.v?mth. Overall..50 calls. or the stock may reverse on you again. Roll up and roll down sparingly.so. and the stock returns to $22.depending on the number of contracts in play and your commission costs -. as with the opposite side of the spectrum. On the flipside. you may want to lock in that profit and let the losing side stay active. Autodesk (Nasdaq: ADSK) has been volatile as investors try to determine when business will improve. although it's unorthodox. the underlying stock needs to move enough so that one side of your straddle (either the calls or puts) gains enough value to offset the losses on the other side.
loof.. tropeR laicepS looF yeltoM A :moc.www//:ptth of the losing option's worth without risking the profits you've already secured on the closed side.60:21 31/21/9002 32 fo 81 ..looF .llAtnirP/10/rfs/05/srettelswen/moc.v?mth.
it's another story. as the value of your purchased options will steadily erode unless the stock makes a lasting.. and break even at $21 or $29. But by writing ("sell to open") straddles.but you don't know which way -..) As an example. you'll at least break even before commissions -. or slightly more advanced Motley Fool Pro. though. you keep the entire $4 per share you were paid in this example. We will notify you the moment either service begins accepting new members. our dedicated options service. the puts you wrote work against you.loof. writing the calls and puts is a way to profit from low or declining volatility. So if you're interested in learning more about Motley Fool Options. Jeff Fischer -. But since . the maximum profit from an uncovered straddle occurs when the stock ends exactly at the strike price. and buying or even shorting isn't likely to land you a profit.just takes a nap. The options still pay well. earn a profit on the trade. (Note: You need a margin account to write an uncovered straddle. And because we're committed to maximizing the profit potential and experience for our premium members -. The stock is trading at $25..looF 32 fo 91 Motley Fool Options. and sideways-moving markets: Uncovered Straddle Writing When writing an uncovered straddle. As the stock declines.. ETFs. the puts you wrote expire (giving you the full $2 value).an extraordinary trader with a documented 93% success rate -. If the stock ends lower in your profit range.llAtnirP/10/rfs/05/srettelswen/moc. How? Simply by collecting option premium payments on either side of a potentially sleepy position. and you facing growing losses (along with an obligation to buy the stock and wait for a recovery) the further it falls below $21. and you expect its volatility will now all but cease. working against you. our slightly more sophisticated trading service. so you write $25 calls and $25 puts and get paid $2 for each contract -.Bottom Line on Buying Straddles If you believe a stock is going to move significantly -. Remember. you buy the calls and puts to profit in either direction from high volatility. employs options. you can generate income from a steady stock. outside your profit range. meaningful move in one direction or another. Motley Fool Pro. You're just looking to profit on the value erosion of the options you write. you were paid $2 for each call and put.v?mth... the calls expire and the puts break even. As the stock rises. But when you expect a big move either up or down. let's say $23.Motley Fool Options and Motley Fool Pro are by invitation only. Motley Fool options wiz. Your total profit declines as the stock moves away from the strike price in either direction -. down.. consider buying a straddle. There are risks. This means as long as the stock ends the expiration period between $21 and $29 ($4 above or below $25). As you know. as the market calms down or catches up on some Z's. so you profit $2 per share overall here. so you'd like to capture the option premium as income.that's $4 total in option premiums per straddle.. but you'll still profit anywhere between $22 and $28. however.") For example. (call this the "profit range. too. However. You face unlimited potential losses as the stock rises above $29 per share. you usually don't intend to get the underlying stock involved. or $4 total. simply click the button below. so the trade pays you $2 per share overall. The enemy of the straddle-buying Fool is a stable or merry-go-round stock price.which is why you want minimal volatility whenever you write straddles. Take a minute to study the table and grasp how this works. As the table on the next page shows.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc.or the market as a whole -. if the stock ends the period at $27. Click Here It's Free! . Setting Up the Trade A straddle involves an identical number of calls and puts with the same strike price and expiration date on the same underlying stock or index. Inversely. suppose a recently volatile stock just announced earnings. Writing Straddles Sometimes a stock -. and other advanced hedging strategies to help members achieve their financial dreams.buying a straddle is a way to profit on either side. or simply from decreasing volatility.and in most cases. and you'll plan to "buy to close" them (or let them expire) once you've earned your targeted profit. has been piling up profits and dazzling members. and the calls break even.leads two exclusive groups committed to achieving bigger returns in up. the naked (or uncovered) calls you wrote increase in value.
v?mth.$4 in either direction -. the trade creates unlimited potential losses outside the profit range. you might buy $30 calls and $20 puts.80 total for the protective calls and puts. One way to greatly mitigate that risk: When you write your straddle. you've hedged and "covered" your written straddle.you wrote the options. If you don't buy protective options initially.loof. For example. Covered Straddle Writing . the range is significant -. too -. and because buying these options generally costs little. you want to capture generous option premiums). or just buy calls to protect you on that side and be ready to buy the stock via your written puts if it falls). Let's take a look. another route is to simply own the underlying stock outright. your profit range decreases by that amount on either side of the strike price. if you paid $0. be ready to do so if the trade starts to work strongly against you. In this example. However. or as low as possible: Stock Price At Expiration $20 and lower $0 Ending Call Value Ending Put Value $5 and higher as the stock falls Your Total Profit Per Share ($1) and worsening as the stock falls $21 $0 $4 Break-even $22 $0 $3 $1 $23 $0 $2 $2 $24 $0 $1 $3 $25 (the strike price) $0 $0 $4 $26 $1 $0 $3 $27 $2 $0 $2 $28 $3 $0 $1 $29 $4 $0 Break-even $30 and up $5 and higher as the stock rises $0 ($1) and worsening as the stock rises To help achieve a successful uncovered straddle. you want the widest possible profit range (in other words.with strike prices at the two ends of your profit range (for this example.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. Given that a steady stock can suddenly make a big move for any number of reasons. it's risky to write uncovered straddles without this added protection. But remember.llAtnirP/10/rfs/05/srettelswen/moc. your desired outcome is that their value goes to $0.assuming the underlying stock isn't exceptionally volatile and your options expire in two to five months (rather than longer)...looF 32 fo 02 . Doing so. you'll still begin with a net credit from your option writing and keep that profit if the stock stays in a now slightly tighter range. use some of your option proceeds to simultaneously buy far out-of-the-money calls and/or puts.
you don't own the underlying stock. Uncovered straddles don't usually lend themselves to rolling forward (to a later expiration date). but you won't need to consider follow-up action. with the same expiration date. if you like) when you set up your straddle. You can "buy to close" both the calls and puts by expiration and capture much of the profit while keeping your existing shares. still have a $1 per share profit on your straddle.but once you start to stagger strike prices on your calls and puts. Since you were paid $4 per share in option income. netting a sell price of $29 (compared with just $27 if you'd only done a covered call and not a straddle). you're not using a straddle anymore. you're covered on that side of your trade. you own the underlying shares. The benefits of writing a covered straddle are two-fold: You believe the market's overall volatility is Your profit can be higher and your profit range wider than with a mere covered call. Let's consider some potential outcomes: You end up selling your stock via the covered calls. The strike price with a straddle is "at-themoney": as close to the current underlying stock price as possible. If you had only written covered calls and not a straddle. Continuing the earlier example. getting paid $2 each. just be ready to buy it via your puts. Use the same strike price and the same month of expiration on both options. you own the stock. You have more ways to close your options profitably -. but at a net $21 given the option premiums you were paid. a covered straddle-writing strategy is basically a covered call strategy.. You believe a stock that was recently volatile will calm down considerably. it's important that you're ready to sell your stock if it rises. If the stock is moving sharply against you in either direction. and you decide you want to keep your shares. but you keep the $4 option premium you were paid on the puts and calls. In fact. As mentioned above.and still keep your stock if you like.but in this case. When you write an uncovered straddle.but your returns are potentially goosed with additional put-writing income. since only your calls are truly covered. . but you still want to keep a watchful eye on your strategy. The stock declines below $25. lowering your risk. As with a covered call. Nice! Finally. you need to be ready to buy more stock if it declines (or close the options early). In this example. presumably to expiration. Writing Straddles: The Basics Write ("sell to open") an equal number of puts and calls on the same stock or index. Here the straddle works like a covered call strategy -. Writing covered straddles is much less risky and requires less upkeep. And as with writing puts. and keep your stock. The key difference with a straddle is that both options are at-themoney. so you can't depend on these defensive follow-up moves being available to you. providing more leeway -. let's assume you want to write a straddle on a steady $25 stock -. so you're more likely to see your options exercised.loof.llAtnirP/10/rfs/05/srettelswen/moc. You end up buying more shares. The most you can earn writing straddles is what the options pay you initially. as an example of the added flexibility here: Assume the stock increases to $28 by expiration. Since you own the stock. You need to be ready to accept more shares if the stock falls below your puts' strike price. some investors will use a lower strike price on the puts they write. . or rolling down (to lower strike prices). rolling up (to higher strike prices). you might close your call options for a loss and let your puts go. The stocks holds steady. you're using a strangle. but it generally offers more profit potential because you're also writing puts on the stock.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. if you buy out-of-the money protective calls (and puts. no matter how high it climbs. For this reason. around $24 to $26. You write $25 calls and puts. One way to do so is to close the losing side of your straddle when the stock reaches your break-even price. Taking Follow-Up Action Writing uncovered straddles requires keeping a close tab on your trade.v?mth. If the stock falls.Owning the underlying stock takes away all of the naked call option risk when writing a straddle. you'd need to book a loss if you wanted to keep your stock. so your risk is high (more on this in a minute). When you write a covered straddle. going to decrease.looF 32 fo 12 Why Write A Straddle? You believe a stock or index is going to hold steady. keeping your overall losses marginal. your potential profit on the straddle is lower. you may want take action to limit your losses. if the stock rises to $29. you could close your calls for $3. You've added to your existing stock holding..
since we're much more concerned about the underlying value of the equity we're targeting. the option's intrinsic value is the difference: $2. Call options are in the money when the underlying stock is above the call's strike price. Premium: Not unlike an insurance premium. Time-value premium: This is the price of an option above its intrinsic value. A call rises in value as a stock rises and declines in value when the stock falls. and would cost you $300 ($1. This occurs when.50 x 200). or no cash cost at all -.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc. It's an option's value in direct proportion to the underlying stock's current price. allowing the holder to sell the stock at $30).. Straddles: Use both puts and calls simultaneously on a stock. Most new LEAPS become available every July.looF 32 fo 22 . Put option: A put option is the right to sell a stock at a set price at or before the option's expiration date. to profit if the stock makes a dramatic move either up or down (when you buy a straddle). . the longer until an option expires. only time value. Protective collars: Profit on a stock you own if it declines. a straddle). after the market closes). the option has been "exercised. expire at least two years in the future. accounting for more unknowns. Intrinsic value: This is the value of an option if it were to expire immediately.in this case. with the same strike price and expiration date. while assuring a higher sell price if that price comes along. and much could change by then. It's the value placed on an option purely to account for unknowns and expected volatility between now and expiration.llAtnirP/10/rfs/05/srettelswen/moc. however. Option contract: Each option contract represents 100 shares of the underlying stock. Sell puts to buy bullish call options. You sell covered calls on a stock you own to buy protective puts. Delta: The amount that an option's price will change with any change in the underlying share price. an option has no intrinsic value. So.Bottom Line on Writing Straddles You're not likely to write uncovered straddles without using some protective options as well.. for example. When an option is converted into a stock transaction. A contract is quoted at the price for just one share. Options Glossary Call option: A call option is the right to buy the underlying stock at a set price (the "strike price") at or before the option's expiration date. or sell.50 each. Although generally more expensive. Also. A put's value increases as a stock falls. if you buy two option contracts for $1. In the money: This term is used when an option has intrinsic value. you have another tool to profit no matter what the market throws your way -.loof. when first offered. it actually represents 200 (2 x 100) shares of stock. or profit it stays in a range (when you write. If a call option gives the owner the right to buy a stock at $10. and exercise: Every option has a strike price and expiration date (which is always the third Friday of a month.this trade can often be set up with a net credit to your account. The option may actually be priced at $3.v?mth. The strike price is the value at which the underlying stock can be bought or sold. even if the market goes nowhere. is a sensible way to increase option profits on a covered call strategy as long as you're also willing to buy more shares if need be. the higher the premium it commands. Time value declines as expiration draws closer. generally the higher the premium on its options." The more volatile a stock is. the value paid for an option contract is called the "premium. expiration. but they're still good things to know). a stock is trading at $8 and a call option has a strike price of $10. Writing covered straddles. so you need to multiply it by 100 to get the full value. LEAPS (Long-Term Equity Appreciation Securities): These are simply stock options that. Gamma: A measure of risk in an option based on the amount that the delta will change with a $1 change in the stock (we don't concern ourselves much with delta or gamma. all else equal." Here. and the stock is trading at $12." Synthetic longs: Approximate stock ownership at a much lower net cost. With this strategy. Put options are in the money when the underlying stock is below the option's strike price (a stock is at $22 and the put option has a strike price of $30. Strike price. Out of the money: This is the opposite condition as "in the money. we like LEAPS because they give you a relatively long time for an investment thesis to play out. with $1 of time value (see below) because it doesn't expire for a few months.
v?mth.loof." to close the position. The new option seller is called the "option writer.www//:ptth 60:21 31/21/9002 tropeR laicepS looF yeltoM A :moc.Writing a contract: Selling a new option contract (opening a position) is usually called writing a contract. the brokerage command to do so is usually "sell to open.llAtnirP/10/rfs/05/srettelswen/moc. the trade command is called "buy to close." just as when you short a stock.looF 32 fo 32 ." ...
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