Sunday, August 19, 2012

Bullish Option Plays

Bullish Limited Risk

Long call
  • Easy to execute and manage
  • The delta of a call tells you your exposure to changes in the stock
  • The delta of a call will change with stock price movement and the passage of time
  • Don't forget about time decay (negative theta)
  • Keep in mind that volatility of the underlying and fluctuations in implied volatility (supply and demand for premium) affect option prices

Call Back Spread
  • Long more higher strike calls and short lower strike call at same expiration
  • Like a long call, it has unlimited upside profit potential with limited risk
  • At expiration, the stock needs to be significantly above the long strike to make money
  • This position has net long options, and is usually long volatility (vega)
  • Be aware that a backspread can be initiated for a debit (pay for it) or credit (receive money for it)
  • The potential liability is the difference between the strikes

Bull Vertical (long call vertical or short put vertical)
  • Long lower strike call (put) and short higher strike call (put) at same expiration
  • The bigger the difference between the strikes, the bigger the potential profit, but also the bigger the cost
  • Your maximum loss and profit are limited
  • Generally speaking, it's an inexpensive way to play the upside in a stock or index
  • It's a good introduction to option spreading, but also a favorite among veterans

Long Higher Strike Butterfly
  • Relatively inexpensive option strategy that has limited risk and limited profit potential
  • The closer a butterfly is to expiration, the more it will react to changes in the stock price
  • A strategy used by professional traders for years because of its protective characteristics
  • For a long butterfly, you want the stock to rise to the middle strike

Long Higher Strike Time Spread
  • Long back month option and short front month option at the same strike
  • Time spreads have limited risk and limited profit potential
  • Relatively low cost position with no margin required
  • Be aware that implied volatility can change at different rates in each month
  • This spread works best if the stock moves up to the strike price slowly, allowing the premium of the short call to erode at a quicker rate.

Bullish Unlimited Risk
Long Stock
  • Buy and hold -- it's a time tested strategy
  • Not as much leverage or protection as certain option positions
  • Isolate your speculation - and you may find an option position that has more desirable risk characteristics
  • Hold it forever, and you'll get any dividends payable

Long Combo
  • “Synthetically” long stock
  • Long call and short put at same strike and expiration
  • Has the same risk exposure as long stock, and dividends and cost of carry are built into the combo price
  • Unlike stock, combos expire, and unless it is exactly at the money, long stock will be the result of the call exercise or the put assignment.
  • In most cases, requires less margin than long stock

Long Semi-Stock (off-strike combo)
  • Similar to long combo, but has smaller positive delta
  • Long higher strike call and short lower strike put at same expiration
  • The position is generally initiated as premium-neutral but that can change quickly as the stock price moves
  • Requires less margin than either long stock or same-strike combo

Short Put
  • Potential profit is limited to the price of the put
  • Risk is limited to the strike price minus the price of the put
  • Generally requires less margin than buying stock
  • Can be a good way to get long a stock you want to buy at a lower price (no guarantee that it will be assigned)

Put Ratio Spread for Credit
  • Long higher strike put and short more lower strike puts at same expiration
  • The most common ratio between short and long is 2:1
  • Ratio spreads have unlimited downside risk – monitor your position carefully
  • At expiration, greatest profit at the lower strike price
  • Because the position is net short options, there is an increased volatility risk

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