tag:blogger.com,1999:blog-39151793580944432882024-02-20T19:08:57.748-08:00Fade The TradeUsing Options and Probability to Profit from Today's MarketJasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.comBlogger332125tag:blogger.com,1999:blog-3915179358094443288.post-42031675943847305742012-08-19T21:27:00.000-07:002012-08-19T21:27:18.885-07:00Volatile Limited Risk Option Plays<br />
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Long Straddle / Long Strangle</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long call and long put at same strike (straddle) or different strikes (strangle) at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Unlimited profit potential to upside and downside</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Loss limited to the cost of the straddle or strangle</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Break-even points are the strike plus and minus the value of the straddle, or high strike plus and lower strike minus the value of the strangle</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The definitive position for volatile markets</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Time decay (theta) is your enemy</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The technique called "gamma scalping" can be used with straddles and strangles to offset time decay</li>
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<a href="" name="backspreads" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Back Spreads</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long more options than short options</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Unlimited profit potential with limited risk</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">This position has net long options, and is long volatility (vega)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Be aware that a backspread can be initiated for a debit (pay for it) or credit (receive money for it)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Sluggish stock price movement and time are your enemies<a name='more'></a></li>
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<a href="" name="shortcondor" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Short At-The-Money Butterfly / Condor</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">This position looks like a long straddle or strangle with the unlimited profit cut off where the short strike prices are</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Profit will be limited to the sale price of the butterfly, loss limited to difference between the first two strikes minus the sale price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The closer a butterfly is to expiration, the more it will react to changes in the stock price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Maybe not the best strategy for this scenario, but our option geniuses forced this copywriter to include it</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The further the short ATM butterfly is from expiration, the less sensitive it is to changes in the stock price but the more sensitive it is to changes in implied volatility</li>
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Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-91220982658338577542012-08-19T21:25:00.000-07:002012-08-19T21:25:22.620-07:00Range Bound Option Plays<span style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; line-height: 17.33333396911621px;"><u><b>Trading Range Limited Risk</b></u></span>
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Long At-The-Money Butterfly/Condor</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">A condor is like a "stretched out" butterfly with two different middle strikes rather than just one</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Can be a relatively inexpensive option strategy that has limited risk and limited profit potential</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The closer a butterfly is to expiration, the more it will react to changes in the stock price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">A strategy used by professional traders for years because of its protective characteristics</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">For a long butterfly, you want the stock to stay near the middle strike</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Time decay (positive theta) is your friend</li>
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<a href="" name="longtimespread" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Long At-The-Money Time Spread</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long back month call (put) and short front month call (put) with the same strike price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Maximum loss is limited to the price of the time spread, but can be greater in certain index options</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">This spread works best if the stock price stays right at the strike price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Implied volatility can change at different rates in different expirations</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The position becomes more sensitive to changes in the stock price as expiration nears<a name='more'></a></li>
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<span style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; line-height: 17.33333396911621px;"><u><b>Trading Range Unlimited Risk</b></u></span>
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Short Straddle / Short Strangle</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Short call and short put at same strike (straddle) or different strikes (strangle) at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Unlimited risk to upside and downside (strike minus premium collected)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Profit potential limited to the price of the straddle or strangle</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Break-even points are the strike plus and minus the value of the straddle, or high strike plus and lower strike minus the value of the strangle</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Short both calls and puts make this very short volatility (vega)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Time decay (positive theta) is your friend</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Not for the squeamish or risk-averse</li>
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<a href="" name="putcall" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Put or Call Ratio Spread for Credit</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The most common ratio between short and long is 2:1</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Ratio spreads have unlimited risk – monitor your position carefully</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">At expiration, greatest profit at the short strike price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Because the position is net short options, there is an increased volatility risk</li>
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Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-23821886354400851172012-08-19T21:21:00.002-07:002012-08-19T21:21:58.258-07:00Bearish Option Plays<table cellpadding="0" cellspacing="0" class="icon_table" style="border: 0px; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 0px; padding: 0px; width: 406pxpx;"><tbody>
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Long Put</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Easy to execute and manage</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The delta of a put tells you your exposure to changes in the stock</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The delta of a put will change with stock price movement and the passage of time</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Don't forget about time decay (negative theta)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Keep in mind that volatility of the underlying and fluctuations in implied volatility (supply and demand for premium) affect option prices</li>
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<a href="" name="putbackspread" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Put Back Spread</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long more lower strike puts and short higher strike put at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Like a long put, it has unlimited downside profit potential with limited risk</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">At expiration, the stock needs to be significantly below the long strike to make money</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">This position has net long options, and is usually long volatility (vega)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Be aware that a backspread can be initiated for a debit (pay for it) or credit (receive money for it)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The potential liability is the difference between the strikes<a name='more'></a></li>
</ul>
<a href="" name="bearvertical" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Bear Vertical (long put vertical or short call vertical)</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long higher strike put (call) and short lower strike put (call) at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The bigger the difference between the strikes, the bigger the potential profit. And also the bigger the cost</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Your maximum loss and profit are limited</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Generally speaking, it's an inexpensive way to play the downside in a stock or index</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">It is a conservative way to get short, less expensively, and with limited risk.</li>
</ul>
<a href="" name="longbutterfly" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Long Lower Strike Butterfly</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Relatively inexpensive option strategy that has limited risk and limited profit potential</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The closer a butterfly is to expiration, the more it will react to changes in the stock price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">A strategy used by professional traders for years because of its protective characteristics</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">For a long butterfly, you want the stock to drop to the middle strike</li>
</ul>
<a href="" name="longtimespread" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Long Lower Strikes Time Spread</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long back month option and short front month option at the same strike</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Time spreads have limited risk and limited profit potential</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Relatively low cost position with no margin required</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Be aware that implied volatility can change at different rates in each month</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">This spread works best if the stock moves down to the strike price slowly, allowing the premium of the short call to erode at a quicker rate</li>
</ul>
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<span style="font-family: Verdana, Arial, Helvetica, Sans serif;"><span style="font-size: 11px;"><br /></span></span></div>
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<span style="font-family: Verdana, Arial, Helvetica, Sans serif;"><span style="font-size: 11px;"><br /></span></span></div>
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<span style="font-family: Verdana, Arial, Helvetica, Sans serif;"><span style="font-size: 11px;"><br /></span></span></div>
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<strong style="background-color: white;"><u><span style="font-size: small;">Bearish Unlimited Risk</span></u></strong>
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<div>
<strong style="background-color: white;"><u><span style="font-size: small;"><br /></span></u></strong></div>
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<h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Short Stock</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Sell short, close your eyes, and pray that it tanks – and don't forget that you owe the dividends</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Check the hard-to-borrow list before you short a stock</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Short stock requires the sale to occur on an up-tick or zero-plus tick in the stock</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Isolate your speculation – and you may find an option position that has more desirable risk characteristics than short stock</li>
</ul>
<a href="" name="shortcombo" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Short Combo</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">"Synthetically" short stock</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long put and short call at same strike and expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Has the same risk exposure as short stock, with interest and dividends built into the combo price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Remember: there is no short stock rebate for retail clients</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">A short combo is a way of getting past the down-tick ruleTemplate for shorting stock</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Unlike short stock, short combos expire, and unless it is exactly at the money, short stock will be the result of the put exercise or the call assignment.</li>
</ul>
<a href="" name="shortsemi" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Short Semi-Stock (off strike combo)</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Similar to short combo, but has smaller negative delta</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long lower strike put and short higher strike call at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The position is generally initiated as premium-neutral but that can change quickly as the stock price moves</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Requires less margin than either short stock or same-strike combo</li>
</ul>
<a href="" name="shortcall" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Short Call</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Potential profit is limited to the price of the call</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Risk is unlimited</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Generally requires less margin than shorting stock</li>
</ul>
<a href="" name="callratio" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Call Ratio Spread for Credit</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long lower strike call and short more higher strike calls at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The most common ratio between short and long is 2:1</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Ratio spreads have unlimited upside risk – monitor your position carefully</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">At expiration, greatest profit at the higher strike price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Because the position is net short options, there is an increased volatility risk</li>
</ul>
</div>
</td></tr>
</tbody></table>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-52831256466119326972012-08-19T21:18:00.001-07:002012-08-19T21:18:43.496-07:00Bullish Option Plays<strong style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; line-height: 17.33333396911621px;"><u>Bullish Limited Risk</u></strong>
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<strong style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 11px; line-height: 17.33333396911621px;"><u><br /></u></strong>
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<h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Long call</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Easy to execute and manage</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The delta of a call tells you your exposure to changes in the stock</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The delta of a call will change with stock price movement and the passage of time</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Don't forget about time decay (negative theta)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Keep in mind that volatility of the underlying and fluctuations in implied volatility (supply and demand for premium) affect option prices</li>
</ul>
<a href="" name="callbackspread" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Call Back Spread</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long more higher strike calls and short lower strike call at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Like a long call, it has unlimited upside profit potential with limited risk</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">At expiration, the stock needs to be significantly above the long strike to make money</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">This position has net long options, and is usually long volatility (vega)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Be aware that a backspread can be initiated for a debit (pay for it) or credit (receive money for it)</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The potential liability is the difference between the strikes<a name='more'></a></li>
</ul>
<a href="" name="bullvertical" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Bull Vertical (long call vertical or short put vertical)</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long lower strike call (put) and short higher strike call (put) at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The bigger the difference between the strikes, the bigger the potential profit, but also the bigger the cost</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Your maximum loss and profit are limited</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Generally speaking, it's an inexpensive way to play the upside in a stock or index</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">It's a good introduction to option spreading, but also a favorite among veterans</li>
</ul>
<a href="" name="longbutterfly" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Long Higher Strike Butterfly</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Relatively inexpensive option strategy that has limited risk and limited profit potential</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The closer a butterfly is to expiration, the more it will react to changes in the stock price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">A strategy used by professional traders for years because of its protective characteristics</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">For a long butterfly, you want the stock to rise to the middle strike</li>
</ul>
<a href="" name="longtimespread" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Long Higher Strike Time Spread</h5>
<ul style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long back month option and short front month option at the same strike</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Time spreads have limited risk and limited profit potential</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Relatively low cost position with no margin required</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Be aware that implied volatility can change at different rates in each month</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">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.</li>
</ul>
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<table cellpadding="0" cellspacing="0" class="icon_table" style="border: 0px; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 0px; padding: 0px; width: 406pxpx;"><tbody>
<tr style="margin: 0px; padding: 0px;"><td class="icon_text" style="color: #444444; line-height: 13pt; margin: 0px; padding: 0px; vertical-align: top;" width="99%"><u><span style="font-size: small;"><br /><br class="Apple-interchange-newline" /><b>Bullish Unlimited Risk<br /></b></span></u><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Long Stock</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Buy and hold -- it's a time tested strategy</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Not as much leverage or protection as certain option positions</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Isolate your speculation - and you may find an option position that has more desirable risk characteristics</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Hold it forever, and you'll get any dividends payable</li>
</ul>
<a href="" name="longcombo" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Long Combo</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">“Synthetically” long stock</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long call and short put at same strike and expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Has the same risk exposure as long stock, and dividends and cost of carry are built into the combo price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">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.</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">In most cases, requires less margin than long stock</li>
</ul>
<a href="" name="longsemi" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Long Semi-Stock (off-strike combo)</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Similar to long combo, but has smaller positive delta</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long higher strike call and short lower strike put at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The position is generally initiated as premium-neutral but that can change quickly as the stock price moves</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Requires less margin than either long stock or same-strike combo</li>
</ul>
<a href="" name="shortput" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Short Put</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Potential profit is limited to the price of the put</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Risk is limited to the strike price minus the price of the put</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Generally requires less margin than buying stock</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">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)</li>
</ul>
<a href="" name="putratio" style="background-color: white; color: #0158c4; font-weight: bold; line-height: normal;"></a><span style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;"></span><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><br style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal;" /><h5 style="background-color: white; font-size: 10pt; line-height: normal; margin: 30px 0px 10px;">
Put Ratio Spread for Credit</h5>
<ul style="background-color: white; color: black; font-family: Verdana, Arial, Helvetica, 'Sans serif'; line-height: normal; margin: 0px; padding: 0px 5px 5px;">
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long higher strike put and short more lower strike puts at same expiration</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">The most common ratio between short and long is 2:1</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Ratio spreads have unlimited downside risk – monitor your position carefully</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">At expiration, greatest profit at the lower strike price</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Because the position is net short options, there is an increased volatility risk</li>
</ul>
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Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-69872120635181440962012-08-19T21:14:00.000-07:002012-08-19T21:14:04.493-07:00Exercise and Assignment<br />
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If you trade options, it's imperative that you understand the basics of exercise and assignment. You don't need to know all the theoretical details, but you must be prepared for it, especially if you're short options where you don't control the exercise feature.</div>
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Exercise is the term used when the owner of a call or put (i.e. someone who has a long position in a call or put) uses his right to buy (in the case of a call) or sell (in the case of a put) the stock. Assignment is the term used when someone who is short a call or put is forced to sell (in the case of the call) or buy (in the case of a put) the stock. Remember, for every option trade there is a buyer and a seller, so if you are short an option, there is someone out there who is long that option and who could exercise.</div>
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As you know from the basic definition of options, a call gives its owner the right, but not the obligation, to buy the stock at the strike price. But the seller of a call must sell the stock at the strike price whenever the call owner exercises. A put gives its owner the right, but not the obligation, to sell the stock at the strike price. But the seller of a put must buy the stock at the strike price whenever the put owner exercises.</div>
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Remember, on expiration, thinkorswim will automatically exercise any equity option that is $0.01 or more in-the-money.</div>
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American-style options can be exercised as soon as they are purchased and all the way up to the expiration date. European-style options can be exercised only on the last trading day before the expiration date. All equity options traded in the U.S. are American-style. But some index options are American-style (OEX), while others are European-style (SPX, NASDAQ). It's very important to know precisely when an option expires, and how it is settled.</div>
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Basically, settlement is what you get if you exercise an option. If an option is stock-settled, you will get a long position in the underlying stock if you exercise a call, or a short stock position if you exercise a put. U.S. equity options are stock-settled. If an option is cash-settled, you will get cash in the amount of the difference between the strike price of the option and the settlement value of the underlying index. The OEX and SPX index options are cash-settled.</div>
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When should you think about exercising a long equity option? When are you at risk of assignment if you are short an option? There is a specific economic rationale for exercising an equity option. Simply, is it cheaper to own the option, or to exercise the option? There are numerous academic treatises that discuss early-exercise, and reading them can be useful. But how an academic looks at early-exercise and how an option trader looks at early-exercise can be different.</div>
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For example, an academic evaluates whether he should exercise a long call based on how much it costs to hold the long position in stock that would result. How much interest would he have to pay to hold the stock for the time until the option would have expired? Are there any dividends payable? Their reasoning is very good, and not incorrect. From their point of view, the only time it is optimal to exercise an American-style call is immediately prior to the last ex-dividend date before expiration. That's because after the ex-dividend date the stock price falls by the dividend amount (which reduces the value of the call), and by exercising before the ex-dividend date, you can capture the dividend and reduce the cost of holding the stock. If a stock doesn't pay a dividend, you should never exercise a call before expiration.</div>
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It can be optimal to exercise an American-style put before expiration. It all has to do with the ability to collect any interest on the cash generated from shorting stock. Generally, it's best to exercise an in the money put immediately after the ex-dividend date, because the stock price will drop by the amount of the dividend (increasing the value of the put) and you won't owe that particular dividend if you become short the stock.</div>
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But an option trader adds one thing to the analysis. Is it cheaper to replicate a long call position by exercising the call and buying the put at the same strike price, or simply hold on to the long call? The trader knows that he can create a long call out of long stock and a long put. He also knows that no matter how ITM his long call is, it still has limited risk. If he exercises the call and becomes long stock, he is subject to unlimited risk.</div>
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So a trader will exercise an option if it's cheaper to replicate that option with stock and another option. How does this work?</div>
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Let's consider exercising a long call. If you exercise the call, you will buy stock at the strike price and your call disappears. Any extrinsic value the call had is lost. You have to pay the amount of the strike price as you take delivery of the stock. If you have to borrow money to buy the stock, you will pay interest. If you have enough cash to pay for the stock, you will stop earning any interest you were making on the cash. Either way, you will incur interest expense. Because you are now long stock, you are entitled to any dividends if you exercise the option before the ex-dividend date. Any dividends payable will offset the interest expense. But in order to have the same risk/reward profile you had with your long call, you have to buy the put of the same strike that the call had. So, you have to buy the put.</div>
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It can be seen, then, that it really wouldn't make sense to exercise a long call unless the dividend were so large that it offset all the interest expenses and the cost of the put.</div>
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For example, you are long 1 XYZ May 150 call expiring in 20 days and trading for $10.125. XYZ stock is at $160, and pays a dividend of $.15 and goes ex-dividend in 5 days. The XYZ May 150 put is trading for $.375. The interest rate to borrow money from your brokerage firm is 7%. What happens if you exercise the call?</div>
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You have to pay $15,000 for the stock ($150 * 100 shares). You will start paying interest of $2.92 per day, or $58.33 over the next 20 days. You will receive $15.00 from the dividend when it is paid (to be a real stickler, you should only count the present value of the dividend). The XYZ May 150 put costs $37.50.</div>
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So, you'll pay $58.33 for interest, $37.50 for the put, and receive $15.00 for the dividend. Netted out, it will cost $80.83 to replicate the long XYZ May 150 call with long XYZ stock and long the XYZ May 150 put. Also, you lose the $12.50 extrinsic value in the call. It wouldn't make sense to exercise the call in this case.</div>
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But what if XYZ paid a dividend of $1.50? In that case, you'll pay $58.33 for interest, $37.50 for the put, and receive $150 for the dividend. You also lose the $12.50 extrinsic value of the call, but netted out, you'll receive $41.67 to replicate the long XYZ May 150 call with long XYZ stock and long the XYZ May 150 put. It would make sense to exercise the call in this case.</div>
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Exercising a long put basically follows the same logic as exercising a long call, except that you would have to buy the call of the same strike as the put, pay dividends on the resulting short stock, and offset that with any interest received.</div>
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But consider the position of 100 shares of XYZ at $105 hedged with 1 XYZ Apr 100 put. The position is a synthetic long call, and if the price of XYZ starts falling, the losses will be limited. If XYZ falls below $100 per share, the XYZ Apr 100 put is in the money. If you believe that XYZ will continue to fall, and you want to exit the position you have a choice. You could exercise the put and deliver the XYZ shares at $100 or you could sell the XYZ Apr 100 call (and create a conversion). Which is better?</div>
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Think of it this way: if you exercise the put, you will be selling XYZ at $100, which generates $10,000 cash in your account. That cash will begin to earn interest. You would also forgo any dividends on XYZ stock. But if you sell the XYZ Apr 100 call, you will lock in any profit or loss on the long stock and put up to this point as if you sold the put and stock. The difference is that you may be able to sell the call at a high enough price to make more money than on the interest collected after selling the stock.</div>
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Let's say the time to expiration of the Apr XYZ options is 30 days and XYZ pays no dividend. The XYZ Apr 100 call is $0.625. The interest rate you could receive on cash is 6.00%. If you exercise the XYZ Apr 100 put, you will get $10,000 in your account, and will earn $50 in interest over 30 days. But if you sell the XYZ Apr 100 call at $0.625, you'll receive $62.50 in your account. At expiration, you will be out of the position whether the price of XYZ rises or falls, and you will make $12.50 more than if you had simply exercised the put.</div>
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So, there is an economic rationale for exercising an American-style option before its expiration. But you must be prepared to handle any margin issues that result. For example, for the XYZ May 175 put, you may have originally paid only $1.00 (or $100 total) for it. XYZ drops, and the value of the put rises to $15.25. If you exercise the put, you will be short XYZ stock at a price of $175. You will need to be able to handle the margin requirement of short $17,500 of stock. If you can't meet the margin requirement, your position may be liquidated.</div>
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A similar situation can occur with short ITM options. You must be alert to the possibility of being assigned on short ITM options, and the margin requirements that you might have to make. For example, if you are short one XYZ May 150 call, and XYZ stock is at $160, your short call may be assigned and you will be short 100 shares of XYZ at $150. You will have to meet the margin requirement for $15000 of short stock. A short put will leave you in the position of having to meet the margin requirement to purchase the stock.</div>
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Be aware also that when you exercise an option, you are giving up the limited risk characteristics of the option, for the unlimited risk characteristic of long or short stock.</div>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-75009784198677005042012-08-19T21:11:00.000-07:002012-08-19T21:11:45.684-07:00The Greeks: What They Are and How to Use Them<br />
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The Greeks have given us feta cheese, philosophy, mathematics, and the Oedipal complex. They also tell us how much risk our option positions have.</div>
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There are ways of estimating the risks associated with options, such as the risk of the stock price moving up or down, implied volatility moving up or down, or how much money is made or lost as time passes. They are numbers generated by mathematical formulas. Collectively, they are known as the "greeks", because most use Greek letters as names. Each greek estimates the risk for one variable: delta measures the change in the option price due to a change in the stock price, gamma measures the change in the option delta due to a change in the stock price, theta measures the change in the option price due to time passing, vega measures the change in the option price due to volatility changing, and rho measures the change in the option price due to a change in interest rates.</div>
<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="delta" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
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Delta</h5>
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The first and most commonly used greek is "delta". For the record, and contrary to what is frequently written and said about it, delta is NOT the probability that the option will expire ITM. Simply, delta is a number that measures how much the theoretical value of an option will change if the underlying stock moves up or down $1.00. Positive delta means that the option position will rise in value if the stock price rises, and drop in value if the stock price falls. Negative delta means that the option position will theoretically rise in value if the stock price falls, and theoretically drop in value if the stock price rises.</div>
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The delta of a call can range from 0.00 to 1.00; the delta of a put can range from 0.00 to –1.00. Long calls have positive delta; short calls have negative delta. Long puts have negative delta; short puts have positive delta. Long stock has positive delta; short stock has negative delta. The closer an option's delta is to 1.00 or –1.00, the more the price of the option responds like actual long or short stock when the stock price moves.</div>
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So, if the XYZ Aug 50 call has a value of $2.00 and a delta of +.45 with the price of XYZ at $48, if XYZ rises to $49, the value of the XYZ Aug 50 call will theoretically rise to $2.45. If XYZ falls to $47, the value of the XYZ Aug 50 call will theoretically drop to $1.55.</div>
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If the XYZ Aug 50 put has a value of $3.75 and a delta of -.55 with the price of XYZ at $48, if XYZ rises to $49, the value of the XYZ Aug 50 put will drop to $3.20. If XYZ falls to $47, the value of the XYZ Aug 50 put will rise to $4.30.</div>
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Now, these numbers assume that nothing else changes, such as a rise or fall in volatility or interest rates, or time passing. Changes in any one of these can change delta, even if the price of the stock doesn't change.</div>
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Note that the delta of the XYZ Aug 50 call is .45 and the delta of the Aug 50 put is -.55. The sum of their absolute values is 1.00 (|.45| + |-.55| = 1.00). This is true for every call and put at every strike. The intuition behind this is that long stock has a delta of +1.00. Synthetic long stock is long a call and short a put at the same strike in the same month. Therefore, the delta of a long call plus the delta of a short put must equal the delta of long stock. In the case of the XYZ Aug call and put, .45 + .55 = 1.00. Remember, a short put has a positive delta. (Note: delta can be calculated with different formulas, which won't be discussed here. Using the Black-Scholes model for European-style options, the sum of the absolute values of the call and put is 1.00. But using other models for American-style options and under certain circumstances, the sum of the absolute values of the call and put can be slightly less or slightly more than 1.00.)</div>
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You can add, subtract, and multiply deltas to calculate the delta of a position of options and stock. The position delta is a way to see the risk/reward characteristics of your position in terms of shares of stock, and it's how thinkorswim presents it to you on the Position Statement on the Monitor page. The calculation is very straightforward. Position delta = option theoretical delta * quantity of option contracts * number of shares of stock per option contract. (The number of shares of stock per option contract in the U.S. is usually 100 shares. But it can be more or less, due to stock splits or mergers.) thinkorswim performs this calculation for each option in your position, then adds them together for each stock.</div>
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So, if you are long 5 of the XYZ Aug 50 calls, each with a delta of +.45, and short 100 shares of XYZ stock, you will have a position delta of +125. (Short 100 shares of stock = -100 deltas, long 5 calls with delta +.45, with 100 shares of stock per contract = +225. –100 + 225 = +125)</div>
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A way to interpret this delta is that if the price of XYZ rises $1, you will theoretically make $125. If XYZ falls $1, you will theoretically lose $125. IMPORTANT: These numbers are theoretical. In reality, delta is accurate for only very small changes in the stock price. Nevertheless, it is still a very useful tool for a $1.00 change, and is a good way to evaluate your risk.</div>
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An ATM option has a delta close to .50. The more ITM an option is, the closer its delta is to 1.00 (for calls) or –1.00 (for puts). The more OTM and option is, the closer its delta is to 0.00.</div>
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Delta is sensitive to changes in volatility and time to expiration. The delta of ATM options is relatively immune to changes in time and volatility. This means an option with 120 days to expiration and an option with 20 days to expiration both have deltas close to .50. But the more ITM or OTM an option is, the more sensitive its delta is to changes in volatility or time to expiration. Fewer days to expiration or a decrease in volatility push the deltas of ITM calls closer to 1.00 (-1.00 for puts) and the deltas of OTM options closer to 0.00. So an ITM option with 120 days to expiration and a delta of .80 could see its delta grow to .99 with only a couple days to expiration without the stock moving at all.</div>
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The delta of an option depends largely on the price of the stock relative to the strike price. Therefore, when the stock price changes, the delta of the option changes. That's why gamma is important.</div>
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<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="gamma" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
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Gamma</h5>
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Gamma is an estimate of how much the delta of an option changes when the price of the stock moves $1.00. As a tool, gamma can tell you how "stable" your delta is. A big gamma means that your delta can start changing dramatically for even a small move in the stock price.</div>
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Long calls and long puts both always have positive gamma. Short calls and short puts both always have negative gamma. Stock has zero gamma because its delta is always 1.00 – it never changes. Positive gamma means that the delta of long calls will become more positive and move toward +1.00 when the stock prices rises, and less positive and move toward 0.00 when the stock price falls. It means that the delta of long puts will become more negative and move toward –1.00 when the stock price falls, and less negative and move toward 0.00 when the stock price rises. The reverse is true for short gamma.</div>
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For example, the XYZ Aug 50 call has a delta of +.45, and the XYZ Aug 50 put has a delta of -.55, with the price of XYZ at $48.00. The gamma for both the XYZ Aug 50 call and put is .07. If XYZ moves up $1.00 to $49.00, the delta of the XYZ Aug 50 call becomes +.52 (+.45 + ($1 * .07), and the delta of the XYZ Aug 50 put becomes -.48 (-.55 + ($1 * .07). If XYZ drops $1.00 to $47.00, the delta of the XYZ Aug 50 call becomes +.38 (+.45 + (-$1 * .07), and the delta of the XYZ Aug 50 put becomes -.62 (-.55 + (-$1 * .07).</div>
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Position gamma measures how much the delta of a position changes when the stock price moves $1.00. Position gamma is calculated much in the same way as position delta. In the Position Statement on the Monitor page, thinkorswim takes the gamma of each option in your position, multiplies it by the number of contracts and the number of shares of stock per option contract, then adds them together.</div>
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Just as delta changes, so does gamma. If you were to look at a graph of gamma versus the strike prices of the options, it would look like a hill, the top of which is very near the ATM strike. Gamma is highest for ATM options, and is progressively lower as options are ITM and OTM. This means that the delta of ATM options changes the most when the stock price moves up or down. Let's look at a deep ITM call option (delta near 1.00), an ATM call option (delta near .50), and an OTM call option (delta near .10). If the stock rises, the value of the ITM call will increase the most because it acts most like stock. Even though the ITM call has positive gamma, its delta really doesn't get much closer to 1.00 than before the stock rose. The value of the OTM call will also increase, and its delta will probably increase as well, but it will still be a long way from 1.00. The value of the ATM option increases, and its delta changes the most. That is, its delta is moving closer to 1.00 much quicker than the delta of the OTM call. Practically speaking, the ATM call can provide a good balance of potential profit if the stock rises versus loss if the stock falls. The OTM call will not make as much money if the stock rises, and the ITM will lose more money if the stock falls.</div>
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Judging how gamma changes as time passes and volatility changes depends on whether the option is ITM, ATM or OTM. Time passing or a decrease in volatility acts as if it's "pulling up" the top of the hill on the graph of gamma, and making the slope away from the top steeper. What happens is that the ATM gamma increases, but the ITM and OTM gamma decreases. The gamma of ATM options is higher when either volatility is lower or there are fewer days to expiration. But if an option is sufficiently OTM or ITM, the gamma is also lower when volatility is lower or there are fewer days to expiration.</div>
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What this all means to the option trader is that a position with positive gamma is relatively safe, that is, it will generate the deltas that benefit from an up or down move in the stock. But a position with negative gamma can be dangerous. It will generate deltas that will hurt you in an up or down move in the stock. But all positions that have negative gamma are not all dangerous. For example, a short straddle and a long ATM butterfly both have negative gamma. But the short straddle presents unlimited risk if the stock price moves up or down. The long ATM butterfly will lose money if the stock price moves up or down, but the losses are limited to the total cost of the butterfly.</div>
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Gamma is a good reason to look at a profit/loss graph of your position over a wide range of possible stock prices. The thinkorswim Analysis page will help you see how risky a negative gamma position might be.</div>
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Theta</h5>
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Theta, a.k.a. time decay, is an estimate of how much the theoretical value of an option decreases when 1 day passes and there is no move in either the stock price or volatility. Theta is used to estimate how much an option's extrinsic value is whittled away by the always-constant passage of time. The theta for a call and put at the same strike price and the same expiration month are not equal. Without going into detail, the difference in theta between calls and puts depends on the cost of carry for the underlying stock. When the cost of carry for the stock is positive (i.e. dividend yield is less than the interest rate) theta for the call is higher than the put. When the cost of carry for the stock is negative (i.e. dividend yield is greater than the interest rate) theta for the call is lower than the put.</div>
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Long calls and long puts always have negative theta. Short calls and short puts always have positive theta. Stock has zero theta – its value is not eroded by time. All other things being equal, an option with more days to expiration will have more extrinsic value than an option with fewer days to expiration. The difference between the extrinsic value of the option with more days to expiration and the option with fewer days to expiration is due to theta. Therefore, it makes sense that long options have negative theta and short options have positive theta. If options are continuously losing their extrinsic value, a long option position will lose money because of theta, while a short option position will make money because of theta.</div>
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But theta doesn't reduce an option's value in an even rate. Theta has much more impact on an option with fewer days to expiration than an option with more days to expiration. For example, the XYZ Oct 75 put is worth $3.00, has 20 days until expiration and has a theta of -.15. The XYZ Dec 75 put is worth $4.75, has 80 days until expiration and has a theta of -.03. If one day passes, and the price of XYZ stock doesn't change, and there is no change in the implied volatility of either option, the value of the XYZ Oct 75 put will drop by $0.15 to $2.85, and the value of the XYZ Dec 75 put will drop by $0.03 to $4.72.</div>
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Theta is highest for ATM options, and is progressively lower as options are ITM and OTM. This makes sense because ATM options have the highest extrinsic value, so they have more extrinsic value to lose over time than an ITM or OTM option. The theta of options is higher when either volatility is lower or there are fewer days to expiration. If you think about gamma in relation to theta, a position of long options that has the highest positive gamma also has the highest negative theta. There is a trade-off between gamma and theta. Think of long gamma as the stuff that provides the power to a position to make money if the stock price starts to move big (think of a long straddle). But theta is the price you pay for all that power. The longer the stock price does not move big, the more theta will hurt your position.</div>
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Position theta measures how much the value of a position changes when one day passes. Position theta is calculated much in the same way as position delta, but instead of using the number of shares of stock per option contract, theta uses the dollar value of 1 point for the option contract. (The dollar value of 1 point in an option contract for U.S. equities is usually $100, but can be different due to stock splits.) thinkorswim takes the theta of each option in your position, multiplies it by the number of contracts and the value of 1 point for the option contract, then adds them together.</div>
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<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="vega" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
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Vega</h5>
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Vega (the only greek that isn't represented by a real Greek letter) is an estimate of how much the theoretical value of an option changes when volatility changes 1.00%. Higher volatility means higher option prices. The reason for this is that higher volatility means a greater price swings in the stock price, which translates into a greater likelihood for an option to make money by expiration.</div>
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Long calls and long puts both always have positive vega. Short calls and short puts both always have negative vega. Stock has zero vega – it's value is not affected by volatility. Positive vega means that the value of an option position increases when volatility increases, and decreases when volatility decreases. Negative vega means that the value of an option position decreases when volatility increases, and increases when volatility decreases.</div>
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Let's look at the XYZ Aug 50 call again. It has a value of $2.00 and a vega of +.20 with the volatility of XYZ stock at 30.00%. If the volatility of XYZ rises to 31.00%, the value of the XYZ Aug 50 call will rise to $2.20. If the volatility of XYZ falls to 29.00%, the value of the XYZ Aug 50 call will drop to $1.80.</div>
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Vega is highest for ATM options, and is progressively lower as options are ITM and OTM. This means that the value of ATM options changes the most when the volatility changes. The vega of ATM options is higher when either volatility is higher or there are more days to expiration.</div>
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Position vega measures how much the value of a position changes when volatility changes 1.00%. Position vega is calculated much in the same way as position theta. thinkorswim takes the vega of each option in your position, multiplies it by the number of contracts and the dollar value of 1 point for the option contract, then adds them together.</div>
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<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="rho" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
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Rho</h5>
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Rho is an estimate of how much the theoretical value of an option changes when interest rates move 1.00%. The rho for a call and put at the same strike price and the same expiration month are not equal. Rho is one of the least used greeks. When interest rates in an economy are relatively stable, the chance that the value of an option position will change dramatically because of a drop or rise in interest rates is pretty low. Nevertheless, we'll describe it here for your edification.</div>
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Long calls and short puts have positive rho. Short calls and long puts have negative rho. How does this happen? The cost to hold a stock position is built into the value of an option. It all has to do with the idea of an option being a substitute of sorts for a stock position. For example, if you think the stock of XYZ is going to rise, you could buy 100 shares of XYZ for $4800, or you could buy 2 of the XYZ Aug 50 calls for $400. (2 XYZ Aug 50 calls would give me a position delta of +90 — pretty close to the XYZ stock position delta of +100.) As you can see, you would have to spend about 12X the amount spent on the options that you would spend on the stock. That means that you would have to borrow money or take cash out of an interest-bearing account to buy the stock. That interest cost is built into the call option's value.</div>
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The more expensive it is to hold a stock position, the more expensive the call option. An increase in interest rates increases the value of calls and decreases the value of puts. A decrease in interest rates decreases the value of calls and increases the value of puts.</div>
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Back to the XYZ Aug 50 calls. They have a value of $2.00 and a rho of +.02 with XYZ at $48.00 and interest rates at 5.00%. If interest rates increase to 6.00%, the value of the XYZ Aug 50 calls would increase to $2.02. If interest rates decrease to 4.00%, the value of the XYZ Aug 50 calls would decrease to $1.98.</div>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-56139485646995672252012-08-19T21:07:00.001-07:002012-08-19T21:07:33.380-07:00Time Spreads & Diagonals<table class="cellBG" style="background-color: white; border-spacing: 0px; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 10pt; margin: 0px; padding: 0px; width: 100%px;"><tbody>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Call Time Spread:</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 50 call @ $2.00, Long 1 XYZ Dec 50 call @ $5.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$300 Debit</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss:</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$300</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit:</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Depends on value of Dec 50 call at time of Sep expiration</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Call Time Spread</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 50 call @ $2.00, Short 1 XYZ Dec 50 call @ $5.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$300 Credit</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss:</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Depends on value of Dec 50 call at time of Sep expiration</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit:</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$300</td></tr>
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<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Put Time Spread</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 50 put @ $1.00, Long 1 XYZ Dec 50 put @ $3.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$200 Debit</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss:</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$200</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit:</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Put Time Spread</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 50 put @ $1.00, Short 1 XYZ Dec 50 put @ $3.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$200 Credit</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss:</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Depends on value of Dec 50 put at time of Sep expiration</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit:</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$200</td></tr>
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Explanation and Application</h5>
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Time spreads are so called because they are positions with options in two different expiration months, with the options being either both calls or both puts. Time spreads involve buying an option in one expiration month and selling another option in a different expiration month but with the same strike as the first option. Specifically; a long call time spread is selling a call in a front month at a certain strike, and buying a call in a deferred month at the same strike. A put time spread is selling a put in a front month at a certain strike, and buying a put in a deferred month at the same strike. A short call time spread or put time spread is simply the reverse of the long time spread: long front month and short deferred month. In time spreads, one option in the position expires before the other. You have to keep this in mind because it does present certain risks and necessary adjustments that other types of positions might not.</div>
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Time spreads, whether they are call time spreads or put time spreads, maximize their value when the stock is at the strike price of the options, and the front month option is expiring. Time spreads have their minimum value when the stock is very far away from the strike price of the options. If you buy a time spread you want the stock price to be at the strike price at expiration. If you sell a time spread you want the stock price to be as far away as possible from the strike price at expiration.</div>
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Therefore, a long time spread might be a good position if you think the stock price is going to move to, then stay at, a particular strike price until expiration of the front month option. The maximum risk of a long time spread is the amount paid for it. The maximum value depends on the value of the deferred month option when the front month option expires. That depends largely on the implied volatility of the deferred month options.</div>
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Another risk of time spreads is that of assignment of the short option, which will transform your time spread into another position. For example, a long put time spread has the risk of assignment on the short front month put. If the short put is assigned, you will receive long stock in your account. That, along with the remaining deferred month put, is a synthetic long call. This position does not have unlimited risk. But it is significantly different from the original long put time spread and could require a great deal of cash or margin in your account to be able to hold the long stock position. You must be aware, then, of the sometimes significant risks due to assignment when you have short ITM options in any position.</div>
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Greeks</h5>
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Delta</div>
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The delta of a time spread is determined by where the stock price is relative to the strike price of the options. Depending on where the price of the stock is relative to the strike price of the time spread, the delta of the time spread can go from positive, to neutral, to negative.</div>
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When the stock price is equal to the strike price, the deltas of the time spread, whether it's long or short, are pretty neutral. This is due to the fact that the deltas of ATM calls (or puts) are very similar to each other no matter how much time there is until expiration, and are relatively unaffected by volatility. The differences between ATM deltas across expirations are relatively small, and depend largely on the carrying costs.</div>
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But as the stock price moves away from the strike price of the options, the deltas of the time spread change very much. No matter if it's a call time spread or put time spread (their P&L profiles are very similar), when the stock price is less than the strike price, a long time spread has positive deltas and a short time spread has negative deltas. When the stock price is greater than the strike price, a long time spread has negative deltas (it wants the stock to come <b>down</b> to its strike price) and a short time spread has positive deltas (it wants the stock to come <b>up</b> away from its strike price). It's interesting to see why the deltas of call and put time spreads are the same. When the stock price is less than the strike price, the calls are OTM and the puts are ITM. Deltas on ITM options get closer to 1.00 the closer the option is to expiration. Deltas on OTM options get closer to 0.00 the closer the option is to expiration. A long OTM call time spread is short a front month OTM call that generates fewer negative deltas than the positive deltas generated by the long back month OTM call. Therefore the long OTM call time spread has positive deltas. A long ITM put time spread is short a front month ITM put that generates more positive deltas than the negative deltas generated by the long back month ITM put. Therefore the long ITM put time spread has positive deltas also.</div>
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Gamma</div>
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The gamma of a time spread, like its delta, depends on where the stock price is relative to the strike price of the options. When the stock is equal to the strike price, a long time spread has negative gamma. Remember, when the stock price is equal to the strike price the time spread maximizes value. Any movement by the stock away from the strike price will cause the time spread to fall in value. The reason is that negative gamma manufactures positive delta if the stock price falls, and negative delta if the stock price rises – both cause the time spread to theoretically lose value.</div>
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The negative gamma is due to the fact that the gamma of an ATM option increases as time goes by. A long ATM time spread, whether it's a call or put, has a short front month option that generates more negative gamma than the positive gamma generated by the long deferred month option. The difference between gamma in the different months is most pronounced for the ATM strike, and diminishes the more OTM or ITM an option becomes until, at a certain point, the deferred month option generates more positive gamma than the negative gamma generated by the front month. That's due to the curvature of gamma. No matter how much time to expiration, gammas for ITM and OTM options are low relative to ATM options. But gammas for ITM or OTM options with more days to expiration are relatively higher than the gammas for ITM or OTM options with fewer days to expiration. And the gamma for ATM options with more days to expiration is relatively lower than the gamma for ATM options with fewer days to expiration. The result is that OTM and ITM time spreads have positive gammas, indicating that they want the stock to move (to their respective strike).</div>
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Theta</div>
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The theta, or time decay, of a time spread corresponds inversely to its gamma. Theta has the same type of curvature as gamma. But where the gamma of a long time spread is negative, its theta is positive. An ATM time spread wants the stock to stay where it is (equal to the strike price) and for time to pass – that's indicated by the positive theta. When the gamma turns positive for long OTM and ITM time spreads, theta turns negative – if the stock stays where it is, and the time spread continues to be OTM or ITM, the value of the time spread will fall as time passes.</div>
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Vega</div>
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Just as deferred month options have greater extrinsic value than front month options, they also have greater vega, or sensitivity to changes in volatility. Like gamma and theta, vega is greatest for the ATM time spreads but unlike gamma and theta, vega is greater in the deferred month at every strike price. Because different option expirations can have different implied volatilities, fluctuations in volatilities between the different months can have a large impact on the value of time spreads. Long time spreads have positive vega, meaning if volatility increases, their value increases, and if volatility decreases, their value decreases. To add to the vega issue, if volatility rises in the front month, and either stays the same or falls in the deferred month, a time spread could lose value. That's why if you're contemplating trading time spreads, you should have an idea of how volatility can change from expiration month to expiration month, because this can be a significant source of risk.</div>
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Structure</h5>
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The relationship between a call time spread and a put time spread at the same strike and in the same months is directly related to the 'jelly roll' spread or simply, the "roll". If your position is a long call time spread, and you sell roll, the resulting position will be a long put time spread. If your position is a long put time spread, and you buy a roll, the resulting position will be a long call time spread. The only difference, then, between a long call time spread and a long put time spread at the same strike is a market-neutral position, the roll.</div>
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The interrelationships of the structures of jelly rolls and time spreads are shown in Exhibit–1. The structure of this short jelly roll consists of a long 100 strike call time spread, spread against a short 100 strike put time spread, which is also equivalent to a far month long combo versus the near month short combo. Simply put; a call time spread is synthetically a put time spread because the difference is a jelly roll (two synthetic underlyings against each other).</div>
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Pricing</h5>
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A time spread's value is determined by the difference in extrinsic values of the front month option and the deferred month option. (The intrinsic values of the options are the same, therefore, they cancel each other out.) All other things (stock price, strike price, dividends, interest rate, and volatility) being equal, an option with more days to expiration will have more extrinsic value than an option with fewer days to expiration. ATM options, whether they are puts or calls, have more extrinsic value than OTM or ITM options. Therefore, the ratio of extrinsic value between the deferred month and front month (which is the value of the time spread) depends on how close the stock price is to the strike price of the options and the difference between the number of days to expiration for the two options.</div>
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The effect of theta on extrinsic value, or how much time decay erodes the extrinsic value of options, is non- linear. That is, the closer an option is to expiration, the greater the effect of time decay on its extrinsic value. Therefore, the ratio of extrinsic value between the deferred month and the front month is also inversely proportional to how close the front month option is to expiration. In practice, an ATM time spread whose front month option is, say 10 days to expiration, will be increasing in value faster than an ATM time spread whose front month option is 90 days to expiration.</div>
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The relationship between a call time spread and a put time spread at the same strike and in the same expiration months depends on the roll. Because the value of the roll is basically a function of the carrying costs between the two expiration dates, and because the difference between a call time spread and a put time spread is a roll (as described above), the difference between the call and put time spreads is also a function of carrying costs.</div>
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The values of time spreads can be better understood with respect to jelly rolls. Jelly rolls in equities are interesting because the early exercise feature causes put spreads to collapse when cheap calls approach a value that is less than the cost of carry. The differences between the call and put time spread prices as well as the conversion/reversal differences become larger as the strikes increase, and then they start to collapse.</div>
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The main thing is that ATM time spreads have the most value because ATM is where they like to be. They get cheaper the farther away from the money that they get. Although call time spreads are synthetically put time spreads via the roll, their pricing and properties differ because of interest rates/dividends and related early exercise valuations.</div>
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DIAGONALS</div>
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A diagonal can be a confusing position. It has long and short options in two different months (like a time spread) but at two different strikes (like a vertical). Therefore, it is helpful to think of a diagonal in terms of a vertical and a time spread. Perceiving diagonals in this way will help you to understand how you can control the risk and understand the Greeks.</div>
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Using a diagonal spread, is simply another way to modify a bull vertical spread or bear vertical spread and for a trader to optimize his or her market objectives based on an analysis of implied volatility levels.</div>
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Diagonal back spreads and ratio spreads also attempt to modify the Greeks to better fit the traders' opinion of what will happen in the market. For example, if traders think that volatility is low and they are going to buy a call spread, then they would buy the far month low strike call rather than the close month on a vertical spread in order to add vega sensitivity to their spread. In this case, they will probably also benefit from a positive theta.</div>
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Conclusion</div>
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Multiple expiration spreads offer the trader a gamut of configurations to choose from. It is recommended to stress-test ratioed time spreads and ratioed diagonal time spreads in the options analyzer to get familiar with their properties. It is these options' relationships that are generally overlooked and thereby have a tendency to become attractive for speculative strategies.</div>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-83237032960956265352012-08-19T21:05:00.000-07:002012-08-19T21:05:25.860-07:00Butterflies & Wingspreads<table class="cellBG" style="background-color: white; border-spacing: 0px; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 10pt; margin: 0px; padding: 0px; width: 100%px;"><tbody>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Call Butterfly</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 50 call @ $2.00, Short 2 XYZ Sep 55 calls @ $1.00, Long 1 XYZ Sep 60 call @ $.50</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $50</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $50</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Dollar value of difference between outside and middle strike prices minus premium paid, $450</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Call Butterfly:</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 50 call @ $2.00, Long 2 XYZ Sep 55 calls @ $1.00, Short 1 XYZ Sep 60 call @ $.50</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Credit Received</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $50</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Dollar value of difference between outside and middle strike prices minus credit received, $450</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $50</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Put Butterfly:</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 30 put @ $.25, Short 2 XYZ Sep 35 puts @ $.50, Long 1 XYZ Sep 40 put @ $1.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $25</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $25</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Dollar value of difference between outside and middle strike prices minus premium paid, $475</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Put Butterfly</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 30 put @ $.25, Long 2 XYZ Sep 35 puts @ $.50, Short 1 XYZ Sep 40 put @ $1.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Credit Received</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $25</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Dollar value of difference between outside and middle strike prices minus credit received, $475</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $25</td></tr>
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Explanation and Application</h5>
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Butterflies, condors and "wingspreads" are so-called because with sufficient -- no, make that CONSIDERABLE imagination, their expiration date risk profiles look like something that could fly. That, and anything that can add a bit of color to the otherwise dreary world of option trading is welcome. When talking about butterflies et al., you'll hear self-proclaimed experts speak of options as "body" and "wings". The "body" refers to options with strikes in between the two exoskeletal outermost strikes. The "wings" refer to options at the diaphanous outermost strikes. We use the term "wingspreads" to identify option positions such as "condors", "pterodactyls" and "albatrosses", which look like butterflies that have been stretched out. Rather than come up with a myriad of names to identify these spreads, we use "wingspreads" because they all have similar risk/reward characteristics and sensitivities, and those flying creatures are much more threatening than butterflies.</div>
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The risks and potential rewards of butterflies and wingspreads are limited. If you buy a butterfly, the most you can lose is the amount you paid for it. The most you can make is the difference between the "body" strike and a "wing" strike minus the amount you paid for it. If you sell a butterfly, the loss and profit are the inverse of buying a butterfly.</div>
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Wingspreads' sensitivity to movement in the stock price is related to the time to expiration. For example, the closer a butterfly is to expiration, the more sensitive its price is to a change in the price of the stock. What this means is that butterflies and wingspreads that are far from expiration don't always change in value that much when the stock moves. This means that all wingspreads aren't necessarily the best tool for exploiting changes in the stock price. Wingspreads can be bullish and bearish – but the closer a wingspread is to expiration, the more bullish or bearish it can be.</div>
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Wingspreads reach their maximum value when the stock price is at (in the case of butterflies) or between (for other wingspreads) the middle or "body" strike(s) at expiration. They are at their minimum value when the stock price is either above the higher "wing" strike or below the lower "wing" strike at expiration. Therefore, wingspreads can be effective when you believe that a stock's price will land within a specified range and within a specified time frame. When you believe that a stock will stay at a single price, long butterflies might be a good choice. When you think a stock will stay in between two prices, long wingspreads with middle "body" strikes at the low and high prices of the stock's range might work best. In this sense, long butterflies and wingspreads are like short straddles and strangles, but without the unlimited risk. Look at a graph of the value of a long butterfly at expiration, and the middle of the butterfly looks like a short straddle.</div>
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Conversely, if you think the price of a stock is going to move a way from a specific point or outside a specific range of prices, short butterflies and wingspreads might be a good choice. They work a bit like long straddles and strangles, but without the unlimited profit potential. They are also generally less expensive. Look at a graph of the value of a short butterfly at expiration, and the middle of the butterfly looks like a long straddle.</div>
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Greeks</h5>
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Note that the price of the butterfly can become very sensitive to changes in the stock price with less than two weeks to go. The greeks of the butterfly also can change very dramatically as the stock price moves up and down. The discussion will concentrate on butterflies, but the same principles can be applied to all wingspreads.</div>
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The delta of a long butterfly is mildly interesting because the delta is positive when the stock price is below the middle strike of the butterfly, neutral when the stock price is at the middle strike, and negative when it is above the middle strike. The intuition behind this is that the butterfly maximizes its value when the price of the stock is at the middle strike. Therefore, if the price of the stock is below the middle strike, it has to rise for the butterfly to make money – hence the positive deltas. If the price of the stock is above the middle strike, it has to fall for the butterfly to make money – hence the negative deltas.</div>
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What's causing the delta to flip from positive to neutral to negative? Your old friend, Captain Gamma. The gamma of a long butterfly runs from positive to negative. At the outer strikes of the butterfly, gamma is positive, indicating that the butterfly would manufacture positive deltas if the stock price rises, and negative deltas if the stock price falls. This corresponds exactly with the way the delta of the long butterfly works as described above. The gamma of the long butterfly is negative when the stock is at the middle strike. This indicates that the butterfly will manufacture negative deltas if the stock price rises, and positive deltas if the stock price falls. This is precisely what you don't want to happen. That's why the long butterfly wants the price of the stock to stay right where it is when it's at the middle strike.</div>
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The theta of the long butterfly is the mirror image of the gamma. Along with the negative gamma comes positive theta, and vice versa. Theta is positive when the price of the stock is at the middle strike, indicating that time passing helps the long butterfly reach its maximum value. At the outer strikes theta is negative, indicating that the butterfly is losing value as time passes.</div>
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Butterflies can be good choices to exploit changes in implied volatility in a limited risk fashion. Like the other greeks, the vega of a butterfly changes depending on where the price of the stock is relative to the strike prices of the butterfly. When the stock price is at the middle strike, the vega of the long butterfly is negative. That means that any increased implied volatility in the stock will decrease the value of the butterfly. This makes sense, because a butterfly's value depends on the likelihood that the stock price will be at its middle strike at expiration. Higher implied volatility decreases the likelihood that the stock will stay at the middle strike price; therefore the value of the butterfly would decrease with an increase in implied volatility. Vega is positive for the long butterfly at the outer strikes. Therefore, an increase in the implied volatility of the stock increases the value of the butterfly because of the greater likelihood that the stock will move toward the middle strike by expiration.</div>
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Butterflies and other wingspreads are interesting positions to test in the analyzer because their greeks, although somewhat complex, make intuitive sense if you know how and when a butterfly increases and decreases in value. The greeks, then, can confirm analytically what you know about butterflies intuitively.</div>
<br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><a href="" name="structure" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Structure</h5>
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A butterfly is a wingspread that has options at three equidistant strikes; a long butterfly is long 1 low strike option, short 2 middle strike options and long 1 high strike option, and a short butterfly is short 1 low strike option, long 2 middle strike options and short 1 high strike option. A condor or other wingspread has options at four strikes, with the same distance between the each wing strike and the lower or higher of the body strikes.</div>
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It is sometimes useful to think of a butterfly (or any wingspread) in terms of two vertical spreads: one bullish, the other bearish. This will enable you to calculate wingspread prices faster. It will also help you understand how to make adjustments to positions like ratio or back spreads to turn them into butterflies.</div>
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Combination of Call or Put Bull Spreads and Bear Spreads Create Butterflies</div>
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<tr style="margin: 0px; padding: 0px; vertical-align: top;"><td align="center" style="border-color: rgb(204, 204, 204); border-style: solid; border-width: 1px 0px 0px; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; line-height: 13pt; margin: 0px; padding: 0px; vertical-align: top;">Calls</td><td style="border-color: rgb(204, 204, 204); border-style: solid; border-width: 1px 0px 0px; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; line-height: 13pt; margin: 0px; padding: 0px; vertical-align: top;"> </td><td align="center" style="border-color: rgb(204, 204, 204); border-style: solid; border-width: 1px 0px 0px; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; line-height: 13pt; margin: 0px; padding: 0px; vertical-align: top;">Puts</td></tr>
<tr style="margin: 0px; padding: 0px; vertical-align: top;"><td style="border-color: rgb(204, 204, 204); border-style: solid; border-width: 1px 0px 0px; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; line-height: 13pt; margin: 0px; padding: 0px; vertical-align: top;">Bull Spread + Bear Spread = Butterfly</td><td style="border-color: rgb(204, 204, 204); border-style: solid; border-width: 1px 0px 0px; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; line-height: 13pt; margin: 0px; padding: 0px; vertical-align: top;">Strike</td><td style="border-color: rgb(204, 204, 204); border-style: solid; border-width: 1px 0px 0px; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; line-height: 13pt; margin: 0px; padding: 0px; vertical-align: top;">Butterfly = Bull Spread + Bear Spread</td></tr>
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It makes sense that a combination of the two P&L graphs of a bull spread at one strike and a bear spread at the next higher strike will form a butterfly spread. Remember that a bull spread can be either long a call vertical or short a put vertical. A bear spread can be either short a call vertical or long a put vertical. So, any combination of bull spread at the lower strikes and bear spread at the higher strikes results in a long butterfly. A bear spread at the lower strikes and a bull spread at the higher strikes results in a short butterfly.</div>
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Given three equidistant strikes, a long butterfly can be a call butterfly, a put butterfly, or an iron butterfly. They all have expiration p/l graphs that look the same. No matter what kind of butterfly it is, its maximum value will be reached if the stock price lands at the middle strike price at expiration. At that point, the lower strike bull spread will maximize in price (the difference between the strikes), and the higher strike bear spread will be theoretically worthless.</div>
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To prove the basic equivalency of call and put butterflies, let's look at the resulting position if you buy a call butterfly and sell a put butterfly at the same three strikes. If you buy a butterfly and sell its equivalent, you should have a neutral position. Consider a position of long a call butterfly and short a put butterfly in XYZ Apr options, long +1 50 call, short –2 55 calls, long +1 60 call, short –1 50 put, long +2 55 puts, and short –1 60 put. The position will be long +1 XYZ Apr 50/55 box and short –1 XYZ Apr 55/60 box, which is a neutral position. The long box and the short box intersect at the 55 strike.</div>
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Other wingspreads can be understood in exactly the same way as butterflies. They are combinations of bull spreads and bear spreads, and a long call condor and a short put condor at the same strikes equals two boxes. But wingspreads can also be seen as being made up of a row of butterflies. The more butterflies that one has in a row, the wider the wingspread is and the more the profit zone is stretched out.</div>
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A note about "iron butterflies" and "iron condors": despite the name, they're nothing special. Iron butterflies, iron condors and iron wingspreads are a seeming contradiction: you receive a credit to be long them. A long iron butterfly has the same risk/reward profile as a long call or long put butterfly, both of which cost money to be long. How is the credit for the long iron butterfly achieved? An iron butterfly is simply a short box added to a long butterfly. An iron butterfly can be either a long call butterfly plus a short box whose strikes are at the lowest and middle strikes of the butterfly, or a long put butterfly plus a short box whose strikes are at the middle and highest strikes of the butterfly.</div>
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An iron butterfly is therefore a regular butterfly plus a short market-neutral box spread. Adding a short box to a butterfly doesn't necessarily change its risk/reward profile, it simply adds a cash loan from the market (which is what a short box is). The credit of the iron butterfly or iron wingspread is nothing magic and confers no real advantage.</div>
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An iron butterfly can also be seen as a short straddle at the middle or body strike and a long strangle at the wing strikes. This corresponds exactly with the middle part of a price graph of a long butterfly at expiration looking like a short straddle.</div>
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Iron wingspreads work in the same way. They are long wingspreads plus a short box, or they are short a strangle at the middle two body strikes, and long a strangle at the outer wing strikes.</div>
<br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><a href="" name="pricing" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Pricing</h5>
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Contrary to popular opinion, butterflies are NOT free. Prior to expiration, wingspread values depend largely on the likelihood of the stock being at a certain price (in the case of butterflies) or between two prices (in the case of other wingspreads) at expiration. The more time there is to expiration, the less certain you can be of where the stock price will be at expiration. The less time there is to expiration, the more certain you can be of where the stock price will be at expiration. This means that if you were to graph the prices of all the consecutive butterflies in each expiration month, the graph would look rather flat in the months far from expiration because of the uncertainty about which butterfly will have the maximum value at expiration. (Remember: a butterfly reaches maximum value when the stock price is at the middle or "body" strike of the butterfly at expiration.) Therefore, butterflies far from expiration have roughly the same value, because only one or two of them can be of any value at expiration, and which one or two will have value are uncertain.</div>
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When there is less time to expiration, there is somewhat more certainty where the price of the stock is going to be at expiration. As a butterfly comes closer to expiration, the graph would begin to develop a "hump" at or near the current stock price. In fact, at the same time, the graph of the prices of all the consecutive butterflies begins to look like the p/l graph of a butterfly itself!! The "hump" on the graph is the price of the most expensive butterfly. It's the most expensive because it's the at-the-money butterfly, which has a middle strike that is the most likely price of the stock at expiration.</div>
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Generally, wingspreads will be more expensive than butterflies because they have a much larger profit range. That is, a butterfly maximizes its value if the stock price is exactly at the middle strike price of the butterfly. But a wingspread maximizes its value over a range of stock prices. Because a wingspread has a greater likelihood of maximizing its value, it has a larger price than a butterfly.</div>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-53526411081226829322012-08-19T21:02:00.001-07:002012-08-19T21:02:42.505-07:00Ratio & Back Spreads<table class="cellBG" style="background-color: white; border-spacing: 0px; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 10pt; margin: 0px; padding: 0px; width: 100%px;"><tbody>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Call Back Spread</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 50 call @ $2.00, Long 2 XYZ Sep 60 calls @ $0.75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$50 Credit</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$950</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Call Ratio Spread</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 50 call @ $2.00, Short 2 XYZ Sep 60 calls @ $0.75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$50 Debit</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$950</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Put Back Spread</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 50 put @ $1.00, Long 2 XYZ Sep 40 puts @ $0.50</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$0 Even Money</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$1000</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Put Ratio Spread:</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 50 put @ $1.00, Short 2 XYZ Sep 40 puts @ $0.50</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$0 Even Money</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">$1000</td></tr>
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Explanation and Application</h5>
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Back spreads and ratio spreads are simply the mirror image of each other. Back spreads and ratio spreads are comprised of either both calls or both puts at two different strike prices in the same expiration month. If the spread has more long contracts than short contracts, it is a Back Spread. If there are more short contracts, it is a Ratio Spread. Any ratio of long to short options is possible, but to keep it simple we will deal mainly with 1 by 2s in this article, i.e. long 1 option and short 2 option ratio spreads, and short 1 option and long 2 option back spreads. When naming this type of spread, the lower strike is generally stated first, whether it is long or short, so, it's the Sep 50/60 call back spread or ratio spread, and the 40/50 put back spread or ratio spread.</div>
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Back spreads and ratio spreads can be executed for debits (you pay money) or credits (you receive money) or Even Money when there is no debit or credit. This occurs because the amount you pay for the long options in the spread is sometimes less than, equal to, or more than the amount you receive for the short options in the spread. This can be a bit confusing at times, because you might be a credit bid for a back spread or ratio spread.</div>
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Call back spreads work best when the stock price makes a large move up; put back spreads work best when the stock price makes a large move down. Call ratio spreads work best when the stock price moves to the strike price of the short call (and no higher) at expiration; put ratio spreads work best when the stock price moves to the strike price of the short put (and no lower) at expiration.</div>
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As you can imagine, the bigger the ratio of short options to long options in a ratio spread, the more risk involved. That's why most professional traders try to keep the ratio of short options to long options no greater than 1 by 2. Also, with the ratio at 1 by 2, the position is one long call or put away from a butterfly. This is a good way to reduce the risk of a ratio spread if the stock price starts going against you – in the heat of the moment it might be easier to buy the next higher call (for a call ratio spread) or lower put (for a put ratio spread) to form a limited-risk butterfly rather than trying to exit the ratio spread. You can then take a breather and trade out of the butterfly if you want, after that.</div>
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Ratio Spread</h5>
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Ratio spreads involve buying one option and selling a greater quantity of an option with a more OTM strike. The options are either both calls or both puts. The "ratio" of the spread is the number of short options divided by the number of long options. So, selling 3 XYZ Nov 60 calls and buying 1 XYZ Nov 50 call is a "1 by 3" ratio spread. It's useful to keep the ratio in terms of "1 by X", even if that "X" isn't a whole number. For example, selling 5 XYZ Nov 60 calls and buying 2 XYZ Nov 50 calls is a "1 by 2.5" ratio spread, although some traders will still refer to it as "2 by 5". But if you keep everything in terms of "1", you can tell much more quickly how many more short options the spread has. It's easier to see the "1 by 3" ratio spread has more short options than the "1 by 2.5" (as opposed to "2 by 5") ratio spread.</div>
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The most common rationale for a ratio spread is to buy some options on a directional speculation and finance the purchase with the sale of options that are further out-of-the-money. Many investors seek to do a ratio spread for a credit, but to do so might mean in some instances that the ratio has to be quite steep (i.e., many more short options than long options). Since the options that the investor is selling are cheaper than the options he is buying, he has to sell more to recoup most of, all of, or even a greater amount than the purchase cost of the long option. That can lead to an extremely risky position. It is usually unwise to have a ratio spread with a ratio greater than 1 by 2. Never get comfortable or complacent with ratio spreads. Call ratio spreads lose money when the stock price rises sharply; put ratio spreads lose money when the stock price drops sharply. Monitor ratio spreads frequently and have a plan that can be enacted at a moment's notice to neutralize the risk. Be prepared for the worst. It is the spread that finishes careers.</div>
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Back Spread</h5>
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Back spreads involve selling one option and buying a greater quantity of an option with a more OTM strike. The options are either both calls or both puts. Like the ratio spread, the "ratio" of the back spread is the number of long options divided by the number of short options.</div>
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The purpose of a back spread is to profit on a quick extended move toward, through and beyond the long strike. The purchase of a quantity of more long options is financed by the sale of fewer short options. The danger is that because the short options are closer to or in the money, they might grow faster than the long out-of-the-money options if the stock price moves more slowly or with less magnitude than expected. This happens even faster as expiration approaches. The long out-of-the-money options may lose value despite a favorable move in the stock price, and that same move in the stock price may increase the value of the short options. This is when the back spread loses value most quickly. This is depicted in the "valley" of the P&L graphs. The current day shows no valley, but over time one forms and gets deeper and deeper, signifying greater and greater losses. The price of the stock at the bottom of the valley, incidentally, is the strike price of the long options.</div>
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If you can establish a back spread for a credit, the position can still be profitable if the stock price moves down (for a call back spread) or up (for a put back spread) enough to escape the "valley" of losses.</div>
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Assessing risk in ratio spreads and back spreads through ratio analysis</h5>
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Here are a few guidelines for assessing risk that traders may want to use to modify their artistic approach:</div>
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<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Use as shallow a ratio as possible.</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Be sure that a large move in the underlying can be withstood without losing any money. This should be of greater concern than doing the spread for a credit.</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Stress-test the spread, assuming that a move will occur any moment.</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">When trying to assess how a spread may perform, look at the spreads of deeper in-the-money options for an indication of relative prices. Should a what-if analysis reveal that traders will lose an uncomfortable amount of money, they should either flatten out their ratio, wait for another opportunity in the cycle, or look for a spread in another stock. This must be monitored often, always checking the prices of the relationships a few strikes deeper. The ratio should be adjusted as necessary, always testing for the chosen tolerance level. When steepening the ratio, consider doing it with a vertical instead of with naked options, so that in case of a devastating move, you will not be faced with exponentially increased exposure.</li>
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Taking a closer look at several spreads gives the trader a sense of where the market believes that these ratios belong over time and movement in the underlying. The same exercise can be performed with butterflies to start building a mental database of price relationships.</div>
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Volatility is not money. There is a different frame of reference for it every day and strikes have many different proximities to the underlying stock price. Spreads, on the other hand, are easier to keep track of; the frame of reference is all of the other spreads. This kind of analysis gives us a different perspective on price relationships and an insight into what the Back Spreaders and Ratio Spreaders do.</div>
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Greeks</h5>
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As with other option spreads, the Greeks of ratio and back spreads depend on where the stock price is relative to the strike prices of the long and short options, the ratio of long options to short options, and how far apart the strikes are from each other. Because of this, the Greeks can change dramatically as the stock price moves and as time passes. It's best to plug a back or ratio spread into the analyzer before doing the trade to see how the spread reacts to changes in the stock price, time, and volatility.</div>
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The delta of a back spread or ratio spread is generally dominated by the option with the greater quantity the further it is from expiration. That makes sense, because the more days to expiration, the deltas of options are not as close to 0.0 or 1.00 as they are when there are fewer days to expiration. For example, if XYZ stock is at $100 and with 100 days to expiration, the XYZ Feb 100 calls have a delta of +.57 and the XYZ Feb 105 calls have a delta of +.48, the delta of the XYZ Feb 100/105 call back spread would be +.39 ((2*.48)-.57). The delta of the back spread is dominated by the long options. But with 5 days to expiration, the XYZ Feb 100 calls have a delta of +.52 and the XYZ Feb 105 calls have a delta of +.16, the delta of the XYZ Feb 100/105 call back spread would be - .20 ((2*.16)-.52). Now, the delta of the back spread is dominated by the short option.</div>
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This is the reason that call back spreads, for example, are generally always long delta as long as there are enough days to expiration. But with fewer days to expiration, the delta of the call back spread is more sensitive to where the stock price is in relation to the strike prices. Remember that a back spread loses the most money when the stock price is at the long strike price at expiration. Close to expiration, if the stock price is close to the short lower strike, the call back spread can have negative deltas. The intuition behind this is that if the stock price rises, it will go to the long higher strike and drop in value. Once the stock price is at the higher strike, the delta of the back spread tilts positive – the delta of the short lower strike option is approaching (but less negative than) –1.00 and the deltas of the long higher strike options are approximately +.50. If there are two long higher strike options, they will typically generate more positive deltas than the negative delta of the short lower strike option. If the stock price rises past the long higher strike, the delta of the back spread will become increasingly positive, as the long higher strike option's delta approaches +1.00, thus offsetting the negative delta at the short lower strike.</div>
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Because a back spread is most profitable when the stock has a large price movement and with a relatively long time to go until expiration of the options, the delta is generally positive for call back spreads and negative for put back spreads. But that can change as time passes. If the stock price is in between the strike prices of the long and short options, the delta changes from positive to negative for call back spreads, and from negative to positive for put back spreads as time passes. This is due to the fact that as time passes, ITM option deltas move towards 1.00, and OTM deltas move towards 0.00. With the stock price in between the strike prices of the back spread, the delta of the short option (which has to be ITM if the stock price is in between the strike prices) dominates the deltas of the long options.</div>
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The same ideas can be applied to put back spreads and call and put ratio spreads, with the appropriate terms reversed.</div>
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The gamma of back spreads and ratio spreads reacts very much like delta to the amount of time to expiration and where the price of the stock is in relation to the strike prices. With many days to go to expiration, back spreads generally have positive gamma, indicating that each wants the stock price to move, and that favorable deltas will be manufactured when the stock price does move.</div>
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But close to expiration, if the stock price is at the short strike of a back spread the gamma is negative. If the stock price moves, unfavorable deltas will be manufactured. Remember that a back spread is at its minimum value when the stock price is at the long strike at expiration. The short gamma indicates that negative deltas will be manufactured if the stock price rises, and positive deltas if the stock price falls.</div>
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If you understand the gamma of a back spread, you already understand theta. Any time gamma is positive, theta is negative. Far from expiration, the theta of a call back spread is negative; the call back spread needs the stock price to make a big move up, and the passage of time decreases the probability of that happening. That's bad for a call back spread, so time passing reduces a back spread's value. Close to expiration, if the stock price is near the strike price of the long options in the back spread, theta becomes increasingly negative. Remember, a back spread loses most money at expiration when the stock price is at the strike price of the long options.</div>
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Vega in a back spread is generally dominated by the long options the more time there is to expiration and the closer the stock price is to the strike price of the long options. The more time there is to expiration, generally the more positive vega the back spread. The reason for this is that far from expiration, the difference between the vega of one strike and the next is relatively small. But as the time to expiration falls, the vega is generally much less positive, and can be negative, depending on whether the stock price is closer to the strike with the short options or the strike with the long options. If the stock price is closer to the strike with the short options, the vega at that strike can be sufficiently negative to offset the positive vega from the options at the long strike.</div>
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Structure</h5>
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One of the easiest ways to think about a ratio spread or back spread is as a vertical with some extra short (in the case of a ratio spread) or long (in the case of a back spread) options. A call back spread is a bear vertical (typically a short call vertical) plus extra long call options at the higher of the two strikes. A put back spread is a bull vertical (typically a short put vertical) plus extra long put options at the lower of the two strikes. A call ratio spread is a bull vertical (typically a long call vertical) plus extra short call options at the higher of the two strikes. A put ratio spread is a bear vertical (typically a long put vertical) plus extra short put options at the lower of the two strikes.</div>
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If you look at a back spread or ratio spread, it's one option away from being a butterfly. Let's look at an XYZ Dec 50/55 call ratio spread, which is long 1 XYZ Dec 50 call and short 2 XYZ Dec 55 calls. If you were to buy 1 XYZ Dec 60 call, you would have transformed the XYZ Dec 50/55 call ratio spread into a long XYZ Dec 50/55/60 call butterfly.</div>
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As another example, consider an XYZ Dec 40/50 put back spread, which is long 2 XYZ Dec 40 puts and short 1 XYZ Dec 50 put. If you were to sell 1 XYZ Dec 30 put, you would have transformed the XYZ Dec 40/50 put back spread into a short XYZ Dec 30/40/50 put butterfly.</div>
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Understanding how ratio and back spreads can be transformed into butterflies or verticals is a very useful technique to get out of trouble. Keep it in mind when trading these spreads.</div>
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Pricing</h5>
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One of the trickiest things to figure out about back spreads and ratio spreads is how they can be established for credits or debits. It all depends on the relative prices of the two different options. If the total money received from the short options is greater than the money paid for the long options, the back spread or ratio spread will be a credit. If the total money received from the short options is less than the money paid for the long options, the back spread or ratio spread will be a debit.</div>
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The main factor in the relative costs of the long versus short options is how far apart their strike prices are. For example, if the XYZ Dec 100 calls are $5.25, and the XYZ Dec 105 calls are $3.25, and the XYZ Dec 110 calls are $1.875, the XYZ Dec 100/105 call back spread would cost a $1.25 debit, while the XYZ Dec 100/110 call back spread would receive a $1.50 credit. If a back spread is established for a credit, the position will make money if the stock price moves big enough either up or down (keep all the 'credit' premium if both options go out worthless). If a back spread is established for a debit, the position will make money only if the stock price moves big enough in the direction of the long options (lose all the 'debit' premium if both options go out worthless).</div>
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If you look at back spreads that are the same width in strikes, say 1 strike apart and all other things being equal, their price declines, from ITM back spreads (the most expensive) to OTM back spreads (the least expensive). The reason for this is quite simple. ITM options are more expensive, and if you think of what a back spread is (a vertical plus an extra long option) the ITM options will add more value to the back spread than the OTM options will.</div>
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An increase in volatility or more days to expiration will make the prices of back spreads more equal, as well as more expensive. That is, all back spreads will be more expensive, and ITM back spreads will be more expensive than OTM back spreads, but the difference will be smaller.</div>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-23355037341057490462012-08-19T20:56:00.000-07:002012-08-19T20:56:50.858-07:00Straddles & Strangles<table class="cellBG" style="background-color: white; border-spacing: 0px; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 10pt; margin: 0px; padding: 0px; width: 100%px;"><tbody>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Straddle</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 50 call @ $2.00, Long 1 XYZ Sep 50 put @ $1.75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option Premium Paid, $375</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option Premium Paid, $375</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited Potential</td></tr>
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<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Straddle</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 50 call @ $2.00, Short 1 XYZ Sep 50 put @ $1.75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Credit Received</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $375</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited Potential</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $375</td></tr>
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<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Strangle</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 40 put @ $1.00, Long 1 XYZ Sep 60 call @ $.75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option Premium Paid, $175</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option Premium Paid, $175</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited Potential</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Strangle</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short1 XYZ Sep 40 put @ $1.00, Short 1 XYZ Sep 60 call @ $.75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Credit Received</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $175</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited Potential</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $175</td></tr>
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Explanation and Application</h5>
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The names "straddle" and "strangle" may give you clues about these option positions. Like your favorite politician trying to win both Democratic and Republican votes, these positions are on both sides of the issue. Long straddles and strangles make money if the stock price moves up or down significantly. Who cares which way the stock goes, so long as it GOES!</div>
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Straddles and strangles are essentially speculations on whether the price of the stock will move a lot or not or implied volatility is going to go up or down. If you think the stock is going to move big in one direction or another and/or if you think implied volatility is going to rise, you would buy a straddle or strangle. If you think the stock is going to sit still or not move very much and/or if you think implied volatility is going to fall, you would sell short a straddle or strangle.</div>
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A long straddle is long 1 call and long 1 put at the same strike price and expiration and on the same stock. A long strangle is long 1 call at a higher strike and long 1 put at a lower strike in the same expiration and on the same stock. Such a position makes money if the stock price moves up or down well past the strike prices of the strangle. Long straddles and strangles have limited risk but unlimited profit potential.</div>
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The simplest reason to buy straddles and strangles is that they manufacture long deltas if the underlying stock rallies, and short deltas if the underlying stock falls. Long deltas on the way up and short deltas on the way down? What's the catch? Straddles and strangles can be expensive to buy, and if the stock price just sits there, or moves very little, losses can be large.</div>
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A short straddle is short 1 call and short 1 put at the same strike price and expiration and on the same stock. A short strangle is short 1 call at a higher strike and short 1 put at a lower strike in the same expiration and on the same stock. Such a position makes money if the stock price stays at the strike of the straddle or in between the strike prices of the strangle. Short straddles and strangles have unlimited risk and limited profit potential.</div>
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Selling straddles and strangles can be attractive, but always dangerous. Just as a long straddle can lose money at an alarming rate when the stock price doesn't move at all, a short straddle makes all the money in that scenario. But the profits collected quickly disappear if the stock price moves too much. Potential losses on short straddles and strangles are unlimited. Being short straddles and strangles is too dangerous for all but the most experienced and well-capitalized trader who can employ defensive tactics quickly if things go wrong.</div>
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Long butterflies and condors are two ways to get some of the advantages of short straddles and strangles without the unlimited risk.</div>
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Greeks</h5>
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If you can understand the greeks for calls and puts, you can understand the greeks for straddles and strangles.</div>
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The delta of straddles and strangles can range from positive to negative to neutral, depending on where the stock price is relative to the strike price(s). Remember that the sum of the absolute value of the deltas of the call and put at the same strike price and expiration equals 1.00. What that means in the case of a straddle is that when the call delta increases, the put delta must decrease. So, for an XYZ Dec 100 straddle with the stock price at $100, the delta of the straddle is very close to 0, because the long call has a delta of around .50 and the long put has a delta around -.50. But if the stock price starts to fall, the delta of the long put might go to -.70, making the delta of the long call around .30. The delta of the straddle would be, then, -.40. If the stock price then began to rise back to $100, the delta of the straddle would move from -.40 back to around 0.</div>
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The delta of a strangle is governed by which strike price the stock price is closest to. When the stock price is at the exact midpoint between the two strikes of the strangle, the delta of the strangle is typically close to zero, but different implied volatilities at the two strikes (volatility skew) can change that. But if the stock price rises to the higher strike, the call delta grows more positive, and the put delta becomes less negative. The delta of the long strangle therefore becomes positive. If the stock price falls closer to the lower strike, the put delta grows more negative, and the call delta becomes less positive. Therefore, the delta of the long strangle becomes negative.</div>
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The gamma of a long straddle or strangle is always positive; the gamma of a short straddle or strangle is always negative. But like delta, the gamma of the straddle depends on where the stock price is relative to the strike price. The gamma of a straddle is highest when the stock price is at the strike price. This makes sense, because gamma for an option is highest when the stock price is equal to the strike price. The long gamma indicates the long straddle wants the stock price to move. The higher the positive gamma, the more positive delta will be manufactured as the stock price rises, the more negative delta as the stock price falls. As the stock price moves away from the strike price of the straddle, gamma starts to decrease. When the stock price moves, the options become either ITM or OTM, and their gamma drops accordingly.</div>
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Just as gamma increases as implied volatility falls or as time passes, the gamma of a straddle grows the closer it is to expiration or if implied volatility falls. That means that the delta of a straddle with many days before expiration will not change as much as that of a straddle with fewer days to expiration when the price of the stock moves up or down. This translates into the price of the straddle with more days to expiration not changing as much as the price of the straddle with fewer days to expiration when the stock price moves. Why, then, wouldn't you buy straddles near expiration? Read on.</div>
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Although it is true that a long gamma position creates deltas in a direction consistent with the market direction (how wonderful!), remember that there is a luxury tax attached to this position (ouch!). The problem is negative theta, which means that your asset is wasting away. Theta, or time decay, is highest for straddles near expiration. So, a long straddle can lose quite a bit of money as it gets close to expiration. When a straddle's gamma is highest, so is its time decay. That's the gamma/theta tradeoff. The gamma gives you lots of power to exploit a change in the price of the stock, but theta is making you pay for that power.</div>
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Gamma and theta are smaller for strangles than they are for straddles. Even if the stock price is exactly at one of the strike prices, remember that you only have one option (either a call or a put) at that strike with the strangle versus two options (a call and a put) with the straddle. So, all other things (implied volatility, time to expiration, interest rates) being equal the straddle has higher gamma and theta than a strangle.</div>
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Long straddles and strangles always have positive vega, and short straddles and strangles always have negative vega. That's why they are popular strategies to exploit changes in implied volatility. If you think volatility is going up, but unsure of the direction of the stock price, buying a straddle or strangle is a good strategy with limited risk. The amount of vega that a straddle or strangle has depends on, like the other greeks, where the stock price is relative to the strike of the options. Vega is highest for a straddle when the stock price is exactly at the strike price. It is highest for a strangle when the stock price is at one of the strikes.</div>
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Vega is higher for straddles and strangles that have more days until expiration. So, if your speculation is that implied volatility will rise, a long straddle with more days until expiration might be the best strategy. Remember, though, that the price of a straddle with more days until expiration will not change as much as one with fewer days until expiration when the stock price moves up or down. That's another tradeoff – a straddle that works best for changes in implied volatility doesn't necessarily work best for changes in the stock price.</div>
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Please allow us a short digression. Have you ever come across an options trader who proudly announced that he bought volatility at 25 percent and sold it at 30 percent, implying that it was a profitable trade? It simply is not enough information to react to. You cannot determine whether the trader made any money when he says that alone. What if the purchase had been 25% with 30 days to go and the sale at 30% had been with 3 days to go, while the stock price was virtually unchanged throughout the period? That would probably be a losing trade. If, on the other hand, the trader is talking about a two-year LEAP option that was liquidated one day after it was purchased with the stock price unchanged, that would probably be profitable. Unfortunately, many people talk about implied volatility as if it were money. Volatility is not money! This is a failure to realize that implied volatility is only one part of an option's value.</div>
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Balancing theta, gamma, and vega and/or isolating your speculation to changes in implied volatility or stock price is something you'll have to think about before trading straddles and strangles. Use the thinkorswim analyzer on the trading application and stress--test your ideas before you do the trade.</div>
<br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><a href="" name="structure" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Straddle and Strangle Structure</h5>
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Straddles and strangles are relatively straightforward positions, you buy a call and a put, or you sell a call and a put. Generally, though, they are established to be delta-neutral (i.e. the delta of the straddle is close 0). So, if you bought one XYZ Apr 100 call and one XYZ Apr 100 put, with the price of XYZ at $100, you would have a long straddle with a delta very close to 0. But what if you bought one XYZ Apr 80 call (with a delta of +.75) and one XYZ Apr 80 put (with a delta of -.25)? That straddle would have a positive delta of +.50 (+.75 - .25). So, in order for the straddle to be delta-neutral, you would have to buy more of those XYZ Apr 80 puts. In fact, you would have to buy 3 of the XYZ 80 puts to create a delta-neutral straddle (+.75 - 3*.25). Any time you buy or sell a straddle with more of one option than another, it's called a "ratioed straddle".</div>
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Where this is most applicable is when you are long stock, and you buy puts or sell calls as a hedge. For example, if you are long 100 shares of XYZ stock, and you want to buy puts as a hedge, you could buy 4 of the XYZ Apr 80 puts (each with a delta of -.25). The resulting delta of the position would be close to 0 (1.00 - (4*.25)). Your position would basically be long a ratioed straddle, and it would act the same as if you were long 1 XYZ Apr 80 call and long 3 XYZ Apr 80 puts. The long 100 shares of XYZ and long 1 of the XYZ Apr 80 puts is synthetically long 1 XYZ Apr 80 call, which leaves long 3 actual XYZ Apr 80 puts.</div>
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If you are long 100 shares of XYZ stock, and you sell calls as a hedge, you could sell 3 of the XYZ Apr 110 calls (each with a delta of .33). The resulting delta of the position would be close to 0 (1.00 - (3*.33)). Your position would basically be short a ratioed straddle, with unlimited risk and limited potential for profit. The long 100 shares of XYZ and short 1 of the XYZ Apr 110 calls is synthetically short 1 XYZ Apr 110 put, which leaves short 2 actual XYZ Apr 110 calls.</div>
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This does not imply that any position that is delta-neutral acts like a straddle - far from it. But do realize that there are different ways of establishing a straddle or ratioed straddle.</div>
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Pricing</h5>
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The price of a straddle or strangle varies according to implied volatility and where the stock price is relative to the strike price. All other things being equal, a straddle whose strike price is equal to the price of the stock is cheaper than a straddle whose strike price is not equal to the price of the stock. The reason is that the straddle whose strike is equal to the price of the stock is made up of a call and put whose value is all extrinsic, while the straddle whose strike price is not equal to the price of the stock is made up of an ITM call (put) and an OTM put (call). Even though extrinsic value is highest for the ATM options, the decrease in extrinsic value for ITM and OTM options is offset by the intrinsic value of the ITM option. This is why straddles make money when the stock price moves up or down -- the accumulation of intrinsic value in the call or put.</div>
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A straddle is theoretically worth zero if the stock price is equal to the strike price at expiration. The reason the straddle is theoretically worth zero in this case is that the call and the put have zero intrinsic value and zero extrinsic value. In reality, even at the strike price, a straddle in a stock, will expire with a little value in it because there is still the chance that some one will want to exercise either the call or put after the market closes on Friday but before the options expire on Saturday. At expiration, the value of a straddle depends on the intrinsic value of either the call or the put. If either call or put has sufficient intrinsic value to offset the original price of the straddle the position is profitable, otherwise it loses money.</div>
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The same principal applies to strangles. If the price of the stock is in between the two strike prices of the strangle at expiration, the strangle is worthless. For a long strangle to be profitable at expiration, the stock price has to be sufficiently higher or lower than the strike prices to give either the call or put enough intrinsic value to offset the original cost of the strangle.</div>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-64052162153381665112012-08-19T20:52:00.000-07:002012-08-19T20:52:41.187-07:00Verticals<br />
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Essentials</h5>
<table class="cellBG" style="background-color: white; border-spacing: 0px; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 10pt; margin: 0px; padding: 0px; width: 100%px;"><tbody>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Call (Bull) Vertical</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 50 call @ $2.00, Short 1 XYZ Sep 60 call @ $.75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $125</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $125</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Dollar value of difference between the strike prices minus premium paid, $875</td></tr>
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<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Call (Bear) Vertical</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 50 call @ $2.00, Long 1 XYZ Sep 60 call @ $.75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Credit Received</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $125</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Dollar value of difference between the strike prices minus credit received, $875</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $125</td></tr>
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<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Put (Bear) Vertical</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 40 put @ $1.00, Short 1 XYZ Sep 35 put @ $.25</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Dollar value of difference between the strike prices minus premium paid, $425</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"> </td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Put (Bull) Vertical</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 40 put @ $1.00, Long 1 XYZ Sep 35 put @ $.25</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Credit Received</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $75</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Dollar value of difference between the strike prices minus credit received, $425</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Net option premium received, $75</td></tr>
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<br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><a href="" name="explanation" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" /><h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Explanation and Application</h5>
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Verticals are the most basic option spread. You're hedging one option with another: when one makes money, the other loses money. The idea is that in exchange for relatively low risk, you're giving up the possibility of stratospheric gains. But don't scoff. Verticals (either a bull vertical or bear vertical) are popular with professionals because of their limited risk nature and their profit potential that, though limited, can still amount to many times the risk taken. In many stocks, option volatility and margin requirements are so high as to prohibit either buying or selling options outright, whereas verticals typically don't have such high cost or prohibitive margin requirements. Verticals can offer investors an efficient way of creating long or short exposure in a stock.</div>
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Before we proceed, understand that a bull vertical is always long a lower strike option and short a higher strike option, and can be either a long call vertical or a short put vertical. Conversely, a bear vertical is always short a lower strike option and long a higher strike option, and can be either a long put vertical or a short call vertical.</div>
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It's not enough to know a bull vertical spread is used when you are bullish and a bear vertical spread when you are bearish. Should you be considering a vertical that's in-the-money (ITM), at-the-money (ATM), or out-of-the money (OTM)? With respect to the stock's current price, a vertical might have one option ITM and one OTM making it an ATM vertical. Therefore, an ITM vertical is one where both options are currently ITM, and an OTM vertical is one where both options are currently OTM. Do you want the passage of time to help you, or are you willing to let it hurt you? Do you think implied volatility will rise, fall, or stay the same during your time frame? Verticals can be created to meet these requirements.</div>
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Verticals are named by their two strikes, with the lower strike first. So, if you buy the XYZ Dec 90 call and sell the XYZ Dec 115 call, you bought the XYZ Dec 90/115 call vertical. Incidentally, this is known as a 25 'point' vertical, because the difference between the strike prices is 25 points.</div>
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At the expiration of the options, a vertical will always have a value between $0 (when totally OTM) and the difference between the strikes (when totally ITM). For example, if the stock price is $120 at expiration, the 90/115 call vertical will have a value of $25 (115 - 90), while the 110/115 put vertical will have a value of $0. A bull vertical maximizes its value when the stock price is above the higher strike price at the expiration of the options. A bear vertical maximizes its value when the stock price is below the lower strike price at the expiration of the options.</div>
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Let's assume that you believe a stock will rise in value, and you want to use the limited risk and limited reward characteristics of a long call vertical to profit from the rise. It's natural to consider one that can earn a lot more money than it can lose. For example, paying $1.00 for a long OTM XYZ Dec 130/140 call vertical that has the chance to go to $10.00 (10 point vertical).</div>
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That's a 'risk 1 to make 9' scenario. But that might require a significant rally in the stock price, and depending on the expiration date of the option, a move of sufficient magnitude may not be very likely. You have to be aware of the fact that until the rise in the stock price happens, time is working against the long OTM vertical's value. Also, a decline of implied volatility would decrease each of the OTM verticals' values.</div>
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You might be able to buy a long ATM XYZ Dec 110/120 call vertical for about $5.00 (10 point vertical), which would be a 'risk $5 to make $5' scenario. It is more likely that the stock price will rise enough for the ATM call vertical to maximize its value than for the OTM call vertical to maximize its value. But your risk is higher ($5 versus $1) and your potential profit is less than for the ATM call vertical ($5 versus $9).</div>
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You could buy a long ITM XYZ Dec 90/100 call vertical for $8.00 with the price of XYZ at $110. Not many beginning option traders would consider paying $8.00 for a 10 point spread. That's a 'risk $8 to make $2' scenario. But let's think about it in terms of the likelihood of the stock price being greater than the higher of the two strike prices (100) of the vertical at expiration. If the stock rallies to $112, the stock price will be greater than the higher strike price, and the long ITM call vertical will profit. If the stock price sits still at $110, the long ITM call vertical will profit again. Even if the stock falls to $105 but stays above the higher of the two strikes in the call vertical, it still profits. Of course, if the stock price falls too far, for example to $90, you'll lose more money on the long ITM call vertical than you would on a long ATM or OTM call vertical ($8 versus $5 or $1). It is more likely that the long ITM call vertical will reach its maximum value, but the risk is higher and profit potential lower than either the ATM or OTM call verticals ($2 versus $5 or $9). The passage of time and changes in implied volatility have the opposite effects on a long ITM call vertical than on a long OTM call vertical.</div>
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Your first thought is that you might just as well buy a further dated vertical because you have more time for the stock price to rise. That is a reasonable assumption, but more time to expiration means that your call vertical will not rise or, for that matter, fall in price as fast as a vertical that's closer to expiration. That's because the gamma for verticals with more time to expiration is smaller than the gamma for verticals that are closer to expiration.</div>
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Another reason for trading verticals is to exit a position in one option and enter into another (called "rolling" risk up or down). For example, if you are long 1 XYZ Dec 50 put, and you wish to sell that put and buy 1 XYZ Dec 40 put, you could sell 1 XYZ Dec 40/50 put vertical in one trade instead of doing two separate trades. When the short 1 XYZ Dec 40/50 put vertical is combined with the original position of long 1 XYZ Dec 50 put, the resulting position is long 1 XYZ Dec 40 put. The vertical allows you to restructure your option position more efficiently and with less cost (1 ticket charge versus 2 and, hopefully, a narrower bid/ask spread on the vertical versus two bid/ask spreads on the naked options).</div>
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Like a lot of people, you might be long stock. But reading this article got you thinking about trying verticals. Rather than selling your stock and buying a vertical, you can sell a call and buy a put, creating what is commonly known as a "fence", but which is basically the same as a vertical. Now you'll see why it's good to understand "synthetics".</div>
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If you want to turn long XYZ stock into a bull vertical, buy a put with a lower strike and sell a call with a higher strike. For example, buy the XYZ Dec 100 put and sell the XYZ Dec 120 call. The long XYZ stock and long XYZ Dec 100 put are a synthetic long XYZ Dec 100 call. Add that to the short XYZ Dec 120 call, and it mimics a long XYZ Dec 100/120 call vertical.</div>
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If you want to turn long XYZ stock into a bear vertical, buy a put with a higher strike and sell a call with a lower strike. For example, buy the XYZ Dec 120 put and sell the XYZ Dec 100 call. The long XYZ stock and short XYZ Dec 100 call are a synthetic short XYZ Dec 100 put. Add that to the long XYZ Dec 120 put, and it mimics a long XYZ Dec 100/120 put vertical.</div>
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Traditionally, brokers have sold fences as a strategy to limit the risk of the long stock with the long put, and then offset the cost of the put by selling a call. Now you know that they are creating verticals. You can even see how your position is doing by monitoring the price of the vertical.</div>
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Greeks</h5>
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The key to understanding the greeks of a vertical is to know where the stock price is in relation to the strike prices. When the stock price is at or close to one of the strike prices, the gamma, theta, and vega are highest for that strike and will dominate the gamma, theta, and vega for the other strike. Investing a little time simulating verticals on the Analysis Page can help you learn the nuances of the greeks of verticals much better than we can possibly write. So use the tools we provide you and zoom up the learning curve.</div>
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The delta of a bull vertical is never negative, and the delta of a bear vertical is never positive. But how positive or how negative the vertical's delta is depends mainly on the where the stock price is relative to the strike prices of the vertical and how far apart the strike prices are from each other. For example, if the strikes of the vertical are relatively close to one another (at adjacent strikes, or one or two strikes away), the relative difference between the deltas of each option can be small, especially if the vertical is OTM or ITM. So, the vertical has a relatively small delta. But if the strike prices are far apart, the relative difference of deltas of each option can be large, and the delta of the vertical will be large also. Add in the skew of implied volatilities for each strike and time to expiration, and the delta of verticals can be a richer tapestry than anything found in The Cloisters.</div>
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The delta of a call bull vertical is the same as the delta of the put bull vertical at the same strikes. To see why, remember that the sum of the absolute values (add them together as if they were both positive) of the call and put at the same strike and expiration is roughly equal to 1.00 (depending on the theoretical model used). If the delta of the long lower strike call is +.90, the delta of the long lower strike put is approximately -.10. If the delta of the short higher strike call is -.85, the delta of the short higher strike put is approximately .15. Therefore, the delta of the long call vertical (+.90 - .85 = +.05) is equal to the delta of the short put vertical (+.15 - .10 = +.05).</div>
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Just as when time passes and the deltas of individual options move closer to 0.0 (if OTM options) or 1.00 (if ITM options), so too do the deltas of verticals. For an OTM vertical, the deltas of both options are moving towards 0.0, for an ITM vertical, the deltas of both options are moving towards 1.00. Therefore, all other things being equal, the delta of both the OTM and ITM vertical is moving towards 0.0. But where one option is ITM and the other option is OTM, all other things being equal, the delta of the vertical moves towards 1.00. The delta of the ITM option is moving towards 1.00, and the delta of the OTM option is moving towards 0.0. That's why you have to watch these verticals very closely as they approach expiration. They begin to act more and more like a stock position as their delta gets closer to 1.00.</div>
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The gamma of a vertical tends to be pretty tame. Sure, it can switch from positive to negative, depending on where the stock price is in relation to the two strike prices of the vertical. But that's about it. The reason why the gamma can switch from positive to negative is easy. When the stock price is close to the strike of the long option, the gamma of that option is bigger than the gamma of the option at the short strike. The gamma of the vertical is positive, and you want the stock to move. When the stock price is close to the strike of the short option, the opposite is true. The gamma of the vertical is then negative, and you want the stock to sit still. Easy, isn't it?</div>
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The gammas of a long call vertical and a short put vertical at the same strikes are the same, because the gammas for calls and puts at the same strike are nearly equal. Just subtract the gamma of the short strike option from the gamma of the long strike option and you'll see they have nearly equal gamma.</div>
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All other things being equal, an increase in volatility decreases the value of ITM verticals and increases the value of OTM verticals. This is because of the increased likelihood the ITM vertical will not stay ITM, and the OTM vertical could become ITM. All other things being equal, time passing increases the value of ITM verticals and decreases the value of OTM verticals. With less time, there is less of a chance the stock price will move enough to hurt an ITM vertical or help an OTM vertical. The vega and theta of verticals indicate this and depend on where the stock price is relative to the strike prices and how far apart the strike prices are from each other. So, considering the long ITM call vertical and short OTM put vertical at the same strikes, each has negative vega and positive theta. A long OTM call vertical and a short ITM put vertical have positive vega and negative theta. You can get the vega and theta exposure you want by selecting which strikes you buy and sell.</div>
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Ultimately, it's very important that you take into account all the factors that influence a vertical's value. Inexperienced traders often only look at delta exposure, and forget to consider their position's vega and theta. Testing a position on the thinkorswim Analysis Page before you do a trade can let you see the effects of changes in the stock price, volatility, and time. It's better to do your homework than be surprised by the unexpected.</div>
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Structure</h5>
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A vertical has options at two strikes in the same expiration month on the same stock. The options are either both calls or both puts, with one long and the other short. A long call vertical is long a lower strike call and short a higher strike call. A short call vertical is short a lower strike call and long a higher strike call. A long put vertical is long a higher strike put and short a lower strike put. A short put vertical is short a higher strike put and long a lower strike put.</div>
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Other sources may describe these as "bull" or "bear" credit or debit spreads. That's not incorrect, but it doesn't really explain what's going on. Yes, a long call vertical gives you the same exposure as a short put vertical, but the former is a debit spread and the latter is a credit spread. Is that a significant difference?</div>
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The relationship between a call vertical and a put vertical at the same strike prices and in the same month is the box spread. The box spread is basically a delta-neutral option position that act's something like a zero-coupon bond. Movement in the stock price doesn't really change the value of the box that much. A long box is made up of a long call vertical and a long put vertical at the same strikes. A short box is made up of a short call vertical and a short put vertical at the same strikes. If your position is a long call vertical (a bull vertical), and you overlay a short box, the resulting position will be a short put vertical (also a bull vertical). If your position is a long put vertical (a bear vertical), and you overlay a short box, the resulting position will be a short call vertical (also a bear vertical).</div>
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One way to capitalize on this knowledge is when holding a vertical that is deeply ITM. This may have occurred after a big move in the stock, which has turned your OTM or ATM vertical into an ITM vertical. Typically, ITM options and verticals have wider bid/ask spreads (because their component options each have a high delta) than OTM verticals. So, rather than taking profits by liquidating an ITM vertical, you could buy the low priced corresponding OTM vertical which should ordinarily have a narrowly quoted market. The result of this trade is to lock in your profit by establishing a box spread. Be aware, though, that the box spread might require later transactions, exercises/assignments or allowing usually two and at least one of the options to expire worthless. If the bid/ask spread on the OTM vertical is sufficiently less than the bid/ask spread on the ITM vertical, it would result in savings that exceed the commissions on the box spread. A box spread has pin risk so make sure you are on top of it at expiration.</div>
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Pricing</h5>
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First, understand that a long box spread (a delta neutral interest rate position) is comprised of a long call (bull) vertical and a long put (bear) vertical at the same strikes. Because we can calculate the fair value of the box all by itself, using simple algebra we can calculate the value of the call vertical from the value of the box and the put vertical, and vice versa. If the box XYZ Dec 100/105 box is worth $4.95, and the XYZ Dec 100/105 call vertical is worth $3.50, the XYZ Dec 100/105 put vertical must be worth $1.45. Because of the box spread, if the call vertical goes up, the put vertical must go down.</div>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-40536898734292115902012-08-19T20:45:00.000-07:002012-08-19T20:47:19.601-07:00Calls, Puts & Covered Writes<br />
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Essentials</h5>
<table class="cellBG" style="background-color: white; border-spacing: 0px; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 10pt; margin: 0px; padding: 0px; width: 100%px;"><tbody>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Call</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 50 call @ $2.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $200</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $200</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"></td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Call</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 50 call @ $2.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Credit Received</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium received, $200</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium received, $200</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"></td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Long Put</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Long 1 XYZ Sep 40 put @ $1.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Cost</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $100</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium paid, $100</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited</td></tr>
<tr style="margin: 0px; padding: 0px;"><td style="margin: 0px; padding: 2px; vertical-align: top;"></td></tr>
<tr style="margin: 0px; padding: 0px;"><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Short Put</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" colspan="2" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Short 1 XYZ Sep 40 put @ $1.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Total Credit Received</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option premium received, $100</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Unlimited</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Maximum Profit</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; vertical-align: top;">Option Premium Received, $100</td></tr>
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<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="explanation" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
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Explanation and Application</h5>
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Before you can trade the more complicated option positions, it would be wise to understand their building blocks: calls and puts. Critics of option trading always point out how risky, speculative, and unnecessary options are. But what they either don't understand or point out is that options are designed to be a tool for transferring risk from one trader to another. It is imperative to understand that when buying calls or puts, the potential loss is limited to the amount paid for the calls or puts. When selling calls or puts, the potential loss is unlimited (short puts really have risk limited to their strike price, but are considered unlimited for all intents and purposes). Therefore, when you buy an option, you are limiting your risk by transferring it to whomever sold the option. When you sell an option short, you are accepting the risk from whoever bought the option. Options can offer a great deal of leverage, meaning that you can have the risk/reward exposure of a large position in stock for a relatively small amount of money.</div>
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It's important to understand that there are trade-offs in options. There are good points and bad points about every option strategy. You must isolate your speculation, i.e. precisely what do you think is going to happen to a stock and when is it going to happen? You must balance potential risk versus potential reward. Always keep in mind that in option trading, you never get anything for free.<br />
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To outline the basics, we'll focus first on a long call. Much of what is learned about long calls can be applied elsewhere. Buying a call is perhaps the most common and straightforward option position there is. It's a strategy that's used if you think a stock's price will rise and can be seen as a substitute for buying stock. Buying a call does offer leverage and limited risk. It usually costs less to buy an option than it does to buy the underlying stock, and is generally considered less risky than a position in stock. But you have to be confident that the stock price will rise sufficiently before the expiration date of the option. Options expire, stock does not. You can "sit" on a stock and hope that eventually it will rise in price. You can't do that with a call option. If the stock price doesn't rise enough by a certain date, the call option may expire worthless or with a lower price than you originally paid. So, it's not enough to be bullish on a stock in order to figure out which call to buy.</div>
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The key is that there are trade-offs between potential risk, the probability of profit, and the potential profit. Generally, the lower the risk or the higher the probability of profit of a trade, the smaller the potential percentage profit. It's highly unlikely that, in a lifetime of trading, there will be massive potential percentage profits that are all but guaranteed to happen with little or no risk. You're more likely to be hit by lightning, twice, after living out your fantasies at the Playboy mansion.</div>
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You have to balance these trade-offs. For example, an option's value is continuously whittled down by the passage of time. There is a constant battle between the erosion of your option's value as time passes and waiting for a favorable move in the stock price or an increase in implied volatility that will push the value of the option back up. Therefore, you need to consider the timing and the magnitude of the anticipated rise in the stock's price. Each one of these is a speculation that you are accepting when you trade options.</div>
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You also have to decide whether to buy a call with more or fewer days to expiration. An option with fewer days to expiration has a couple things going for it. First, all other things being equal, it's cheaper than an option with more days to expiration. That means you'll have a smaller absolute loss if your speculations are incorrect. Second, all other things being equal, if the stock price moves up, it will probably have a greater percentage increase in value than an option with more days to expiration. So why ever consider an option with more days to expiration?</div>
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Well, options with more days to expiration have their advantages. First, there's more time for the stock to make a favorable move. For a given level of volatility, a stock will have a chance to make a much greater up or down move if there is more time. There will be a greater opportunity for the stock to rise sufficiently and/or recover from any price declines in order for the call to be profitable. You don't want the stock to make its big move the day after your options expire. Second, an option with more days to expiration will experience less price erosion as time passes, and have a smaller percentage loss if the price of the stock remains unchanged or falls.</div>
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Changes in implied volatility affect options with more or fewer days to expiration differently. Calls with more days to expiration are more sensitive to changes in implied volatility than are calls with fewer days to expiration. You have to remember that implied volatility can move up and down, and can hurt badly if it moves against you.</div>
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Remember, you never get anything for free.</div>
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Whether to buy an ITM, ATM, or OTM call is another decision you have to make because each of them responds differently to changing conditions. An ITM option acts the most like a stock position. Depending on how deeply it is ITM, it will act more and more like stock. It will be affected less by time and changes in volatility, and more by the stock price moving up and down. An ITM call may require a smaller rise in the stock price to be profitable, but its percentage gains won't be as great as those of an ATM or OTM call.</div>
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An ATM option has the greatest uncertainty. It is the most sensitive to changes in the stock price and volatility, and time passing. This can be good or bad. If all your speculations are wrong, the ATM option can hurt you the most.</div>
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An OTM option begs for a very large rise in the price of the stock. If you get a big enough move in the stock, an OTM call can deliver a much higher percentage profit than an ITM or ATM call. And if the stock price falls dramatically, the loss on the OTM call will be smaller than on an ATM or ITM call. But remember that a big move in the stock price is less likely than a smaller move, and OTM options will expire worthless if the move in the stock isn't big enough.</div>
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Selling a call short is the mirror image of buying a call. It's a speculation that the price of the stock will fall, stay the same, or rise only very little. You have to consider the same things as when buying a call, except in reverse. It's a zero-sum game: where a long call loses money, a short call makes money. Just remember, a short call has limited profit potential in exchange for unlimited risk if the stock decides to skyrocket. When thinking about selling a call short, you should probably consider another option strategy that more effectively expresses your market opinion with less risk.</div>
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Buying puts is a strategy that profits from a drop in a stock's price. The only practical difference between buying puts and buying calls is that you want the stock price to go down if you buy a put, and up if you buy a call. The decisions about days to expiration, volatility, ITM, ATM, and OTM are all basically the same for a call and put.</div>
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Buying a put is an effective alternative to selling stock short. Short stock can have high margin requirements, and (unlike thinkorswim) some brokers restrict their clients from shorting stock. Unlike short stock, buying puts has limited risk. No matter how high the stock goes, you can only lose the premium you paid. The max potential profit on a long put is the dollar value of the strike price of the put minus the premium of the put, and would be achieved if the stock goes to $0 at expiration</div>
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Selling a put short is the mirror image of buying a put. Like a short call, a short put requires you to assume unlimited risk. Like the potential profit on a long put, the risk of a short put is the dollar value of the strike price of the put minus the premium of the put. Because a stock can never have a value less than zero, the potential loss on a short put can be very, very large, but it is not infinite. When thinking about selling a put, consider other trades that would take advantage of your market opinions with less risk.</div>
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When trading options, you have to refine your speculation to incorporate how much you think the stock may move, how much time it will take for the stock to move, and how implied volatility might change. Not accounting for these factors is a major reason why novice option traders lose money. Understanding the trade-offs in options will help you understand how and why your option position is acting the way it is.</div>
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<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="greeks" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
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Greeks</h5>
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Buying an option, whether it's a call or put, is known as buying premium; selling or shorting an option, whether it's a call or put, is known as selling premium. This terminology implies a certain equivalency between calls and put. Indeed, calls and puts share many characteristics.</div>
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The greeks of calls and puts are calculated from the price of the stock, the strike price of the option, the estimate of volatility of the stock, the time to expiration of the option, the current interest rate and any dividends payable on the stock before the expiration date of the option. You can read more about the greeks in their own article.</div>
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The delta of a long call is positive; the delta of a long put is negative. The delta is reversed for short calls and puts. This can be understood by knowing that, all things being equal, a long call makes money if the stock price goes up, and a long put makes money if the stock price goes down. One of the things you will probably watch the most when trading is the delta of your position. The delta of a position is simply the sum of the quantity of each option times each option's delta. Thinkorswim presents position deltas in terms of shares of stock, i.e. long 1 call option representing 100 shares of stock and with a delta of +.75 with shows a position delta of +75. Therefore, if you are long 5 calls, each with a delta of +.75, your position delta would be +375. Keep in mind that some options represent something other than 100 shares of stock. This occurs when there are stock splits, takeovers, or mergers. The delta of your position is affected accordingly.</div>
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And just what does make delta as "watchable" as the girl from Ipanema? It's that it changes. The main factor in the delta of an option is where the stock price is relative to the strike price of the option. So, a call that starts out with very little delta can have very large delta if the stock price rises sufficiently. Your exposure in the stock increases as the stock price rises. Now isn't that long and lovely.</div>
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Time passing and changes in volatility also affect delta. Time and turmoil ravage more than the looks of Brazilian hotties. Use the thinkorswim Analysis Page to see how time passing or a drop in volatility will push the delta of an ITM option closer to 1.00, and the delta of an OTM option closer to 0.0.</div>
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Remember that delta is only a theoretical approximation of your exposure in the stock. So, don't be surprised if your options don't have prices that match what your delta predicted. With the stock price, time, and volatility changing, you may have to monitor the delta of your position vigilantly to make sure you have the exposure you want.</div>
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Gamma is the greek that gets your delta going. If you look at delta as the "speed" of your option position, gamma is the "acceleration". The gamma of long options, calls or puts, is always positive; of short options, always negative. Gamma is highest for the ATM strike, and slopes off toward the ITM and OTM strikes. One good way of interpreting gamma is that long gamma "manufactures" deltas in the direction the stock is moving. That is, positive gamma is why long calls get more positive delta when the stock price rises, and why long puts get more negative deltas when the stock price falls. That's why short gamma can be so dangerous. When your speculation on stock price is wrong, short gamma makes it hurt really bad. With a small gamma, your position delta probably won't change much. The more gamma your position has, your position delta can change a great deal and probably needs close monitoring.</div>
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But if you think the price of a stock is going to move a great deal very quickly, you want to buy an option with relatively high gamma. The high positive gamma will get you more deltas if the stock price moves the way you want it to, and reduce your deltas if the stock price moves against you.</div>
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Theta measures the daily whittling down of an option's value. It's inescapable. Long calls and puts have negative theta and, all other things being equal, lose money as time passes. Short calls and puts have positive theta and, all other things being equal, make money as time passes. The theta of options is indirectly proportional to gamma. When gamma is big and positive, theta tends to be big and negative. That's the trade-off. A position that has a lot of gamma (good for fast changing stocks) also has lots of theta that is continuously eroding its value.</div>
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It's highest for the ATM strike, and slopes off to the ITM and OTM options, and responds to the passage of time and changes in volatility the same way that gamma does.</div>
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Don't let anyone tell you different: vega is not a Greek letter. So why does it get to be a greek, and not the lost-but-not-forgotten "digamma"? Sounds like a conspiracy to me. Vega measures how much the value of an option changes when the implied volatility of that option changes. Long calls and puts both have positive vega and, all things being equal, make money when implied volatility rises. Short calls and puts both have negative vega and, all things being equal, make money when implied volatility falls. Implied volatilities move up and down, sometimes in frighteningly large amounts. When markets are sluggish, implied volatilities often drop, combining with theta to make long option positions cry out for mercy.</div>
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The more time there is until expiration, the higher the vega is for an option. Vega also depends on where the price of the stock is relative to the strike price of the option. Like gamma and theta, vega is highest for the ATM options, and drops for the OTM and ITM options. So, ATM options with lots of time to expiration are the most sensitive to changes in implied volatility.</div>
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The theoretical assumptions made here are only as good as the data input. Stress testing with changes in overall implied volatility and at each individual strike will help you understand this concept.</div>
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From a purely theoretical standpoint calls and puts would be perfectly opposite were it not for the probability assumption, which implies that calls can theoretically go further in the money than puts and therefore have bigger deltas than puts when they are both at-the-money or equidistant from the money.</div>
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Some readers will cite minuscule differences between the greeks of puts and calls at the same strike. For all intents and purposes, gamma, theta, and vega are the same for long calls and long puts. A fair wager would be that there is no way to make or save money by playing for any differences.</div>
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<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="structure" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
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Structure</h5>
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Calls, puts, and stock are the building blocks of all trading strategies. Buying or selling any one of these is a strategy unto itself. The discussion of structure is really about how any two of the three – calls, puts, and stock – can be combined to make the third. Synthetics are most useful to arbitrageurs who look for opportunities to purchase one instrument cheaper than they sell its synthetic, a process that can at times be somewhat complicated.</div>
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When referring to options, synthetics are positions that are made up of two things to act like a third. That is, you can create a "synthetic" long call by buying stock and buying a put. You can sell "synthetic" stock by selling a call and buying a put with the same strike price. The basic synthetic equivalents are:</div>
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<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long Stock = Long Call and Short Put</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Short Stock = Short Call and Long Put</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long Call = Long Stock and Long Put</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Short Call = Short Stock and Short Put</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Long Put = Short Stock and Long Call</li>
<li style="color: #444444; font-size: 8pt; line-height: 13pt; list-style-image: url(https://www.thinkorswim.com/images/listitem_bullet.gif); margin: 0px 0px 0px 29px; padding: 0px 0px 10px; text-align: left;">Short Put = Long Stock and Short Call</li>
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It can be seen that a short put is equal to the popular covered write, which is long stock and short a call.</div>
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To show you a simple way to prove that synthetics "work" we use a conversion, which is short a synthetic put and long an actual put, or long a synthetic call and short an actual call, or short stock and long synthetic stock. (N.B. being able to see an option position in different ways can be a useful skill in managing risk and taking advantage of market conditions.) The idea is that if you buy something at a certain price, and sell its synthetic equivalent at the same price, you shouldn't make or lose any money.</div>
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Let's consider the ABC Nov 50 call price priced at $4.00, the ABC Nov 50 put priced at $2.00, and ABC stock at $52.00 (the options prices are ignoring interest rates). The conversion is long 100 shares of ABC stock, long 1 ABC Nov 50 put, and short 1 ABC Nov 50 call. By performing "what–if" analyses, it can be determined that the conversion breaks even (that is, neither makes nor loses money) at all stock prices at the expiration of the options. We'll test scenarios where the price of ABC stock is $52.00, $100.00, and $25.00 at expiration.</div>
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<table class="cellBG" style="background-color: white; border-spacing: 0px; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 10pt; margin: 0px; padding: 0px; width: 100%px;"><tbody>
<tr style="margin: 0px; padding: 0px;"><td bgcolor="#D1D7FF" style="margin: 0px; padding: 2px; vertical-align: top;"></td><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Stock @ $52.00</th><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Stock @ $100.00</th><th class="header" colspan="2" style="background-color: #cdd3d2; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 8pt; margin: 0px; padding: 3px 2px;">Stock @ $25.00</th></tr>
<tr style="margin: 0px; padding: 0px;"><td class="rowHeader" style="margin: 0px; padding: 2px; vertical-align: top;"></td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: center; vertical-align: top;">Value at Expiration</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: center; vertical-align: top;">Profit/<br />
Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: center; vertical-align: top;">Value at Expiration</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: center; vertical-align: top;">Profit/<br />
Loss</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: center; vertical-align: top;">Value at Expiration</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: center; vertical-align: top;">Profit/<br />
Loss</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="rowHeader" style="margin: 0px; padding: 2px; vertical-align: top;">Sold 50 Call @ $4.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$2.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$2.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$50.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">($46.00)</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$0.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$4.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="rowHeader" style="margin: 0px; padding: 2px; vertical-align: top;">Bought 50 Put @ $2.00</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$0.00</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">($2.00)</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$0.00</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">($2.00)</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$25.00</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$23.00</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="rowHeader" style="margin: 0px; padding: 2px; vertical-align: top;">Bought Stock @ $52.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$52.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$0.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$100.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$48.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$25.00</td><td class="row2" style="background-color: #dddddd; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">($27.00)</td></tr>
<tr style="margin: 0px; padding: 0px;"><td class="rowHeader" style="margin: 0px; padding: 2px; vertical-align: top;"></td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;"></td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$0.00</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;"></td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$0.00</td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;"></td><td class="row1" style="background-color: #eeeeee; background-position: initial initial; background-repeat: initial initial; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 7pt; margin: 0px; padding: 2px; text-align: right; vertical-align: top;">$0.00</td></tr>
</tbody></table>
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So, a conversion is a flat position, that is, it has virtually no exposure to the risk of the stock price moving up and down. That's because you bought a synthetic call, and sold an actual call.</div>
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It is important to understand the nature of risk and the synthetic properties that are inherent in options. People too often look at how much they can win and not often enough at what they can lose. This approach has made many people rich, but it is unfortunately only a matter of time before the market eventually ruins those who carry positions that they were ill–prepared to deal with. Traders often suffer from tunnel vision and lose sight of the fact that they hold a position on a security that they never wanted. It is usually too late to act by the time they realize this.</div>
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<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="pricing" style="background-color: white; color: #0158c4; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 13px; font-weight: bold;"></a><span style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;"></span><br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
<h5 style="background-color: white; color: #444444; font-family: Verdana, Arial, Helvetica, sans-serif; font-size: 10pt; margin: 30px 0px 10px;">
Pricing</h5>
<br style="background-color: white; font-family: Verdana, Arial, Helvetica, 'Sans serif'; font-size: 13px;" />
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At expiration, an option is worth any intrinsic value or 0. Option values depend on the price of the stock, the strike price, the implied volatility of the stock price, the time to expiration, interest rates, and any dividends payable before the expiration of the option. We won't go into a discussion of theoretical pricing models at this time. Suffice it to say that theoretical values really give you a good guess as to what the real value of an option is. They don't guarantee that you'll make money. Read the article on "The Matrix of Options", and get an insight on option pricing without theoretical models.</div>
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As a ruleTemplate of thumb, the higher the volatility, the more expensive the option, and the more days until expiration, the more expensive the option. Dividends reduce the value of calls and increase the value of puts. An increase in interest rates increases the value of calls and decreases the value of puts.</div>
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Remember, whenever an option trade occurs, the buyer thinks the option is too cheap and the seller thinks the option is too expensive. The fact that people disagree on value is why any trading occurs at all. Rather than worrying about the value of an option, you should concentrate on the risk/reward of an option trade. thinkorswim provides you with professional-level risk management tools to help you make sense of all this.</div>
Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-75076775144797302712012-01-11T12:42:00.000-08:002012-01-11T12:42:16.156-08:00A Gold Update<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdTjPgPvuFaYR6DIvJWEtuFJdO4QUlD5RLOifrgTvtoGo0iT0F8CQ4ZZ_mPAHth2cH8dKk_ziOHPELTfzVW0Wqjhqy7ZCasbI_a3j3oJtUd9BGxKCIpiOFT0TSF4mRlApqM6TG2340IFAv/s1600/gc+daily.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="372" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdTjPgPvuFaYR6DIvJWEtuFJdO4QUlD5RLOifrgTvtoGo0iT0F8CQ4ZZ_mPAHth2cH8dKk_ziOHPELTfzVW0Wqjhqy7ZCasbI_a3j3oJtUd9BGxKCIpiOFT0TSF4mRlApqM6TG2340IFAv/s640/gc+daily.png" width="640" /></a></div>
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<br />
Gold has been on a wild ride the past month or so after collapsing below 1700 just days after I posted about the <a href="http://fadethetrade.blogspot.com/2011/12/gold-triangle.html">"The Gold Triangle"</a> breaking down. The gold market built an impressive and impulsive rally up over 120 points since bottoming a few weeks back at 1525. Today we touched a high of 1648 before pulling back and closing a bit off the high. This area is important because the swing high from Dec 21 was 1643 and if gold can close above this level it will be on its way to attracting buyers up to 1680 next.<br />
<br />
It is a bit overextended short term and could use a 1-2 day pullback and if this occurs it should hold the 1613 level of support which is now a 1 year VPOC where alot of business has been done as you can see the daily chart above. On the profile there is a little volume pocket up to about 1700 so buyers could drag it up to there easily.<br />
<br />
The downtrend line from the Sept and Nov highs comes into play a little higher near the 1690-1700 zone and will definitely give gold a tough time if it gets there. Also the LRC channel has resistance in that area currently.<br />
<br />
On the bullish side the TTM trend has been back to a buy signal for 6 days now and the DMI is crossing back into green buy mode. We are entering a more quiet time of year for metals as they historically consolidate into early Spring so this could result in a base being built between 1600 and 1700 in the coming weeks. All in all, it seems to me like downside in gold is limited and dips are buys as long as it holds above the 1613 zone of support.Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com1tag:blogger.com,1999:blog-3915179358094443288.post-63837160255252169302011-12-12T12:50:00.000-08:002011-12-12T13:43:26.207-08:00The Gold Triangle<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgaV01NDFdISoJLhQSzjvXXc4O-VC8XXU_stCNOFur_-eZSvkIKkmdPpiL0c1opU9YekpZ-26KbnTqf1ZCMXOLgwv5ScMX5FAqcEUJp-MrlqOEJVNvWodKWTuH9HbRcurynTrMPWrEnzfKR/s1600/2011-12-12-PROPHET.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="444" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgaV01NDFdISoJLhQSzjvXXc4O-VC8XXU_stCNOFur_-eZSvkIKkmdPpiL0c1opU9YekpZ-26KbnTqf1ZCMXOLgwv5ScMX5FAqcEUJp-MrlqOEJVNvWodKWTuH9HbRcurynTrMPWrEnzfKR/s640/2011-12-12-PROPHET.png" width="640" /></a></div>
<br />
Feb Gold futures $GC_F have been consolidating into a big triangle the last few months since topping in early September. The price action has been less than bullish most of the last month forming a sloppy slanted head and shoulders pattern which should point to a move back down to 155 at the least. Gold tried to get back above the 1800 level--which was just about the 61.8% retracement of the entire decline from early Sept--but failed to attract buyers at that level and quickly auctioned lower.<br />
<br />
Today the break of the big triangle is confirming that the gold market is going lower in the short term. The big signal to me was last week when gold ran up to 1760 and stopped on a dime and reversed back down to 1710 that same day to put in a bearish outside reversal candle trapping bulls above 1750-1760. That usually indicates much more than a 1 day move coming.<br />
<br />
Looking at the volume profile chart you can see the big supply overhead that put a ceiling in gold and there is some decent support down to 1625 but below that there is a volume pocket down to about 1540, which coincidentally is also where the 61.8% retracement of the entire bull run of 2011 from 1309 low in January to 1923 high in September.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaVIn1hAWfga8fM5TQWIG8jBYRwVw-zva7hmPHJrhNPMmynVg9O5fa2TlsY-Yvz_G4yYrUDQ0_BywOPleMCFZPPK2b2SHfSWw6MTalVKGrJLLZSVpGXCSc8-2qiQJS40Wg0-ZTrNS-ofxi/s1600/gld.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="372" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaVIn1hAWfga8fM5TQWIG8jBYRwVw-zva7hmPHJrhNPMmynVg9O5fa2TlsY-Yvz_G4yYrUDQ0_BywOPleMCFZPPK2b2SHfSWw6MTalVKGrJLLZSVpGXCSc8-2qiQJS40Wg0-ZTrNS-ofxi/s640/gld.png" width="640" /></a></div>
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<br />
<br />
<ul>
<li>Today, the TTM trend turned back to confirmed sell signal with two red bars on the daily.</li>
<li>The DMI also is in bear trend mode with the histograms still red, saying the sellers are in control.</li>
<li>I dont think gold crashes into the next month but short term the risk is to the downside no doubt and shorting rallies into resistance is a profitable strategy.</li>
<li>The 200 EMA on GLD is near 157 and that looks to be tested if today's high (1718) is not regained.</li>
<li>I would look to buy January puts or put spreads on any bounce back to the 1680s on the gold futures or about the 163's on GLD.</li>
<li>Also for daytrading the gold futures are a great contract to trade for intraday and should provide plenty opportunity going into 2012 as well.</li>
<li>Long term I think gold is still alright on the monthly chart and should hold 150 on $GLD during this correction before it starts a new uptrend but not right now, there are just too many trapped bulls who bought the parabolic climb in late summertime and are now providing the fuel on downside as they sell. </li>
</ul>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-16210675141306565132011-11-19T14:24:00.001-08:002011-11-19T15:14:47.849-08:00GOOG Option Trade ReviewOne of my favorite trade setups for stocks during options expiration week is the "pinning trade" that shows up late in the week or the day of expiration. Long story short, I look at a stocks open interest and if there is considerable OI present at one strike versus all others then I like to then look at the short term trend and momentum of the stock to see if it likely that a move towards that high open interest strike price unfolds. This logic of pinning and why it happens is a whole post for another day but here I just wanted to do a trade review of my put spread trade in GOOG from Friday that I tweeted out live.<br />
<br />
GOOG traded between 601-604 in the first hour of the day and I already saw that the 600 strike had the most open interest out of any strikes. It also is a good round number that traders monitor. So while I watched the market chop around slightly higher and tech kind of weaker overall on the day I kept my eye on GOOG and if it traded with any intention of going towards 600. The plan was to buy the slightly in the money 605 puts and look for a move to 600 AND THEN short the 600 puts to be in a vertical spread and expect the stock to pin at 600. Even if the stock tanks below 600 I still make the spread. My max risk on the trade was basically above the high of the day which would have risked about 1.00 on the spread.<br />
<br />
<b>Thought Process:</b><br />
<br />
<br />
<ul>
<li>Watching the 5 minute chart on the left I took alert when the TTM trend bars closed 2 red candles in a row. At this point I see the stock decisively below the VWAP (red dashed line) and a fresh TTM squeeze setting up as shown at the bottom of chart. I want to buy the 605 puts on a pop back to the VWAP expecting the stock to roll over to new lows.</li>
<li>As the arrow shows I scaled into the 605 puts where I marked the blue vertical line. I added to the position a few minutes later as the VWAP held as intraday resistance. </li>
<li>My mental stop was the highs and if GOOG broke down under 600 as planned I would put in a hard stop at breakeven to ensure no risk on the trade.</li>
<li>Within 20 minutes GOOG tested the 600 level and I shorted the 600 puts to create a vertical put spread at an average price of 2.25.</li>
<li>The TTM squeeze fired off a short signal and GOOG fell all the way to about 594. In hindsight, it would have been nice to simply be long the 605 puts with no spread but I cant trade in hindsight.</li>
<li>The max my 605/600 put spread could be worth would be 5.00 since that is the difference in the strikes. That max wouldn't be reached til near the close when the premium evaporated so I was very happy with simply selling for 4.75 if I could instead of being greedy for the last few dimes.</li>
<li>By the next hour I was filled for 4.75 on the put spreads after an entry of 2.25. A gain of about 111% or +2.50 per contract.</li>
<li>A huge winner for a relatively small move in the stock, percentage-wise. That is the best part about using options and spreads during options expiration when you know the likely strikes that are in play for pins.</li>
</ul>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi39-BDPpOp5zQpoVvDvVYBsxFefFoqWbnOyJtyBnyKKUDoL3mPYC6uJcYLkuh7Bu65MdmW3cxPWBP4mfhWSp2nFx0b8ibT8LVx91FqSOdmoZo2MLBhpX6zr60N5-HWhlVK6tKekjroWJOl/s1600/goog.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="372" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi39-BDPpOp5zQpoVvDvVYBsxFefFoqWbnOyJtyBnyKKUDoL3mPYC6uJcYLkuh7Bu65MdmW3cxPWBP4mfhWSp2nFx0b8ibT8LVx91FqSOdmoZo2MLBhpX6zr60N5-HWhlVK6tKekjroWJOl/s640/goog.png" width="640" /></a></div>
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<br /></div>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-89981035531155434802011-11-16T18:18:00.001-08:002011-11-16T18:38:24.173-08:00Dollar Index Wants Higher<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEikyxXPx_Z9EQymMvq2gLfx8s7MehAlx9Wi1Qm35iQr9VnMZ1YVRucIwUF5uEHqLsX6CwJu7l0I7zZX9XC6zSaSSN2qDe4ftMiMfga3dIVpyHY1bmXcx4-w-wi3kCk_nJxRGRNmfH5P0a7-/s1600/dx.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="364" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEikyxXPx_Z9EQymMvq2gLfx8s7MehAlx9Wi1Qm35iQr9VnMZ1YVRucIwUF5uEHqLsX6CwJu7l0I7zZX9XC6zSaSSN2qDe4ftMiMfga3dIVpyHY1bmXcx4-w-wi3kCk_nJxRGRNmfH5P0a7-/s640/dx.png" width="640" /></a></div>
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<br />
As a follow up to my <a href="http://fadethetrade.blogspot.com/2011/11/euro-gets-stopped-at-618-retracement.html">previous Euro post</a> I thought I would look at the dollar index and where it might be headed. The dollar index futures have been in bullish mode for most of November as it bounces off its 13 day EMA and holds the 200 day at 76.79. It has now gotten above and CLOSED above the 61.8% retracement of the down move during October that took the dollar from 80.46 to 74.86. Because of this I think it will bring in more buyers on any dip back to the mean. I think at the least there should be a retest of 80 coming soon and eventually Fibonacci extension targets as shown in the chart point to a move up to 81.94. This fib target would make alot of sense because it matches up with the 52 week high from January at 81.63.<br />
<br />
If the move really gets legs in the longer term the second target would be the 161.8% fib extension of 83.87. That would be quite a move and while I doubt we see it that high...the possibility exists.<br />
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The TTM wave in the chart is positive saying bulls are in control in this timeframe. Momentum in the squeeze is rising also. If the dollar index continues to rally towards 80 it would make sense the foreign currencies like AUD, CAD, BP, EUR would sell off and all of these daily charts are in bearish trends at the moment so it matches up well.Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-64847735522524661692011-11-09T20:22:00.000-08:002011-11-09T20:22:21.852-08:00VIX a Sale at 40?I will be watching the VIX and the 40 level to look at selling volatility in stocks. The main reason is based on the LRC I have on the chart. The linear regression channel I use shows when the market gets too stretched in one direction based on its recent activity. The outer red lines are two standard deviation bands and the LRC channel dynamically updates in real time. The outer band is sitting near 39-40 so this will likely be a tough level for the VIX to sustain above for more than 1-2 days. This is also a very similar concept to using the bollinger bands on the VIX.<div>
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<li>If/when the VIX tests the 39-40 area it would probably also mean the SPX is testing the 1200-1210 zone of support. A big line in the sand for bulls going into year end.</li>
<li>Thanksgiving is in 2 weeks. That means holiday trading mode. It also means theta decay will start to be priced into the options markets in the next few weeks. </li>
<li>It would take a lot of new information from Europe that isn't already somewhat priced in to get the VIX to explode thru 45-50 into the holiday season. Unlikely. Not impossible, but just not probable.</li>
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The easiest way to sell vol is to sell put credit spreads into support on strong stocks. Selling SPY iron condors works as well. Or maybe even just buying a calendar spread on the SPY going into the next month (Buying Jan/selling Dec). Expecting price to stay range bound and volatility to come in. Just some ideas here.</div>
</div>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-61963670867408005772011-11-09T12:23:00.000-08:002011-11-09T13:26:10.217-08:00Apple Rotting?AAPL stock has had a tough time attracting buyers above the 400 dollar level since it first got to it back on July 22nd. Since then it has closed above 400 on ONLY 21 days out of 77 trading days. Granted we have been in a pretty strong selling mode since early August but this just shows there is a lack of buyer interest at these high levels.<br />
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The earnings gap from mid October left a bearish island reversal top in place at the 426 high and AAPL has been struggling to hold the 400 level once again as it bear flags on top of the 50MA. This could be a pretty big turning point for the stock that has been so loved by Wall Street for so long.</div>
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AAPL is breaking hard with the market today and I think it has a date with the 389 open gap from Oct 10th. Below that there is little support at the uptrend line of the larger scale rising wedge near 375. The 200 MA is down at 362 and could be where AAPL is headed if it cannot get its act together and get back above 410 and attack that island gap top.</div>
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Looking at the volume profile on AAPL you can see the 1 year VPOC (volume point of control) or where the most volume has traded, is down at 346 so that is huge support if it ever goes there. But the thing to keep in mind is there is a decent volume pocket between 355-385.</div>
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Buying Dec puts on bounces is not a bad idea and then selling weekly's against them is a decent way to play a choppy to down move over the intermediate term.</div>
</div>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-21276678988243582542011-11-02T12:33:00.000-07:002011-11-02T12:33:54.166-07:00Euro Gets Stopped at the 61.8% Retracement<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">The short covering rally in the EUR/USD since October ran up about 1000 pips and got stopped cold right at the 61.8% retracement of the larger downtrend in place since May 2011. Pretty amazing how these fibonacci levels work in the markets, especially currencies. The 1.4250 level has been a huge level of interest for the past year as this was where the Euro topped out in late 2010 and then found support throughout mid-2011 as the currency made a major top before falling to 1.3145.</span><br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWCzDbrdu9uEdb66y2LFvmJa2yjpWkqtpCpiiZc-UEe0zPq6T64UkzepkAy-7vKZam4GUyh4TAB5qNuyXaxmpNZ6Bx3mXu2ab5zU7KwMBovK8xFznnjXpAcxr0LEYzbujp17F1H-HfSQy2/s1600/euro+daily.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="444" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjWCzDbrdu9uEdb66y2LFvmJa2yjpWkqtpCpiiZc-UEe0zPq6T64UkzepkAy-7vKZam4GUyh4TAB5qNuyXaxmpNZ6Bx3mXu2ab5zU7KwMBovK8xFznnjXpAcxr0LEYzbujp17F1H-HfSQy2/s640/euro+daily.png" width="640" /></a></div>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">Now after the bounce back to resistance it failed and slipped back below the 200 EMA which sits at 1.3955 on the daily. The daily chart has flipped back to a short term sell signal based on the color of my TTM trend bars and if it doesn't recover the 1.4000 zone soon it should continue a multi-month decline. </span><br />
<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;"><br /></span><br />
<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">This is even more significant based on the fact that the weekly chart is possibly forming the right shoulder of a bearish head and shoulders top with the slanted neckline shown below coming in near 1.3400.</span><br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEggZxrkJUy9jjjK2sP1NKhWbKpspu0XJaLd4uaxRe6QujadAEEd-FV8trtHNmCpX6ZOyXUKgXladnom30og-XQeKAzQC0F7M8rUfYDgKvqvdIvnMJRb104fYESyTMBhFibX6dZueulQs_v8/s1600/euro+weekly.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="444" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEggZxrkJUy9jjjK2sP1NKhWbKpspu0XJaLd4uaxRe6QujadAEEd-FV8trtHNmCpX6ZOyXUKgXladnom30og-XQeKAzQC0F7M8rUfYDgKvqvdIvnMJRb104fYESyTMBhFibX6dZueulQs_v8/s640/euro+weekly.png" width="640" /></a></div>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">This definitely depends on the direction of the dollar as well but I think in the intermediate term there are more downside risks to the Euro than the US buck. It will be interesting to see where the Euro goes into year end but last week's blowoff top at 1.4250 has all the makings of a important high that we might look back at in 3-6 months. If it does actually breakdown I can see the EUR/USD at 1.25 to 1.2750 very easily as initial targets.</span>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-56567999958961360602011-11-01T18:11:00.000-07:002011-11-01T18:11:38.278-07:00Fascinating Similarities Between 2008 and Now<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">There are some crazy interesting similarities in price action between the present market and the early 2008 patterns of price. So I went back to compare the analog chart between then and now. I trade in the short term but I always have a view of the big picture. Just wanted to point out the possibilities of where the stock market might go in the intermediate term-long term. </span><div>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">First chart shows the 5 year weekly chart of $SPX from 2006-present with some simple 50 and 200 period SMA's. The highlighted rectangles are what I am focusing on. Notice each top clearly shows a bull trap above previous highs and classic 6 month head and shoulders rounding formations which led to longs being trapped with plenty of supply overhead.</span></div>
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<li><span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">2007-08: The Oct 11th high of 1576 to the March 17th low of 1256 was a </span><b style="font-family: 'Trebuchet MS', sans-serif;">decline of 20.3%</b></li>
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<li><span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">2011: The May 2nd high of 1370 to the Oct 4th low of 1074 was a </span><b style="font-family: 'Trebuchet MS', sans-serif;">decline of 21.6%</b></li>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">Fairly equal percentage moves right?</span></div>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;"><i>Here is where it gets nutty.</i></span></div>
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<li><span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">Each decline from high to low lasted a total </span><b style="font-family: 'Trebuchet MS', sans-serif;">duration of 23 weeks.</b></li>
<li><span style="font-family: 'Trebuchet MS', sans-serif;">Each decline found support and eventually bounced off the 200 week SMA</span></li>
<li><span style="font-family: 'Trebuchet MS', sans-serif;">Both price lows were bear traps which undercut the previously made lows. In 2008 it was the March 17th "Bear Stearns" low.</span></li>
<li><span style="font-family: 'Trebuchet MS', sans-serif;">Both of the subsequent rallies up were stopped at resistance at the 200 day SMA. In 2008 at a level of 1440 and 2011 at a level of 1292 SPX.</span></li>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_mMLfvBHKcnqhp2HQYCPssQxAcjLJyXB6dlBLrLsHAV9MH7P4Dd_BF60xXSIgT3AoCCyg36jyqcpRPt5aBJ6dueDD8EFrX7JZcfb0O8sR6b9EuXgsVc0HBesv1lI9O_stVNHoSl3gRYXx/s1600/daily+2008.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="364" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi_mMLfvBHKcnqhp2HQYCPssQxAcjLJyXB6dlBLrLsHAV9MH7P4Dd_BF60xXSIgT3AoCCyg36jyqcpRPt5aBJ6dueDD8EFrX7JZcfb0O8sR6b9EuXgsVc0HBesv1lI9O_stVNHoSl3gRYXx/s640/daily+2008.png" width="640" /></a></div>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">As the 2nd and 3rd charts show there are a few key differences as well.</span></div>
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<li><span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">In 2008 the slope of the 200 day SMA was pointing much sharper down than it currently is. However it is still pointed slightly down in the present 2011 market.</span></li>
<li><span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">The rally back up off the lows was faster and sharper in 2011 than in Spring 2008.</span></li>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">Even so, I think its been interesting to keep an eye on the similarities between this analog chart and the present markets. History repeats itself because human nature is constant. I think this is even more significant because we have just had a 5 wave up bull market for the past 2.5 years and the long term investor sentiment is clearly bullish in the "acceptance" stage.</span></div>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">Remember the technical's move far before the "data" confirms reality because the market is the smartest in the room.</span></div>
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<span class="Apple-style-span" style="font-family: 'Trebuchet MS', sans-serif;">Simply ignore the outside noise and media and focus in on the pure price action. Clearly, it is not 2008. It is 2011. But like in the 1930's when the "great recovery" began, the government interfered and helped welcome the double dip recession of 1937-38. The public is losing confidence in the leaders as shown by the Occupy movement. A lot of the same ingredients are in place at this time so is the market predicting the same fate? We shall see over the next year!</span></div>
</div>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-88038155956488338432011-06-25T16:43:00.000-07:002011-10-29T15:38:26.794-07:00Trading Grains (Part 4): Managing Risk with ATR<div style="color: #111111; font-family: Verdana; font-size: 13px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px; text-align: left;">
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To close out the mini-series of Trading Grain Futures I want to focus a bit on managing risk and how to maximize profit targets. When it comes down to it if you're not managing the risk on a trade you will not be around very long. When trading, my goal right off the bat is to know where I'm getting out in case I am wrong. I obviously take a trade because it shows me a high probability of making money but my focus is always the risk involved.Your job as a trader should be to always manage the risk to an acceptable amount related to your tolerance and account size. The winners then take care of themselves. </div>
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So after discussing some of the ways I trade and analyze corn and the other grains futures in Parts 1-3 of Trading the Grains lets finish out this series with how I use the ATR to manage risk. The ATR is the average true range and I like to watch it on a number of markets and stocks to see how far a move can go. The ATR is a dynamic way to measure volatility in a constantly changing market.</div>
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I always use hard stops in the futures markets and usually get into a corn day trade with a fixed stop of 10 ticks or 2.5 points. I try to get into day trades with very precise entry points but still like to give my trades some room to wiggle and develop. Sometimes the volatility is so high you need to have wider stops and targets so how do I quickly decide on this in a fast moving market?</div>
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The ATR. I watch the 60 minute chart of corn as pictured below and here was today's action. The ATR was 5.22 which means the average price range of the last 14 candles was 5.22 points. This usually is between 4-6 points on the 60 minute corn chart. So you can either use a stop equal to the ATR or use a more precise entry and have a stop of half the ATR.</div>
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With this ATR I like to target a profit of 1 times the ATR on the trade so in this case I would be looking for a profit of 5.25 points in corn or 21 ticks. If you trade more than one lot you can take half off at 1 times the ATR and look for a move of 2 times the ATR on the rest of the position with a breakeven stop once the first target is hit. </div>
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These are just a few of the ways I like to use ATR to manage risk and look for profit targets in the grains futures. And of course you can apply this to any futures contracts or stocks on any timeframes.</div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEit4hc2y6y1i7aSseNCNP0SpiVNhZlKzk2Ol83ppPTpVxTFfUBsz3nAwvQj3XjWJoN2zbFq6seIOZ7LKflHafAMp_1AIW5BLWOlwut16tCyZwVAhC-HrXyIbMliL_IVqci1Gpw8igI6CSc/s1600/corn+ATR.png" imageanchor="1" style="background-color: transparent; color: #111111; margin-bottom: 0px; margin-left: 1em; margin-right: 1em; margin-top: 0px; outline-color: initial; outline-style: none; outline-width: initial; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px; text-decoration: none;"><img border="0" height="444" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEit4hc2y6y1i7aSseNCNP0SpiVNhZlKzk2Ol83ppPTpVxTFfUBsz3nAwvQj3XjWJoN2zbFq6seIOZ7LKflHafAMp_1AIW5BLWOlwut16tCyZwVAhC-HrXyIbMliL_IVqci1Gpw8igI6CSc/s640/corn+ATR.png" style="border-bottom-width: 0px; border-color: initial; border-left-width: 0px; border-right-width: 0px; border-style: initial; border-top-width: 0px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; max-width: 100%; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;" width="640" /></a></div>
</div>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-24190965837113718542011-06-25T16:39:00.000-07:002011-10-29T14:53:03.474-07:00Trading Grains (Part 3): The Box Play<div style="color: #111111; font-family: Verdana; font-size: 13px; line-height: 22px; margin-bottom: 5px; margin-left: 0px; margin-right: 0px; margin-top: 5px; padding-bottom: 5px; padding-left: 0px; padding-right: 0px; padding-top: 5px;">
In my <a href="http://www.younggunstrading.com/2011/04/limit-moves-in-grains-part-2.html" style="background-color: transparent; color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; outline-color: initial; outline-style: none; outline-width: initial; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px; text-decoration: none;">previous post on grains</a> I talked about limit moves and how to play them. In Part 3 of this series on trading the grains let's take a look at <i style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">The First Half Hour Range </i>and how to capitalize on this momentum trade using the <b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Box Play.</b><br />
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Between the pit session open at 10:30 am EST and 11am EST alot of volume and activity occurs in the grains futures. Orders come in from all over the place as farmers hedge their production, commodity funds initiate positions, and speculators try to scalp the volatility in price action. The volume calms down after that first half hour but because there was so much activity it means there are plenty of positions that are open. Once the first half hour range breaks either up or down the momentum takes over and carries the market in that direction usually for the remainder of that day.<br />
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I've noticed this works best in corn and soybeans and less in wheat, which is a quirky market compared to corn and beans. After 11am EST each day I label the first half hour high and low with a horizontal line on my chart. If the first half hour range is not broken by 1:45 pm EST it usually means its a rare choppy slow day in the grains so I stay away and pass on the trade.<br />
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<i style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">You can enter this trade in a few ways:</i></div>
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<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Or just simply place a buy stop above the high and a sell stop below the low of the first half hour range and walk away. If it breaks the highs you are long with an open target and the sell stop now becomes your stop on the trade. You can either target a move the equal distance of the first half hour range or just come back at 2pm EST before the grains close and flatten the position. If you have a wider tolerance for risk this becomes a nice simple way to play the range break or <b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">"The Box Play."</b></li>
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Here are a few examples of the Box Play in corn and soybeans.</div>
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In this first chart of corn from April 12th you can see the break below 758.25 triggered a big move down very quickly which you could have shorted and netted 9 points before the TTM trend turned back to two blue bars. </div>
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In the 2nd chart we have soybeans on May 3rd. The dashed horizontal lines show the first half hour range. The break below the low at 1369 triggered a flurry of selling that dumped beans 15 points in less than an hour. Even if you waited til the close to cover your short you still would have booked about 7 points from 1369 to 1362. </div>
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<br /></div>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-62973585024014400512011-06-25T16:27:00.001-07:002011-10-29T14:53:44.579-07:00Limit Moves in the Grains (Part 2)<div style="color: #111111; font-family: Verdana; font-size: 13px; line-height: 22px; margin-bottom: 5px; margin-left: 0px; margin-right: 0px; margin-top: 5px; padding-bottom: 5px; padding-left: 0px; padding-right: 0px; padding-top: 5px;">
<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">We had a sweet limit down move in corn futures today so its a perfect time to highlight limit moves in grains and show you how I traded the action today!</span><br />
<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"></span><br />
<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">One of the most interesting aspects of the grain futures is the frequency and power of daily <b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">limit moves </b>in price. Drier than expected weather in Iowa cornfields can move the price of corn violently. A freak thunderstorm in the plains can make wheat rally hard. Soybeans can tank or rise with the fluctuation of oil prices intra-day. All this and more can make forced liquidation an exciting trading opportunity in the grains futures, both on the way up and down.</span><br />
<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"></span><br />
<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">As I described in <i style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><a href="http://fadethetrade.blogspot.com/2011/06/trading-grain-futures-part-1.html" style="background-color: transparent; color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; outline-color: initial; outline-style: none; outline-width: initial; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px; text-decoration: none;"><b>"Part 1" of Trading the Grains</b></a>, </i>corn, wheat, and soybeans are a true momentum market in which the pit session is open from <span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">10:30 am EST-2:15 pm EST. Here are some of the basic specs of contract months and LIMIT price rules:</span></span><br />
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<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Corn Futures Months traded: March (H), May (K), July (N), September (U), December (Z).</span></span></li>
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<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Daily price limit of 40 cents</b> or "points" expanded to 60 cent limit the day after the market closes at limit.</span></span></li>
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<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Soybeans Futures Months traded: January (F), March (H), May (K), July (N), August (Q), September (U), November (X).</span></span></li>
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<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Daily price limit of 70 cents</b> or "points" expanded to 105 cent limit the day after the market closes at limit.</span></span></li>
</ul>
<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Wheat Futures Months traded: March (H), May (K), July (N), September (U), December (Z).</span></span></li>
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<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Daily price limit of 60 cent</b>s or "points" expanded to 90 cent limit the day after the market closes at limit.</span></span></li>
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</ul>
<span class="Apple-style-span" style="color: #111111; font-family: Verdana; font-size: 13px;"><span class="Apple-style-span" style="color: #111111; font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">The important thing to know when trading on volatile days where limit moves are possible is to NEVER fade the trend. Ever. If you do then you risk getting stuck in a limit move that closes locked limit and opens up gapping huge in your face the next day. You could get a margin call, not to mention a sleepless night in which you will quickly develop a close personal relationship with Jesus, praying that the market comes back in your direction, lol.</span></span><span class="Apple-style-span" style="color: #111111; font-family: Verdana; font-size: 13px;"><br />
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<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"></span><span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">So how do you trade limit moves?</span></span></div>
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<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"></span><span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Let's use corn as an example. The daily price limit is now 40 points these days so if we get a move of 30+ points during the day it becomes a very high probability that corn will test the limit of 40 points. I like to call it the "Magnet trade" because once you get that close to limit you have margin clerks and poor folks on the wrong side of the trade liquidating their longs (if its a limit down move) or their shorts (on a limit up).</span></span></div>
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<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"></span><span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Also, when it hits LIMIT and comes off that limit maybe back to only down 30-35 points on the day to consolidate a little, then you almost ALWAYS see that limit retested by the end of the day. So you want to stick with the power of the trend and forced liquidation. Its a true magnet trade!</span></span></div>
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<span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"></span><span class="Apple-style-span" style="color: #111111; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Finally, here is a 333 tick chart of corn today. I originally planned on taking the day off from trading but then looked at my phone after about 9am PST and saw corn was down 23 handles, lol. So I raced to my computer to see if I can get a piece of the action expecting a possible limit down! The perfect entry on the short side would have been on the break of the "first half hour range" as shown by the white rectangle and arrow below. If I was at my desk I would have shorted corn as the TTM squeeze fired off near 750 and corn tanked 20 points in less than a half hour.</span></span><br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjcE6n-YSJBhwb4isWeTVP6FqCOXeoKkIwRbxPaODm3iTMEBHKTqcWmxz_MCuZVOvOjUNLRuCEBAJuudlPaG8mk-cX-VIEQvx995k1DNOzV-7lnzmtjFJ8lAiFSVrvV7DBjuRkO7Mq1NCU/s1600/corn+limit+down.png" imageanchor="1" style="background-color: transparent; color: #111111; margin-bottom: 0px; margin-left: 1em; margin-right: 1em; margin-top: 0px; outline-color: initial; outline-style: none; outline-width: initial; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px; text-decoration: none;"><img border="0" height="444" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjcE6n-YSJBhwb4isWeTVP6FqCOXeoKkIwRbxPaODm3iTMEBHKTqcWmxz_MCuZVOvOjUNLRuCEBAJuudlPaG8mk-cX-VIEQvx995k1DNOzV-7lnzmtjFJ8lAiFSVrvV7DBjuRkO7Mq1NCU/s640/corn+limit+down.png" style="border-bottom-width: 0px; border-color: initial; border-left-width: 0px; border-right-width: 0px; border-style: initial; border-top-width: 0px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; max-width: 100%; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;" width="640" /></a></div>
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<span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">The vertical white line shows when I got to my computer. You can see corn was down about 23 points and so I immediately started looking for a short entry. No squeeze showed up here but with the TTM wave (bottom blue indicator) below zero so I waited for a red TTM trend bar to switch from blue.</span></span></div>
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<span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">I shorted 735.50 and put in a 3 point stop at 738.50. My target was the limit down price of 729.25. Corn started to fall back towards the lows and I got filled about 20 minutes later for +6.25 points or $312.50 per contract.</span></span></div>
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<span class="Apple-style-span" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;"><span class="Apple-style-span" style="font-family: Arial, Helvetica, sans-serif; line-height: 19px; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">When limit down was hit there was about 100 contracts on the bid and over 100,000 on the offer panicking to sell at limit down. Its pretty amazing at the power of forced liquidation when it occurs as traders and big funds are literally willing to get OUT at any price.</span></span></div>
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</div>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-81783133962701338182011-06-25T16:23:00.001-07:002011-10-29T14:54:13.680-07:00Trading Grain Futures (Part 1)<div style="color: #111111; font-family: Verdana; font-size: 13px; line-height: 22px; margin-bottom: 5px; margin-left: 0px; margin-right: 0px; margin-top: 5px; padding-bottom: 5px; padding-left: 0px; padding-right: 0px; padding-top: 5px;">
I wanna do a series of posts on trading the grains futures; corn, soybeans and wheat. I think the grains offer up the most amount of opportunity than almost any other futures contracts out there. In this post I will highlight the basics you need to know and the specs between the different contracts. Corn and soybeans specifically are the two that I focus on day trading the most for several reasons. And don't worry you wont get delivery of 5000 bushels of corn in your driveway if you trade it.<br />
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So why trade corn instead of, say, the ES or other stock index futures?<br />
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<a href="http://www.blogger.com/blogger.g?blogID=3915179358094443288" name="more" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; outline-color: initial; outline-style: none; outline-width: initial; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px; text-decoration: none;"></a><br />
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<ul style="color: #111111; font-family: Verdana; font-size: 13px; line-height: 19px; margin-bottom: 1em; margin-left: 0px; margin-right: 0px; margin-top: 0.4em; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">
<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">The grains are a true momentum market in which once they pick a direction they trend in that direction for quite a while without many fake outs or bull/bear traps at highs or lows. In other words, you can buy breakouts and sell breakdowns without worrying about trend reversals. The moves made in corn or soybeans are very trendy and smooth, allowing a trader to stay in for the big move that often comes while still being able to manage risk.</li>
<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">The pit session is open from 10:30 am EST-2:15 pm EST. So if you don't like long hours then this market is for you! There is also an overnight session that runs until 8:30 am EST each morning then closes for two hours but I just focus on trading the pit session and usually you can count on some great moves occurring in just the first hour or two.</li>
<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">The daily ATR (average true range) for corn currently is 22. This means on average it moves 22 points per day, or about 3%. Soybeans have a current daily ATR of 28 or about 2%. Compare this with the ES e-mini contract ATR of 16 points or 1.2% and you can clearly see the added volatility in the grains. And where there is volatility, there is OPPORTUNITY.</li>
<li style="list-style-position: outside; margin-bottom: 0px; margin-left: 1.6em; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">There is basically one USDA crop report per month. That's it. You don't have to constantly await new economic data coming out and try to anticipate the market's reaction to it. Just trade the trend. The trading is great on these crop report days as you often see limit moves up or down in price. I will get into price limits another time.</li>
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The tick increments for corn, wheat and soybeans are $12.50 per quarter point ticks or $50 per point. So the same as the ES mini futures. The intraday and overnight margins are also very low for corn and just a bit higher for beans and wheat. For example, corn has a margin of just over $2,000 per contract and if you have a good futures broker you can get intraday margins of just $500 per contract.</div>
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Now that we got some of the basics out of the way let's look at a real trade example from last month to highlight my strategy. My strategy is trend following and follows the concepts I discussed in my previous post you can <a href="http://www.younggunstrading.com/2011/04/how-i-trade-trend.html" style="background-color: transparent; color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; outline-color: initial; outline-style: none; outline-width: initial; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px; text-decoration: none;">read here</a>. </div>
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I usually trade corn off a 233 or 333 tick chart and get my big picture view off the 60 minute chart. So if the 60 minute is bullish and rising then I focus on buy setups to go long and vice versa. I almost never fade the trend of the 60 minute chart in corn and there is a simple reason. Trends in the grains can last longer than you can imagine. That's why daily limit moves in price happen so often.</div>
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So in this trade from 3/25 you can see the corn market was trending up and the lower TTM wave is all above the zero line and blue so I am focusing on buying. When the squeeze indicator pops up as shown by the arrow, I already know the trend is up so I am looking for the trend bars to change back to blue to indicate the uptrend is resuming. </div>
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This trade starts at the red vertical line. I go long corn at 690 and within a half hour I sell it at 695 when I see two red trend bars in a row. A net profit of +5 points or $250 per contract. </div>
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Instead of trying to over-think things and attempting to catch tops or bottoms I just let the market price action tell me when the buying or selling pressure is changing. Sometimes that means you get stopped out for breakeven or even a loss, other times it means you catch a nice runner of 10+ points in the grains.</div>
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</div>Jasonhttp://www.blogger.com/profile/02889687773208038946noreply@blogger.com0tag:blogger.com,1999:blog-3915179358094443288.post-76523223202082255142011-06-01T19:58:00.000-07:002011-10-29T14:42:59.525-07:00How I Trade The Trend<span class="Apple-style-span" style="font-family: Verdana, sans-serif;"><span class="Apple-style-span" style="color: #111111; line-height: 22px;">I day trade the grain futures, specifically corn; and I swing trade options on big liquid momo stocks such as AAPL. So what's my trading strategy? I'm a student of price action and market sentiment and work off of that. I like to keep it as simple as possible because complexity breeds confusion. When it comes to indicators there are only a select few I put my money behind and they are the TTM trend, TTM squeeze, and TTM wave indicators developed by John Carter, who I have learned a ton from over the last few years and highly recommend his book</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"> </span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><i style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">Mastering the Trade</i></span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"> </span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">for anyone trying to make this a career. Anyway, how do I use these indicators to develop a trading strategy?</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><br />
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</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">Simple as 1, 2, 3...</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><br />
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</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"></span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><a href="http://www.blogger.com/post-edit.g?blogID=3915179358094443288&postID=7652322320208225514" name="more" style="color: #111111; margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; outline-color: initial; outline-style: none; outline-width: initial; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px; text-decoration: none;"></a></span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"></span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"></span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><br />
</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">First, the</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"> </span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">TTM trend</b></span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"> </span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">is just the color of the candles or bars you see in the charts. Either blue or red. You can see that once the color changes it tends to stay in a decent trend for awhile until things change. Each candle incorporates the close of the previous 6 periods in order to get an idea of what the actual TREND in the market is, which for me is valuable and much more important then the look or close of one candlestick.</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><br />
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</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">Second, the</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"> </span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">TTM squeeze</b></span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"> </span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">is the momentum bars with occasional red dots appearing on the midline. When they appear it tells you the stock or market is resting and getting ready for its next move so get ready!</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><br />
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</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">Third, the</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"> </span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><b style="margin-bottom: 0px; margin-left: 0px; margin-right: 0px; margin-top: 0px; padding-bottom: 0px; padding-left: 0px; padding-right: 0px; padding-top: 0px;">TTM wave</b></span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"> </span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">is the bottom indicator that shows two different wave's. A blue wave that shows the longer term momentum and a shorter term red/yellow wave. The blue wave is a filter for me to keep me on the right side of the market. For example, if the long term blue wave is completely positive then I am only looking for long setups and will buy the next time the shorter term yellow wave crosses back above 0.</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><br />
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</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">All of these TTM indicators are available for free on ToS under studies.</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;"><br />
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</span><span class="Apple-style-span" style="color: #111111; line-height: 22px;">Here is a real 60 minute chart example of a trade I took on AAPL about 2 weeks ago. AAPL had been underperforming a strong market that week so on Friday after it gapped up above 350 only to fade and then turn red on the day I was looking to go short.</span></span><br />
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<span class="Apple-style-span" style="color: #111111; line-height: 22px;"><span class="Apple-style-span" style="font-family: Verdana, sans-serif; line-height: normal;">1. Arrow one shows when AAPL broke 348 support the TTM trend changed to red looking at lower timeframe's like the 15 minute chart I scaled into some in-the-money 355 puts.<br />
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2. Arrow two shows the 60 minute squeeze forming on AAPL for several days saying that move is coming. Once it breaks support at 348 and the TTM trend bars are red I can assume the squeeze will eventually fire off short.<br />
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3. Arrow three shows my last confirmation of the TTM wave red bars going negative and then the wave completely below 0. Indicating game on and I added to my 355 puts Friday before the close.<br />
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I stayed with the trade until AAPL gapped down on Tuesday morning and opened at 336. I could have waited for two blue bars in a row to show me the change in trend but I covered the AAPL at 336 that morning because 12 points in two trading days is a great move!<br />
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I do this on basically any timeframe with any stock or market. Rinse and repeat and follow the trend.</span></span><br />
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