Options as a Strategic Investment » Stock Options Trading

Options Mastery Lesson: Straddles

admin — Mon, 18 Jan 2010 11:23:27 +0000

In our previous reports, we discussed option strategies that feature the use of options in combination with stock such as the buy-write and the use of options against each other in the form of spreads. We will focus on the Straddle, which uses options in unison with each other.
Unlike a spread that features a long option versus a short option, the Straddle features one position (either long or short) and two options – a call and its corresponding put. A Straddle is the strategy composed of a long (or short) call and a long (or short) put where both options have the identical strike price and expiration month.
When putting together a Straddle, the construction should be as follows:
-Different options (call and its corresponding put)
-Same stock
-Same strike
-Same expiration
-One-to-one ratio
Straddle positions are referred to as ‘long Straddle’ or ’short Straddle’ depending on whether you purchase the call and its corresponding put (long) or sell the call and its corresponding put (short). For example, we will construct the long Straddle by purchasing both the July 60 call and the July 60 put. We will construct the short Straddle by selling both the July 60 call and the July 60 put. It is important to note that the Straddle is a one-to-one ratio strategy. For every call that you buy (or sell), you must purchase (or sell) exactly one corresponding put.
Straddle Scenarios
The Straddle relies on movements in stock price or in implied volatility to establish profit opportunities. The Straddle buyer looks for the stock to move aggressively in either direction or for the anticipated perception of possible aggressive moves that will bring about an increase in implied volatility.
Sellers of the Straddle hope for the opposite scenario. A lack of stock movement or a perceived lack of movement, causing implied volatility to decrease, will create profitable scenario.
Straddle Mechanics
Let’s look at how a Straddle works. In our illustration, we see the July 65 Straddle. We can either buy or sell the Straddle. If we purchase both the July 65 call and the July 65 put simultaneously in a one-to-one ratio we have a long Straddle. To construct a short Straddle we would sell both the July 65 call and July 65 put simultaneously in a one-to-one ratio.
Continuing with our illustration, we will set the price for each of the options. With our imaginary stock trading at $65.50, the July 65 call trades at $3.13 and the July 65 put trades at $2.47. The combination of these two prices accounts for the $5.60 cost of the Straddle. Fast forward to expiration and observe what happens to the value of the Straddle at different stock prices.
Price Call Put Straddle P & L
50 0.00 15.00 15.00 9.40
55 0.00 10.00 10.00 4.40
60 0.00 5.00 5.00 -.60
65 0.00 0.00 0.00 -5.60
70 5.00 0.00 5.00 -.60
75 10.00 0.00 10.00 4.40
80 15.00 0.00 15.00 9.40
As you can see, the Straddle’s value increases the further the stock moves away from the strike. The closer the stock is to the strike, the lower the value of the Straddle at expiration. The chart clearly shows that the more the stock moves away from the strike, the higher the Straddle’s value becomes. Conversely, the closer the stock finishes to the strike, the lower the value of the Straddle. Owners of Straddles want and need movement while sellers of Straddles want and need stagnation.
How does this example influence your investment strategy? If you feel that a stock is likely to move aggressively in either direction or if you feel that implied volatility is likely to increase, possibly due to impending news (such as earnings, FDA approval, etc.), look into the purchase of a Straddle. If you feel a stock is likely to enter a stagnant phase, or if you feel that implied volatility is likely to decrease, the sale of a Straddle can be a very profitable trade for you.

Options Trading Mastery: Behavior of the Time Spread

admin — Sun, 10 Jan 2010 11:24:56 +0000

Time spreads can be a profitable investment strategy if you understand the concept of time decay. A time spread is designed to take advantage of the fact that an options decay curve is non-linear, that is, an option’s value does not decay evenly over time. As an option gets closer to expiration, its rate of decay increases meaning the option loses value more quickly. That decay rate increases progressively until expiration.
An option’s decay rate begins to accelerate when the option is about 45 days out. It picks up steam at 30 days out and really comes under decay pressure at about 15 days out. This scenario is similar to a boulder rolling down from a hilltop. As it starts, it rolls slowly, then gains more speed, and momentum the further it gets down the hill until it achieves its maximum speed at the bottom. Option decay acts the same way – gathering speed and momentum as the option approaches expiration.
In time spreads, both options have the same strike price that remains constant. Each option’s value decays at different rates and over different lengths of time. The option, with one month until expiration, experiences value decay at a faster rate than the one with three months until expiration.
If you buy an option with three months to go and sell an option with the same strike but with one month to go, you have set up a spread between the two options values (prices). As time passes, your short option loses value more quickly than your long option that decays more slowly. The value of the spread widens and you profit from that spread’s expansion. This is the fundamental behavior of the time-spread.
Consider that you are long the 60-30 day time spread. That means you are long the 60-day option and short the 30-day option. We will assign a price of $3.00 to the 60-day option and $2.00 to the 30-day option. Since you pay for the one and receive payment for the other, the bottom line cost of what you put out for the spread is $1.00.
During the same 30-day period, it goes from $3.00 to $2.00. Remember, the spread’s bottom line cost was $1.00. The 30-day option (now expired) will be worth $0 while the 60-day option (now a 30-day option) will be worth $2.00. If you had invested in this spread, after 30 days decay you would be holding one option worth $2.00. The investment has provided a nice return!
This is an ideal situation. The stock price and volatility remain constant and you capture the decay. The time spread has worked just as it should. It does work that way sometimes, but nothing works as it should all the time. As we know, stock prices and volatility levels do not remain constant. They are always changing. In the time spread strategy, the investor must choose opportunities carefully. In addition to picking a stock that will be in a stagnant period, the investor should look for two other situations where the spread has profit possibilities: changes in volatility and to a lesser degree stock price movements.

Learning to Trade Stock Options Could Enhance Your Ability to Make and Keep Money from the Markets

admin — Thu, 17 Dec 2009 00:09:47 +0000

Stock options trading can be dangerous business–very dangerous. Of course, folk get entangled with it because it can also be very , very rewarding. With options, you leverage underlying assets for a certain time period. You don’t have to buy the assets, just pay a premium up front in order to have control over them during the specified time. But , as with all investments, the more that you stand to potentially make, the more that you stand to possibly lose. So. You want to know what you’re doing for stock options to work for you. First, you have to have a strategic plan in mind up front. There are many stock options secrets that different financiers use. You need to study them and select those that you think are best suited to your risk toleration and your objectives. Never enter into a trade without knowing ahead why you are taking that approach and what you may do under certain circumstances, no matter how you’re feeling about them. In line with this, you have to select a good stock options broker. Find those online who are renowned for good reputations and good experience, and then compare their fee structures and what you get for your money. A good broker will be a good guide, but won’t try to tell you what to do. Another aspect of preparing your strategy is knowing the market. This means that you can understand the fundamental assets of the stock options you select. Follow online stock charts and economics reports concerning those assets so that you can make informed decisions and anticipate wisely, not shooting from your hip. And yet more preparation for the arena of stock options trading will entail good money management. You will keep your investment money budgeted and separated from the money that you require to live on and cannot risk. If you run out of that money, stop investing till you have reconstructed your bank account thru careful savings and even handed spending. However–don’t get out of a choice contract too shortly. You will take losses, especially when you’re getting your first experiences. You may expect to always take some losses, but the way to success is reasonably simply to make more than you lose over a period. Never give up too easily. At the same time, with stock options, you don’t want to hold it too long. Know when it’s time to sell a choice so that you can lessen your losses. But when it does come to your earning profits, don’t blow it by taking a heavy loss shortly after. That’s the worst experience in the world. Instead, understand how to use trailing stops. You must also be well informed in the easiest way to figure out a break-even point. Study both of these basic and obligatory stock options trading techniques before you dig into this world. But in the end, success in stocks options all boils down to ceaseless research. Again, know the market, know the stocks, know the corporations, know the basics, and know what methods to use when. And how can you be most guaranteed of keeping up with all this? Thru reading a high quality options newsletter. An options newsletter written by experienced, successful options trading professionals can be like gold itself to you. So, let your research start with finding such a service.