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October 8, 2015

An Iron Condor

An iron condor is when a trader combines a bear call spread and a bull put spread. It is essentially combining two credit spreads as one trade. The trade is executed by buying a lower-strike out-of-the-money put and selling an out-of-the-money put with a higher strike. Then the trader sells an out-of-the-money call with a higher strike and buys another out-of-the-money call with an even higher strike. Learning to trade more advanced option strategies like an iron condor is not essential for option traders but it can give you more means in which to possibly extract money from the market.

A short iron condor consists of four legs as described above and results in a net credit received. As for profit potential, the maximum potential profit is the initial credit received upon entering the trade. This profit will occur if the underlying stock price, on expiration date, is between the two middle (short) strikes.

One of the rationales behind selling an iron condor is implied volatility (implied volatility is – simply defined – the volatility component of an option price). When IV is inflated (meaning the implied volatility has pushed the option price higher) it lifts the premium values for option sellers. In addition, the profitable range on the short iron condor can be rather large depending on how it is implemented. Certainly the larger the profitable range, the smaller the maximum profit and the greater the risk. The smaller the profitable range,  the larger the maximum profit will be and there will be less overall risk but there is less of a chance the underlying will remain in that range. Like many spreads in option trading, there is a trade-off.

One of the benefits of a short iron condor (and potentially options in general) is limited risk. For short condors, the maximum loss comes when the underlying stock price drops below the lowest strike (long put) or above the highest strike (long call). If you want an equation for max loss, think of it as the difference in strike prices of the two lower-strike options (or the two higher-strike options) less the initial credit for entering the trade.

Being that earnings season is just ahead of us, it is a major concern to implement iron condors over an earnings announcement due to its volatile nature. It may be best to construct the iron condor to expire before the actual announcement. If not, then it may be best to exit the trade before the announcement especially if the trade is profitable up to that point or just wait until the earnings have past. 

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

October 1, 2015

How Option Delta and Gamma Influence Each Other

Not sure if you have noticed, but the market has been very volatile lately. Stocks have been moving in sometimes dramatic fashion on a daily basis so it might be wise to review how option prices change when the underlying changes. The option “greeks” help explain how and why option prices move. Option delta and option gamma are especially important because they can determine how movements in the stock can affect an option’s price. Let’s take a brief look at how they can affect each other.

Delta and Gamma

Option delta measures how much the theoretical value of an option will change if the stock moves up or down by $1. For example, if a call option is priced at 3.50 and has an option delta of 0.60 and the stock moves higher by $1, the call option should increase in price to 4.10 (3.50 + 0.60). Long calls have positive deltas meaning that if the stock gains value so does the option value all constants being equal. Long puts have negative deltas meaning that if the stock gains value the options value will decrease all constants being equal.

Option gamma is the rate of change of an option’s delta relative to a change in the stock. In other words, option gamma can determine the degree of delta move. For example, if a call option has an option delta of 0.40 and an option gamma of 0.10 and the stock moves higher by $1, the new delta would be 0.50 (0.40 + 0.10).

Think of it this way. If your option position has a large option gamma, its delta can approach 1.00 quicker than with a smaller gamma. This means it will take a shorter amount of time for the position to move in line with the stock. Stock has a delta of 1.00. Of course there are drawbacks to this as well. Large option gammas can cause the position to lose value quickly as expiration nears because the option delta can approach zero rapidly which in turn can lower the option premium. Generally options with greater deltas are more expensive compared to options with lower deltas.


Option gamma is usually highest for near-term and at-the-money (ATM) strike prices and it usually declines if the strike price moves more in-the-money (ITM) or out-of-the-money (OTM). As the stock moves up or down, option gamma drops in value because option delta may be either approaching 1.00 or zero. Because option gamma is based on how option delta moves, it decreases as option delta approaches its limits of either 1.00 or zero.

An Example

Here is a theoretical example. Assume an option trader owns a 30 strike call when the stock is at $30 and the option has one day left until expiration. In this case the option delta should be close to if not at 0.50. If the stock rises the option will be ITM and if it falls it will be OTM. It really has a 50/50 chance of being ITM or OTM with one day left until expiration.

If the stock moves up to $31 with one day left until expiration and is now ITM, then the option delta might be closer to 0.95 because the option has a very good chance of expiring ITM with only one day left until expiration. This would have made the option gamma for the 30 strike call 0.45.

Option delta not only moves as the stock moves but also for different expirations. Instead of only one day left until expiration let’s pretend there are now 30 days until expiration. This will change the option gamma because there is more uncertainty with more time until expiration on whether the option will expire ITM versus the expiration with only one day left. If the stock rose to $31 with 30 days left until expiration, the option delta might rise to 0.60 meaning the option gamma was 0.10. As discussed before in this blog, sometimes market makers will look at the option delta as the odds of the option expiring in the money. In this case, the option with 30 days left until expiration has a little less of a chance of expiring ITM versus the option with only one day left until expiration because of more time and uncertainty; thus a lower option delta.

Closing Thoughts

Option delta and option gamma are critical for option traders to understand particularly how they can affect each other and the position. A couple of the key components to analyze are if the strike prices are ATM, ITM or OTM and how much time there is left until expiration. An option trader can think of option delta as the rate of speed for the position and option gamma as how quickly it gets there.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring Inc.

September 24, 2015

Do Your Equity Options Have Insurance?

If you have ever bought an option and watched the premium go south because of the underlying traded sideways or moved the wrong way, I bet you have thought what it would be like to be the seller of that option. Selling options can be a great way to generate income but it can also produce a large amount of risk as well. If the underlying moves against the position, a huge loss can be realized. A better way to generate income by selling premium might be to consider a spread instead.

Selling a credit spread involves selling an option while purchasing a higher or lower strike option (depending on bullish or bearish) with the same expiration and with the short option being more expensive than the long option. For example, selling a put credit spread involves selling a put and buying a lower strike put with the same expiration. Maximum profit would occur if the underlying is trading at or above the sold put strike at expiration; the spread would expire worthless. Selling a call spread involves selling a call and buying a higher strike call with the same expiration. Maximum profit would be realized if the stock is trading at or below the sold call strike at expiration; the spread would expire worthless.

The long options are there to protect the position from the potential losses associated with selling options. With a spread, the most the position can lose is the difference between the strikes minus the initial credit received. This would occur if the stock is trading above at or above the long call or at or below the long put. Using a call credit spread as an example, if a trader sold a 50 call and bought a 55 call, creating a credit of $1, the most the trader can lose is $4 (5 – 1) if the underlying closed at or above $55.

The Objective

The objective of a credit spread is to profit from the short options’ time decay while protecting gains with further out-of-the-money (OTM) long options. The goal is to buy back the spread for less than what it was sold for or not at all (meaning it expires worthless). Just like selling short stock, a trader wants to sell something that is expensive and buy it back for cheaper. The same holds true for credit spreads.

An Example

Here is a credit spread trade idea we recently looked at in Market Taker LIVE Advantage Group Coaching. When Amazon Inc. (AMZN) was trading around $545, an October 495/500 put spread could have been sold for 0.60 with about 25 days to go until expiration. This means the October 500 put strike was sold and the October 495 put strike was purchased for a credit of 0.60. The maximum profit in the spread was the credit received (0.60) and would be realized if AMZN was trading at or above $500 at October expiration. Remember that a profit would be realized if the spread could be bought back (closed out) for less than the credit of 0.60. The most that can be lost on the spread is 4.40 (5 – 0.60) and that would be realized if the stock was to close at or below $495 at expiration.

What’s the Point?

The risk/reward ratio of this credit spread begs the question why would anyone want to risk maybe eight times or more on what they stand to make in the example above? The simple answer is probability. Given the ability to repeat the trade over and over again with different outcomes, the trader will make $60 many, many more times than he or she will take the $440 loss. This was a hypothetical situation, but let’s say that the strategies winning percentage was close to 85% like in the example above. The trader needs to look at prior historical price action of the stock to determine probability of success.


How does this seem similar to insurance you ask? The credit spread strategy is similar to the insurance business because insurance companies get to keep premiums if people don’t get sick or if people don’t have accidents, etc. Traders turn themselves into something like an insurance company when they implement credit spreads and keep premium as long as something doesn’t go drastically wrong.

Just like an insurance company has to decide if the risk is worth the potential reward, option traders that trade vertical credit spreads have to analyze how much can they collect, how much can they lose and the probability of having a profitable trade. In a future blog, we’ll discuss how a trader can use options implied volatility to help put probability on his or her side.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 17, 2015

Chicago Cubs and Exiting Your Positions

Can you believe it? The Chicago Cubs look like they will make the playoffs and have a legitimate chance of winning it all! As a life-long Chicagoan, that does not happen very often. Unfortunately, the Cubs have exited the playoffs way to soon over the past 100 years.

The World Series playoffs are about to begin and it is the most exciting time of the year if you are a fan of baseball. But did you ever stop and think for a minute how these fantastic athletes got to be where they are? It took a lot of dedication, courage and a well thought out plan to make it to their elite level. If that sounds familiar it should because those same attributes are what it takes to learn to trade and become a successful options trader.

Need a Plan

You might be dedicated and have the courage to be an options trader, but do you have a trading plan that you follow? I talk to a lot of option traders and sadly it is true. Option traders spend a lot of time looking for solid trades that they often neglect probably the most important part: the management of the trade. If that is you take a little solace because you are not alone.

A simple way to combat this problem is by having a plan in place before even entering the trade. This is the psychological part of trading. Having a plan in place will remove emotions from getting in the way of decision making and possibly producing unwanted results. Should I stay in the trade or should I exit? Decisions like that should not be made after the trade is executed because many option traders can become too emotional when the trade is in progress especially when they are losing money on the trade. Here are a few things to consider about trade management.

Plan Should Include Determining Exits

It is not a good thing for the Cubs to exit the playoffs too soon but it might be a good idea if you exit your option position too soon. Option traders should think about how they are determining their exits for profit and loss. Don’t forget to consider how the greeks and the implied volatility may be affected if the outlook or environment changes. In a volatile market like this, an options trader may need to make some adjustments especially about taking early profits or exiting for a loss.

I generally determine my exits two ways; a certain percentage or based on the chart. When using a certain percentage, I determine how much percentage-wise I am winning to risk on the trade and what percentage I am looking to take profits. When using the chart, I determine at what levels I will exit my position for a loss if that area is violated and I always look to take some profit off if the stock comes into an area I deem a target area (maybe a support or resistance level).

Option traders should also think about how they will exit if their targets are not met. How will the exit or stop be determined? Once again, don’t forget to use the greeks and implied volatility in your methods because it could make the difference between profiting or losing.


All trading including option trading can be very difficult at times just like training to be a professional athlete and appear in the World Series. Not having plan in place can make it exponentially more difficult and determining exits is just one part of that plan. It helps to have courage and be dedicated to reaching your goals but a solid trading plan can go a long way towards potential success. Athletes that train without a plan are similar to option traders letting their emotions make decisions for them. Once there is well thought out plan in place and most importantly the plan is followed, an option trader removes unwanted emotions which can hinder his or her chances of being successful. Go Cubs!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 10, 2015

Option Delta Multiplied

As an option trader, there are quite a few areas to learn and master before being able to extract money from the market on a regular basis. Learning what the option greeks mean and how they function alone and in relation to the other greeks is very important as an option trader. Here we will take a look at one of the greeks and consider what many option traders often fail to consider.

Option Delta

Delta is probably the first greek an option trader learns and is focused on. In fact it can be a critical starting point when learning to trade options. Simply said, delta measures how much the theoretical value of an option will change if the stock moves up or down by $1. A positive delta means the position will rise in value if the stock rises and drop in value of the stock declines. A negative delta means the opposite. The value of the position will rise if the stock declines and drop in value if the stock rises in price. Some traders use delta as an estimate of the likelihood of an option expiring in-the-money (ITM). Though this is common practice, it is not a mathematically accurate representation.

The delta of a single call can range anywhere from 0 to 1.00 and the delta of a single put can range from 0 to -1.00. Generally at-the-money (ATM) options have a delta close to 0.50 for a long call and -0.50 for a long put. If a long call has a delta of 0.50 and the underlying stock moves higher by a dollar, the option premium should increase by $0.50. As you might have derived, long calls have a positive delta and long puts have a negative delta. Just the opposite is true with short options—a short call has a negative delta and a short put has a positive delta. The closer the option’s delta is to 1.00 or -1.00 the more it responds closer to the movement of the stock. Stock has a delta of 1.00 for a long position and -1.00 for a short position.

Taking the above paragraph into context, one may be able to derive that the delta of an option depends a great deal on the price of the stock relative to the strike price of the option. All other factors being held constant, when the stock price changes, the delta changes too.

AAPL Example

What many traders fail to understand is that delta is cumulative. A trader can add, subtract and multiply deltas to calculate the delta of the overall position including stock. The overall position delta is a great way to determine the risk/reward of the position. Let’s take a look at a couple of examples.

Let’s say a trader has a bullish outlook on Apple (AAPL) when the stock is trading at $111 and purchases 3 October 110 call options. Each call contract has a delta of +0.55. The total delta of the position would then be +1.65 (3 X 0.55) and not just 0.55. For every dollar AAPL rises all factors being held constant again, the position should profit $165 (100 X 1 X 1.65). If AAPL falls $2, the position should lose around $330 (100 X -2 X 1.65) based on the delta alone.

Using AAPL once again as the example, lets say a trader decides to purchase a October 110/115 bull call spread instead of the long calls. The delta of the long $110 call is once again 0.55 and the delta of the short $115 call is -0.40. The overall delta of the position is 0.15 (0.55 – 0.40). If AAPL moves higher by $3, the position will now gain $45 (100 X 3 X 0.15) with all factors being held constant again. If AAPL falls a dollar, the position will suffer a $15 (100 X -1 X 0.15) loss based on the delta alone.

Last Thought

Calculating the position delta is critical for understanding the potential risk/reward of a trader’s position and also of his or her total portfolio as well. If a trader’s portfolio delta is large (positive or negative), then the overall market performance will have a strong impact on the traders profit or loss.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 3, 2015

Option Collars are Still in Fashion

Fashion comes and goes but there are some items that never go out of style. They simply are classics. The same could be said of some option strategies which never go out of style. Although the market has dropped lately and maybe your investments have gone down in value, it may still make sense to consider a collar.

A collar strategy is an option strategy that can particularly benefit investors. In this blog we generally have a lot more options education for traders and less for long-term investors. So a collar is a strategy that both can consider. A collar is simply holding shares of stock and buying a put and selling a call. Usually both the call and the put are out-of-the money (OTM) when establishing this option combination. A basic single collar represents one long put and one short call along with 100 shares of the underlying stock. A collar strategy is frequently implemented after stock (investment) has increased in price. The main objective of a collar is to protect profits that have accrued from the shares of stock rather than increasing returns. Is that an option strategy you might consider? Let’s take a look.

Why a Collar?

Since the market has been declined after trading relatively sideways for several months, there are a plethora of stocks that have decreased in value but are still profitable on the P/L ledger. But what if the market and your investments continue to decline? One option strategy is to buy a put. The investor has some protection for the unrealized profits in case the stock declines. The other part of the combination is selling the OTM call. By doing this, the investor is prepared to sell his or her shares of stock if the call is exercised because the stock has moved above the call’s strike price.


The advantage of a collar strategy over just buying a protective put is being able to pay for some or the entire put by selling the call. In essence, an investor buys downside stock protection for free or almost free of charge. Until the investor exercises the put, sells the stock or has the call assigned, he or she will retain the stock.

Volatility and Time Decay

Implied volatility (IV) has been really high over the last several weeks in the market with this recent decline. Although it is advantageous to sell options when implied volatility is high (selling the OTM call), volatility and also time decay are not usually big issues when it comes to a collar strategy. The simple explanation is because the investor is long one option and short another so the effects of volatility and time decay will generally offset each other.

An example:

An investor could have bought 100 shares of Delta Air Lines (DAL) in October of last year for about $32 a share. Like many equities, the stock declined but at the time of this writing, the stock has climbed back to about $46 a share and the investor is still worried about the current market conditions and protecting his unrealized gains. The investor can utilize a collar strategy.

The investor can buy an October 42 put for 1.20. If the stock falls, the investor will have the right to sell the shares for $42 up until October expiration. At the same time the investor can sell an October 48 call for 1.45. The $48 area has provided some resistance in the past for the stock. This will make the trade a net credit of 0.25 (1.45 – 1.20). If the stock continues to rise, it can do so for another $2 until the stock will most likely be called away from him.

Three Possible Outcomes

The stock finishes over $48 at October expiration. If this scenario happens, another $2 per share is realized on the stock and $25 on the net credit of the combination is the investors to keep.

The stock finishes between $42 and $48 at October expiration. In this case, both options expire worthless. The stock is retained and the $25 net credit is the investors to keep.

The stock finishes below $42 at October expiration. The investor can sell the put option if he wishes to retain the stock or exercise the right to sell the stock at $42. Either way the $25 net credit is the investors to keep.


The nice thing about a collar strategy is that an investor knows the potential losses and gains right from the start. If the stock climbs higher, the profits may be curbed due to the short call but if the stock takes a dive, the investor has some protection due to the long put and having protection might not be such a bad idea if the market continues to be weak. See…even an investor can benefit from some options education!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

August 27, 2015

A Directional Option Spread

With the huge selloff in the market last week, it might take some time for stocks to get back to levels they had been trading at just a few sessions ago. In fact, they might not ever make it back to those levels truth be told. Wouldn’t it be nice if there was an option strategy with low risk and a high reward that rewards a big move close to a certain time frame?

For the most part,  option traders use butterfly spreads for a neutral outlook on the underlying. The position is structured to profit from time decay but with the added benefit of a “margin of error” around the position depending on what strike prices are chosen. Butterflies can be great market-neutral trades. However, what some traders don’t realize is that butterflies can also be great for trading directionally.

A Butterfly

The long butterfly spread involves selling two options at one strike and the purchasing options above and below equidistant from the sold strikes. This is usually implemented with all calls or all puts. The long options are referred to as the wings and the short options are the body; thus called a butterfly.

The trader’s objective for trading the long butterfly is for the stock to be trading at the body (short strikes) at expiration. The goal of the trade is to benefit from time decay as the stock moves closer to the short options strike price at expiration. The short options expire worthless or have lost significant value; and the lower strike call on a long call butterfly or higher strike put for a long put butterfly have intrinsic value. Maximum loss (cost of the spread) is achieved if the stock is trading at or below the lower (long) option strike or at or above the upper (long) option strike.

Directional Butterfly

What may not be obvious to novice traders is that butterfly spreads can be used directionally by moving the body (short options) of the butterfly out-of-the-money (OTM) and maybe using slightly wider strike prices for the wings (long options). This lets the trader make a directional forecast on the stock with a fairly large profit zone depending on the width of the wings.

To implement a directional butterfly, a trader needs to include both price and time in his outlook for the stock. This can be the most difficult part for either a neutral or directional butterfly; picking the time the stock will be trading in the profit zone. Sometimes the stock will reach the area too soon and sometimes not until after expiration. If the trader picks narrow wings (tighter strikes), he can lower the cost of the spread. If the trader desires a bigger profit zone (larger strikes), he can expand the wings of the spread and the breakevens but that also increases the cost of the trade. It’s a trade-off.

Recent Example

Amazon Inc. (AMZN) was trading in the $540 area less than two weeks ago. At the time of this writing, the stock was hovering just below $490. What if you believed the stock would make it back somewhere close to that area by September expiration? A trader could buy a September 530/540/550 (long the 530 – short 2 540 – long the 550) call butterfly for around 0.60. That is the most that can be lost is what was paid. Maximum profit would be earned if the stock closed right at $540 at expiration. The profit would be $9.40 (10 – 0.60) which is derived from the difference between the bought and sold strikes minus the cost of the spread. That is over 1 to 15 risk/reward ratio.

The breakevens on the butterfly are fairly sizable. The spread will profit anywhere between $530.60 and $549.40 at expiration. This was derived from adding the cost of the butterfly to the lowest strike (530 + 0.60) and subtracting the cost from the highest strike (550 – 0.60). In other words, if the trader is not spot on with the $540 prediction, the trade can still profit with some wiggle room.

Final Thoughts

One of the biggest advantages of a directional butterfly spread is that it can be a relatively low risk and high reward strategy depending on how the spread is designed. Maybe one of the biggest disadvantages of a directional butterfly spread is that its maximum profit potential is reached close to expiration. But being patient can be very good for a trader…most of the time!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

August 20, 2015

Choosing Between Different Risk/Reward Scenarios

As an option trader, you have so many different strategies and risk/reward scenarios to think about before initializing a trade. Many of my students in my Group Coaching class as well as my one-on-one students ask me all the time how do you decide between buying a debit spread and selling a credit spread as one example. Let’s take a look at a scenario below and some things for an option trader to think about.

Risk and Reward

A debit spread such as a bull call spread or a bear put spread is considered to have a better risk/reward ratio then a credit spread such as a bull put spread or a bear call spread depending on how it is initiated. Usually the reason is because the debit spread is implemented close to where the stock is currently trading with an expected move higher or lower. A credit spread is usually initiated out-of-the-money (OTM) in anticipation the spread will expire worthless or close to worthless with the underlying barely moving. Here is a recent example I talked about with a student less than a week ago. LinkedIn Corp (LNKD) was trading around $187.50 last week. The stock looked like it could drop lower. The trader could consider buying a bear put or selling a bear call spread.

If the option trader expected a move lower into the close of Friday, he or she could have considered buying a 185/187.5 debit spread for August expiration (4 days). If the 187.5 put cost the trader 2.25 and 1.15 was received for selling the 185 put, the bear put (debit) spread would cost the trader $1.10 (also the maximum loss if the stock is at $187.50 or higher at expiration) and have a maximum profit of $1.40 (2.50 (strike difference) – 1.10 (cost)) if the stock was trading at or below $185 at expiration. Thus the risk/reward ratio would be 1/1.27.

If the option trader was unsure if the $187.50 stock was going to move lower but felt the stock would at least stay below a resistance area around $190 by August expiration, the trader could sell a 190/192.5 credit spread with August expiration. If a credit of 1.00 was received for selling the 190 call and it cost the trader 0.50 to buy the 192.5, a net credit would be received of $0.50 for selling the bear call (credit) spread. The maximum gain for the spread is $0.50 if the stock is trading at $190 or lower at expiration and the maximum loss is $2 (2.50 (strike difference) – 0.50 (premium received)) if the stock is trading at or above $192.50 at expiration. Thus the risk reward ratio would be 4/1.


The risk/reward ratio on the credit spread (4/1) does not sound like something an option trader would strive for does it? Think of it this way though, the probability of the credit spread profiting are substantially better than the debit spread. The debit spread most certainly needs the stock to move lower at some point to profit. If the stock stays around $187.50 or moves higher, the puts will expire worthless and a loss is incurred from the initial debit ($1.10). With the credit spread, the stock can effectively do three things and it would still be able to profit. The stock can move below $187.50, trade sideways and even rise to just below breakeven at $190.50 (190 (sold call) + 0.50 (initial credit)) at expiration and the credit spread would profit. Of course if it closes at $190 or lower, the maximum profit of $0.50 is achieved because the spread expires worthless. A loss is only realized if the stock closes above the breakeven level of $190.50. I like to say OTM credit spreads have three out of four ways of making money and debit spreads usually have one way of profiting especially if the underlying is basically around the long option when the spread is initialized.


There are several more factors to consider when choosing between a debit spread and a credit spread like time until expiration, implied volatility and bid/ask spreads just to mention a few. We will talk about these other factors in future blogs. The risk/reward of the spread and the probability of the trade profiting are just a few to consider mentioned above. A trader always wants to put the odds on his or her side to increase the chances of extracting money from the market. The credit spread can put the odds substantially on the trader’s side but it comes at a cost of a higher risk/reward ratio.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

August 13, 2015

Have Your Stocks Taken a Hit?

It has been a tough couple of weeks for bullish traders and investors as several events have moved the market and stocks lower. Some stock buyers are waiting for some of their losers to rally and some are buying more stock at cheaper prices. But as most experienced investors know, the market can always go lower now or in the future. Here is one option strategy that can make sense in some cases; the stock repair strategy.

Introduction to the Stock Repair Strategy

The stock repair strategy is a strategy involving only calls that can be implemented when an investor thinks a stock will retrace part of a recent drop in share price within a short period of time (usually two to three months).

The stock repair strategy works best after a decline of 20 to 25 percent of the value of an asset. The goal is to “double up” on potential upside gains with little or no cost if the security retraces about half of its loss by the option’s expiration.


There are three benefits the stock repair strategy trader hopes to gain. First, little or no additional downside risk is acquired. This is not to say the trader can’t lose money. The original shares are still held. So if the stock continues lower, the trader will increase his loses. This strategy is only practical when traders feel the stock has “bottomed out”.

Second, the projected retracement is around 50 percent of the decline in stock price. A small gain may be marginally helpful. A large increase will help but have limited effect.

Third, the investor is willing to forego further upside appreciation over and above original investment. The goal here is to get back to even and be done with the trade.

Implementing the Stock Repair Strategy

Once a stock in an investor’s portfolio has lost 20 to 25 percent of the original purchase price, and the trader is anticipating a 50 percent retracement, the investor will buy one close-to-the-money call and sells two out-of-the-money calls whose strike price corresponds to the projected price point of the retracement. Both option series are in the same expiration month, which corresponds to the projected time horizon of the expected rally. The “one-by-two” call spread is ideally established “cash-neutral” meaning no debit or credit. (This is not always possible. More on this later). To better understand this strategy, let’s look at an example.


An investor, buys 100 shares of XYZ stock at $80 a share. After a month of falling prices, XYZ trades down to $60 a share. The investor believes the stock will rebound, but not all the way back to his original purchase price of $80. He thinks there is a reasonable chance for the stock to retrace half of its loss (to about $70 a share) over the next three months.

The trader wants to make back his entire loss of $20. Furthermore, he wants to do it without increasing his downside risk by any more than the risk he already has (with the 100 shares already owned). The trader looks at the options with an expiration corresponding to his two-month outlook, in this case the September options.

The trader buys 1 November 60 call at 6 and sells 2 November 70 calls at 3. The spread is established cash-neutral.

Bought 1 Nov 60 call at 6
Sold 2 Nov 70 call at 3 (x2)

By combining these options with the 100 shares already owned, the trader creates a new position that gives double exposure between $60 and $70 to capture gains faster if his forecast is right. The P&L diagram below shows how the position functions if held until expiration.

If the stock rises to $70 a share, the trader makes $20, which happens to be what he lost when the stock fell from $80 to $60. The trader would be able to regain the entire loss in a retracement of just half of the decline. With the stock above 60 at expiration, the 60-strike call could be exercised to become a long-stock position of 100 shares. That means, the trader would be long 200 shares when the stock is between $60 and $70 at expiration. Above $70, however, the two short 70-strike calls would be assigned, resulting in the 200 shares owned being sold at $70. Therefore, further upside gains are forfeited above and beyond $20.

But what if the trader is wrong? Instead of rising, say the stock continues lower and is trading below $60 a share at expiration. In this event, all the options in the spread expire and the trader is left with the original 100 shares. The further the stock declines, the more the trader can lose. But the option trade won’t contribute to additional losses. Only the original shares are at risk.

Benefits and Limitations of the Stock Repair Strategy

The stock repair strategy is an option strategy that is very specific in what it can (and can’t) accomplish. The investor considering this option strategy must be expecting a partial retracement and be willing to endure more losses if the underlying security continues to decline. Furthermore, the investor must accept limiting profit potential above the short strike if the stock moves higher than expected.

Some stocks that have experienced recent declines may be excellent candidates for the stock repair. For others, the stock repair strategy might not be appropriate. For stocks that look like they are finished or may even head lower, the Stock Repair Strategy can’t help – just take your lumps! But for those that might slowly climb back, just partially, this can be a powerful option strategy to recoup all or some of the losses.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

August 6, 2015

ITM Put Options

There is always potential for the market or individual stocks to move lower. In fact many traders never even think about bearish strategies because they are always looking for bullish options. Option traders know that stocks and markets do not always go up, but many will wait until they think the decline is over to once again look for a bullish strategy instead of taking advantage of bearish opportunity at hand. Understanding put options is a must for option traders but I am often asked how to choose strike prices. There are several different options to consider and here are a few things to consider specifically based on an expected small move in the underlying. But first let us take break down the anatomy of a put option.

A buyer of a put option has the right, but not the obligation to sell shares of underlying stock at a certain price on or before an expiration day. The price at which the buyer can sell the shares is called the strike price. There are many strike prices and expirations to choose from which can be overwhelming for a trader. When expecting a stock to make a small move especially if the stock is lower in price, it may be advantageous for the trader to select an in-the-money (ITM) put option. An ITM put option is a put with a strike price that is higher than the stock’s current price. Before going further, here’s a look at a possible scenario where buying an ITM put might be warranted.

An ITM put option can be used to capture a relatively small move lower. Suppose an option trader is watching a $10 stock in a downtrend. The stock then rallies higher and now he thinks it is a good time to enter a bearish position with a put option. He surmises the stock might be able to drop about $0.50.

A critical point about capturing this potential $0.50 move down revolves around option delta. Option delta is the rate of change in the option’s value relative to the change in the stock price. Puts have a negative option delta because if the stock rises, puts will lose some of their value. Since puts give the owner the right to sell stock, puts gain value as the stock falls. In this example, the trader is expecting only a $0.50 move lower. Buying an ITM put that has a higher option delta will profit more than a put with a smaller option delta if the anticipated move comes to fruition.

With the stock trading just under $10, the option trader looks at the 10 and 12 strike puts. The 10 strike puts have an option delta of about -0.55 and the 12 strike puts have an option delta of about -0.90. This means that for every $1.00 the stock moves down, the 10 strike put’s premium should increase by $0.55 and the 12 strike put’s premium should increase by $0.90 all other factors held constant. The reverse is also true. If the stock moves higher by $1.00, each put would lose value in the amount of their deltas. Since the expected move is only $0.50, half the deltas would be gained or loss depending on the direction of the stock.

Final Thoughts…

Buying an ITM put option is not always the best way to capture a stock’s move lower, but when it comes to profiting on a perceived small move, an option trader should consider a put option position with a higher option delta and do so with the satisfaction of knowing their loss potential is limited to the cost of the put option.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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