March 31, 2010
March 24, 2010
The Road Goes On Forever And The Party Never Ends
One of the effects of the seasonality of options (that I talk a lot about with my students) is that premium sellers see the most dramatic erosion of the time value of options they have sold during the last week of the options cycle. Most premium sellers strive to keep the options they have sold short (also known as options they have “written”) out of the money (OTM) in order that the entirety of the premium they have sold represents time (extrinsic) premium and is subject to this rapid time decay.
With 12 monthly cycles, there historically have been only 12 of these final weeks per year in which premium sellers have seen the maximum benefit of their core strategy. The recent advent and widespread use of weekly options has changed the playing field. Options with one week durations are available on SPX and OEX indices. For variety, they also come in flavors of a mini contract (SPX) and European style (OEX). These options have been in existence since October 2005 but only in the past 12 months have they gained widespread recognition and achieved sufficient trading volume to have good liquidity.
Standard trading strategies employed by premium sellers can be executed in these options. The advantage is to gain the “sweet spot” of the time decay of premium without having to wait through the entirety of the 4 to 5 week option cycle. The party never ends for premium sellers using these innovative vehicles.
Traders interested in using these weeklies MUST understand settlement procedures and be aware of last days for trading. An excellent discussion of details is provided on the CBOE website: http://www.cboe.com/micro/weeklys/introduction.aspx
March 15, 2010
March 2, 2010
Naked Puts on TGT STock
The Strategy
Let’s take a look at an option strategy that involves the selling of a put, often referred to as an uncovered put write or a naked put write. A naked put write is when a trader sells a put that is not part of a spread. This strategy is generally considered to be a bullish-to-neutral strategy.
The maximum profit is the premium received for the put. The maximum profit is achieved when the underlying stock is greater than or equal to the strike price of the sold put. Though this allows for a lot of room for error (The stock can be anywhere above the strike at expiration), note that the maximum loss is unlimited and occurs when the price of the underlying stock is less than the strike price of the sold put less the premium received. So, executing this trade in the right situation is essential. To calculate breakeven, subtract the premium received from the sold put’s strike price.
The Example
For our example we will use discount retailer Target (TGT). For this example we will assume the stock is trading around $50 a share. A trader sells the March 50 put, which carries a bid price of $1.00 (rounded to make the math a bit easier). Should TGT stock be trading above $50 a share at expiration, the March 50 contract will expire worthless and the trader will keep the premium collected. (Do not forget to take any commissions the trader may pay from the equation.) All is good, right? Well, what if the stock falls?
If TGT falls to, say, $45 at expiration, the put would expire in-the-money and would have to be purchased back to avoid assignment. This could cost the trader a rather hefty sum. Assigning values, our investor collected $1 in premium. The 45 put expired with $5 in intrinsic value. The trader loses the $5, less the $1 premium collected results in a loss of $4, or $400 of actual cash.
Why Sell Naked Puts?
We have already discussed the profit potential of selling naked puts, but there is another reason to do so – owning the stock. Selling naked puts is a good way to purchase at a specific price by choosing a strike near said target price. Should the stock price drop below the put strike and the puts are assigned, the trader buys the stock at the strike price minus the option premium received. Again, should the put not reach the strike price, the premium is pocketed at expiration.