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August 30, 2012

Buying Call Options Rather Than Stock for AAPL

You have your eye on a stock, a very high-valued stock like Apple (NASDAQ: AAPL ). You believe that this stock, despite its high price, continues to have tremendous upside potential and could easily make it to $700 soon. The problem is that you don’t want to shell out $675 for one share of the technology giant. What can you do to maximize your money and cash in on the perceived upside? Easy, buy a call option rather than the stock.

Quick Definition

For the uninitiated, a call option is a bullish strategy wherein a trader purchases the right (but not the obligation) to purchase a stock at a specified price within a specific time period. One advantage to buying a call option rather than purchasing a stock is that you can gain a much larger percentage return on your investment. To learn more advantages, please check out the Options Education section on our website.

The Example

If you want to purchase 100 shares of AAPL stock at $675 it is going to cost you (100 X $675) $67,500. However, let’s say that you decide to purchase 1 call option on AAPL (each option represents 100 shares) with a strike price of, say, 675 with a October expiration, which carries a price tag of $27. Rather than dishing out $67,500 for 100 AAPL stock shares, you instead pay $2,700 for the options – a rather nice difference of $64,800 that you can use for something else or to purchase other options.

The Money

The cost efficiency of purchasing call options can be far greater than simply purchasing shares of a stock, especially when you are dealing with high-priced stocks like AAPL. Remember that one option contract is the right to purchase 100 shares of a stock at that price. So, rather than purchasing 100 AAPL shares at $675 at the massive cost of $67,500; you have dished out a more reasonable $2,700 for the transaction. Of course this is the scenario if you want to be simply bullish on AAPL stock.

Conclusion

As you can see, it is possible to lay out far less money to purchase call options on a stock that to by the call itself. In fact, the earlier the expiration you choose, the lower the price you could pay. No matter what math you use, paying $2,700 is far better than paying $67,500 for the same product. What if you want to sell these options to someone who is willing to pay a higher ask price than you paid? That is another subject for another time. Remember, there is no fool-proof way to make money in the market – there is risk involved in any trading strategy. One way to make sure you maximize your cash is to make sure you study your subject, remember that knowledge is power.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

August 23, 2012

Fractal Position Management

Option traders manage risk. Want a job description? That’s about it. Every trade has a risk and reward associated with it and traders must realize that especially when first learning how to trade. But because options are instruments of leverage, it is very easy to let risk get out of control, if you’re not careful. Traders must manage risk carefully, instituting tight reins their options, spreads and portfolio. The management technique of each is essentially the same because position management is fractal.

Something that is fractal has a recurring pattern that has continuity within its scale. For example, a tree is fractal. A tree has a trunk with limbs extending from it; limbs with smaller branches extending from it; smaller branches with yet smaller branches; and leaves with veins that branch off within each leaf. The pattern is repetitive within each iteratively smaller extension of the last. This is found in option position management too.

Individual options have risk that must be managed. They have direction, time and volatility risk which are managed by setting thresholds for each of the corresponding greeks which measure them. When individual options are a part of a spread, the resulting spread has these same risks of direction time and volatility. The spread’s risk must consequently be managed likewise. A trader’s complete option portfolio, which may be comprised of many spreads has systematic risk in accordance to the market. These risks are the same as for individual options or individual spreads: direction, time and volatility. Traders should treat their all encompassing portfolio as a single, macro spread and use the portfolio greeks to set parameters to minimize the total risk of the portfolio.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

August 2, 2012

Option Delta and Apple (AAPL)

Filed under: Uncategorized — Tags: , , , , , — Dan Passarelli @ 11:56 am

Option Delta and Apple ( AAPL )

Apple (NASDAQ: AAPL) sure is making a lot of news lately. The company recently reported earnings and subsequently fell in price. Since the fall, the stock has once again moved higher. One may expect the AAPL stock to push higher (after this dip), but some may believe the rebound will be still short-lived. Perhaps a smart move is to purchase a short-term, out-of-the-money option on the equity – let’s look for an option with a delta greater than 20 on Apple and see how the option could play out.

Option Delta and the Trade

First, let’s define option delta before we go into the option play. Option delta is a ratio that compares a stock’s change in price to the corresponding price change in said stock’s option. For this example, we are going to use the Apple September 650 call that has about an option delta of 23 percent.

What does the 23 percent mean? Let’s convert the option delta into dollars to see. This percentage means that this particular Apple option will gain or lose value just like 23 percent of 100 shares of Apple as the price changes. Look at the definition this way if it is easier, for every $1 Apple advances; the call option will increase 23 cents attributable to delta. So, Apple is currently trading at around $605 (rounded for simplicity) and we have purchased the 650 call. We need the call to advance past $650 in order (which is not out of the question) for the option to be in-the-money, but can we benefit from a rally that falls short of $650?

The Benefit of Option Delta

Apple is a major momentum stock, just look at what happens after good news – more often than not the stock rallies. In fact, I don’t think it is a stretch to say that the stock often moves quite a bit. Look at 2009 when Apple dropped as low as the $78 region in late January then rallied to finish the year above $210. That is a major gain.

Playing the September 650 call affords a trader the chance to make money in the case that the stock rallies. If the stock hits $650, that means it has moved 45 points. Take the 45 points and multiply that by 23 cents (option delta of .23) and you have a move of $10.35 in the call (45 X 0.23).

Conclusion

By looking at the option delta, we were able to have clear expectations for option profit based on stock movement. Does this mean that playing the delta is a fool-proof to analyze an option? No. There are other important pricing factors that affect the value of an option, too. Time (theta), volatility (vega) and more also play an important role. Delta is just one of the greeks that can be taken into account when looking for the right option to purchase. Make sure to do your homework so you can enter the option game prepared to succeed.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring