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March 28, 2013

Buying Calls Instead of Apple Stock

You have been watching Apple (NASDAQ: AAPL ) and you believe this downtrend for the stock is about to end. You believe that this stock, despite its high price, now has potential and could easily make it back to $500 soon. The problem is that you don’t want to shell out $450 for one share of the technology giant. What can you do to maximize your money and cash in on A potential move to the upside? Simple, buy a call option rather than the stock.

Quick Definition

A call option is a bullish strategy where 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 $450 it is going to cost you (100 X $450) $45,000. 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, 450 with a May expiration, which carries a price tag of $22. Rather than shelling out $45,000 for 100 AAPL stock shares, you instead pay $2,200 for the options – a pretty sunstantial difference of $42,800 that you can use for something else or to purchase other options.

The Money

The cost savings 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 $450 at the massive cost of $45,000; you have dished out a more reasonable $2,200 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 spend 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 $2,200 is far better than paying $45,000 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 is used correctly.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

March 21, 2013

Implied Volatility Discrepancies

Filed under: Uncategorized — Dan Passarelli @ 11:01 am

It is often a daunting task deciphering the tremendous amount of options information contained within an option chain for the trader beginning his study of the world of options. One of the most nuanced variables embedded within the prices quoted for the chains is that of the relative values of implied volatility (IV) amongst the various strike prices and the various months of expiration.

The IV of each of the various available options for a given underlying is not usually constant for each individual strike price and expiration cycle. The IV can and often does vary between individual strike prices within the same cycle; this variation is termed vertical skew. In addition, IV often varies at the same exact strike price when considered between various expiration cycles; this variation is termed a horizontal skew.

To review briefly, remember that option prices depend largely on the three variables: time to expiration, price of the underlying, and IV. The only one of these factors not immediately accessible to anyone with a quote screen and a calendar is IV.

It is by changes in the magnitude of IV that future events of potential major import to the price of the underlying are expressed.

As an example of the information that can be gained by considering skewed values for IV is the stock AFFY. This biopharmaceutical stock is represented in upcoming expiration cycles of: April, May, July, October, January 2014 and January 2015. Considering the example of the 3 strike call, the IV for these various months at the time of this writing are: 222, 189, 171,131, 137 and 110 respectively.

The company just announced a significant reduction of their workforce due to an ongoing investigation surrounding one of their product. The options markets are pricing a substantial probability of a significant price move earlier than later. These types of IV spikes are typically seen in biotech stocks ahead of significant FDA decisions or product investigations like in this instance.

The bottom line for an option traders is to make sure they know how the IV might influence their decision making and understanding why there are discrepancies in the first place.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

November 8, 2012

Thoughts on AAPL Risk

Hurricane Sandy and the recent decline in Apple Inc. (AAPL) stock is a reminder of how “black swan” events can impact our lives in unforeseen and unforeseeable ways. Yogi Berra summed it up succinctly in his aphorism that “the future isn’t what it used to be.” It never is.

One helpful organizational concept of financial risk is to consider that risk comes in two categories. The usual type of risk is analyzed by the bell shaped curve of a Gaussian (log normal) distribution that most traders are familiar with. The other general category of risk is characterized by the unforeseen events that result in major alterations of the financial landscape. It is this category of risk to which Nassim Taleb has drawn attention in his books regarding the lack of predictability of consequential rare events.

How does this impact the world of the trader and the usefulness of options? The fact is that all funds invested in the market are totally at risk at all times and the comfort that stop losses may give can give a trader can be a false sense of security. From this concept, the ability to control stock with far less invested capital becomes inescapably attractive.

Such is one core function of options; control of stock with commitment of far less capital than outright purchase. To take a straightforward example, shares of AAPL which has taken center-stage on many traders and investors radars, currently trades around $560 after a major decline. The stock may now look attractive to buyers after its fall from around $700. To control 100 shares by outright stock purchase would require $56,000. A substantially delta equivalent position using deep in-the-money calls, the December 400 strike, could be purchased for approximately $16,200. As is characteristic of a deep in-the-money option, there is very little eroding time premium for which the trader is paying. In this example, there is substantially less risk buying the call option than purchasing the stock outright.

Should Armageddon arrive unannounced again and it might, which position is better: the total loss of the value of the stock position or the vaporization of the money paid for the option?

John Kmiecik

Senior Options Instructor

Market Taker Mentoring Inc.

October 25, 2012

Learn to Adjust Options Positions

Dan’s online Options Education series this month has all been all about helping traders learn to adjust options positions. Adjusting option positions is an essential skill for options traders. Adjusting options positions helps traders repair strategies that have gone wrong (or are beginning to go wrong) and often turn losers into winners. Given that, it’s easy to see why it’s important to learn to adjust options positions.

Adjusting 101

Adjusting options positions is a technique in which a trader simply alters an existing options position to create a fundamentally different position. Traders are motivated to adjust options positions when the market physiology changes and the original trade no longer reflects the trader’s thesis. There is one golden rule of trading: ALWAYS make sure your position reflects your outlook.

This seems like a very obvious rule. And at the onset of any trade, it is. If I’m bullish, I’m going to take a positive delta position. If I think a stock will be range-bound, I’d take a close-to-zero delta trade that has positive theta to profit from sideways movement as time passes. But the problem is gamma. Gamma is the fly in the ointment of option trading.

Gamma

Gamma—particularly negative gamma—is the cause of the need for adjusting.

Gamma definition: Gamma is the rate of change of an option’s (or option position’s) delta relative to a change in the underling.

Oh, yeah. And, just in case you forgot…

Delta definition: Delta is the rate of change on an option’s (or option position’s) price relative to a change in the underlying.

In the case of negative gamma, trader’s deltas always change the wrong way. When the underlying moves higher, the trader gets shorter delta (and loses money at an increasing rate). When the underlying moves lower, negative gamma makes deltas longer (again, causing the trader to lose money at an increasing rate).

Wrap Up

Therefore, traders must learn to adjust options positions, especially income trades, in order to stave off adverse deltas created by the negative gamma that accompanies income trades.

To find out more about next month’s topic and have access to the archived previous seminars including “Option Trade Adjustments” please visit Options Education.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 20, 2012

Bull Call Spread vs. Purchasing a Call on AAPL

Bull Call Spread vs. Purchasing a Call

Let’s say that you have a moderately bullish bias toward a stock and the overall market is slightly bullish. Is there a way that you can take advantage of this investing scenario while limiting risk? Certainly, there are a few. One that is often superior to the rest is the bull call spread. To learn to trade more option strategies, please visit our website.

Definition

When executing a bull call, you purchase call options at one strike and sell the same number of calls on the same company at a higher strike with the same expiration date. Let’s use Apple Inc. (AAPL) which is currently trading around $700 as an example. In this case you would purchase October calls at the 700 at-the-money strike at the ask price of $20. You would then sell the same number of October calls with a higher strike price, in this case 720 at the bid, $11.

The Math

Your maximum profit in the bull call spread is limited, you can make as much as the difference between the strike prices less the net debit paid. For simplicity, let’s assume that you purchased one October 700 call and sold one October 720 call resulting in a net debit of $9 (that’s $20 – $11). The difference in the strike prices is $20 (720 – 700). You, therefore, subtract 9 from 20 to end up with a maximum profit of $11 per contract. So, if you traded 10 contracts, you could make $11,000.

Although you limited your upside, you also limited the downside to the net debit of $9 per contract. To simply breakeven, the stock would have to trade at $709 (the strike price of the purchased call (700) plus net debit ($9)).

Advantage versus Purchasing a Call

When trading the long call, your downside is limited to the net premium paid. If you simply purchased the at-the-money October 700 call you would have paid 20. The potential loss is, therefore, greater when employing a call-buying strategy. If you move to a call with a longer time frame to expiration, you would pay even more for the option. This would also increase your potential loss per option.

Conclusion

By implementing a bull call spread, you have hedged your bets – limiting the potential loss. This is the advantage when comparing to purchasing a call outright. Remember that there are no fool-proof ways to make money by using options. However, knowing your strategy is a good way to limit losses.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 13, 2012

To Buy Puts or Not to Buy Puts…

Filed under: Uncategorized — Tags: , , , , , — Dan Passarelli @ 10:36 am

A lot of traders especially those who are just learning to trade options are enamored by the all mighty put – especially buying the shortest-term, or front month, put for protection. The problem, however, is that there is a flaw to the reasoning and practice of purchasing front-month puts as protection. Ah, yes; it’s true. Front-month contracts have a higher theta – and relying on front-month puts to protect a straight stock purchase is not, necessarily, the best way to protect an investment. If you were to continually purchase front-month puts as protection, that can end up being a rather expensive way to by insurance.

Although front month options are often cheaper, they are not always your best bet. The reasoning may be sound, the trader purchases a number of shares of the stock and purchases out-of-the-money puts to protect his position; but sound reasoning does not always lead to good practice. Let’s take a look at an example.

We will use a hypothetical trade today. The stock is trading a slightly above 13 and our hypothetical trader wants to own the stock because he/she thinks the stock will report blow-out earnings in each of the next two quarters. This investment will take at least six months, as the trader wants to allow the news events to push the stock higher.

Being a savvy options trader, our stock trader wants some insurance against a potential drop in the stock. The trader decides to buy a slightly out-of-the-money July 13 put, which carries an ask price of $0.50 (rounded for simplicity purposes). That 0.50 premium represents almost 4 percent of the current stock price. In fact, if the investor rolled option month after month, it would put a big dent in the initial investment. To be sure, after about seven months (assuming the stock hangs around $13) the trader would lose more than 25 percent on the $13 investment.

What if the stock drops? That is the ultimate rationale for the strategy in the first place: protection. The put provides a hedge. The value of the option will increase as the stock drops, which counterbalances the loss suffered as the stock drops. Buying the put is a hedge, a veritable insurance policy – though, albeit, an expensive one. Investors can usually find better ways to protect a stock.

Learn a better way to hedge with this FREE options report.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 6, 2012

Butterflies and Weekly Options

The weekly options have been the topic of our blog many times before. Despite this topic being the trendy subject and in the forefront of many discussions, it is helpful to recognize the functional flexibility this dramatically shortened lifespan brings to a variety of option strategies. If you need to find out more about weekly options or other option strategies, feel free to visit the options education section on our website.

As an example, consider the case of a frequently traded spread vehicle, the butterfly. For those first encountering this strategy, it is helpful to consider briefly its components. It is constructed by establishing both a credit and a debit spread sharing a central strike price. It can be constructed in either all puts or all calls.

Butterflies can be designed to be either a non-directional or directional trade strategy. Functional characteristics include: negative vega, variable delta and accelerating gamma and theta during its life span. In the case of the long standing monthly duration option cycles which had heretofore been available, these characteristics developed over weeks to months and reached their final expression during the week of option expiration.

These functional characteristics have limited the utility of butterflies over brief duration moves occurring early in the options cycle. Many butterfly traders have had the experience of correctly predicting price action early in the cycle only to have the butterfly deliver little, if any, profit.

The short nine day duration of the weekly options has dramatically accelerated the pace of butterfly trading as the changes begin to occur literally over the extent of a few hours. As such, it is possible to gain the advantage of this trade structure over brief directional moves or in the case of non-directional traders to have market exposure for briefer periods of time.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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

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