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May 28, 2015

Option Gamma and AAPL

Many option traders will refer to option delta as the most important option greek. It is debatable but in my opinion the next most important greek for me is option gamma. Option gamma is a one of the so-called second-order option greeks. It is, in theory, a derivative of a derivative. Specifically, it is the rate of change of an option’s delta relative to a change in the underlying security.

Using option gamma can quickly become very mathematical and tedious for novice option traders. But, for newbies to option trading, here’s what you need to learn to trade using option gamma:

When you buy options you get positive option gamma. That means your deltas always change in your favor. You get longer deltas as the market rises; and you get short deltas as the market falls. For a simple trade like an AAPL June 131 long call that has an option delta of 0.56 and option gamma of 0.0588 , a trader makes money at an increasing rate as the stock rises and loses money at a decreasing rate as the stock falls. Positive option gamma is a good thing.

When you sell options you get negative option gamma. That means your deltas always change to your detriment. You get shorter deltas as the market rises; and you get longer deltas as the market falls. Here again, for a simple trade like a short call, that means you lose money at an increasing rate as the stock rises and make money at a decreasing rate as the stock falls. Negative option gamma is a bad thing.

Start by understanding option gamma from this simple perspective. Then, later, worry about figuring out the math, even if a calculator is still needed!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

February 19, 2015

Your Overall 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.

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 $128 and purchases 3 March 130 call options. Each call contract has a delta of +0.40. The total delta of the position would then be +1.20 (3 X 0.40) and not just 0.40. For every dollar AAPL rises all factors being held constant again, the position should profit $120 (100 X 1 X 1.20). If AAPL falls $2, the position should lose $240 (100 X -2 X 1.20) based on the delta alone.

Using AAPL once again as the example, lets say a trader decides to purchase a March 130/135 bull call spread instead of the long calls. The delta of the long $130 call is once again 0.40 and the delta of the short $135 call is -0.22. The overall delta of the position is 0.18 (0.40 – 0.22). If AAPL moves higher by $3, the position will now gain $54 (100 X 3 X 0.18) with all factors being held constant again. If AAPL falls a dollar, the position will suffer a $18 (100 X -1 X 0.18) loss based on the delta alone.

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

August 14, 2014

AAPL and Option Gamma

Many option traders will refer to option delta as the most important option greek. It is debatable but in my opinion the next most important greek is option gamma. Option gamma is a one of the so-called second-order option greeks. It is, in theory, a derivative of a derivative. Specifically, it is the rate of change of an option’s delta relative to a change in the underlying security.

Using option gamma can quickly become very mathematical and tedious for novice option traders. But, for newbies to option trading, here’s what you need to learn to trade using option gamma:

When you buy options you get positive option gamma. That means your deltas always change in your favor. You get longer deltas as the market rises; and you get short deltas as the market falls. For a simple trade like an AAPL September 95 long call that has an option delta of 0.55 and option gamma of 0.0478 , a trader makes money at an increasing rate as the stock rises and loses money at a decreasing rate as the stock falls. Positive option gamma is a good thing.

When you sell options you get negative option gamma. That means your deltas always change to your detriment. You get shorter deltas as the market rises; and you get longer deltas as the market falls. Here again, for a simple trade like a short call, that means you lose money at an increasing rate as the stock rises and make money at a decreasing rate as the stock falls. Negative option gamma is a bad thing.

Start by understanding option gamma from this simple perspective. Then, later, worry about figuring out the math.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

December 26, 2013

Gamma and AAPL

Many option traders will refer to the trifecta of option greeks as delta, theta and vega. But the next most important greek is gamma. Options gamma is a one of the so-called second-order options greeks. It is, if you will, a derivative of a derivative. Specifically, it is the rate of change of an option’s delta relative to a change in the underlying security.

Using options gamma can quickly become very mathematical and tedious for novice option traders. But, for newbies to option trading, here’s what you need to learn to trade using gamma:

When you buy options you get positive gamma. That means your deltas always change in your favor. You get longer deltas as the market rises; and you get short deltas as the market falls. For a simple trade like an AAPL January 565 long call that has a delta of 0.51 and gamma of 0.0115 , a trader makes money at an increasing rate as the stock rises and loses money at a decreasing rate as the stock falls. Positive gamma is a good thing.

When you sell options you get negative gamma. That means your deltas always change to your detriment. You get shorter deltas as the market rises; and you get longer deltas as the market falls. Here again, for a simple trade like a short call, that means you lose money at an increasing rate as the stock rises and make money at a decreasing rate as the stock falls. Negative gamma is a bad thing.

Start by understanding options gamma from this simple perspective. Then, later, worry about working in the math.

Happy New Year!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 5, 2013

Naked on AAPL

The Strategy

If you want to learn to trade here’s a really useful option strategy that all traders should and need to know. 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 simply a naked put. A naked put 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 the breakeven point, subtract the premium received from the sold put’s strike price.

The Example

For our example we will use Apple Inc. (AAPL). Apple shares have moved higher since the beginning of July but recently pulled back again. Now the trader thinks after this brief pullback the stock will once again continue to move higher. For this example we will assume the stock is trading around $490 a share at the beginning of September. A trader sells the October 460 put, which carries a bid price of $8.00 (rounded to make the math a bit easier) because there is an area of support at that level that the trader thinks will hold. Should AAPL stock be trading above $460 a share at expiration, the October 460 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 below that area of support?

If AAPL falls another $50 to $440 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 $8 in premium. The 460 put expired with $20 in intrinsic value. The trader loses the $20, less the $8 premium collected results in a loss of $12, or $1,200 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. Traders should be aware of the risk when selling naked puts and that potential losses can be extreme when compared to other option strategies.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring