Testimonials

April 3, 2014

Different Option Strategies on AAPL

Compared to trading stocks, there are so many more strategies available to an option trader. But more importantly: Do you know why there are so many different types of options strategies? This is the real reason of our discussion and why getting a proper options education can help a trader better understand all of those strategies and when and how to use them.

Different options strategies exist because each one serves a unique purpose for a unique market condition. For example, take bullish AAPL traders. The stock has recently moved higher after declines in January and February. There are traders who continue to be extremely bullish on AAPL as it heads closer to its earnings announcement and want to get more bang for their buck and buy short-term out-of-the-money calls. This might not be the most prudent way to capture profits but that is a discussion for another time. Less bullish traders might buy at- or in-the-money calls. Traders bullish just to a point may buy a limited risk/limited reward bull call spread. If implied volatility is high (which it currently is not but it has been rising) and the trader is bullish just to a point, the trader might sell a bull put spread (credit spread), and so on.

The differences in options strategies, no matter how apparently minor, help traders exploit something slightly different each time. Traders should consider all the nuances that affect the profitability (or potential loss) of an option position and, in turn, structure a position that addresses each difference. Traders need to consider the following criteria:

  • Directional bias
  • Degree of bullishness or bearishness
  • Conviction
  • Time horizon
  • Risk/reward
  • Implied volatility
  • Bid-ask spreads
  • Commissions
  • And more

Carefully defining your outlook and intentions and selecting the best options strategies makes all the difference in a trader’s long-term success. Leaving money on the table with winners, or taking losses bigger than necessary can be unfortunate byproducts of selecting inappropriate options strategies. With spring hopefully ending soon (cold and snowy winter here in Chicago)and supposedly the volatile markets, now is a great time to spend optimizing your options strategies over the next few weeks to build the habit heading into the summer season!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

March 13, 2014

AAPL Options and Moneyness

Dan Passarelli often uses the word “moneyness” and he even has a section about it in his books. Moneyness isn’t a word, is it? It won’t be found on spell-check, but moneyness is a very important term when it comes to learning to trade options. There are three degrees, if you will, of moneyness for an option, at-the-money (ATM), in-the-money (ITM) and out-of-the-money (OTM). Let’s take a look at each of these terms, using tech behemoth Apple (AAPL) as an example. At the time of writing, Apple was hovering around the $535 level, so let’s define the moneyness of Apple options using $535 as the price.

At-the-Money
An at-the-money AAPL option is a call or a put option that has a strike price about equal to $535. The ATM options (in Apple’s case the 535-strike put or call) have only time value (a factor that decreases as the option’s expiration date approaches, also referred to as time decay). These options are greatly influenced by the underlying stock’s volatility and the passage of time.

In-the-Money
An option that is in-the-money is one that has intrinsic value. A call option is ITM if the strike price is below the underlying stock’s current trading price. In the case of AAPL, ITM options include the 530 strike and every strike below that. One will notice that option positions that are deeper ITM have higher premiums. In fact, the further in-the-money, the deeper the premium.

A put option is considered ITM when the strike price is above the current trading price of the underlying. For our example, an ITM AAPL put carries a strike price of 540 or higher. As with call options, puts that are deeper ITM carry a greater premium. For example, a March AAPL 545 put has a premium of $11.50 compared to a price of $7.95 for a March 540 put.

If an option expires ITM, it will be automatically exercised or assigned. For example, if a trader owned a AAPL 515 call and AAPL closed at $520 at expiration, the call would be automatically exercised, resulting in a purchase of 100 shares of AAPL at $515 a share.

Out-of-the-Money
An option is out-of-the-money when it has no intrinsic value. Calls are OTM when their strike price is higher

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than the market price of the underlying, and puts are OTM when their strike price is lower than the stock’s current market value. Since the OTM option has no intrinsic value, it holds only time value. OTM options are cheaper than ITM options because there is a greater likelihood of them expiring worthless.

If this is the case, why purchase OTM options? If you have little investing capital, an OTM option carries a lower premium; but you are paying less because there is a higher possibility that the option expires worthless. OTM options are attractive because OTM calls can see their premium increase quickly. Of course, OTM options could see their premium decrease quickly as well. Remember that OTM options can log the highest percentage gain on the same move in the underlying, in comparison to ATM or ITM options.

Have a great week of trading!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

February 27, 2014

Naked AAPL Options

With March finally here, traders are still assessing when or if ever this market will have a correction like it had in January. That being the case, there are several option strategies that traders can consider depending on their outlook. Below is an explanation of a option strategy that may be right for you depending on your goals and trading personality. Regardless, understanding this option strategy is something all traders should and need to know even if they may never use it.

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 lower since the middle of February and are attempting to rally 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 $525 a share at the beginning of March. A trader sells the April 500 put, which carries a bid price of $6 (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 $500 a share at expiration, the April 500 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 $40 to $485 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 $6 in premium. The 500 put expired with $15 in intrinsic value. The trader loses the $15, less the $6 premium collected results in a loss of $9, or $900 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

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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

February 20, 2014

Socrates and Another Famous Greek

We all know options are derivatives, and their prices are derived from the underlying stock, index, or ETF. But with other factors at work such as implied volatility, time decay, etc. Have you ever wondered how can you know how much an option is going to move with respect to say the underlying? Very simple – check out its delta.

Delta is arguably the most

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heavily identifiable Greek (unless you count Socrates or Aristotle) especially by individuals learning to trade options. It offers a quick and relatively easy way to tell us what to expect from our option positions as we watch the price action of the underlying. Calls have positive deltas, as they typically move higher on a rise in the stock, and puts have negative deltas, as they typically move lower when the stock rises.

While some investors view delta as the percentage chance an option has of expiring in-the-money, it is really more of a way to project expected appreciation or depreciation. A delta of 0.50 for an AAPL call suggests the option should move 50 cents higher when the AAPL jumps a dollar, and lose 50 cents for every dollar loss in AAPL.

But delta is only foolproof when all other factors are held constant, which is rarely the case (and certainly never the case for time decay). If an option is moving more (or less) than its delta would suggest, it is likely because other variables are shifting. For example, buying demand might be pushing implied volatility higher, raising the price of the options. Still, this king of all Greeks is a good starting point for gauging how your options are likely to move.

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

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perspective. Then, later, worry about working in the math.

Happy New Year!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

December 18, 2013

Strangles and AAPL

Today we are going to discuss an option strategy that you may not have thought about in quite some time. A straddle is an option strategy that traders can use when the market is volatile but direction is uncertain. Another play similar to the straddle is the option strangle. In a straddle, the trader is betting on both sides of a trade by purchasing options with the same strike price and the same expiration date, on the same underlying. A trader can create a similar trade, but with a lower price by trading a strangle instead. Rather than purchasing a put and a call at the same strike (which makes up a straddle), the trader purchases a put and a call at different strikes, still with the same expiration. By using a put and a call that are out-of-the-money (OTM), a trader pays a lower initial price. However, this comes with a price so-to-speak; the stock will have to make a much larger move than if the straddle were implemented. The trader is, arguably, taking a larger risk (because a bigger move is needed than with a straddle), but is paying a lower price. Like many trade strategies there are pros and cons to each. If this all sounds a little overwhelming to you, I would invite you to checkout the Options Education section on our website.

The Particulars
Like a straddle, a strangle has two breakeven points. To calculate these points simply add the net premium (call premium + put premium) to the strike price of the call (for upside breakeven) and subtract the net premium from the put’s strike (to calculate downside breakeven). If at expiration, the stock has advanced or dropped past one of these breakeven points, the profit potential of the strategy is unlimited (yes, unlimited). The position will take a 100% loss if the stock is trading between the put and call strikes upon expiration. Remember that the maximum loss a trader can take on a strangle is the net premium paid.

Example Trade
To create a strangle, a trader will purchase one out-of-the-money (OTM) call and one OTM put. We can use Apple (AAPL) as an example which at the time of this writing is trading at around $540

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after a volatile couple if weeks. The trader would buy both a January 545 call and a January 535 put. For simplicity, we will assign a price of $17 for both – resulting in an initial investment of $34 for our trader (which again is the maximum potential loss).

Should the stock rally past $545 at expiration, the 535 put expires worthless and the $545 call expires in-the-money (ITM) resulting in the strangle trader collecting on the position. If, for example, the intrinsic value of the call at expiration is $38, the profit is $4 (intrinsic value less the premium paid). The same holds true if the stock falls below $535 at expiration, it then is the put that is ITM and the call expires worthless. The danger is that the stock moves nowhere by the time option expiration occurs. In this case, both legs of the position expire worthless and the initial $34, or $3,400 of actual cash, is lost.

Notice that the maximum loss is the initial premium paid, setting a nice limit to potential losses. Potential profits on the strangle are unlimited which can be very rewarding but as always, a traders needs to decide how he or she will manage the position.

I hope you have a safe and very Happy Holiday!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

November 21, 2013

Long Calls and Bull Call Spreads in AAPL

Purchasing a Call vs. Bull Call Spread
With the Dow and S&P 500 at all-time highs recently, it probably made sense to have at least a moderately bullish bias towards many stocks. The market is due for some type of pullback but whose to say it won’t continue on its bullish pace. Even if it does pullback sooner than later, there will be another bullish opportunity at some point. Is there a way that you can take advantage of this bullish investing scenario while limiting risk? Certainly, there are a couple. One that may be a better option compared to the rest is the bull call spread. To learn to trade this strategy and more in detail please visit our website for details.

Definition
When implementing a bull call, a trader purchases call options at one strike and sells 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 $515 as an

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example. In this case you would purchase December calls at the 515 at-the-money strike at the ask price of $13. You would then sell the same number of December calls with a higher strike price, in this case 535 at the bid, $4.

The Math
The trader’s maximum profit in the bull call spread is limited; he can make as much as the difference between the strike prices less the net debit paid. For simplicity, let’s assume that he purchased one December 515 call and sold one December 535 call resulting in a net debit of $9 (that’s $13 – $4). The difference in the strike prices is $20 (535 – 515). He would subtract 9 from 20 to end up with a maximum profit of $11 per contract. So if he traded 10 contracts, you could make $11,000.

Although he limited his upside, the trader also limited the downside to the net debit of $9 per contract. To simply breakeven, the stock

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would have to trade at $524 (the strike price of the purchased call (515) plus net debit ($9)) at expiration.

Advantage versus Purchasing a Call
When trading the long call, a trader’s downside is limited to the net premium paid. If he simply purchased the at-the-money December 515 call he would have paid $14. The potential loss is, therefore, greater when implementing a call-buying strategy. If he had moved to a call with a longer time frame to expiration, he would have even paid more for the option. This would also increase his potential loss per option.

Conclusion
By implementing a bull call spread, traders can hedge their bets – limiting the potential loss. This is the advantage when comparing to purchasing a call outright. Remember that there are no sure-fire ways to make money by using options. However, knowing and understanding the strategy is a good way to limit losses.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

October 31, 2013

Controlled Stops and AAPL

If you are like a lot of other option traders, you probably avoided trading Apple Inc. (AAPL) during its recent earnings announcement. Now that the volatility event is over, you might be looking to take an option position. Even though the company announced its earnings, there may still be some volatile action ahead. Here are a few thoughts that should be considered on AAPL or any other position you may enter.

Learning to trade options offers a number of unique advantages to the trader, but perhaps the single most attractive characteristic is the ability to control risk precisely in many instances. Much of this advantage comes from the ability to control positions that are  equivalent to stock with far less capital outlay.

However, a less frequently discussed aspect of risk control is the ability to moderate risk by the careful and precise use of time stops as well as the more familiar price stops more generally known to traders. Because time stops take advantage of the time decay of extrinsic premium to help control risk, it is important to recognize that this time decay is not linear by any means.

As a direct result, it may not be obviously apparent the time course that the decay curve will follow.  An option trader has to take into account that the option modeling software that most brokers have is essential to plan the trade and decide the appropriate time at which to place a time stop.

As a simple example, consider the case of a short position in AAPL established by buying in-the-money December 530 puts. A trader could establish a position consisting of 10 long contracts with a position delta of -540 for approximately $25,000 as I write this.

At the time of this writing, the stock is trading around $522; these puts are therefore $8 in-the-money.  Let’s assume a trader analyzes the trade with an at-expiration P&(L) diagram and wants to exit the trade as a stop loss if AAPL is at or above $525 at expiration. The options expiration risk is $20,000 or more. However, if the trader takes the position that the expected or feared move will occur quickly—long before expiration—he could implement a time stop as well.

Using a stop to close the position if the stock gets to $525 at a point in time around halfway to expiration would reduce the risk significantly. Because the option would still have some time value, the trader could sell the option for a loss prior to expiration, therefore retaining some time value and fetch a higher price. In this event, closing prior to expiration helps the trader lose less when the stop executes, especially if there is a fair amount of time until expiration and time decay hasn’t totally eroded away.

Options offer a variety of ways to control risk. An option trader needs to learn several that match his or her risk/reward criteria.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

August 15, 2013

Determining Option Strategies on AAPL

Compared to trading equities, there are so many more option strategies available to an option trader. But more importantly: Do you know why there are so many different types of options strategies? This is the real root of our discussion and why getting a proper options education can help a trader better understand all of those strategies and when and how to use them.

Different options strategies exist because each one serves a unique purpose for a unique market condition. For example, take bullish AAPL traders. Now that the stock has recently broken through several resistance areas, there are traders who continue to be extremely bullish on AAPL and want to get more bang for their buck and buy short-term out-of-the-money calls. This might not be the most prudent way to capture profits but that is a discussion for another time. Less bullish traders might buy at- or in-the-money calls. Traders bullish just to a point may buy a limited risk/limited reward bull call spread. If implied volatility is high (which it currently is not but it has been rising) and the trader is bullish just to a point, the trader might sell a bull put spread (credit spread), and so on.

The differences in options strategies, no matter how apparently minor, help traders exploit something slightly different each time. Traders should consider all the nuances that affect the profitability (or potential loss) of an option position and, in turn, structure a position that addresses each difference. Traders need to consider the following criteria:

  • Directional bias
  • Degree of bullishness or bearishness
  • Conviction
  • Time horizon
  • Risk/reward
  • Implied volatility
  • Bid-ask spreads
  • Commissions
  • And more

Carefully defining your outlook and intentions and selecting the best options strategies makes all the difference in a trader’s long-term success. Leaving money on the table with winners, or taking losses bigger than necessary can be unfortunate byproducts of selecting inappropriate options strategies. With summer ending soon and supposedly the slow markets, now is a great time to spend optimizing your options strategies over the next few weeks to build the habit heading into the fall season!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

July 18, 2013

Earnings and Other Influences of Option Prices

With earnings season in full gear and major players like Apple and Netflix ready to announce soon, it is probably a good time to review how option prices are influenced.

Perhaps the most easily understood of the options price influences is the price of the underlying. All stock traders are familiar with the impact of the underlying stock price alone on their trades. The technical and fundamental analyses of the underlying stock price action are well beyond the scope of this discussion, but  it is sufficient to say it is one of the three pricing factors and probably the most familiar to traders learning to trade.

The price influence of time is easily understood in part because it is the only one of the forces restricted to unidirectional movement. The main reason that time impacts option positions significantly is a result of the existence of time (extrinsic) premium. Depending on the risk profile of the option strategy established, the passage of time can impact the trade either negatively or positively.

The third price influence is perhaps the most important. It is without question the most neglected and overlooked component; implied volatility. Because we are in the midst of earnings season, it can become even a greater influence over the price of options than usual. Implied volatility taken together with time defines the magnitude of the extrinsic option premium. The value of implied volatility is generally inversely correlated to price of the underlying and represents the aggregate trader’s view of the future volatility of the underlying. Because implied volatility responds to the subjective view of future volatility, values can ebb and flow as a result of upcoming events expected to impact price (e.g. earnings, FDA decisions, etc.).

New traders beginning to become familiar with the world of options trading should spend a fair amount of time learning the impact of each of these options pricing influences. The options markets can be ruthlessly unforgiving to those who choose to ignore them especially over an earnings announcement.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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