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August 21, 2014

Short-Term Call Options

With the market once again considering a move higher as earnings wind down, it might be a good time to talk about call options. When an option trader buys a call option, he or she has the right to buy the underlying at a particular price (strike price) before a certain time (expiration). Keep in mind that just because the option trader has the right to buy the stock, doesn’t mean that he or she has to necessarily do so. The call option just like a put option can be sold anytime up until expiration for a profit or loss.

A lot of traders especially those who are just learning to trade options can fall in love with call options and especially short-term call options because they are cheaper than call options with longer expirations. We can classify short-term call options as call options that expire in less than thirty days for the sake of this discussion. But there is a potential problem with purchasing short-term call options. The shorter the amount of time that is purchased, the higher the option theta (time decay) will be. The higher the time decay, the quicker the premium will erode away the call option’s premium. The call option may be cheaper due to a shorter time until expiration, but it may not be worth it overall. Let us take a look.

With Tesla Motors (TSLA) trading around $260 last week, an option trader might have considered call options to profit from an expected move higher. He could have purchased the August 260 calls for 3.30 that expired in 3 days. Yes, the options are cheap and yes they will profit if TSLA moves up vigorously in the next couple of days. But the option theta is 0.70 on the call options meaning they will lose $0.70 for everyday that passes with all other variables being held constant, In fact if the stock trades sideways, the option theta will increase the closer it gets to expiration since there is currently no intrinsic value (the in-the-money portion of the option’s premium) on the call options.

If an option trader purchased the September 260 calls for TSLA, it would have cost him 12.00 and it would have made the at-expiration breakeven point of the trade $272 (260 + 12) versus only $263.30 (263 + 3.30) with the August call options. But the major benefit to buying further out is option theta. The September 260 calls had an option theta of 0.15 meaning for every day that passes, the option premium would decrease $0.15 based on the option theta and all other variables being held constant. This is certainly a smaller percentage of a loss based on option theta for the September options (1.25%) versus the August options (21.21%) especially if the stock trades sideways or moves very little.

Fast forward to August expiration, TSLA closed basically at $262. The August 260 call would have expired with an intrinsic value of $2 (262 – 260). If the option trader did nothing up until expiration, the long August 260 call would have lost $1.30 (3.30 – 2) because there would be no time value (option theta) left and only the intrinsic value. The September 260 call would have lost approximately $0.45 (3 X 0.15) in theta but also gained $1 (2 X 0.50) from delta based on a delta of 0.50 and a $2 (262 – 260) move higher. The September 260 calls would now be worth $12.55 (12 + 0.55) and profited $0.55 (12.55 – 12).

Having enough time until expiration is a critical element when an option trader is considering buying options like the call options we talked about above. Keep in mind that as a general rule, options lose value over time and the option theta starts to accelerate even more with 30 days or less left until expiration. Buying a call option with more time until expiration will certainly cost more than one with less time but the benefits, including having a smaller option theta, might be worth the more expensive price especially if the underlying fails to move higher.

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 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 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

May 30, 2013

Waiting for a Top: Is There a Bear Market Coming?

Filed under: Options Education — Tags: , , , , , , — Dan Passarelli @ 12:57 pm

It’s been a good run this year so far. The market is up over 17 percent as I write this post. Many traders would say that market conditions are not fundamentally much different than they were on January 1. But the market apparently is not aware of that fact. Most of the professional traders I’ve talked to are looking for a market pullback, if not a bonifide retracement.

But, do you know what these same bear market seeking traders are not doing? They are not getting short. That’s right. These smart money traders who believe the market is too high and should come down won’t touch a put with a 10-foot pole. Why? There is no bear market technical set up.

In order to properly craft a downside option trade, the bear market set up has to be there. Right now, we have an SPX chart that has no resistance to speak of. There are no lower lows. There are no signs of being strongly over extended with any indicator. There are no bear market patterns. Technically, there is no reason to sell.

Of course, that is not to say these traders are buying however. They are trading very cautiously, as if they are planning which block to remove from an already rickety Jenga tower.

This, I believe, is one of the reasons why we’re seeing such weird VIX trading lately. Typically VIX and SPX move in opposite directions. Or at least, 87 percent of the time they do, historically. But not lately. We’ve seen plenty of times over the past few weeks where as the market rises, so does the VIX. Why? I think it’s because when the market rises, the smart money doesn’t step in and put their money down on stocks. They instead buy limited-risk calls and keep the bulk of their cash in a protected money market account. One could look at a call as a hedge. Traders can hedge against missing out on a rally, while keeping most of their cash safe by buying a call instead of buying stock.

So, when is it time to get short? When will there be a REAL bear market? We’ll have to wait for the technicals to give us something to trade. IF, and when, that happens, it could be a doozie.

Dan Passarelli

CEO

Market Taker Mentoring

April 11, 2013

Trading a Long Call or Trading a Bull Call Spread AAPL

Purchasing a Call vs. Bull Call Spread
With the market moving higher at unprecedented levels 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. 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 $435 as an example. In this case you would purchase May calls at the 435 at-the-money strike at the ask price of $18. You would then sell the same number of May calls with a higher strike price, in this case 455 at the bid, $10.

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 May 435 call and sold one May 455 call resulting in a net debit of $8 (that’s $18 – $10). The difference in the strike prices is $20 (455 – 435). He would subtract 8 from 20 to end up with a maximum profit of $12 per contract. So if he traded 10 contracts, you could make $12,000.

Although he limited his upside, the trader also limited the downside to the net debit of $8 per contract. To simply breakeven, the stock would have to trade at $443 (the strike price of the purchased call (435) plus net debit ($8)) 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 May 435 call he would have paid $18. 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

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

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.

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