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options expiration « Options Blog
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April 11, 2013

Trading a Long Call or Trading a Bull Call Spread AAPL

Filed under: Options Education — Tags: , , , , , , , , — Dan Passarelli @ 1:17 pm

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

Filed under: Uncategorized — Tags: , , , , , , — Dan Passarelli @ 12:21 pm

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

February 21, 2013

Expiration Week: Butterflies

Filed under: Options Education — Tags: , , , , , , , , , — Dan Passarelli @ 2:25 pm

One of the major differences when learning to trade options as opposed to equity trading is the impact of time on the various trade vehicles.  Remember that quoted option premiums reflect the sum of both intrinsic (if any) and extrinsic (time) value.  Also remember that while very few things in trading are for certain, one certainty is that the time value of an option premium goes to zero at the closing bell on expiration Friday.

While this decay of time premium to a value of zero is reliable and inescapable in our world of option trading, it is important to recognize that the decay is not linear.  It is during the final weeks of the option cycle that decay of the extrinsic premium begins inexorably to race ever faster to oblivion.  In the vocabulary of the options trader, the rate of theta decay increases as expiration approaches. It is from this quickening of the pace that many examples of option trading vehicles gain their maximum profitability during this final week of their life.

Some of the most dramatic changes in behavior can be seen in the trading vehicle known as the butterfly. For those new to options, consideration of the butterfly represents the move from simple single legged strategy such as simply buying a put or a call to multi-legged strategies that include both buying and selling options in certain patterns.

To review briefly, a butterfly consists of a vertical debit spread and vertical credit spread sharing the central strike price constructed together in the same underlying in the same month.  It may be built using either puts or calls and its directional bias derives from strike selection rather than the particular type of option used for construction.  For a (long) butterfly, maximum profit is always achieved at expiration when the underlying closes at the short strike shared by the two vertical spreads.

The butterfly has the interesting functional characteristic that it responds sluggishly to price movement early in its life, for example in the first two weeks of a four week option cycle. However, as expiration approaches, the butterfly becomes increasingly sensitive to price movement as the time premium erodes and the beast becomes increasingly subject to delta as a result of increasing gamma. It is for this reason that many butterfly traders restrict their use to the more responsive part of the options cycle. For a butterfly, the greatest sensitivity to time (and, therefore, profit potential) is reaped in the final week of the life cycle of the butterfly, i.e. expiration week.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

February 7, 2013

Stop AAPL in Time

Filed under: Options Education — Tags: , , , , , , , — Dan Passarelli @ 11:28 am

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 and to do so with  precision. Much of this advantage derives from the ability to control positions equivalent to stock with far less capital commitment.

However, a less frequently discussed aspect of risk control is the ability to moderate risk by the astute 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.

As a direct result, it is not obviously apparent the time course that the decay curve will follow.  An option trader has to take into account that the option modeling software is essential to plan the trade and decide the appropriate date 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 March 470 puts. A trader could establish a position consisting of 10 long contracts with a position delta of -595 for approximately $22,000 as I write this.

At the time of this writing, the stock is trading around $459; these puts are therefore $11 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 $462 at expiration. The options expiration risk is $14,000 or more. However, if the trader takes the position that the expected/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 $462 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. Learn and use all risk control maneuvers available; life is a risky business.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

January 24, 2013

Naked Puts on AAPL Stock

Filed under: Options Education — Tags: , , , , , , — Dan Passarelli @ 11:30 am

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

The Example
For our example we will use Apple (AAPL). Apple just recently announced earnings and the stock dropped over $50. For this example we will assume the stock is trading around $460 a share. A trader sells the March 435 put, which carries a bid price of $10.00 (rounded to make the math a bit easier). Should AAPL stock be trading above $435 a share at expiration, the March 435 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 even more after earnings?

If  AAPL falls another $50 to $410 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 $10 in premium. The 420 put expired with $25 in intrinsic value. The trader loses the $25, less the $10 premium collected results in a loss of $15, or $1,500 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.

Edited by John Kmiecik

Senior Options Instructor

Market Taker Mentoring

September 6, 2012

Butterflies and Weekly Options

Filed under: Uncategorized — Tags: , , , , , , , — Dan Passarelli @ 11:39 am

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

Filed under: Uncategorized — Tags: , , , , , , , , — Dan Passarelli @ 8:33 am

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