Options Trading Tutorial
pSivida to Webcast Presentation at Rodman & Renshaw Health Care Conference
BOSTON—-pSivida Corp, , a leader in the development of sustained release back of the eye drug delivery systems for difficult-to-treat conditions, today announced that it will webcast a live presentation at the Rodman & Renshaw Annual Health Care Conference in New York, Monday, September 13.
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Helicos BioSciences Files Patent Infringement Lawsuit Against Pacific Biosciences
CAMBRIDGE, Mass.—-Helicos BioSciences Corporation announced today that it has filed a lawsuit against Pacific Biosciences of California, Inc. for patent infringement. The lawsuit, filed in the United States District Court for the District of Delaware, accuses PacBio of infringing four patents and seeks injunctive relief and monetary damages.
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Goldman: There’s Now A 25% Chance Of A New Recession
It’s one thing when Nouriel Roubini says there’s a high chance of a double-dip recession, since such bearishness is to be expected from him. Yet now Goldman says there’s a 25% chance of a double-dip recession:
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Political punters taken on wild roller-coaster ride
Despite the slow pace of the vote count and the negotiations with the balance of power MPs, it has been a wild roller-coaster ride on the post-election betting markets.
Read more on Brisbane Times
Research and Markets: ARCH Models for Financial Applications
DUBLIN–(BUSINESS WIRE)–Research and Markets (http://www.researchandmarkets.com/research/cee107/arch_models_for_fi) has announced the addition of John Wiley and Sons Ltd’s new report “ARCH Models for Financial Applications” to their offering. Autoregressive Conditional Heteroskedastic (ARCH) processes are used in finance to model asset price volatility over time. This …
Read more on Business Wire
Bull call spreads are option trading strategies involving the simultaneous purchase of call options at a lower strike price and shorting (selling) the same amount of call options at a higher strike price. Both long and short positions will have the same expiry date.
They are called “bull call spreads” because you enter them on the understanding that the outlook for the underlying financial instrument is bullish and you’re creating an overall debit position in your account using call options.
Being a vertical debit spread, the bull call spread will enable you to enter a position much cheaper than simply going long the call options, as well as allowing greater flexibility if the underlying share price should not proceed in the anticipated direction.
To place a bull call spread, do the following:
1. Search the market or analyze your watchlist for a stock you expect to be modestly bullish. Look at a chart showing trends and price action for at least the past year, to determine where the stock is in its overall price cycle.
2. Ensure there are options available for this stock and that there is sufficient liquidity to enter and exit the trade easily, without being at the mercy of market makers.
3. Bull call spreads are most effective for options with at least 90 days to expiry, so check option premiums for strike prices with at that timeframe. You may even wish to consider using LEAPS options for this purpose.
4. Check the implied volatility in the option prices you are considering, to see if any are overpriced or underpriced. Overpriced options for the short leg of the trade give you an advantage, but they are not essential to a successful trade. Beware of overpriced premiums for the long (bought) leg of the spread.
5. Decide which lower and higher strike prices are most appropriate for your spread. You should consider at least 10 percent of the current market value of the share price as a basis for your strike price difference.
6. Consider the following before deciding which spread is best:
(i) Limited Risk – the net debit to place the trade is your maximum loss
(ii) Limited Reward – the difference in strike prices minus the net debit to place the trade.
(iii) Breakeven – the net debit plus the lower strike price
(iv) Return on Investment – the maximum potential reward divided by the amount risked.
7. Create a risk graph to visually represent the trade’s potential. You can use freely available downloadable software such as from Peter Hoadley for this purpose.
8. Make a note in your trading journal of the details of the trade and the reasons why you chose it.
9. Plan your exit strategy before placing the trade. For example, you may consider exiting half the trade once its overall value has doubled, leaving the remainder as a risk-free trade, which you could let run without stress for greater profit potential. Or you may simply wish to set a target such as 80 percent profit for your exit. Option prices work in such a way that the last 20 percent usually takes much longer to realize in a verticial debit spread, so your money would be better used elsewhere.
10. Contact your broker or go online and place your trade. Make sure you do it as a limit order to minimize the cost of the trade.
11. Watch the market in the ensuing days. If it falls below the breakeven but you believe it will rise again, you may wish to consider waiting till the (higher) short position is very cheap and closing it out. This will leave your long position still current – and even if the stock only returns to its original price before expiry date, will usually make you a profit. This strategy is best suited for a stock that has already made a sustained downwards move before you place the trade. Otherwise, go to the next step.
12. Decide when to exit based on what happens to the underlying stock.
(i) If it rises above the short strike price – the maximum profit becomes available and more so with the passing of time as option theta (time decay) goes to work.
(ii) If it rises above the breakeven but not as high as the short strike price – close out the entire position for some profit.
(iii) If it remains below the breakeven but above the long strike price – there may still be a small profit in it, if time value or implied volatility works in your favour. Decide whether to close the trade or risk waiting until expiry date and then sell the long call while letting the short call expire worthless.
(iv) If the underlying stock falls below the long call strike price – consider the strategy in point 11, or close the entire position if you think the stock won’t recover.
The great thing about a straddle is that it’s non-directional. This means that you can make money without forecasting market direction. In other words, it doesn’t matter whether the stock price goes up or down in the near future – you can still make money either way – as long as it moves somewhere. The method behind a straddle is that you simultaneously purchase the same number of call and a put options, with the same expiry date. The plan is, that the profit from the winning option will more than compensate for the loss on the losing one, with a good profit remaining.
The straddle trade is a “slow moving” trade that can take anywhere from a few days up to a month to do its thing, so it’s not like you need to be watching it every few hours. It works best on stocks that are in a period of price consolidation with the expectation that a breakout may be coming soon. If you are a technical trader, one of the best chart patterns I have found for straddle trade setups, are what are commonly known as “triangle” or “wedge” formations. This is where the recent highs and lows of the daily bar charts are coming together. In other words, the highs are getting lower while the lows are getting higher, so that if you draw a trendline over the highs and lows, you’ll see them converging into a point. You want to trade straddles as near as possible to the convergence of the two trendlines. The most volatile straddle breakouts come after you see this pattern forming for about 3 months. Anything shorter than that, may result in a breakout that doesn’t have sufficient momentum to give you the maximum profit.
Another vital thing when taking out straddle trades, is that is that you need to ensure that when you buy the options they have at least 60 days to expiry. 90 Days is better. If you do this during a period of price consolidation, such as in the triangle pattern above, the option prices are likely to be the cheapest around that time, due to low price volatility. This is ideal for straddle trades.
The downside of straddle positions is that they cost more to enter, than other trading strategies such as spreads. Nevertheless, on the US markets where option contracts only cover 100 shares, they are still quite affordable. You also want to avoid stocks that are historically slow moving, because the whole idea behind a straddle is to anticipate a short term price breakout that moves far enough before expiry date, to give you a net profit. Another indicator that a price breakout could be imminent, is an upcoming earnings report. Alternatively, a large movement in the overall market can also affect individual stocks.
Coming back to “triangle” patterns, there are three main types. Where the highs and lows are converging, this is called a “symmetrical triangle”. However, you often see the lows getting higher, but the highs being equal because they are hitting a resistance level. This is called an “ascending triangle”. The reverse of this is the third type, namely, descending triangles. These are ideal conditions to implement a straddle strategy.
The final thing you want to check before placing your straddle trade, is the “implied volatility” in the option prices, compared to the “historical volatility” of the stock price. Ideally, the former should be lower than the latter. Any decent options broker will be able to provide this information.
Straddle option trading is one of the safest and most stable option trading strategies available, because you’ve eliminated the need to predict market direction. It does have some risk, namely, that the stock goes nowhere, in which case, time decay on your bought positions will work against you. But if you’ve purchased when the volatility is low and price is cheap, your losses will be minimal.
Call And Put Options Investopedia
One of the many steps in trading is having a pulse on the markets, or at the very least having a pulse on the stock you are about to trade. Having the pulse, or being in the know, or having an ear to the ground, or however you might want to say it is what we refer to as market sentiment.
Investopedia.com defines it like this: Call And Put Options Investopedia
“What Does Market Sentiment Mean? The feeling or tone of a market (i.e. crowd psychology). It is shown by the activity and price movement of securities. For example, rising prices would indicate a bullish market sentiment. A bearish market sentiment would be indicated by falling prices.”
Most people believe that gauging market sentiment is as easy as turning on CNBC and listening to the talking heads in the morning, or watching Jim Cramer’s Mad Money show to see how he feels about what’s currently going on in the markets. While neither thing is necessarily bad, there is a lot more that goes into gauging market sentiment than just one person’s opinion. No one news show or financial talking head should ever be taken as the all knowing soothsayer in what the markets will or will not do.
Market sentiment goes a little beyond simple rising or falling stock prices. It is also about trying to predict as accurately as possible what direction the market is more likely to move in the future, near and far term. Always remember, “more likely”, not absolutely!
Market sentiment can be gauged in a variety of ways: 1) put/call ratios 2) VIX 3) technical indicators 4) news and general market conditions 5) common sense.
1. Put/Call Ratios
Put/call ratios are simply the number of puts being bought vs. the number of calls being bought on the same stock or index in the same month of expiration. It can be measured in short or long term expectations. It gives an investor an idea of what the rest of the market is thinking. If more people are putting in orders for puts on a near term option than calls on the same near term option it is an indicator that short term the investors in that stock are thinking bearish. The opposite is true if the call orders significantly outweigh the put orders.
The Chicago Board of Options Exchange publishes put/call ratios on its website at the end of every week of trading. The data must be looked at in context because it is a measure of what has already happened, yet at the same time it is gauging the sentiment of investors as they prepare for the following week of trading. A ratio of 1.0 means that the same number of calls and puts were traded in that week of trading (remember, this is on all traded options not just one index or stock). A ratio higher than 1.0 means more put than call orders and less than 1.0 means more call orders than put orders. But a 1.0 ratio is not considered to be even or non-directional. Because most traders are more optimistic by nature an even ratio of call and put orders is actually considered to be more on the bearish sentiment side and a ratio of.85-.90 is considered more balanced. This of course also means that a ratio below.85 (meaning for every 1 call order there is.85 put orders) is what investors would consider a bullish sentiment. The farther below.85 you go in the ratio (meaning the stronger the call orders are outpacing the put orders) the stronger bullish the sentiment. Conversely, the higher above 1.0 the ratio the more bearish the sentiment.
While the CBOE put/call ratio gauges sentiment on the market overall, you can gauge investor sentiment on an individual stock simply by looking at an option chain and examining the put/call ratio on that particular stock. A stock can have short term sentiment that is very bearish while having a long term bullish outlook like in the figure below.
This will help you decide how you should play the stock yourself, but you have to keep in mind that this is simply following the crowd. That in and of itself is not a bad thing, but your trades should be based on more than just following what others are doing. As with many individual components of trading put this into context of the big picture.
2. VIX
The ticker symbol for the Chicago Board of Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility is VIX. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the “investor fear gauge”.
(From investopedia.com) More often than not when the indexes are going down the VIX is going up because bearish markets are either a result of or help cause “fear”. (Notice that when the DOW Jones Index is going down the VIX is going up.)
The VIX measures fear in the market and fear often means bears. The difficult thing about the VIX as an indicator of sentiment is that it really just states the obvious. This is because the number you are seeing is an indicator of what happened that day and on a day when the market indexes drop 2-4% you simply expect the VIX to be high. Anything above 20 on the VIX means that fear is relatively high and that hedging your positions is not a bad idea.
The best way to read the VIX is to see if volatility is still very high after a bullish day in the market. This is often referred to as a deviation and may help you if you are undecided on a trade. For example you might be thinking that after a strong bullish day in the DOW that it’s time to buy back some covered calls that are being used to hedge a long stock position, but a look at the VIX could give you pause if after that bullish day the VIX is still quite high. This means that in spite of a bullish day, fear is still prevalent in the market and waiting a day or two would be more prudent. Like other indicators, use the VIX as one measure of what is going on in the market, but not the only one. Call And Put Options Investopedia
3. General Market Conditions
When you are looking at technical indicators such as the 5/20 day EMA or the RSI or MACD to see if a stock is moving bearish or bullish, look at the same indicators on the indexes. Don’t ever forget that even though the DOW Jones Industrial Average only measures the 30 largest companies in the US, 85% of all publicly traded companies follow its lead. If the DOW gives bearish technicals the company you are trading has an 85% chance of following. So if you are trading a stock in the opposite direction of the general market make sure you have very good reason to do so.
Too many times in my trading experience I have seen a company report great earnings, give a good guidance or outlook statement for the next quarter or even the next full year, and still not be able to overcome the momentum of a bearish market. Stocks like AAPL, BA, and CAT in spite of being big fundamentally sound companies are still very prone to follow what the rest of the market is doing.
4. World Events
War; hurricanes; political contests – all of these things can have an effect on what the markets will do. While you don’t have to be a news junkie, you do have to pay attention to what is going on around you and place your positions accordingly. News events will often times only effect a stock’s short term movement, but bigger global events like the Iraq War can put major pressure on the stock market.
A great example of political events effecting market sentiment is election times. When there is a real chance of political powers changing hands, people can either get very optimistic or get very scared. It doesn’t matter what your personal politics are, you just need to be aware that politics comes in to play probably more often than we would like. At the time this article is being written the 2010 midterm Congressional elections are only months away. The balance of power in the United States House and Senate could possibly change from very liberal to split or slightly conservative. Don’t believe for one second that this potential change won’t affect the markets. It will! Time will only tell what change may come, but change in the political landscape often brings change in the financial landscape.
Today more than ever we are becoming a global economy. Recent news about the financial solvency of countries in Europe is having a huge effect on the markets in the United States. Reports of banking and finance in China can cause our own markets to rise or fall depending on how the news affects the average consumer or the US as a whole. It is more important than ever to keep an ear to the ground on things that can affect the US markets. “News rules” on many days, weeks, and months in the stock market so never let yourself become out of touch with current events.
5. Common Sense
You don’t always want to play “follow the leader” but remember that volume moves the market direction. If all the fish are swimming upstream you could be bold and move the other direction, but in stocks and options that kind of attitude will most likely end in trouble.
Pay attention to everything and make sure you place trades that if the worst case scenario happens, will not blow up your portfolio. If you go into every position looking at the worst case scenario and you have a plan that deals with a trade gone bad, you will come out ahead more often than not and be a very successful trader. Call And Put Options Investopedia
Teryl Resources Acquires an Option on Mineral Claims in Alaska
VANCOUVER, BRITISH COLUMBIA–(Marketwire – Sept. 1, 2010) – Teryl Resources Corp. (TSX VENTURE:TRC)(OTCBB:TRYLF) is pleased to announce that an agreement, subject to a 30 day due diligence by Teryl, was completed to acquire an option on a 50% interest in 11 State of Alaska mining claims located approximately 130 kilometers northwest of Anchorage, AK.
Read more on Marketwire
While everyone has a right to his or her opinion, the people who are informed have more of a right – BILL DIXON
My experience is that most people who trade options do not do very well. A major reason is that most option traders don’t know how options are priced. Without having a basic understanding as to how they are priced, it’s difficult to understand how, and why, they will change in value. This makes formulating good trading strategies practically impossible.
Before we can become good at understanding which strategies to implement, it’s important to know the basics. Just like stocks or futures, options are independent vehicles and trade differently than their underlying security. So, what makes the option value rise and fall? Options will basically track the underlying stock or future, but there are many variables in their pricing traders should know about. A way to help measure these variables is known as “The Greeks”.
“The Greeks” are really a series of calculations that measure risk/reward changes in the option price, with respect to changes in interest rates, time value, implied volatility and changes in the price of the underlying stock or future.
The four basic measurements are as follows:
1- The Delta is a measurement of the change that will take place in the option premium with respect to price changes in the underlying stock or futures contract. The values range from 0-100 where 100 would reflect 100% correlation to the underlying instrument. A delta of 50 would mean the option would move 50% to the underlying instrument. So if a stock or contract moved two points the option would move one point at a 50 delta. The delta is constantly changing with price changes in the underlying security.
2- The Gamma measures the rate of change of the delta. This is how fast the delta changes with movement in the underlying instrument.
3- The Theta measures the rate of decline in the value of the option caused by the time decay. Options have specific expiration dates, and the closer we move toward that date, the more the option will decay in value. This assumes no movement in the underlying instrument or changes in volatility.
4- The Vega measures the rate of change in the option with respect to increases and decreases in volatility. As volatility increases the option price will tend to increase even though there is no change in the price of the underlying stock or future.
Interest rates are always changing. Time does slip away. The prices of the stocks and futures do go up and down, and volatility is always changing. This is why it is critical to look at these “Greeks” and understand how they can help you formulate better trading strategies to buy “cheap options” and sell “expensive options”.
Click here to see a great summary sheet on 46 different commodities and their respective volatility ranges. Also on the link, click an individual commodity to see detailed analysis.
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Charles Maley
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