Posted on March 24th, 2010 
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A bought strangle is made up of a bought call option and a bought put option. Combine these two trades together and if there is a different exercise price you have a strangle. A bought strangle pay-off is demonstrated below.
Bought Call |
Bought Put |
Bought Strangle
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To receive ASX Option Recommendations or to learn more about straddles and strangles please request the complete Straddles and Strangles eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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Posted on March 10th, 2010 admin No Comments
It is important to always be aware of the strategy risks. The primary risk when placing a bear call spread is when the share price increases past the sold call option and an ever greater concern is if the share price increases above the bought call option (protection). Since you receive a premium to enter this trade there is a required margin. This margin can increase to as much as 1.2 times your maximum loss. For example if you were risk $5,000 the cash margin required in the account can increase to $6,000 (5000 *1.2) which includes the premium received. So it is important to know your maximum risk and make sure there are enough funds to cover the worst case scenario.
Another risk inherent with selling options is volatility. When you open the bear call spread you want the volatility to be high so you can sell the call options for as much value as possible. Once the trade is placed you want the volatility to drop off and time decay to kick in. So even if the share price stays still but volatility increases the position may not profit in the short-term. Increased levels in volatility mean to close out it will cost more to buy back the sold call option. If the share price increase above the sold put option prior to expiry there is potentially a risk of exercise.
The main risk of credit spreads is the risk of being exercised. If the sold call option is exercised it means that you are obligated to sell shares at the exercise price of the sold call option. This can have a negative impact in terms of you have sold shares you do not own which means you need to buy them back at the higher level and therefore locking in a loss on that position. If the share price is above the bought call option (protection) when exercised then you can sell the call option which will reduce the loss from being exercised. It is still not possible to lose more than the maximum risk before entering the trade. Another disadvantage of being exercised is the brokerage on the share sale and purchase so it is a good idea to try an avoid exercise. To avoid being exercised you need to monitor your position and more importantly the delta of the sold call option. If the share price is above the sold call option an indication of the likelihood of being exercised can be identified by the delta. If the delta on the sold call option is above 0.95 there is a chance being exercised. If the delta is above 0.98 then it is necessary to implement one of your exit strategies.
To avoid exercise there are two options. If you think the share price will keep increasing you can close the trade for a loss. If you think you view is correct and the share price will fall from this level and want to keep the position you can roll out to the next month. What this means is you can close the positions you have an open the same position for the next month and do this for no cost or a small credit. Therefore if the share price then decreases below the sold call by the next month you can still make maximum profit. This options is normally recommended unless your analysis, technical or fundamentals, indicate a change is trend or market conditions.
To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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Posted on March 9th, 2010 admin No Comments
When identifying trades it is essential to look at the delta of the option legs. In particular it is important to calculate the net delta of the bear call spread. The net delta is calculated by the delta of the bought call option minus the delta of the sold call option. The net delta will always be positive. The net delta indicates if the share price decreases quickly what the value of the bear call spread will be worth. For example, if a bear call spread had a net delta of 0.20, and the share price decreased by $1.00, the bear call spread would have decreased by 20 cents.
The volatility affect on a bear call spread is varied. When looking to enter a bear call spread you look to sell an out-of-the-money call option. The idea is to sell a call which has a relatively high volatility and therefore trading above its theoretical value. The bear call spread can be traded when volatility is high on the call option which allows the spread to be higher above the current share price so the stock would have to increase further before affecting the trade.
Credit spreads are trades that take advantage of the time decay nature of options. The effect or time decay is a positive for this trade. When the share price is below the sold call if the share price and volatility remain constant this value of the position will reduce and therefore increase your profit. If the stock price is closer to the lower strike price of the sold call, profits generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the higher strike price of the bought call, profits generally decrease at a faster rate as time passes.
To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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Posted on March 9th, 2010 admin No Comments
It is essential to understand the option pay-off diagram for the option strategy you are trading. It allows you to know to determine at what share price you achieve maximum profit, maximum loss and breakeven level at expiry. The bear call spread is made up of a sold call option and a bought call option at a higher strike. When combined it creates a bear call spread. See below for how the bear call option pay-off diagram is constructed. The dotted green line is the sold call and the dashed green line represents the bought call.
Sold Call
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Bought Call
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To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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Posted on March 8th, 2010 admin No Comments
Advantages of Bear Call Spread
Disadvantages of Bear Call Spread
To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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Posted on March 5th, 2010 admin No Comments
There are a number of advantaged of implementing the bear put spread instead of buying a put option. A bear put spread has lower risk than strictly buying put options, but limited profit potential. The bear put spread also has a higher breakeven so the share price does not have to fall as far as a bought put option. The advantages of a bear put spread over a bought put is that the strategy reduces time decay and volatility influence on the strategy pricing. This is because we are selling the out-of-the-money options therefore that option benefits from time decay and volatility reducing the opposite characteristic to a bought call option. Bear put spread can be used when volatility is high and buying a put is too expensive as it eliminates the risk of volatility decreasing. Another reason to trade bear puts is that you might have identified a support level; you can sell the out-of-the-money options at that level to reduce the cost and that will be the maximum profit level at expiry. The main benefit to just buying options is large potential profits and a better delta meaning easier to exit the trade earlier. Also if you are expecting volatility to increase significantly a bought positions will improve as a bear put spread would not.
To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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Posted on February 26th, 2010 admin No Comments
There are a number of advantaged of implementing the bull call spread instead of buying a call. A bull call spread has lower risk than strictly buying call options, but limited profit potential. The advantages of a bull call spread over a bought call is that the strategy reduces time decay and volatility influence on the strategy pricing. This is because we are selling the out-of-the-money options therefore that option benefits from time decay and volatility reducing the opposite characteristic to a bought call. If a bought call is too expensive due to the high volatility then the bull call spread is a good strategy so the trade does not cost too much to enter and there is still a high percentage return possible. Another reason to trade bull calls is that you might have identified a resistance level; you can sell the out-of-the-money options at that level to reduce the cost and that will be the maximum profit level at expiry. The main benefit to just buying options is unlimited profit and a better delta meaning easier to exit the trade earlier.
To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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Posted on February 25th, 2010 admin No Comments
It is essential to understand the option pay-off diagram for the option strategy you are trading. It allows you to know to determine at what share price you achieve maximum profit, maximum loss and break even level at expiry. The bull call spread is made up of a bought call option and a sold call option at a higher strike. When combined it creates a bull call spread. See below for how the bull call option pay-off diagram is constructed. The dotted green line is the sold call and the dashed green line represents the bought call
Bought Call
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Sold Call
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Posted on February 23rd, 2010 admin No Comments
A bull call spread is used when a moderate rise in the price of the underlying share is expected. It is achieved by simultaneously purchasing call options at a specific strike price while also selling the same number of calls of the same asset and expiration date but at a higher strike. A bull call spread is also a technique to buy call options at a discount. Because you sell an out-of-the-money call option in this option strategy, it effectively reduces your investment on your bought call options. This reduces upfront payment and therefore the risk of the position.
Maximum profit is achieved when the share price is above the sold call at expiry. The maximum profit in this strategy is the difference between the strike prices of the bought and sold options, less the net cost of options.
If the stock price decreases below the bought call option at the expiration date, then the investor has a maximum loss of the net debit. The net debit is the premium received for selling the out-of-the-money call option minus the cost associated to purchase the call option.
The breakeven is lower with the bull call spread then buying a call option. The breakeven point is the strike price of the bought call plus the net debit paid.
To receive ASX Option Recommendations or to learn more about Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread Strategies please request the Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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Posted on February 18th, 2010 admin No Comments
Buy 1 contract BHP May 3000 Call option @ 230 cents
This option gives you the right to buy 1000 BHP Billiton Limited (BHP) shares for $30.00 each, on or before the expiry date in May. If BHP rises strongly above $30.00 by expiry of the option, you have locked in a lower buying price for the shares.
As the buyer of the option, you have a choice as to whether you want to exercise and buy the 1000 BHP shares or if you just want to sell the option.
For example, if you are right in your assumption, and BHP rises to above $30.00 over this time, you have locked in a lower buying price for the 1000 BHP shares at $30.00. You could elect to exercise your option and buy the shares, paying the full face value of $30.00 per share plus other fees and transaction costs that might be applicable. Also, the option premium you paid at the start for this option would be added onto the $30.00 purchase price, so the break-even on this trade will be increased by this amount.
Alternatively, if you decide that you don’t want to buy the shares, perhaps you were interested only in participating in the increase in BHP’s share price; you could sell the option and profit from the increase in premium.
Worst case scenario, should BHP fall below $30.00 over this time, your option would lose value. If BHP is below $30.00 at expiry, the option would expire worthless. Should you now want to purchase the shares, you could buy them at a lower price in the market. Even though the initial premium paid might be lost, the decreased purchase price of the shares will at least partially offset this.
To receive ASX Option Recommendations or to learn more about trading options please request the complete Introduction to Options Trading eBook by contacting us on 1300 368 316 or info@totaloptions.com.au
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