Sold Put Option

Posted on February 22nd, 2010 admin No Comments

Writing a put represents a short put option, which is a slightly bullish or neutral position. This strategy entails writing (selling) the put option with an obligation to buy a fixed number or amount of the underlying asset from the holder at a fixed price on or before a specific period of time. The trader or investor who executes this strategy is called the writer. The risk inherent of naked put writing can be extremely high and always carries margin requirements.

The reward in this strategy is limited to the option premium received for selling the put option. The risk is unlimited. Writing puts is used if you are bullish on the underlying asset, and is used basically to collect the premium when a trader or investor feels strongly that the put option contract will expire worthless, or will be worth less than the premium received.

Selling put options can be an alternative to buying shares. For example rather than buy 1000 BHP at the current share price $30.00, you can sell at-the-money puts expiring in a month and receive $1.50 ($1500). This means your break even price on the shares is $28.50. You have basically sold insurance so if the share increases you get to keep the $1500 and sell another put option. If the share decreases you have bought the share at $28.50 instead of $30.00 anyway. There are many more variables to take into account regarding this strategy which will be discussed later in the course under income strategy. Please contact me in the meantime if you wish to discuss trading this strategy.

Summary:

Market Outlook Neutral/Bullish
Risk Limited to strike price less premium
Potential Reward Premium Received
Premium Received at purchase, margin required
Time Decay (Theta) Positive
Volatility (Vega) Negative


To receive The ASX Options Recommendation 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

Bought Put Option Example:

Posted on February 19th, 2010 admin No Comments

Buy 1 contract CBA May 2500 Put option @ 180 cents

This option gives you the right to sell 1000 CBA shares for $25.00 each, on or before the expiry date in May. If CBA decreases strongly below $25.00 by expiry of the option, you have locked in a higher selling price for the shares.

As the buyer of the option, you have a choice as to whether you want to exercise and sell the 1000 CBA shares or if you just want to sell the option.

For example, if you are right in your assumption, and CBA falls to below $25.00 over this time, you have locked in a higher selling price for the 1000 CBA shares at $25.00. You could elect to exercise your option and sell the shares, receiving the full face value of $25.00 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 deducted from the $25.00 selling price, so the break-even on this trade will be decreased by this amount.

Alternatively, if you decide that you don’t want to sell the shares, perhaps you were interested only in participating in the decrease in CBA’s share price; you could sell the option and profit from the increase in premium.

Worst case scenario, should CBA increase above $25.00 over this time, your option would lose value. If CBA is above $25.00 at expiry, the option would expire worthless. Should you now want to sell the shares, you could sell them at a higher price in the market. Even though the initial premium paid might be lost, the increased sale price of the shares will at least partially offset this.

Trade Summary

 

Exposure 1000 shares

Initial Investment = $1,800

Max Loss = $1,800

Breakeven = $23.20

Max Profit = $23,200

 


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 07 5504 2244 or info@totaloptions.com.au

Option Trading: Delta

Posted on February 17th, 2010 admin 1 Comment

Delta is the amount an option price will move either up or down for a given change in the underlying share price. A deep out-of-the-money call option has a delta of 0, while an at-the-money call has a delta of approximately 0.5 and a deep in-the-money call has a delta of 1. This is the same with a put option but the values are negative.

This diagram shows that as the bought call option moves to at-the-money the delta accelerates compared to when the option is deep in or out of the money.

For example if I had a bought call option with a delta of 0.6, for every $1 increase in share price the option premium should increase approximately 60 cents. This is a guide only as the delta is not constant; it varies when the share price moves as demonstrated above.


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

Options Pricing

Posted on February 16th, 2010 admin No Comments

Trading options requires an understanding of all factors that can affect the option premium. Many factors impact the value of an option premium. The option premium is made up of intrinsic value and time value. Time value includes factors such as volatility, days to expiration, and interest rates. As the option approaches its expiration date the time value component of the option premium decreases. Intrinsic value is the portion of the premium equal to the amount an option is in-the-money. For instance if a call option costs $2.40 and it is $1.00 in-the- money the time value is the $1.40 and intrinsic value is the $1.00. At-the-money options have no intrinsic value and the premium is equal to the time value.


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 07 5504 2244 or info@totaloptions.com.au

Why Trade Options?

Posted on February 15th, 2010 admin No Comments

Why Trade Options?

Leverage

Options are an investment product used for its leveraged nature. Many traders turn to options because they can start investing with just a fraction of the money that would be required to trade the underlying asset. Trading in options can allow you to benefit from a change in the price of the share without having to pay the full price of the share. The option premium you initially pay is your maximum risk. A bought call option also has potential unlimited returns. The risk vs. reward characteristic of buying options is the primary reason traders use options.

Flexibility

Options can be used for a number of different objectives. Portfolio managers use options to insure or hedge their portfolios. Traders use options to take advantage of market conditions that can not be traded with just the underlying share. If you can accurately analyse the direction of the underlying share, there is an option strategy that you can use to make a profit. These strategies can profit whether the underlying shares goes up, down or sideways. This is exactly what this seminar series will teach and is the reason I trade options.

Share Portfolio Management

Options can allow you to build and manage a diversified share portfolio. You can use options to either buy or sell shares. If a sold put is exercised you are obligated to buy shares. Additional income can be generated by selling calls. If a sold call is exercised you are obligated to sell the shares at the exercise price. Options can also be used as a form of risk management. Bought put options allow you to hedge against a possible fall in the value of shares you hold. This can be considered similar to taking out insurance against a fall in the share price.


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 07 5504 2244 or info@totaloptions.com.au

Options Pay-off Diagram

Posted on February 12th, 2010 admin No Comments

Pay-off diagrams are essential to demonstrate how the different strategies alter the profit and loss diagrams. The profit and loss is shown on the y-axis and the share price on x-axis. Below is an example of a call option, it shows that as the share price increases the profit also increases. An option can be in-the-money, at-the-money or out-of-the-money. A bought call option is deemed in-the-money when the share price is greater than the strike price (C). In-the-money options have the most expensive option premium. An option is at-the-money when the strike price is the same as the share price (B). An option is out-of-the-money when the strike price is greater than the share price (A). Out-of-the-money options are the cheapest and hold the least option premium.

Figure 1 – Option Pay-off Diagram

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 07 5504 2244 or info@totaloptions.com.au

Option Contract Specifications

Posted on February 12th, 2010 admin No Comments

Contracts

The Australian Exchange Traded Options (ETO) usually have 1000 share per contract. Some shares can have a different contract size for instance 1060. This may be due to a corporate action such as a stock split or consolidation. Option contracts also vary depending on the different national exchanges, for example options in the USA have 100 shares per contract. Similarly the contract size changes for different types of assets, for instance gold future options are based on the number of ounces per contract.

Expiration

The ETO options expiration date is usually the last Thursday of every month. Index options expiry is usually the second last Thursday of every month. When placing an options trade you should always confirm the expiration date.

Strike Price

The strike price is the price at which you have the right to buy the underlying shares. Most traders would not exercise the option because they could sell their option for the same gross profit but with less transaction costs, therefore greater net profit. Also if you close the position before expiry there will also be some time value in the option and therefore greater profit than at expiry. However, if using options to manage your share portfolio you may want to buy/sell the stock at the strike price.

Option Premium

The premium is the price of an option.

Option Type

There are two types of options: American style options and European style options. American options can be exercised anytime until expiry. All options on the ASX that are on shares are American style options. European options can only be exercised at expiry and these are the index options (e.g. XJO options).

Exercises

When an option is exercised they are settled with physical delivery of the underlying asset. For example Australian ETOs are settled by physical delivery of shares. Whereas, index options are settled by physical delivery of cash. This is because it is unable to take physical delivery of the index. To take delivery of the index you would have to buy every share in the index which is not realistically possible or cost effective.

Example:

Buy 2 contracts BHP Mar 2009 3000 Calls @ 120

• “Buy” determines it is a bought option

• “2 contracts” means exposure to 2000 shares

• “BHP” is the underlying asset

• “March 2009” is the expiration date of the option

• “3000” refers to 3000 cents or $30.00 which is the strike price

• “Calls” determines it is a call option

• “120” refers to 120 cents or $1.20 which is the premium to buy this option. So the person would have paid 2000 multiplied by $1.20 = $2,400 for this option.


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 07 5504 2244 or info@totaloptions.com.au

What is an option?

Posted on February 12th, 2010 admin No Comments

An option is an agreement, or a contract, between two people: the buyer and the seller. There are two types of options: calls and puts. A call option is the right to buy and a put option is the right to sell a specific item (the underlying asset), at a specific price (the strike price), for a specific time (until expiration).You must pay an option premium when buying an option. However, when you sell an option you receive this premium.

Bought Calls

After you have paid the option premium you then have the right, as a call owner, to buy the underlying shares by paying the strike price. However, there is no obligation to do so. If the bought call owner does choose to exercise this right, then they are said to have exercised the option.

Bought Puts

After you have paid the option premium you then have the right, as a put owner, to sell the underlying shares by receiving the strike price. Again, there is no obligation to do so. If the bought put owner does choose to exercise this right, then they are said to have exercised the option.

Sold Calls

A call seller will initially receive the option premium, however has no control over when, or if, the call owner exercises the option. If the call owner exercises the option the call seller is obligated to sell the underlying shares at the strike price and is said to have been exercised.

Sold Puts

A put seller will initially receive the option premium, however has no control over when, or if, the put owner exercises the option. If the put owner exercises the option the put seller is obligated to buy the underlying asset at the strike price and is said to have been exercised.


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 07 5504 2244 or info@totaloptions.com.au

Covered Calls – Trade Analysis Checklist

Posted on February 11th, 2010 admin No Comments

I always go through my checklist before placing any trade. The checklist I have for covered calls is:

1. High Option Volatility

2. What month option to sell

3. What strike price to sell

4. If exercised what is my profit

5. What is the breakeven of the share purchase and option premium received


To receive ASX Option Recommendations or to learn more about The Covered Call or The Buy – Write Option Strategies please request the Covered Calls eBook by contacting us on 07 5504 2244 or info@totaloptions.com.au

Covered Calls – Exercise Price

Posted on February 10th, 2010 admin No Comments

There are a number of factors to take into account when deciding which exercise price to sell the call option. Firstly determine what your breakeven is on the share. The breakeven is the purchase price less the entire option premium received. Make sure the strike price you select is above the breakeven price.


To learn more about The Covered Call or The Buy – Write Option Strategies please request the Covered Calls eBook by contacting us on 1300 368 316 or info@totaloptions.com.au