Bear Call Spread: Strategy Risks

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.

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

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

Bought Put Option

Posted on February 19th, 2010 admin No Comments

A bought put is a long put, which is a bearish or very bearish position. It gives the holder the right, but not the obligation, to sell the underlying asset at a fixed price or amount on or before a specific period of time. The risk for the holder is limited to the premium paid for the option. The reward is unlimited to an underlying price of 0. The Put purchase strategy benefits from a decrease in the price of the underlying asset.

Put purchases are used if you are bearish on the underlying asset. They can be used as an alternative to shorting (or selling) the underlying asset. A bought put can also be used to protect a currently held position with the underlying asset by locking in a selling price (via the strike price).

Buying a put can be used to hedge or protect existing shares. This can be seen as a form of insurance. You can protect your shares at any level but just like insurance the more you pay for the put the higher your protection. So you can work out if you want to risk 5% of your portfolio and hedge out the remaining position. This is the most important role of a bought put as it can be used as a form of protecting capital and is essential to Self Managed Super. This strategy will be discussed later in the course under protected equity. Please contact me in the meantime if you wish to discuss trading this strategy.

Summary:

Market Outlook Bearish
Risk Premium Paid
Potential Reward Limited to strike price less premium paid
Premium Paid at purchase, no margin calls
Time Decay (Theta) Negative
Volatility (Vega) Positive


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

Bull Put Spread Recommendation: Suncorp-Metway (SUN)

Posted on February 15th, 2010 admin 1 Comment

This trade is a bull put spread trade on SUN. This trade is for the short-term option traders not wanting to purchase the SUN shares but profit from the time decay of the sold puts. This trade is set up to receive maximum profit if SUN is above $8.82 at February expiry. This trade should profit from Suncorp strengthening into the ex-dividend date and this trade will expiry before the ex-dividend date in 2010.

Trade

  • Sell 25 contracts SUN February $8.82 Put Options @ 15 cents
  • Buy 25 contracts SUN February $8.57 Puts Options @ 8.5 cents

Shares per contract = 1020

Net Credit 7.5 cents

Trade Summary

Maximum Profit = $1,912.50

Maximum Loss = $4462.50

Breakeven = $8.745

Return on Risk = 42.86%

Dividend

Suncorp is announcing their First Half Profit Announcement on the 24th February 2010. On this day they will confirm the Dividend amount and when SUN will go ex-dividend. Without knowing with certainty the dividend amount and the date we can use last year’s details as an approximation. Last year SUN went exercise 27th February for 20 cents. If this is relatively accurate this tells us that our position will expire before the ex-dividend date. 20 cents dividend is also a 2.2% yield which makes it highly attractive and should keep SUN strong until after the ex-dividend date.

Chart

Daily Chart:

  • Short-term uptrend
  • Buy on Stochastic

Weekly Chart:

• SUN is in a medium term uptrend and still a buy on the stochastic.


To receive ASX Option Recommendations or to learn more about Bull Put Spreads please request the complete Option Spreads eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Options vs. CFDs

Posted on February 15th, 2010 admin No Comments

Options vs CFDs

There are a number of factors to take into account when trading options. Trading options is less risky than trading Contracts For Difference (CFD’s) as your risk (maximum loss) is known when entering a trade and you have the same upside potential. It is possible to trade options on overseas index, US shares, futures and foreign exchange. Options allow you to trade directional and non-directional strategies and allow flexibility in your trading. There are only ETO’s on a limited number of ASX stock which can be a good thing as all stock that are covered are blue chips which provide greater liquidity. An example of options flexibility is that we have been able to buy puts while short selling has been banned and affected CFD traders. With options, we can also set up a synthetic short – buy a call option and sell a put option at the money. Synthetics shorts are not covered in this course but you can email me for more information on this topic.

CFD trading has a number of advantages and disadvantages. With CFD’s you can place a stop loss but there is a risk of gapping. Gapping refers to when a stock closes in the afternoon and opens the next day at a price that is lower than your stop loss. This is common when there is a particularly big overnight move in the US. When trading CFD’s there is no expiry date, instead an interest expense is incurred over time. An advantage is there are CFD’s on smaller stocks which may not be traded on options at all. Day trading CFD’s minimises the risk of gapping to a certain degree. The main risk with day trading is intra-day trading halts due to company announcements but it does eliminate the risk of overnight movements.


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

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

Introduction to Options Trading eBook

Posted on February 11th, 2010 admin No Comments

The Introduction to Options Trading eBook is designed to give you a comprehensive introduction to options trading. The objective is to teach the principals of options trading which are essential if you wish to manage your share portfolio more effectively or trade the more exotic option strategies that advanced traders implement.

The information is designed to demonstrate how trading options works in real life rather than a text book. This is done by using real trade examples and simplified text book explanations to improve you’re trading. The aim of the course is to teach you the required skills to analyse the market and decide what option strategy best suits your market outlook. This will give you the flexibility to adapt to the ever changing market conditions and increase profitability of your trading plan.


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

The Income Strategy Recommendation: Santos Ltd (STO)

Posted on February 10th, 2010 admin 1 Comment

The Income Strategy is an extremely powerful portfolio strategy that incorporates a combination of Stock and Options. It is designed to produce a consistent monthly income while providing capital protection for the portfolio.

The Income Strategy is very popular with Self Managed Super Fund (SMSF) and longer term wealth building individuals.

This is an Income Strategy Recommendation for investors looking to buy STO shares at a discount to market. The recommended trade is to sell put options on STO with the intent to purchase the shares. This recommendation is designed for investor looking to generate monthly income with capital protection. If you do not wish to own the shares we will send out a STO Bull Put Spread designed for short-term traders.

Trade

  • Sell 3 contracts STO September $15.55 Puts   @ 50 cents 
  • Buy 3 contracts STO September $13.67 Puts   @ 5 cents 

Shares per contract = 1061

Net Credit 45 cents

Trade Summary

Maximum Profit – $1432.35

Maximum Loss – $4551.69

Breakeven – $15.10

Return on Share Value – 3.01%

Annualised Return on Share Value – 36.12%

Return on Risk (ROR) -31.47

STO Daily Chart

 

 

To speak with a Total Options Advisor or receive ASX Option Recommendations please contact us on 07 5504 2244 or info@totaloptions.com.au