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 1300 368 316 or info@totaloptions.com.au

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Bought Call Option Trade Example

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.

Trade Summary

  • Exposure 1000 shares
  • Initial Investment = $2,300
  • Max Loss = $2,300
  • Breakeven = $32.30
  • Max Profit = Unlimited


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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Bought Call Option

Posted on February 18th, 2010 admin No Comments

A bought call option purchase is also known as a long call option, which is a bullish or very bullish position. It gives the holder the right, but not the obligation, to buy the underlying asset at the exercise price 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. The bought call strategy benefits from an increase in the price of the underlying asset.

Buying calls is a bullish strategy that can be used as an alternative to the outright purchase of the underlying asset, giving you the benefits of limited risk and increased leverage. To profit from bought calls you are looking for a break out with a very bullish move. One way to identify this move is by using technical analysis.

If a call is in-the-money you can exercise your right to buy the shares at the strike price. The reason for exercising would be to hold the shares instead of closing the option and locking in the intrinsic value at expiry. Most option holders will close the position instead of exercising their right to buy the shares. An alternative strategy for buying shares is to sell put options.

Summary:

Market Outlook Bullish
Risk Premium Paid
Potential Reward Unlimited
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 1300 368 316 or info@totaloptions.com.au

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Introduction to Options Trading: Option Vega

Posted on February 18th, 2010 admin No Comments

Options trading revolves around the understanding of volatility. Vega refers to the change in the prevailing level of option volatility. When volatility is low and you expect a move in a share price it is best to buy options to take advantage of this move. When volatility is high and you expect it to decrease selling options best suits this market. The advanced traders sell options in periods of high volatility and buy options in periods of low volatility.

Volatility and time have a strong relationship. The graph below indicates that the more time to expiry the greater the uncertainty. Therefore increased time means increased volatility.

The volatility smile is a long-observed pattern in which at-the-money options tend to have lower implied volatility than other options. The pattern displays different characteristics for different markets and results from the probability of extreme moves. The reasons for the volatility smile are due to behavioural causes. These include crash protection which is the buying of out-of-the-money puts for fear of a market crash. Also, expectation of changes in volatility over time can affect the options prices. Technical analysis also explains increased activity in out-of-the-money options with support/resistance levels at various strikes being traded more actively. The vega of at-the-money options is relatively insensitive to change in volatility compared to out-of-the-money see below.


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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Introduction to Options Trading: Theta

Posted on February 18th, 2010 admin No Comments

Theta is the ratio of the change in an option price as the expiry date approaches. An option value declines over time if the share price stays still. As an option approaches its expiry date without being in-the-money, its time value declines since the probability of that option being profitable (in-the-money) is reduced. If time decay works against buyers of options, then it stands to reason that it must be working in favour of option writers (sellers). To mitigate the effect of time decay you can trade place option spreads where you sell against a bought position. (More detail in Bull Call & Bear Put Spreads Seminar)

Time decay of an option accelerates as it approaches expiry see the below chart. In particular, notice how in the last 30 days before the expiry of the option the time decay is most rapid. This means that an option will lose more time value in the last 30 days before expiry than at any other time during the life of the option.

Buying out-of-the-money options (a long way from the current market price) with less than 30 days to expiry will require substantial moves in the underlying market in order to become profitable. Most times these out-of-the-money-options will expire worthless. Look to take advantage of this fact by writing (selling) these options as part of an overall strategy when time decay is most pronounced.


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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Option Trading: Dividends

Posted on February 17th, 2010 admin No Comments

Dividends can have a significant affect on option premiums. When dividends increase it causes call option premiums to decrease in value and put option premiums to increase in value. Basically call option premiums have an inverse relationship to dividends. When a share goes ex-dividend the share price decreases accordingly by the amount of the dividend. This price movement is priced into the options value so it is very hard to profit from buying puts before the dividend unless you expect the share price to fall more than the dividend 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 1300 368 316 or info@totaloptions.com.au

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Option Trading: Stock Analysis

Posted on February 17th, 2010 admin No Comments

Technical Analysis is the ability to forecast the future direction of share prices through the study of past market data, primarily price and volume. Technical analysis is more of a visual analysis which allows the identification of key levels of support and resistance. Basic technical analysis teaches you to identify trends, momentum, reversal, support and resistance. It is essential to ensure your technical analysis suits your options strategy. For example if your technical analysis indicates a short-term price movement, it is important that your options strategy best suits the short-term price movement.

Fundamental Analysis is the analysing of a company’s financial statements, its management and competitive advantages, and its competitors and markets. This analysis is based on historical data and can be a lagging indictor regarding the company’s current financial situation. When placing a trade it is important to check ex–dividend dates and company announcements. These announcements may result in unexpected share price moves.


To receive 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

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Option Trading: Delta

Posted on February 17th, 2010 admin No Comments

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

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Option Greeks

Posted on February 16th, 2010 admin No Comments

The “Greeks” in options trading is known as a way to measure the sensitivity of an option price to changes in its parameters. The Greeks can help option traders to better understand the potential risk and reward of an option position. However, it is important to note that the numbers given for each of the Greeks are strictly theoretical, as they are only projections based on mathematical models.

  • Delta: is a measure of the change in the option price resulting from a change in the underlying stock price.
  • Gamma: is a measure the rate of change of delta due to a one-point change in the price of the underlying stock.
  • Theta: is a measure of the rate of decline of an option’s time value resulting from the passage of time known as time decay.
  • Vega: is a measure of the sensitivity of an option’s price to changes in Implied Volatility (IV).
  • Rho: is a measure of the change in an option’s price due to a change in interest rate. If interest rates increase this will mean that the call options value increases and the put options value decreases.


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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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 1300 368 316 or info@totaloptions.com.au

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