Bear Put Spread: Strategy Risks

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It is important to always be aware of the strategy risks. The main risk to be aware when trading bear put spreads is there is a potential to lose all of money invested. Time decay is a risk if the share price stays still as the sold put option does not totally eliminate the risk of time decay. Also if the share price move happens too quickly the bear put spread may only have a small profit because the volatility would have increased in the out-of-the-money option, meaning it would be expensive to buy back to close out the trade.


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

Bear Put Spread: Identifying Trades – The Greeks

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Delta

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 put spread. The net delta is calculated by the delta of the bought put option minus the delta of the sold put option. The net delta of a bear put spread is always negative. The net delta indicates if the share price decreases quickly what the value of the bear put spread will be worth. For example, if a bear put spread had a net delta of -0.30, and the share price decreased by $2.00, the bear put spread would have increased by 60 cents.

Vega

The volatility affect on a bear put spread is varied. When looking to enter a bear put spread you look to buy an at-the-money put option. The idea is to buy a put which has a relatively low volatility and therefore trading at its theoretical value. The sold put is sold out-of-the-money and the aim to sell puts with higher volatility so you receive a larger premium. The strategy can be traded with high volatility as the volatility does not affect this trade as much as buying a put option. This is because the high volatility is priced into both the bought and sold call options.

Theta

The effect of time decay on this strategy varies with the underlying stock’s price level in relation to the strike prices of the bought and sold options. If the stock price is midway between the strike prices, the effect can be minimal. If the share price is closer to the higher strike price of the bought put, losses generally increase at a faster rate as time passes. Alternatively, if the share price is closer to the lower strike price of the sold put, profits generally increase 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

Bull Call Spread vs. Bought Call

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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

Bull Call Spread: Identifying Trades – The Greeks

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Delta

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 bull call spread. The net delta is calculated by the delta of the bought option minus the delta of the sold option. The net delta of a bull call spread will always be positive. The net delta indicates if the share price increases quickly what the value of the bull call spread will be worth. For example, if a bull call spread had a net delta of 0.35, and the share price increased by $1.00, the bull call spread would have increased approximately by 35 cents.

Vega

The volatility affect on a bull call spread is varied. When looking to enter a bull call spread you look to buy an at-the-money call option. The idea is to buy a call which has a relatively low volatility and therefore trading at its theoretical value. The sold call which you are selling out-of-the-money you are looking for as much volatility as possible. So you are selecting an option that is trading a lot higher than theoretical value. This means you receive greater premium for that option and it makes the bull call spread cheaper to enter. A bought call is best purchased when volatility is low but when volatility is high and the call is too expensive a bull call spread is an alternative strategy. This is because the higher volatility on the bought option is offset by the high volatility on the sold option.

Theta

The effect of time decay on this strategy varies with the underlying stock’s price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal. If the stock price is closer to the lower strike price of the bought call, losses generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the higher strike price of the sold call, profits generally increase 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

Bull Call Spread: Strategy Risk

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It is important to always be aware of the strategy risks. The main risk to be aware when trading bull call spreads is there is a potential to lose all of money invested. Time decay is a risk if the share price stays still as the sold call option does not totally eliminate the risk of time decay. Also if the share price move happens too quickly the bull call spread may only have a small profit because the volatility would have increased in the out-of-the-money option, meaning it would be expensive to buy back to close out the trade.


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 07 5504 2244 or info@totaloptions.com.au

Introduction to Option Trading: Combination Trades

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Introduction to Option Trading

These basic option positions when combined create option combination orders. These can be created via buying and selling options either put options or call options. Each of the following seminars and e-books will cover one combination strategy in more detail.

Summary

When buying options look to take advantage of their leveraged nature to allow large return with small capital outlay. When selling options look to sell when volatility is high and expected to decrease to help use time decay in your favour.

The information in this e-book is designed so the following Total Option Education Webinars and eBooks will build on this knowledge. The strategies in this book are used by traders everyday however they are normally used together to try and mitigate risks like time decay and volatility.


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

Selection Criteria – Selling Options

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When selling options, there are a number of variables to take into consideration. When you enter a sold call option your outlook needs to be that the share price will stay still or fall. Conversely, when you enter a sold put option your outlook needs to be that the share price will stay still or increase. Your objective is to sell time and you profit from your positions time decay. Also you can sell options when the volatility is high and expected to decrease throughout the trade. Your risk profile will determine whether you sell out-of-the-money calls for lower returns and lower risk at-the-money calls to receive more premiums with higher risk of exercise. Before placing any trade you must make sure there is enough open interest and volume through the options so liquidity is not an issue.


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

Selection Criteria – Buying Options

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When buying call options and put options it is critical to have good timing. When buying call options you don’t only need the stock to increase in value you need it to do so before the time decay in the option starts to affect the option value. Selecting the entry point (timing) of the trade can be assisted through technical and fundamental analysis. You can use technical analysis to identify break-out patterns to trade through buying calls or puts. It is important to make sure you buy enough time for expected movements. Also to make sure you buy your option at a reasonable price, you must analyse the volatility and make sure you are buying when volatility is low and expected to increase. Always make sure the option has enough open interest so liquidity is not an issue. If you stick to the blue chips this should not be an issue. Buying out-of-the-money calls is higher risk but potentially has large percentage returns. However, buying at-the-money calls has a higher delta but costs more so percentage returns are smaller.


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 Call Option

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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 07 5504 2244 or info@totaloptions.com.au

Introduction to Options Trading: Option Vega

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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 07 5504 2244 or info@totaloptions.com.au