Option Income TradesActive Trend Trading: Dennis W. Wilborn
“Observe things how they are;
See things how they can be!”
Disclaimer
Copyright ATTS 2007-2017
• U.S. Government Required Disclaimer – Commodity Futures Trading Commission Futures
and Options trading has large potential rewards, but also large potential risk. You must be aware
of the risks and be willing to accept them in order to invest in the futures and options markets.
•
Don’t trade with money you can’t afford to lose. This is neither a solicitation nor an offer to
Buy/Sell stocks, futures or options. No representation is being made that any account will or is
likely to achieve profits or losses similar to those discussed in this training. The past performance of
any trading system or methodology is not necessarily indicative of future results.
• CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN
LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT
REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE
RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN
MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN
GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF
HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY
TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
• All Materials presented are for training purposes only . Traders should paper trade any new
method prior to risk of personal capital.
- Founder & Lead Technical Analyst for Active Trend Trading - Certified Candlestick Technician- Affiliate of Market Technician Associations- Guest Speaker on IBD How to Make Money in Stocks Radio Show- Highlighted in the book “How to Make Money in Stocks-Success Stories”- Publish “Art & Science of Active Trend Trading—Trader’s Report” Weekly- Host “How to Make Money Trading Stocks Show” Weekly- Systems Researcher- Former Forbes Contributor
- Retired US Navy, Commander- Civil Engineer- Adjunct Professor MBA Program Chaminade University, Oahu, Hawaii- Started Trading in 1989- Started Trading For a Living in 2006
- Research Colleague Mike Trager, Dallas, Texas
Our Motto: Clarify, Simplify & Multiply
Copyright ATTS 2007-2017
How it was & How it is…
Options are a contracts with rights and obligations. Options introduce additional variables in the trade. Options can expire worthless. Some strategies they call “High Probability” will break your account!
How it was—Monthly Covered Calls, Monthly Spreads and Monthly Naked Positions
- Traders would tend to give credit positions a lot of room for breathing during the 2-6 weeks the position was open. Target return 1-3% per month.
How it is—Weekly Covered Calls, Spreads and Naked Positions
- Traders provided greater flexibility because risk is reduced due to shorter hold period. Target return 0.7 – 1.5% per week.
Copyright ATTS 2007-2017
Option Income Trades
Market timing
Copyright ATTS 2007-2017
1. Covered Calls: Own the stock or ETF. Sell monthly or weekly option premium against the long position.
• If stock or ETF is rising quickly limits potential gains!
• If Option exercised, the stock/ETF is take away!
• Selling too far out of the money provides small downside protection!
How it works: TQQQ bought at 85.50, when price of ETF is at 87.75 sell the 28Apr 88C for 1.60
If position is called away we earn $88 – 85.50 = $2.50 + $1.60 for a total gain of $4.10
One week return of 4.10/85.50 = 4.79%
If position closes the week below $88 we keep the $1.60 or 1.60/85.50 = 1.87% for the week. This reduces the cost basis of the position by 1.60
If position drops below $85.50, it stays profitable if it remains above 85.50 – 1.60 = $83.90
Drawbacks = Requires $8550 investment to earn $160 for the week.
If we do this for the month the return would be 7.48%
Option Income Trades
Market timing
Copyright ATTS 2007-2017
1. Spreads - Many Types but the most popular and easiest to understand is the Vertical Spread.
• Same Expiration but different Strike Prices
• Can be either Credit or Debit Spreads
• Debit Spread can be done in the direction of the trend and caps loss at cost of spread
• Credit Spread can be done in direction of the trend, selling put spread in an uptrend
2. Pros & Cons • 3 out of 4 moves can be profitable. Position will either not move, move for you, move
slightly against you or move against you
• The further out of the money the higher the probability of closing worthless, but if it goes against you represents the largest loss potential. Some do exotic option positions that are complicated and then repair the position if it goes against them—but!
• Paper Trade, Paper Trade, Paper Trade
Option Income Trades
Market timing
Copyright ATTS 2007-2017
1. Spreads - Many Types but the most popular and easiest to understand is the Vertical Spread.
TSLA at 305 with expectation it will fall or that its at strong resistance
• Sell a Call Spread or Buy a Put Spread that expires 28Apr
• Sell the Call Spread: How Far Out of the Money - ATM• 28Apr 305 x 310 Call spread = Credit of 2.20 per contract pair or $220 for the week
• Risk is capped at $5 – 2.20 = 2.80 or $280
• Greatly reduces capital needed to do covered calls. To own 100 shares of TSLA would cost $30,000, the spread $280
• Buy a Put Spread: How Far out of the Money - ATM • 28Apri 305 x 310 Put Spread = Debit of 2.80 per contract pair or $280 max loss for week
• Must close below 305 to be profitable. Max Profit $2.20
Option Income Trades
Market timing
Copyright ATTS 2007-2017
1. Spreads - Many Types but the most popular and easiest to understand is the Vertical Spread.
TSLA at 305 with expectation it will fall or that its at strong resistance
• Sell a Call Spread or Buy a Put Spread that expires 28Apr
• Sell the Call Spread: How Far Out of the Money – 1 Strike OTM• 28Apr 307.5 x 312.5 Call spread = Credit of 1.79 per contract pair or $179 for the week
• Risk is capped at $5 – 1.79 = 3.21 or $321
• Greatly reduces capital needed to do covered calls. To own 100 shares of TSLA would cost $30,000, the spread $321
• Buy a Put Spread: How Far out of the Money – 1 Strike OTM• 28Apri 307.5 x 312.5 Put Spread = Debit of 3.11 per contract pair or $311 max loss for
week
• Must close below 307.5 to be profitable. Max Profit $1.89
Option Income Trades
Market timing
TSLA at 305 with expectation it will fall or that its at strong resistance go out of the money on Strike and reduce the spread
• Sell the Call Spread: One Strike OTM w/Reduced Spread• 28Apr 307.5 x 310 Call spread = Credit of 1.00 per contract pair or $100 for the week
• Risk is capped at $2.5– 1 = 1.50 or $150
• Must close below 307.5 for max profit of $1.00
• Buy a Put Spread: One Strike OTM w/Reduced Spread• 28Apr 307.5 x 310 Put Spread = Debit of 1.50 per contract pair or $150 max loss for
week
• Must close below 307.5 to be profitable. Max Profit $1.00
If the Stock or ETF is expected to move up, just reverse the above.
Copyright ATTS 2007-2017
Option Income Trades
Market timing
Copyright ATTS 2007-2017
Other considerations:
1. Assure the underlying has liquid weekly options
2. Exit Strategy to pull out partial profits, i.e. on a multiple contract position pull some profit off at 50% max gain
3. Have a solid stop loss if trade goes against you. If this happens it will be gradual at first due to Time Value (Extrinsic Value) of the options. With Weekly Options the time value starts falling dramatically on Thursday & Friday
4. Stay Small—if I gain an extra $100 per week that adds to $5200 over a year.
5. Look at these Trades as Icing on the Cake-but not the Cake!
6. Apply ATTS Rules to trade Option Spreads
Option Income Trades
Market timing
Going Naked!
1. Most pros sell naked Puts – Why?• They actually want to buy the underlying
• Selling Puts reduces Cost Basis
• May not get the underlying but still are able to participate in the bullish move
• Margin Accounts or IRA’s with approval-but different rules
With Margin Accounts the amount of cash needed is .25-.50 the cost of buying the underlying
With IRA Accounts must have full cash value of the shorted underlying
2. Don’t mess with shorting Calls
Copyright ATTS 2007-2017
Option Income Trades
Market timing
Option Basics
Is it worth the hassle?
Presented by: Dennis W. Wilborn
DISCLAIMERU.S. GOVERNMENT REQUIRED DISCLAIMER – COMMODITY FUTURES TRADING COMMISSION
FUTURES AND OPTIONS TRADING HAS LARGE POTENTIAL REWARDS, BUT ALS O LARGE
POTENTIAL RISK. YOU MUST BE AWARE OF THE RISKS AND BE WILLING TO ACCEPT THEM IN
ORDER TO INVEST IN THE FUTURES AND OPTIONS MARKETS.
DON’T TRADE WITH MONEY YOU CAN’T AFFORD TO LOSE. THIS IS NEITHER A SOLICITATION
NOR AN OFFER TO BUY/SELL FUTURES OR OPTIONS. NO REPRESENTATION I S BEING MADE
THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE
DISCUSSED IN THIS TRAINING. THE PAST PERFORMANCE OF ANY TRADING SYSTEM OR
METHODOLOGY IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS H AVE CERTAIN
LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESU LTS DO NOT
REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE
RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF AN Y, OF CERTAIN
MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PRO GRAMS IN
GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT
OF
HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY
TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
ALL MATERIALS PRESENTED ARE FOR TRAINING PURPOSES ONLY . TRADER S SHOULD
PAPER TRADE ANY NEW METHOD PRIOR TO RISK OF PERSONAL CAPITAL.
Option Basics
What are Options?o A Contract or Agreement between two partieso Each Option Contract comes with Rights and Obligations
Why do people trade options? Perceived benefit of Leverage & Variable Strategies
New Vocabulary
More Variables that just trading stocks (can work for or against the trader)
Copyright 2014--Active Trend Trading
Resources
www.cboe.com Chicago Board of Options Exchange
Books:
The Option Advisor, Author: Bernie Schaeffer
Options as a Strategic Investment, Author: Lawrence G. McMillan
The Option Course, Author: George A. Fontanills
Copyright 2014--Active Trend Trading
Option BasicsVocabulary
Contract: Typically controls 100 shares (Mini’s Control 10 shares)
Obligation: Typically the responsibility of the seller
Rights: Typically the benefit to the buyer
Premium: Price of the Option
Greeks: Variables used in the Black Scholes Option Model
Implied Volatility:
Expiration Month: Month the Option will expire typically on the Friday after the 3rd Thursday
(Settles on Saturday for non-European Options)
Strike Price: Contract Price of underlying stock/ETF
Open Interest: Contracts currently open
Bid/Ask Spread: The price difference between the Bid & Ask
Intrinsic Value: The positive price difference between Strike and Stock $
Extrinsic Value: Time Value (influenced by Vega & Gamma)
Exercise: Put to me or Called away
Copyright 2014--Active Trend Trading
Option BasicsVocabulary (Cont)
Theoretical Value: Theoretical Price of an Option determined by an option calculator
Time Decay: Amount price goes everyday (Theta)
At the Money (ATM): Price of option strike that is closest to the price of the stock/ETF
In the Money (ITM): Price of option strike that has Intrinsic Value
Out of the Money (OTM): Price of option strike outside the parameters of the trade
Volatility Inflation: Volatility is growing due to VIX or other events like earnings
Volatility Crunch: Volatility deflation due to falling VIX or event passes
Leaps: Options that expire in January each year and are more that 6 months in the future
Option Chains: List of option strike prices and months presented in a table
Directional: Option trades placed in the direction of the trend
Spreads: Credit or Debit two option trade with limited upside and fixed downside
Condors: Exotic type option trade selling premium with a very low Delta
Butterflies: Exotic type option trade made up of three separate options of the same type
Copyright 2014--Active Trend Trading
Option Basics
What are Options?o A Contract or Agreement between two parties
o Each Option Contract comes with Rights and Obligations
Types: Puts & Calls, American, European, Mini’s, Standard & more
Time: Weekly, Monthly, Leaps
Variables: Greeks (Delta, Gamma, Theta, Vega, Rho)
Model Options Calculators: Black Scholes, Binomial, Brownian & Others
Copyright 2014--Active Trend Trading
Option Basics
Variables: Greeks (Delta, Gamma, Theta, Vega, Rho)
-Delta: How much price increases or decrease per dollar movement in the underlying. Also tells us how many equivalent shares of stock one contract actually approximates. 50 delta is approximately like 50 shares of the stock
-Theta: How much value the options looses every day this is an a complex equation and not straight line decay
-Vega: Price variation due to Volatility
-Gamma: How much Delta Changes per dollar increase or decrease in movement of the underlying stock/ETF
-Rho: Associated with interest rates
Model Options Calculators: Black Scholes, Binomial, Brownian & Others
Copyright 2014--Active Trend Trading
Option Basics
Call Options: Long: Expect Stock Price to go up
Rights & Obligation: Buyer has the right to buy the stock/ETF at the agreed on price. Seller is obligated to sell stock/ETF at the agree on Price
Short: Expect Stock Price to go downRights & Obligation: Buyer has the right to buy the stock/ETF at the agreed on price. Seller is obligated to sell stock/ETF at the agree on Price
The Catch: All Options are made up of both Intrinsic and Extrinsic Value—If an option has high Extrinsic Value due to High Implied Volatility I want to be a seller and not a buyer because even if the price of the stock goes up, the value of my option can go down!
Copyright 2014--Active Trend Trading
Option Basics
Put OptionsLong: Expect Stock Price to go down
Rights & Obligation: Buyer has the right to sell the stock/ETF at the agreed
on price. Seller is obligated to buy stock/ETF at the agree on Price
Short: Expect Stock Price to go upRights & Obligation: Buyer has the right to sell the stock/ETF at the agreed on
price. Seller is obligated to buy stock/ETF at the agreed on Price
Copyright 2014--Active Trend Trading
Intrinsic + Extrinsic = Option Price
Intrinsic: Price of the stock/ETF less the Strike Price
Extrinsic: Primarily Time Value impacted by Implied Volatility & Time Decay
If a stock’s price is currently at $75
Intrinsic Value of a $70 strike price would equal (75-70) = $5.00
If the $70 option is selling for $7.50 the Extrinsic Value would be:
Extrinsic Value = Price of the option – Intrinsic Value (7.50 – 5) = $2.50
If the stock stays at $75 until expiration you loose $2.50 on this trade.
Copyright 2014--Active Trend Trading
Fatal Mistakes1. Trying to trade options before having a strong System Foundation
Not buying enough time
Selling too much time and too little volatility (can be an emotional roller coaster)
Buying too far Out of the Money (too much Extrinsic Value)
Buying too much Volatility (earnings are especially risky to buy premium)
Not knowing that option market can open up to 10-20 minutes after the regular market—Risky for Market orders
Not knowing that volatility is inflated at the beginning of the day
Chasing the Bid/Ask—Place your order at the Mark and it gets filled or doesn’t
Copyright 2014--Active Trend Trading
How Do I Chose?
1. How long do I want to hold the option?
2. How much do I want the price to change with a move in the underlying? Choose proper Delta.
3. How much Bid/Ask Spread am I willing to risk?
4. Do I buy or sell premium?
5. How much Volatility
6. How Much Open Interest?
7. When are Earnings?
Copyright 2014--Active Trend Trading
How Do I Chose?1. How long do I want to hold the option? Buying 2-6 Weeks
2. How much do I want the price to change with a move in the underlying? Choose proper Delta. Minimum of 0.50
3. How much Bid/Ask Spread am I willing to risk? .10-.50 cents unless I know the Option Chain Personality
4. Do I buy or sell premium? Depends on volatility
5. How much Volatility? Find the Chain with the lowest to buy & Highest to sell
6. How Much Open Interest? 50 – 250 Contracts Open unless I know the Option Chain
7. When are Earnings? Volatility tends to increase approaching earnings
8. Use ATTS Rules for Entry & Exit, estimate value of option
Copyright 2014--Active Trend Trading
Example
Choose a Stock?
Copyright 2014--Active Trend Trading
Key Points
-Trading Options Introduces Variables to the Trading Equation
-These variables can significantly increase risk
-Directional Options & Covered Call trades are the most basic
-Complex option trades add more variables (spreads & exotics)
Copyright 2014--Active Trend Trading
Option Basics
Is it worth the hassle?
Presented by: Dennis W. Wilborn
DISCLAIMERU.S. GOVERNMENT REQUIRED DISCLAIMER – COMMODITY FUTURES TRADING COMMISSION FUTURES
AND OPTIONS TRADING HAS LARGE POTENTIAL REWARDS, BUT ALSO LARGE POTENTIAL RISK. YOU
MUST BE AWARE OF THE RISKS AND BE WILLING TO ACCEPT THEM IN ORDE R TO INVEST IN THE
FUTURES AND OPTIONS MARKETS.
DON’T TRADE WITH MONEY YOU CAN’T AFFORD TO LOSE. THIS IS NEITHER A SOLICITATION NOR AN
OFFER TO BUY/SELL FUTURES OR OPTIONS. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT
WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE DISCUSSED IN THIS
TRAINING. THE PAST PERFORMANCE OF ANY TRADING SYSTEM OR METHODOL OGY IS NOT
NECESSARILY INDICATIVE OF FUTURE RESULTS.
CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN
LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESU LTS DO NOT
REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN E XECUTED, THE
RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN
MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PRO GRAMS IN
GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF
HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY
TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
ALL MATERIALS PRESENTED ARE FOR TRAINING PURPOSES ONLY . TRADER S SHOULD PAPER TRADE
ANY NEW METHOD PRIOR TO RISK OF PERSONAL CAPITAL.
Option Basics
What are Options?o A Contract or Agreement between two partieso Each Option Contract comes with Rights and Obligations
Why do people trade options? Perceived benefit of Leverage & Variable Strategies
New Vocabulary
More Variables that just trading stocks (can work for or against the trader)
Copyright 2014--Active Trend Trading
Resources
www.cboe.com Chicago Board of Options Exchange
Books:
The Option Advisor, Author: Bernie Schaeffer
Options as a Strategic Investment, Author: Lawrence G. McMillan
The Option Course, Author: George A. Fontanills
Copyright 2014--Active Trend Trading
Option BasicsVocabulary
Contract: Typically controls 100 shares (Mini’s Control 10 shares)
Obligation: Typically the responsibility of the seller
Rights: Typically the benefit to the buyer
Premium: Price of the Option
Greeks: Variables used in the Black Scholes Option Model
Implied Volatility:
Expiration Month: Month the Option will expire typically on the Friday after the 3rd Thursday
(Settles on Saturday for non-European Options)
Strike Price: Contract Price of underlying stock/ETF
Open Interest: Contracts currently open
Bid/Ask Spread: The price difference between the Bid & Ask
Intrinsic Value: The positive price difference between Strike and Stock $
Extrinsic Value: Time Value (influenced by Vega & Gamma)
Exercise: Put to me or Called away
Copyright 2014--Active Trend Trading
Option BasicsVocabulary (Cont)
Theoretical Value: Theoretical Price of an Option determined by an option calculator
Time Decay: Amount price goes everyday (Theta)
At the Money (ATM): Price of option strike that is closest to the price of the stock/ETF
In the Money (ITM): Price of option strike that has Intrinsic Value
Out of the Money (OTM): Price of option strike outside the parameters of the trade
Volatility Inflation: Volatility is growing due to VIX or other events like earnings
Volatility Crunch: Volatility deflation due to falling VIX or event passes
Leaps: Options that expire in January each year and are more that 6 months in the future
Option Chains: List of option strike prices and months presented in a table
Directional: Option trades placed in the direction of the trend
Spreads: Credit or Debit two option trade with limited upside and fixed downside
Condors: Exotic type option trade selling premium with a very low Delta
Butterflies: Exotic type option trade made up of three separate options of the same type
Copyright 2014--Active Trend Trading
Option Basics
What are Options?o A Contract or Agreement between two parties
o Each Option Contract comes with Rights and Obligations
Types: Puts & Calls, American, European, Mini’s, Standard & more
Time: Weekly, Monthly, Leaps
Variables: Greeks (Delta, Gamma, Theta, Vega, Rho)
Model Options Calculators: Black Scholes, Binomial, Brownian & Others
Copyright 2014--Active Trend Trading
Option Basics
Variables: Greeks (Delta, Gamma, Theta, Vega, Rho)
-Delta: How much price increases or decrease per dollar movement in the underlying. Also tells us how many equivalent shares of stock one contract actually approximates. 50 delta is approximately like 50 shares of the stock
-Theta: How much value the options looses every day this is an a complex equation and not straight line decay
-Vega: Price variation due to Volatility
-Gamma: How much Delta Changes per dollar increase or decrease in movement of the underlying stock/ETF
-Rho: Associated with interest rates
Model Options Calculators: Black Scholes, Binomial, Brownian & Others
Copyright 2014--Active Trend Trading
Option Basics
Call Options: Long: Expect Stock Price to go up
Rights & Obligation: Buyer has the right to buy the stock/ETF at the agreed on price. Seller is obligated to sell stock/ETF at the agree on Price
Short: Expect Stock Price to go downRights & Obligation: Buyer has the right to buy the stock/ETF at the agreed on price. Seller is obligated to sell stock/ETF at the agree on Price
The Catch: All Options are made up of both Intrinsic and Extrinsic Value—If an option has high Extrinsic Value due to High Implied Volatility I want to be a seller and not a buyer because even if the price of the stock goes up, the value of my option can go down!
Copyright 2014--Active Trend Trading
Option Basics
Put OptionsLong: Expect Stock Price to go down
Rights & Obligation: Buyer has the right to sell the stock/ETF at the agreed
on price. Seller is obligated to buy stock/ETF at the agree on Price
Short: Expect Stock Price to go upRights & Obligation: Buyer has the right to sell the stock/ETF at the agreed on
price. Seller is obligated to buy stock/ETF at the agreed on Price
Copyright 2014--Active Trend Trading
Intrinsic + Extrinsic = Option Price
Intrinsic: Price of the stock/ETF less the Strike Price
Extrinsic: Primarily Time Value impacted by Implied Volatility & Time Decay
If a stock’s price is currently at $75
Intrinsic Value of a $70 strike price would equal (75-70) = $5.00
If the $70 option is selling for $7.50 the Extrinsic Value would be:
Extrinsic Value = Price of the option – Intrinsic Value (7.50 – 5) = $2.50
If the stock stays at $75 until expiration you loose $2.50 on this trade.
Copyright 2014--Active Trend Trading
Fatal Mistakes1. Trying to trade options before having a strong System Foundation
Not buying enough time
Selling too much time and too little volatility (can be an emotional roller coaster)
Buying too far Out of the Money (too much Extrinsic Value)
Buying too much Volatility (earnings are especially risky to buy premium)
Not knowing that option market can open up to 10-20 minutes after the regular market—Risky for Market orders
Not knowing that volatility is inflated at the beginning of the day
Chasing the Bid/Ask—Place your order at the Mark and it gets filled or doesn’t
Copyright 2014--Active Trend Trading
How Do I Chose?
1. How long do I want to hold the option?
2. How much do I want the price to change with a move in the underlying? Choose proper Delta.
3. How much Bid/Ask Spread am I willing to risk?
4. Do I buy or sell premium?
5. How much Volatility
6. How Much Open Interest?
7. When are Earnings?
Copyright 2014--Active Trend Trading
How Do I Chose?1. How long do I want to hold the option? Buying 2-6 Weeks
2. How much do I want the price to change with a move in the underlying? Choose proper Delta. Minimum of 0.50
3. How much Bid/Ask Spread am I willing to risk? .10-.50 cents unless I know the Option Chain Personality
4. Do I buy or sell premium? Depends on volatility
5. How much Volatility? Find the Chain with the lowest to buy & Highest to sell
6. How Much Open Interest? 50 – 250 Contracts Open unless I know the Option Chain
7. When are Earnings? Volatility tends to increase approaching earnings
8. Use ATTS Rules for Entry & Exit, estimate value of option
Copyright 2014--Active Trend Trading
Example
Choose a Stock?
Copyright 2014--Active Trend Trading
Key Points
-Trading Options Introduces Variables to the Trading Equation
-These variables can significantly increase risk
-Directional Options & Covered Call trades are the most basic
-Complex option trades add more variables (spreads & exotics)
Copyright 2014--Active Trend Trading
Bonus Slides
Options Basic
Copyright ATTS 2007-2017
Option Basics
Is it worth the hassle?
Presented by: Dennis W. Wilborn
DISCLAIMER
U.S. GOVERNMENT REQUIRED DISCLAIMER – COMMODITY FUTURES TRADING COMMISSION
FUTURES AND OPTIONS TRADING HAS LARGE POTENTIAL REWARDS, BUT ALS O LARGE
POTENTIAL RISK. YOU MUST BE AWARE OF THE RISKS AND BE WILLING TO ACCEPT THEM IN
ORDER TO INVEST IN THE FUTURES AND OPTIONS MARKETS.
DON’T TRADE WITH MONEY YOU CAN’T AFFORD TO LOSE. THIS IS NEITHER A SOLICITATION
NOR AN OFFER TO BUY/SELL FUTURES OR OPTIONS. NO REPRESENTATION I S BEING MADE
THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO
THOSE DISCUSSED IN THIS TRAINING. THE PAST PERFORMANCE OF ANY TR ADING SYSTEM
OR METHODOLOGY IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
CFTC RULE 4.41 – HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS H AVE CERTAIN
LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESU LTS DO NOT
REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE
RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF AN Y, OF CERTAIN
MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PRO GRAMS IN
GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT
OF
HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY
TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
ALL MATERIALS PRESENTED ARE FOR TRAINING PURPOSES ONLY . TRADER S SHOULD
PAPER TRADE ANY NEW METHOD PRIOR TO RISK OF PERSONAL CAPITAL.
Option Basics
What are Options?o A Contract or Agreement between two partieso Each Option Contract comes with Rights and Obligations
Why do people trade options? Perceived benefit of Leverage & Variable Strategies
New Vocabulary
More Variables that just trading stocks (can work for or against the trader)
Copyright 2014--Active Trend Trading
Resources
www.cboe.com Chicago Board of Options Exchange
Books:
The Option Advisor, Author: Bernie Schaeffer
Options as a Strategic Investment, Author: Lawrence G. McMillan
The Option Course, Author: George A. Fontanills
Copyright 2014--Active Trend Trading
Option BasicsVocabulary
Contract: Typically controls 100 shares (Mini’s Control 10 shares)
Obligation: Typically the responsibility of the seller
Rights: Typically the benefit to the buyer
Premium: Price of the Option
Greeks: Variables used in the Black Scholes Option Model
Implied Volatility:
Expiration Month: Month the Option will expire typically on the Friday after the 3rd Thursday
(Settles on Saturday for non-European Options)
Strike Price: Contract Price of underlying stock/ETF
Open Interest: Contracts currently open
Bid/Ask Spread: The price difference between the Bid & Ask
Intrinsic Value: The positive price difference between Strike and Stock $
Extrinsic Value: Time Value (influenced by Vega & Gamma)
Exercise: Put to me or Called away
Copyright 2014--Active Trend Trading
Option BasicsVocabulary (Cont)
Theoretical Value: Theoretical Price of an Option determined by an option calculator
Time Decay: Amount price goes everyday (Theta)
At the Money (ATM): Price of option strike that is closest to the price of the stock/ETF
In the Money (ITM): Price of option strike that has Intrinsic Value
Out of the Money (OTM): Price of option strike outside the parameters of the trade
Volatility Inflation: Volatility is growing due to VIX or other events like earnings
Volatility Crunch: Volatility deflation due to falling VIX or event passes
Leaps: Options that expire in January each year and are more that 6 months in the future
Option Chains: List of option strike prices and months presented in a table
Directional: Option trades placed in the direction of the trend
Spreads: Credit or Debit two option trade with limited upside and fixed downside
Condors: Exotic type option trade selling premium with a very low Delta
Butterflies: Exotic type option trade made up of three separate options of the same type
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Option Basics
What are Options?o A Contract or Agreement between two parties
o Each Option Contract comes with Rights and Obligations
Types: Puts & Calls, American, European, Mini’s, Standard & more
Time: Weekly, Monthly, Leaps
Variables: Greeks (Delta, Gamma, Theta, Vega, Rho)
Model Options Calculators: Black Scholes, Binomial, Brownian & Others
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Option Basics
Variables: Greeks (Delta, Gamma, Theta, Vega, Rho)
-Delta: How much price increases or decrease per dollar movement in the underlying. Also tells us how many equivalent shares of stock one contract actually approximates. 50 delta is approximately like 50 shares of the stock
-Theta: How much value the options looses every day this is an a complex equation and not straight line decay
-Vega: Price variation due to Volatility
-Gamma: How much Delta Changes per dollar increase or decrease in movement of the underlying stock/ETF
-Rho: Associated with interest rates
Model Options Calculators: Black Scholes, Binomial, Brownian & Others
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Option Basics
Call Options: Long: Expect Stock Price to go up
Rights & Obligation: Buyer has the right to buy the stock/ETF at the agreed on price. Seller is obligated to sell stock/ETF at the agree on Price
Short: Expect Stock Price to go downRights & Obligation: Buyer has the right to buy the stock/ETF at the agreed on price. Seller is obligated to sell stock/ETF at the agree on Price
The Catch: All Options are made up of both Intrinsic and Extrinsic Value—If an option has high Extrinsic Value due to High Implied Volatility I want to be a seller and not a buyer because even if the price of the stock goes up, the value of my option can go down!
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Option Basics
Put OptionsLong: Expect Stock Price to go down
Rights & Obligation: Buyer has the right to sell the stock/ETF at the agreed
on price. Seller is obligated to buy stock/ETF at the agree on Price
Short: Expect Stock Price to go upRights & Obligation: Buyer has the right to sell the stock/ETF at the agreed on
price. Seller is obligated to buy stock/ETF at the agreed on Price
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Intrinsic + Extrinsic = Option Price
Intrinsic: Price of the stock/ETF less the Strike Price
Extrinsic: Primarily Time Value impacted by Implied Volatility & Time Decay
If a stock’s price is currently at $75
Intrinsic Value of a $70 strike price would equal (75-70) = $5.00
If the $70 option is selling for $7.50 the Extrinsic Value would be:
Extrinsic Value = Price of the option – Intrinsic Value (7.50 – 5) = $2.50
If the stock stays at $75 until expiration you loose $2.50 on this trade.
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Fatal Mistakes1. Trying to trade options before having a strong System Foundation
Not buying enough time
Selling too much time and too little volatility (can be an emotional roller coaster)
Buying too far Out of the Money (too much Extrinsic Value)
Buying too much Volatility (earnings are especially risky to buy premium)
Not knowing that option market can open up to 10-20 minutes after the regular market—Risky for Market orders
Not knowing that volatility is inflated at the beginning of the day
Chasing the Bid/Ask—Place your order at the Mark and it gets filled or doesn’t
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How Do I Chose?
1. How long do I want to hold the option?
2. How much do I want the price to change with a move in the underlying? Choose proper Delta.
3. How much Bid/Ask Spread am I willing to risk?
4. Do I buy or sell premium?
5. How much Volatility
6. How Much Open Interest?
7. When are Earnings?
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How Do I Chose?1. How long do I want to hold the option? Buying 2-6 Weeks
2. How much do I want the price to change with a move in the underlying? Choose proper Delta. Minimum of 0.50
3. How much Bid/Ask Spread am I willing to risk? .10-.50 cents unless I know the Option Chain Personality
4. Do I buy or sell premium? Depends on volatility
5. How much Volatility? Find the Chain with the lowest to buy & Highest to sell
6. How Much Open Interest? 50 – 250 Contracts Open unless I know the Option Chain
7. When are Earnings? Volatility tends to increase approaching earnings
8. Use ATTS Rules for Entry & Exit, estimate value of option
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Example
Choose a Stock?
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Key Points
-Trading Options Introduces Variables to the Trading Equation
-These variables can significantly increase risk
-Directional Options & Covered Call trades are the most basic
-Complex option trades add more variables (spreads & exotics)
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5 Objective Profit Exits
- Profit Exits can be planned based on
several objective parameters.
- Profit Exit parameters can be used in
combination
5 Objective Profit Exits
- Set Percentage, Fib Extensions, Symmetry
Extensions, Keltner or Moving Average
Extensions
Set Percentage: 5%, 10%, 15%, 20% from
Entry
Copyright ATTS 2007-2017
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