Options, Investing No Comments »

“How do you feel about futures options? Have you dabbled in that? I find future to be much more predictable in cyclical studies…”

To answer questions, I have done a few trades in futures. I am using the term futures to define any expiration beyond 4 months. My largest problem with futures is that it seems that I am paying a much higher premium for that possible volatility.

That is the long answer to say that I do not spend much time in futures, and here is why.

If I think that a stock is going to go up or down in the next two months, then I will buy an option (either call or put) to profit from that stock. If I think that a stock has the potential for the price to go up, but I don’t think it is going to happen for about another 6 months, then I will wait for about 4 months and play it as a short term option. Does this limit my opportunities of making a profit? YES; however, there are many short term trades out there that are good enough for me.
Like I said above, my large problem with futures, is that I feel that I am paying a high premium for the time value of that option. The other problem that I have is that it tends to tie up some of my capital for extended periods of time as if I had purchased a stock.

There is only a few reasons that I can think of to invest in futures. The first of these is if you think that a stock will go up a significant amount but in small increments (ie. a stock currently valued at $40 that you think is going to go to $55 by next December. You think that it is going to gain $1 to $1.50 a month. The 12 month out $50 call is probably going to cost you around $3.00 depending on the stock.) In that case you could make money on a futures purchase.

The other time that I would consider playing a future is in the tech industry where the release of some new technology could make their stock go way up, or if a competitor released the new technology first, their stock could go way down. In this case, I would look to buy a futures strangle.

If you are unsure what I strangle is, stay tuned, and I will get to them in my progression of options strategies. Bottom line, there is money to be made either way, I just prefer the short term because it costs less, does not tie up my capital, and I can wait and make the same trade later usually without paying the high premium. Good luck in the strategy that you choose.

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Put Spreads

Options, Investing No Comments »

In my last options posting, I talked about call spreads. Put spreads are remarkably similar except that you are expecting a downturn in that underlying security. Put spreads, like call spreads, minimize the risk to the investor, because they allow your initial investment to be reduced. Note here that it is important to always use the same expiration date on both the put that you buy to open and the put that you sell to open.
So the put spread is buying a put close to the money (or in the money) and selling a put further away from the money.
For example:
I have been watching another stock that is currently trading at $82.65, up a $1.50 on Friday. It is somewhat near the high end of it’s 52 week high/low. I am considering buying a put spread on this stock. The JAN $80 put is selling for $2.10. The JAN $75 put is selling for $0.80. So if I were to buy into this trade, it would cost me a total of $1.30 per share. So for my 10 contracts, it would cost me $2,100 ($2.10 x 100 shares per contract x 10 contracts) for the JAN $80s. I would then receive $800 back ($0.80 x 100 x 10) for the JAN $75s. So the total cost to enter the trade would be $2,100 - $800 for a grand total of $1,300 plus commissions. This is also my total risk. In this case as with buying call spreads, the maximum that I can lose is the amount that I invest.
If the stock goes to $77 at expiration:
my $80 put is worth $3 per share x 100 shares x 10 contracts for a total of $3,000. The $75 put expires worthless. You might be asking why the $80 put is worth $3? Again a put allows me to sell the stock at a certain price on or before a certain date. So what is the ability to sell a stock at $80 worth if I can buy the stock on the market at $77? Three dollars. So all in all, I sell the JAN $80s and buy back the JAN $75 for the $3,000. I subtract the $1,300 that I paid to get into the trade, and I am now at my profit of $1,700.
If the stock goes to $72 at expiration:
my $80 put is worth $8,000. I could sell the put for that. However, the put that I sold initially, JAN $75, is now worth $3,000. So my total take is $5,000 - $1,300 to get into the trade, for my profit of $3,700.
If the stock goes to $80 or higher at expiration:
Both puts expire worthless, and I lose my entire $1,300.
So again the bottom line is, I am willing to risk up to $1.50 to make $3.50. In this case, the trade is even better because I am only risking $1.30 to possibly make $3.70.
Why I Like Spreads?
The biggest reason that I recommend spreads is because it allows smart investors like me to invest in closer to the money markets for a reduced amount. The underlying stock does not have to move as much in order for me to make a profit, and if the stock moves the other way, I lose less money.
The Risks?
The stock moving in the other direction and potentially higher commission rates because of more contracts being traded are the two that come to mind. For me, the upsides are better than the downsides, and that is why I trade them.
What is Left?
I could type an article every day for a year and would not cover all there is to know about options, picking stock candidates, and everything else involved. Stay tuned; I do plan on getting into some trades that will make money as long as the stock moves in either direction. If these topics interest you, sign up to receive Jeffry’s RSS feed. Until next time…

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Call Spreads

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So I mentioned call spreads a few times in my last few posts. What are those you might be asking? As I mentioned in my earlier posting titled Options are a Viable Option Right Now, options were created to reduce risk. Call spreads and put spreads (sometimes called vertical spreads) are the next step.
When options are referred to, they are referred to in one of a couple ways. They are either “in the money” or “out of the money.” As you can probably guess, “in the money” means that the stock has intrinsic or real value (i.e. a $25 call when the underlying stock’s market price is $28.) An “out of the money” derives its’ only value from the time value (i.e. a $50 call when the underlying stock is valued at $46.)
We have talked about buying calls and puts. Today we will move into the category of both buying and selling calls of different strike prices at the same time. So the call spread is buying a call close to the money and selling a call further away.
For example:
A stock is currently valued at $25.92. The JAN $27.50 call price is priced at $1.30 while the JAN $30 call is valued at $0.55.
Wait a minute….I thought you said that options are in $5 increments only? Mostly true, most stocks offer $2.50 increments up to $30 or $40.
So back to the example, I will buy 10 contracts of the JAN $27.50 for $1.30 and sell 10 contracts of the JAN $30 for $0.55 at the same time. So purchasing the call would cost me 10 contracts x 100 shares per contract x $1.30 for each for a total of $1,300. At the same time, since I am selling the JAN $30, I will receive 10 x 100 x $0.55 for a total of $550. So I pay $1,300 and receive $550 for a total cost of entering the trade of $750.
So let’s say the stock goes up to $30 at expiration, my $27.50 calls are now worth $2.50 and the $30 calls that I sold are worth nothing. I sell the $27.50 calls for $2.50 a piece for a total of $2,500, subtract my initial investment of $750 for a total profit of $1,750. That is a 233% return on my money. Not bad.
Now let’s say the stock goes to $35 at expiration, my $27.50 call is now worth $7.50 each, but my $30 call that I sold is worth $5.00 a piece. So I sell my $27.50 calls for the $7,500 and re-buy my $30 calls for $5,000 for a difference of $2,500. I then subtract the $750 that it cost to enter the trade for the same return.
If the stock stays at or below $27.50, then both the calls I bought and sold expire worthless, and I lose my $750.
If the stock expires at $28.25,then my $27.50 call is now worth $0.75. So after I sell my $27.50 calls for $750, I do not make or lose money on the trade.
The Pros: If the stock goes in the direction that I think it will go, I make a great return on investment. My bottom line on a $2.50 call spread (what I explained above) is that I will risk $0.75 to make $1.75. On a $5.00 call spread (say buying the $25 and selling the $30,) I will risk $1.50 to make $3.50 if the stock goes the way I want it too. The other big pro, I limit my risk by recouping some of my initial investment.
The Con: If the stock goes a long way in the direction I think it will, I limit my upside to either $1.75 or $3.50 depending on whether I buy a $2.50 or $5.00 call spread.
Again, these are more advanced options investing. Many brokerage firms will not allow beginners to do these trades because they think they are too risky. Why? They do not understand the nature or original reason for options. The trades are also sometimes hard to find, but they too are out there. Good Luck!

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Playing a Bear Market with Options

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So, if there is a way to make money when the market goes up, there must be a way to make money when the market is going down. The way for me is puts. As I defined earlier, a put is nothing more than buy the option to put a stock to someone at a certain price on or before a certain date.
So if we go back to our portfolio that we created, we can again see the big movers. Now looking at the chart of a volatile stock, we might find that it is at historical highs or on the high side of its’ normal range. I used to see this and say, well maybe I can buy into that one in a few months if it comes down.
NOT ANYMORE!! Now I look at it and say, this is a potential candidate for buying a put option on it. I again generally stay within the 1 1/2 to 2 month time frame. This gives that stock the time to have that downward move that I am expecting. If I think that it is going to take longer than that to drop, then I will put it on my watch list and wait for the right time. On to a new example.

I have been watching a stock for a while now that is currently at $35.63. The 52 week high is $38 and the low is $12. So I am checking the chart and it seems that it is in its high cycle. After looking through the information available online, I believe that the price will fall to around the $28 in the next 6-8 weeks. So I am looking at the Jan 08 expiration date at the $30 put. They are trading today for $1.15. I am going to wait until Monday or Tuesday of next week and will probably buy 10 of those contracts. I am guessing that the price will drop by then to approximately $0.95. So my initial investment will be $950 ($0.95 x 100shares per contract x 10 contracts) plus commission.
If the stock goes up or stays the same, I lose my investment. However, if the stock goes down to $28 like I think it will, that option will be worth at least $2. When I sell those 10 contracts for $2, it will be worth $2,000 ($2 x 1000shares).

I will continue posting a few more articles on this topic in the near future. Notice that I will not give out recommendations or stocks that I trade. This is purely because I do not believe in giving or taking tips. If I give a tip and one of my friends executes that and it loses money, I stand the risk of him being upset. However, all of the examples that I use are real stocks, real prices and many of them are trades that I am executing in my portfolio. Good luck on all your investments.

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How I am Making Money on Options Right Now

Retirement Investing, Options 2 Comments »

The last couple of posts have been dealing with trying to give a base line knowledge of options. Today I will get down to how I have been making money on the call side. I will try to continue with some posts on puts and eventually how I have been making money on puts too.
What is the Market Doing?
This is the question that drives investment. However, with options, I can control, not own, more shares for a limited time with less risk. My first recommendation would be to go to any of the major websites that offer financial information and create a portfolio. I use yahoo finance. I have a fairly broad selection of stocks in mine. This gives me a quick snapshot at what the market is doing for that day. I do not have a lot of time usually to continually check the market.

What am I Looking for in Picking a Stock?
In one word, VOLATILITY. If I can find a stock that I think is going to move, I can make money on it. So if I see some big movers in my portfolio, I have learned what their average range is just by watching them for awhile. I will also typically look at the 6 month to a year chart to see where that stock is in its’ natural curve. If it is on the low end of its’ average range, I will click on the options tab to see how much the premium is on usually a month to two months out. This gives the stock time to move to my target range. The reason that I like the one to two month range is that they are cheaper than farther out options because of what I wrote yesterday about time value.
If the stock goes up as I expected, then I will sell the calls that I purchase. This is called selling to close.
So back to our example from 2 days ago (Options are a Viable Option Right Now) where stock XYZ closed at almost $27, I wanted to buy 10 contracts. So why didn’t I?
Remember when I said that options expire on the 3rd Friday of the month? Well, tomorrow is the 16th (or the 3rd Friday) and the November strike prices will all expire. This is the primary reason why I didn’t purchase the $30 December calls. Typically the Monday after an expiration, the prices go down because investors realize that time is starting to run short on the next month’s options. So if stock XYZ hasn’t gone up significantly, I will look at buying the January $30 calls probably on Tuesday. I guess only time will tell if this is a good investment.

We will continue on in the next couple of days, and I will try to explain puts, vertical spreads, and straddles. Again, these are more complex strategies that require extensive knowledge to trade. I would highly recommend using a website like Think or Swim to paper trade. This will give you valuable experience in executing these trades while using fake or paper money. Again, feel free to ask questions. These are complicated issues. When it comes to investing, remember the old saying, “Time is Money.”

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More Option Basics and the Covered Call

Retirement Investing, Options No Comments »

Okay, so yesterday may have been a little much for some readers that are new to the option world. So I will back track just a little. Options are traded in increments of $5 strike prices for stocks over $25. For stocks under $25, they are traded in $2.50 increments. That means that you can usually buy the $20 strike price, the $22.50 strike price, the $25, $30, $35, etc for any given month. The market value of each option is based on 2 things. The first is intrinsic value, or what the difference is between the strike price and the market price. So what is a $30 call worth if the market value is $33. Intrinsically, it is worth $3 because I can call it from someone at $30 and sell it for $33. The second value is time value. So the further away the expiration date, the higher the time value is.
One thing to remember, options for a given month expire on the 3rd Friday of the month.

The Covered Call
This is probably the most basic form of trading options. This type is often times what brokerage firms will allow you to trade with out any options experience. Selling a covered call is generally seen as having very little risk, and it is even allowed in your Roth IRA or Traditional IRA.
The fundamental of this trade is that you own the underlying stock. You are then selling someone else the right to buy that stock from you at a certain price (strike price) on or before a certain date (expiration date). Of course for this privilege, you will charge a premium. The premium can fluctuate as often as the stock price. If the stock price goes above the strike price before the expiration, someone will call the the stock away from you. You get to keep the premium, and you sell the shares of stock at the agreed upon price (strike price). If the stock stays below or at the strike price, the call expires worthless, and you keep the premium and the stock.
Example Time:
Say I own 1,000 shares of ZYX stock, which is currently valued at $27.50. The $30 Dec call option is currently valued at $.55. So to execute the covered call trade, I would sell 10 contracts (each contract equals 100 shares) at $.55 a share. This would equal the premium that someone would give me in exchange for the right to call those 1,000 shares away from me at any point until 21 December (the expiration date). So my total premium would be $.55 x 1000 = $550.
Question: What happens if the stock goes to $31 before December 21st?
Answer: The purchaser of my call option would call the shares from me for $30 a share. So I would get the $30,000 for the sale of the stock plus keep the $550 for a total of $30,550.
Question: What happens if the stock stays below $30 a share until December 21st?
Answer: I would keep the 1,000 shares and the $550. I could then sale the January or February options to continue making a profit.
This option is usually used when you believe that a stock that you currently own is not going to increase in value beyond the strike price before the expiration date.

In my next post, I will continue deeper into our endeavor of potential ways to make money through options in this volatile market. Feel free to continue asking questions and posting comments.

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Options are a Viable Option Right Now!

Paying Off Debt, Student Loans, Tax Planning, Paying for College, Options 3 Comments »

by guest author Nicholas

This is the beginning of a multi-part series because options are generally thought of as complex transactions. Do you think options are risky? Options were originally created to reduce risk. I preface the next few days postings by saying, do not rush out to invest in options until you understand the risks involved.

What is an Option?
An option is a contract to buy or sell a specific financial product officially known as the option’s underlying instrument. The underlying instrument that I will focus on is a stock. The contract itself is very precise. It establishes a specific price, called the strike price, at which the contract may be exercised. It has an expiration date. Upon expiration, it no longer has value and no longer exists.

What does an Option Consist of?
An option is either a call or a put.
A call gives the owner the right to buy the underlying security at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a call option, the contract represents an obligation to sell the underlying stock if the option is assigned.
A put gives the owner the right to sell the underlying security at a specified price (its strike price) for a certain, fixed period of time (until its expiration). For the writer of a put option, the contract represents an obligation to buy the underlying stock if the option is assigned.

What does that Mean?
I will start today by only discussing call options from the buyers point of view. Let’s take an example. Say I want to purchase 1000 shares of XYZ stock. XYZ closed today at $26.95. I could purchase those 1000 shares, and I would pay $26,950.
Question: Why does anyone buy a stock?
Answer: Because they think it will move up.
With options, the question that I have to ask myself is when will it move?
I personally believe that XYZ stock will go up to $31.00 by the middle of December. So instead of risking my $26,950, I could buy 10 call contracts (one contract equals 100 shares of the underlying instrument) of the $30 December strike price. Each December call is currently valued at $0.65 per share. These expire on the 21st of December. So if each call is $0.65 and I want 10 contracts of 100 shares each, I will pay $0.65 x 1000 for a total of $650. So I now control, that is not to say own, 1000 shares of XYZ until the 21st of December.
Looking to the future if:
XYZ goes down to $22.00: my 10 calls will expire worthless, and I lose my $650 had I bought the options.
Had I bought the stock, it would be worth $22,000, and I would have lost $4,950.

XYZ goes up to $34.00: my 10 calls give me the right to buy those 1000 shares at $30, and I could sell them on the open market for $34. The calls are then worth at least $4 per share. So I sell them for $4 a share x 1000 shares for a total of $4,000. I subtract my $650 for a gain of $3,350 or a 515% return on my money.
Had I bought the stock, the 1000 shares would be worth $34,000 minus my initial $26,950 for a gain of $7,050 or a 26% return on my money.

XYZ stays at $26.95: my 10 calls expire worthless, and I lose my $650 had I bought the options.
Had I bought the stock, the 1000 shares would be worth $26,950, and I lose nothing other than the time value of money.

Tomorrow I will continue the discussion, but from the above example, one can see how an option will allow you control over a certain amount of shares of a stock for a specific time with a limited amount of money required, relative to buying the stock. The upside is that it is possible to execute many of these trades with the same amount of money required to purchase one stock. The downside is that the option is only valid for a specific amount of time.
Stay tuned for more. Feel free to ask questions, and I will answer them as best as possible.

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