I've realized that many traders that traded in other markets besides Forex do so to spread out risks fearing too many correlated trades.
Is it better to stay focused on one market ?
Is it better to stay focused on one market ?
- #6
- Dec 4, 2005 3:53pm Dec 4, 2005 3:53pm
- Joined Jan 2005 | Status: Keep Learning | 1,180 Posts
Ya Iso, the only method to trade options as a buyer is before major news, that's how you increase your odds dramatically. There are way too many strategies for such a thing, but the best of them I know is the straddle which you mentioned.
However, some pre-requisites must apply:
1- You need to be 70% sure that the news are going to have a significant effect on the underlying instrument (Index, stock, future contract or currency)
2- You need to be 80% sure that volatility is going to increase after news hits
3- And finally you need to be 90% that a trend will develope either up or down in the underlying instrument
Let me give you a good example:
Take ABC stock for example, earnings release is due in a 2 days, the company is expected to beat expectations and the stock has been seeing accumulation over the past period by investors and is making new 52 wk high at least every month. A hot and good stock in an uptrend, cool.
Now, let's say that the stock is trading at $50, and we thought of looking at the options. You will see that we have calls and puts on 30, 35, 40, 35, 50, 55, 60, 65, 70 and so on, difference between strikes is $5 (Sometimes it's $2.5, sometimes it's $10)
Anyway, the stock is trading at $50, so we look at the calls and puts of the $50 strike, since the stock has a bullish bias, the calls are going to be higher in price than the puts by a small margin. Let's say we saw the call contract at $150 and the put contract at $135.
Now the trick is to allocate an amount of money, divide it by 2 and buy calls with one half and puts with the other. This of course will result in an unequal amount of contracts for calls and puts, but most important that the dollar amount is the same.
So we decide to buy calls worth of $1500 and puts worth another $1500, that's 10 calls and 11 puts.
Now the fact that as an option buyer, your risk is only limited to the premium you paid, thus you can't lose more than $1500+$1485 = $2985, and in our case, you can't lose 100% of the money because the position you are taking dictates that for one side of the trade to be worth zero, the other must worth something.
Anyway, now time for calculations. If the previous 3 points are fulfilled, you make profit regardless the stock goes up or down, but there are 2 breakeven points in which you need to breach to make profits either way. In between those 2 points, you make a loss.
For an upward move in the stock price, for you to break even, the stock must trade at $53. Any point above the $53 mark, you make a profit. How is this calculated??
Your total investment is $2985, when the stock moves up, you throw 11 puts out of the window, so you actually paid $2985 for a winning 10 calls, thus your cost for each call here is $298.5. For the call to worth $298.5 without accounting to volatility or time value, the stock must be at $53. The call at the day of expiration will have a value of $300 if the stock is trading at $53, so $3000 is the total value of your 10 calls and your puts are worthless, you are at breakeven. This is the safest break even point. This point can be lower if you account for volatility or time value (Time till expiration), but I recommend that you drop those 2 because you won't be able to measure those 2 factors 1 day in the future. You might be able to measure time value using formulas, but the market will always prove you a certain deviation, so better play it safe.
Now for every $1 above the $53 mark, you make a $100 per contract in profit and $1000 overall, thus a 100% return needs the stock to go just $4 above the $53 mark. From the $50, that's a 14% increase, which is not a huge amount and can be seen in a week.
Now let's see what happens when the stock goes down. For a downward move in the stock price, for you to break even, the stock must trade at $47.28. Any point below the $47.28 mark, you make a profit.
In this case you are throwing away the 10 call contracts out of the window, and you are assuming that your initial investment is distributed over 11 winning puts. Thus the cost of each put is $271.36, so you need to see the price of the stock go down by $2.71 for you to break even.
Once again this is the safest breakeven point. When the stock is trading at $47.28, every put will be wroth around $272 x 11 = $2992, approx break even.
It's a little bit different in here, as for every $1 down, you will make a $1100 profit per contract since you are having 11 puts and not 10 as in the case of calls. You will think that this is not fair, but actually it is, since the stock actually carries a bullish bias from the beginning, and a downward move is not likely, so you must be rewarded if the stock goes down more than you should be rewarded if the stock goes up.
In the above case, you lose money if the stock price stays between $47.28 and $53. You can easily calculate how much of your initial investment are you going to lose. If the stock is trading at $52, your puts are worthless and your calls worth $200 each, thus you lost around $985, which is around 33% of your initial investment.
If the stock is trading at $49, your calls are worthless and your puts are worth $100x11 = $1100, thus you lose $1885 or 63% of your initial investment,
As a rule of thumb, as closer the stock price to the strike price of your options, as your loss curve increases, and as closer to any of the break even points, as lower your loss.
You can see how the curve looks like in the attachment, sorry, I drew this by hand, as I am not installing the options analysis software
Hope that I have been helpful and feel free if you want to dicuss further strategies. If you would like, I have a great options tool, it's free and you can request it and I will send it immediately. I downloaded it from The Chicago Board Options Exchange, not sure if it's still there or not.
Thanks,
Nader
However, some pre-requisites must apply:
1- You need to be 70% sure that the news are going to have a significant effect on the underlying instrument (Index, stock, future contract or currency)
2- You need to be 80% sure that volatility is going to increase after news hits
3- And finally you need to be 90% that a trend will develope either up or down in the underlying instrument
Let me give you a good example:
Take ABC stock for example, earnings release is due in a 2 days, the company is expected to beat expectations and the stock has been seeing accumulation over the past period by investors and is making new 52 wk high at least every month. A hot and good stock in an uptrend, cool.
Now, let's say that the stock is trading at $50, and we thought of looking at the options. You will see that we have calls and puts on 30, 35, 40, 35, 50, 55, 60, 65, 70 and so on, difference between strikes is $5 (Sometimes it's $2.5, sometimes it's $10)
Anyway, the stock is trading at $50, so we look at the calls and puts of the $50 strike, since the stock has a bullish bias, the calls are going to be higher in price than the puts by a small margin. Let's say we saw the call contract at $150 and the put contract at $135.
Now the trick is to allocate an amount of money, divide it by 2 and buy calls with one half and puts with the other. This of course will result in an unequal amount of contracts for calls and puts, but most important that the dollar amount is the same.
So we decide to buy calls worth of $1500 and puts worth another $1500, that's 10 calls and 11 puts.
Now the fact that as an option buyer, your risk is only limited to the premium you paid, thus you can't lose more than $1500+$1485 = $2985, and in our case, you can't lose 100% of the money because the position you are taking dictates that for one side of the trade to be worth zero, the other must worth something.
Anyway, now time for calculations. If the previous 3 points are fulfilled, you make profit regardless the stock goes up or down, but there are 2 breakeven points in which you need to breach to make profits either way. In between those 2 points, you make a loss.
For an upward move in the stock price, for you to break even, the stock must trade at $53. Any point above the $53 mark, you make a profit. How is this calculated??
Your total investment is $2985, when the stock moves up, you throw 11 puts out of the window, so you actually paid $2985 for a winning 10 calls, thus your cost for each call here is $298.5. For the call to worth $298.5 without accounting to volatility or time value, the stock must be at $53. The call at the day of expiration will have a value of $300 if the stock is trading at $53, so $3000 is the total value of your 10 calls and your puts are worthless, you are at breakeven. This is the safest break even point. This point can be lower if you account for volatility or time value (Time till expiration), but I recommend that you drop those 2 because you won't be able to measure those 2 factors 1 day in the future. You might be able to measure time value using formulas, but the market will always prove you a certain deviation, so better play it safe.
Now for every $1 above the $53 mark, you make a $100 per contract in profit and $1000 overall, thus a 100% return needs the stock to go just $4 above the $53 mark. From the $50, that's a 14% increase, which is not a huge amount and can be seen in a week.
Now let's see what happens when the stock goes down. For a downward move in the stock price, for you to break even, the stock must trade at $47.28. Any point below the $47.28 mark, you make a profit.
In this case you are throwing away the 10 call contracts out of the window, and you are assuming that your initial investment is distributed over 11 winning puts. Thus the cost of each put is $271.36, so you need to see the price of the stock go down by $2.71 for you to break even.
Once again this is the safest breakeven point. When the stock is trading at $47.28, every put will be wroth around $272 x 11 = $2992, approx break even.
It's a little bit different in here, as for every $1 down, you will make a $1100 profit per contract since you are having 11 puts and not 10 as in the case of calls. You will think that this is not fair, but actually it is, since the stock actually carries a bullish bias from the beginning, and a downward move is not likely, so you must be rewarded if the stock goes down more than you should be rewarded if the stock goes up.
In the above case, you lose money if the stock price stays between $47.28 and $53. You can easily calculate how much of your initial investment are you going to lose. If the stock is trading at $52, your puts are worthless and your calls worth $200 each, thus you lost around $985, which is around 33% of your initial investment.
If the stock is trading at $49, your calls are worthless and your puts are worth $100x11 = $1100, thus you lose $1885 or 63% of your initial investment,
As a rule of thumb, as closer the stock price to the strike price of your options, as your loss curve increases, and as closer to any of the break even points, as lower your loss.
You can see how the curve looks like in the attachment, sorry, I drew this by hand, as I am not installing the options analysis software
Hope that I have been helpful and feel free if you want to dicuss further strategies. If you would like, I have a great options tool, it's free and you can request it and I will send it immediately. I downloaded it from The Chicago Board Options Exchange, not sure if it's still there or not.
Thanks,
Nader
- #8
- Dec 8, 2005 9:13am Dec 8, 2005 9:13am
- Joined Sep 2004 | Status: Trader | 1,464 Posts
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- #9
- Last Post: Dec 8, 2005 7:29pm Dec 8, 2005 7:29pm
- Joined Jan 2005 | Status: Keep Learning | 1,180 Posts