A lot of people are wondering if they should buy Bitcoin. A lot of people are also wondering if it is a viable option to the methods of payment we currently have available. We can all agree that the idea of peer-to-pun currencies like cryptocurrencies is ingenious! Are you wondering if you should purchase Bitcoin? Keep reading to learn the answer to this question and more!

What Is Bitcoin?

When considering buying Bitcoin, it is important to understand what Bitcoin is. Bitcoin is a digital currency that is decentralized and can be used as an investment and as a means of payment. Transactions are verified and approved using cryptography, which helps to ensure their security. Platforms and analytics services often read blockchain transaction records using an onchain data API so balances and transfers can be tracked accurately across the network. Bitcoin can also be used as a store of value and a medium of exchange like traditional currencies. Investing in Bitcoin has its advantages as it can potentially provide a higher return on investment than traditional currencies. But, it is also known to be volatile and can be affected by many external factors. So, it is important to research further and understand the implications of investing in Bitcoin before purchasing any coins.
 

Uses of Bitcoin

It is a digital currency with many potential uses. It can be used to purchase goods and services online, as well as to make payments to people all over the world. It can also be used for investment purposes, as it is an extremely volatile asset with the potential for significant returns. It is essential to consider the risk involved with investing in this relatively new asset class. It is also not supported by any central bank, so the user must take all responsibility for the security of their funds. For these reasons, it is important to do your research and think carefully about whether investing in Bitcoin is right for you.
 

Different Types of Bitcoin Investors

It is crucial to know the different types of Bitcoin investors. First, some invest for long-term gains. They usually have a good understanding of the cryptocurrency and expect its growth. Second, some traders buy with the hopes of making short-term profits by selling it at a higher price. Lastly, some speculators buy based on rumors and news. They are likely to take greater risks for a higher reward. The investor should decide whether their risk tolerance and goals are aligned with the respective type of Bitcoin investor before buying. With educated speculation, the proper outlook, and a long-term mindset, investors can achieve success with Bitcoin.
 

Understanding the Legal and Regulatory Environment

It is important to understand the legal and regulatory environment of Bitcoin. Bitcoin is treated differently by different countries in terms of taxation, as well as regulatory compliance. For example, some countries may tax Bitcoin acquisitions as capital gains while others may not. Moreover, individuals should be aware of the regulations in their jurisdiction in terms of exchanging, trading, and otherwise using Bitcoin. It is recommended that users consult with a financial or legal advisor to understand the legality and regulatory environment of buying, selling, and using Bitcoin. Furthermore, one should always be extra cautious when handling digital assets since they are not always insured or protected in the same way as traditional asset classes. With a full understanding of the legal and regulatory environment of Bitcoin, it is then up to the individual to decide if they wish to purchase Bitcoin.

Calculate the Potential Risks and Benefits of Investing

It is also vital to consider the potential risks and benefits of Bitcoin associated with cryptocurrency. On the one hand, it is decentralized, meaning it is not regulated by any government or bank. It can be seen as a benefit and a downside because it makes it volatile and subject to market forces. Also, the profit potential is high in uncertain economic times, as it has the potential to appreciate rapidly. It is also important to consider the potential security risks as a digital currency can be subject to cyber thieves or hackers. It is vital to understand the technology behind Bitcoin, as well as the market forces. It is also a good idea to use a wallet specifically for Bitcoin transactions, as it will provide an extra level of security. Ultimately, investing in one is a personal decision that requires careful consideration of the potential risks and benefits.
 

How to Buy Bitcoin

Bitcoin is a digital currency, meaning that it can only be used online. To purchase Bitcoin, one must first find a reliable exchange where they can buy and store it securely. After finding a trusted exchange, the user will create an account before depositing their traditional currency. Once the transaction is complete, the user will then become the owner of Bitcoin. The decision to buy Bitcoin is an individual one. Check this to find out more about how to buy cryptocurrency in another country. Potential buyers should weigh the risks and rewards before considering an investment.
 

Should I Buy Bitcoin? Weigh Your Needs

Investing in Bitcoin can be a risky endeavor. But, with the proper research and understanding, it can also be a lucrative investment with the potential for future growth. It depends on your existing circumstances and the level of risk you're willing to take. It could potentially pay off big if you invest wisely, but as with any form of investing, there is associated risk. If you're considering buying Bitcoin, do your homework and talk to financial professionals before proceeding. Investing is always a gamble, so it’s best to make informed decisions when it comes to your finances.

This is a contributed post

So without further ado, let’s walk through some of the most common red flags below. 

Be Careful About Reputation

You’ve heard about a great new currency you like the sound of, and it’s doing well on the market right now. You want to get involved and invest, and that’s great too.

But before you do, double check where this currency has come from. 

What information is publicly available about the creator(s)? Look for white papers, read up on forums, and look for past projects they may have gone into. 

The latter is incredibly important, as you need to know what (if any) projects these creators have worked on before, as well as what ended up happening to them. 
 

Don’t Take Anyone at Their Word

If a friend told you about a cryptocurrency they’d invested in, and they were pleased with the way it was performing, would you immediately invest in it too? 

There’s a chance, because you know this person and you trust them. 

But never take anyone at their word. You first need to know for yourself what ‘performing well’ really means. 

Avoid Anyone Trying to Rush You

This is a classic scam technique. The person trying to get your details and/or money makes you feel like there’s a time limit on making a decision. 

That sense of urgency is going to be what trips you up more than anything else. 

Of course, in the world of crypto, a scammer is unlikely to tell you that you’ll be going to prison unless you invest in their new currency. 

Instead, they’re going to play on hype in the form of ‘FOMO’, as no one wants to miss out on a great investment while the market looks strong. 

Hype can be dangerous

Buy into the hype and you might end up putting all of your investment fund into a currency, only for the same person who encouraged you to invest to turn around and ‘pump and dump’ it.

This result is quite common across social media, with various content creators and influencers hyping up certain currencies to their audience. 

Even if they don’t intend to run a pump and dump scheme, they still end up being one of the few people who actually made a return.

Once again, never just take a public figure at their word. Conduct your own checks and make your own decisions. 

Staying Safe with Crypto: Top Tips

Now you know some common red flags, how do you actually avoid falling prey to them? 

For one, always approach the crypto market with a healthy sense of skepticism. If you want to be an experienced trader one day, you need to take your time with the market. 

But there’s a couple of other things you should do to stay safe as well:

Find out as much as you can about chains

No crypto investor should be just be slinging their coins around without any care. The market for crypto isn’t regulated in the same way usual financial markets are - and that’s one of the main appeals of investing in crypto. 

You can make money, you can move money, and you can keep your crypto investments in whatever place is best for you. All you need is access to trading platforms and your own wallet. 

But even with this freedom to grow your investment, you need to be careful about this decentralized aspect. If you’re using a non-centralized platform to trade, that’s one thing. But with new currencies and chains being launched at break-neck speed, you always need to be in the loop. 

Use a clever bit of automation to help yourself out here. Sign up to block explorer software that lets you investigate blockchain in the same way you’d tap something into Google to find out more. 

You can even launch custom a block explorer to uncover and track the specific targets you’re interested in, and you don’t even need to be a tech expert to get it up and running. 

Keep your accounts secure by following best safety practices

We all know the standard online safety rules, right? If you don’t, we’re here to serve you a quick reminder. 

1. Make a strong password and never share it with anyone, no matter how close they are to you.

2. Try not to share private details with strangers. You’ll be making traders across platforms, both public and private, but you should be protected by that platform’s encryption system.

3. Turn on 2 factor authentication, if you can. If someone needs both your actual password and a code sent to your phone or email, they’re not going to get into your account.

Crypto Trading: Take Note of a Red Flag When You See One

There’s quite a few to be on the lookout for, and that can be a worry. You don't want to miss a single hint of red whenever you’re looking into a new chain or currency. 

But all in all, you may just need to trust your gut here. 

After all, we’ve all been taught the golden rules of keeping your money safe: 

• Get rich quick schemes don’t exist

• Everyone is trying to sell you something

These rules are usually the basis of all our money decisions in adult life. Stick to them in the crypto world and you’re far less likely to fall for any red flags pretending to be green ones.

When you’re trading crypto from the comfort of your own home, don't let the ease of this kind of investing lull you into a false sense of security. 

Stay sharp, stay smart, and stay safe.

This is a contributed post.

Building wealth is a sprint; it rewards speed and concentration. Protecting wealth is a marathon; it rewards patience and design. The strategies that brought you to where you are today may not be those that protect what you have created. The concept of diversifying is no longer a chase for upside as much as designing an intentionally, flexible and secure lifestyle.

Redefining Risk After Success

Risk can be thrilling when you're climbing, and taking an opportunity at risk can turn things around fast. At some point, as you build wealth, risk will start to feel differently; a bad decision could undo all you've worked for over many years. When this happens, diversification isn't just buying more things. Rather, it's identifying areas of exposure. 

While many successful individuals may own large amounts of money in one type of business, one asset class, or one geographic area, they continue to hold a high level of concentrated risk. That same concentration can become a silent threat to their long-term financial stability. Take a hard look at how much of your total wealth is tied up in a single industry. 

Next, think about how liquid your assets really are? Finally, ask yourself what would happen if interest rates rose, markets were unable to sell positions, or your primary source of income was reduced? To preserve what you have, first, be honest about the areas of vulnerability. Don't pull all of your assets out into cash and hide. Instead, spread your risks in ways that seem intentional rather than reactionary.

Building A Layered Asset Structure

Wealth preservation works best when assets serve different roles. Some provide growth. Some generate income. Others create optionality. Public equities will remain important; however, their objective may be changing. 

Rather than pursuing speculation, public equity investors should seek to invest in stable companies with solid financials and consistent cash flows. Dividend income now appears appealing as it creates an opportunity for a more controlled sale strategy during market volatility.

Bonds have never been sexy; however, bonds have historically smoothed out the variability of investment returns. In addition, bonds provide a known income stream regardless of what happens in the markets. This is particularly true if the bond portfolio has been constructed through a mix of various maturity dates. Private investments will likely continue to be relevant, however, private equity investors will need to be cautious of position sizing.

The days of investing a large portion of your portfolio into one single start-up or fund are coming to an end. Private equity investors will need to allocate smaller portions of their portfolio among multiple funds or managers. The goal here is to reduce the risk of one event determining your future. 

Think about your portfolio in layers. Top layer growth (i.e., the companies with the greatest potential); middle layer stability (i.e., the companies that generate the most free cash flow); bottom layer liquidity (i.e., the cash available to meet short-term obligations). As markets fluctuate, you will be better able to manage your emotions if you have a balanced portfolio rather than a panicked one. 

Real Estate With Purpose

Real estate often becomes a cornerstone for those who have reached financial independence. It offers tangible value and the potential for steady income. Yet owning property without a clear plan can create complexity rather than security. Diversification within real estate matters just as much as diversification in stocks. Residential properties behave differently than commercial ones. Markets in the Midwest do not mirror coastal cities. Short term rental demand can shift quickly based on tourism trends. 

Professional systems can make a real difference here. Many investors rely on rental property management software to track performance, manage tenants, and keep expenses organized. When used well, it turns a collection of properties into a disciplined operation. That level of clarity supports preservation because it reduces surprises. It is also worth considering real estate investment trusts for additional exposure without direct management responsibilities. They provide liquidity and professional oversight while still offering access to property markets.

Expanding Beyond Traditional Investments

The inclusion of art, collectibles, and direct business investment can provide a richer experience for your portfolio (financially and emotionally). These types of investments require knowledge, time and are not substitutes for your core holdings, but they can be used to support them. 

Strategic giving through philanthropy using tools such as donor-advised funds or private foundations is also part of the diversification conversation. Strategic giving can help with tax efficiency, while allowing you to build your legacy. Many times, strategic giving is used by families to bring their members together around common goals, and can even become one of the ways that you use charitable planning. 

Family investments in education and/or experiences will never show up on a balance sheet, however, these can make your wealth more resilient over the long-term. If you fund the education of your children beyond what would have been expected, or if you invest in a business venture within your family, you may be able to generate future income from those ventures and establish a sense of community among your family members.

At this point, your diversification efforts are no longer about making money. Diversification at this point is about creating a "life architecture" that reflects who you are today. 

Designing For The Next Generation

True wealth preservation involves planning past one's death. A true diversified investment portfolio also needs to reflect the interaction of the heirs with their inheritance. Educating your heirs on money matters is very important. Structured exposure to heirs' making financial decisions as they grow up can help prevent them from making poor financial choices. 

Family meetings that include discussions on investments, philanthropy, and long-term family objectives increase transparency.

You may want to consider staggering inheritances, or tying incentives to trusts in order to encourage productive activity by the heirs. However, this does not have to involve controlling your heirs from beyond the grave. Rather it creates an environment which encourages growth and independence rather than dependency. 

Moving from wealth building to wealth preserving is a powerful transition. It reflects achievement and foresight. Diversification becomes a tool for stability, flexibility, and legacy rather than a buzzword. At this level, the question is no longer how fast you can grow. It is how thoughtfully you can protect. Preservation is not passive. It is active stewardship. It honors the effort that built your wealth in the first place while ensuring that it continues to serve you, your family, and your community for decades to come.

This is a contributed post

Although there is no such thing as a 100 percent safe bet in the world of trading, there are 10 things that you can do to minimize your risks and ensure that you're the best trader you can possibly be. 

Whether you trade stocks, futures, forex, or crypto, these core principles can significantly raise your performance over time, so let’s take a look at them, shall we?

1. A clear, written trading plan

If you want to start off on a solid foundation, then you really do need to start out with a clear trading plan that you have written down and can refer back to as often as you need to. Without one, every decision becomes reactive and emotional. A solid plan defines what you trade, when you trade, how much you risk, and when you exit, both for profits and losses.

Your plan should answer questions such as:

• What markets do I trade?

• What setups qualify as valid trades?

• How much do I risk per trade?

• When do I stop trading for the day or week?

Writing this down removes ambiguity and helps you stay consistent, even during volatile periods.

2. Strong risk management habits

Risk management is what keeps traders in the game long enough to succeed. You can be wrong many times and still be profitable if losses are controlled.

Limiting risk to a small percentage of your account per trade protects you from emotional decision-making and catastrophic drawdowns. Stops should be placed logically, not emotionally, and position sizes should always be calculated before entering a trade.

Professional traders focus less on how much they can make and more on how much they can lose, because survival always comes first, right?

3. Emotional discipline and self-awareness

Trading psychology is often the biggest obstacle to consistent results. Fear, greed, impatience, and overconfidence can sabotage even the best strategies.

Becoming a better trader means learning to recognize your emotional triggers. Do you revenge trade after a loss? Do you overtrade when bored? Do you hesitate to take valid setups after a losing streak?

Awareness allows you to build rules that protect you from yourself, such as mandatory breaks after losses or limits on daily trades.

4. A focus on probabilities, not certainty

Markets are probabilistic, not predictable. Even the best setups fail sometimes. Accepting uncertainty is essential to long-term success. 

Good traders think in terms of expectancy: over a large number of trades, does the strategy produce a positive outcome? Once you understand this, individual wins or losses become less emotionally charged, making it easier to stick to your plan.

5. Using indicators as tools, not crutches

Indicators can be useful, but only when used correctly. Too many traders overload their charts, creating confusion and conflicting signals.

The goal of indicators is to support decision-making, not replace it. Price action, market structure, and context should come first. Indicators work best when they complement a clear trading thesis rather than drive it entirely. 

Some traders look for resources such as the 3 ‘Better’ trading indicators at emini-watch. to improve clarity and reduce noise. The key is not the indicator itself, but how consistently and intelligently it’s applied within a broader strategy.

6. Understanding market context

Markets behave differently depending on time of day, volatility levels, and broader economic conditions. A setup that works well in a trending market may fail in a choppy, range-bound environment.

Better traders learn to identify context:

• Is the market trending or consolidating?

• Is volatility expanding or contracting?

• Are major economic events approaching?

Trading in alignment with current conditions significantly improves odds and reduces frustration, so it is a really important part of the equation if you are looking to be a successful trader.
 

7. Keeping a detailed trading journal

A trading journal is one of the most powerful tools for improvement. Recording trades, screenshots, emotions, and outcomes allows you to identify patterns in both your strategy and behavior.
 

Over time, you may notice that certain setups perform better than others, or that specific mistakes repeat under stress. Journaling turns experience into actionable data and accelerates learning.

Even a simple journal can reveal insights that charts alone cannot, so even if it seems like a silly thing for you to do, it really isn’t and it is really worth it.
 

8. Continuous development

Markets evolve, and traders must evolve with them. Ongoing education helps you refine your edge and adapt to changing conditions.

This doesn’t mean chasing every new strategy. Instead, focus on deepening your understanding of market mechanics, price behavior, and risk management. Reviewing past trades, studying charts, and learning from experienced traders all contribute to long-term growth.

The best traders remain students of the market throughout their careers.
 

9. Patience and selectivity

One of the most underrated trading skills is patience. You don’t need to trade every day or every setup. In fact, overtrading is one of the fastest ways to erode capital.

Waiting for high-quality setups that align with your plan improves consistency and reduces emotional fatigue. Many professional traders make the bulk of their profits from a small number of well-executed trades.

Sometimes, not trading is the most profitable decision you can make.
 

10. Reviewing performance honestly

Improvement requires honest self-assessment. Regularly reviewing your performance helps you spot strengths, weaknesses, and areas for adjustment.

Ask yourself:

• Did I follow my plan?

• Did I manage risk correctly?

• Were losses due to execution errors or normal variance?

Avoid blaming the market. Focus on what you can control like your preparation, execution, and discipline.
 

Becoming better is a process, not a destination

Trading mastery is not achieved overnight. It’s built through repetition, reflection, and refinement. Every losing trade contains information, and every winning trade reinforces discipline when executed correctly. By doing the 10 things mentioned above, you can better your knowledge, better your decisions and better your bank balance, so what’s stopping you?

This is a contributed post

If you’re interested in investing as a beginner for the first time or expanding your portfolio, here are some effective steps to reduce investment risks in 2026. 

Prioritize research

Research is vital, regardless of whether you’re a new investor or a seasoned pro with an extensive portfolio. Investing is risky by nature, and it comes in many guises. Even the most experienced financial advisers and investors can benefit from undertaking rigorous research before spending money. Research will enable you to learn about patterns and trends, get to grips with how specific types of investments work, understand what options are available to you, and get an idea of the level of risk involved. 

When researching, it’s critical to utilize high-quality resources and access guidance and advice from people who have the relevant knowledge. In the age of online trading and 24-hour access to apps, news channels, blogs, and online magazines, it’s easy to find information. The trouble is that not all of it is useful, accurate, or trustworthy. Stick to high-profile organizations and authorities and secure websites. 

Utilize expert advice

Investing may seem simple on the surface, but it can be incredibly complex. Expert advice can help you gain clarity, make decisions, and determine which routes are best for you. Whether you’re exploring new commodities or stocks, you want to diversify, or you’re new to investing and you have a lump sum ready to go, it’s wise to take advantage of professional financial advice and investment portfolio services provided by trustworthy, top-rated firms. Experts can help you streamline strategies and explore different pathways based on your goals, how much you want to invest, and your existing assets. It’s important to note that you don’t have to act on advice. There should be no pressure or obligation to invest if you’re seeking guidance. Take your time to make decisions. 

You can find investment firms and trusted advisers online or ask people you trust for recommendations. It’s helpful to read verified reviews, check credentials, and arrange consultations to learn more about organizations or individuals before you proceed. 

Aim to diversify

Diversifying is one of the best ways to lower risks as an investor. Investors are often warned about the perils of putting all their eggs into one basket. If you have a diverse portfolio, or your money covers a wide range of stocks, for example, there’s a smaller chance of losing everything if one investment fails. It’s wise to make sure you’re not too heavily reliant on a single commodity, type of investment, market, industry, or type of asset. 

Before you spread your bets, it’s beneficial to consider the best ways to build a more diverse portfolio. Your decisions should reflect your personal investment goals, your risk tolerance, and how active or passive you plan to be. Having a mixture of investments with varied risk levels and different ways of generating income can protect you against unexpected crashes or volatility. 

Outline personalized objectives

It’s common to think about multi-million dollar portfolios when you hear the word ‘investment,’ but in reality, almost anyone can invest. More than 60% of Americans have stocks, but the richest 1% of investors hold half of the total value of the stock market. Many people invest small amounts in a bid to boost their income, save for the future, or lay down foundations for a comfortable retirement. When you invest, it’s crucial to outline personalized objectives. There are multiple ways to make money, but not all of them will be suitable for every investor. 

Before you decide where to spend money, what to buy or sell, or how much to invest, it’s wise to consider your goals. Are you eager to make as much money as quickly as possible? Are you interested in short or long-term investments? Are you planning to use the money as an extra income source or is growth your main objective? Once you know what you want to achieve, it’s easier to figure out a strategy that aligns with your targets and preferences. It’s important not to get sidetracked by others, as they may have different aims. 

Review your investments regularly

The picture can change very quickly and unexpectedly when you invest money. From trading to flipping real estate, investments are vulnerable to external factors and forces that impact their value. If you’re an investor, reviewing your assets regularly, tracking market trends and prices, and evaluating your goals is beneficial. It may be advisable to adjust and modify your strategy to lower risks and respond to potential hazards. You may want to explore different types of investments or adapt timeframes if prices have fallen or new opportunities have emerged, for example. 

Using tools and cutting-edge tech can be helpful if you’re keen to be proactive in managing your portfolio, keeping up with news, and tracking market moves without spending all of your time worrying about your investments. Look for highly rated apps and reputable websites that offer access to news articles, guides, tutorials, and market updates with expert insights. 

Keep an eye on your cash reserves

Investing is designed to help you increase your income and grow your wealth, but it isn’t always plain sailing. One of the main risks is that investors often have a lot of money tied up, with limited access to ready cash. Keeping an eye on your cash reserves is important to lower risks, protect assets, and minimize disruption if you do need money fast. 

A new year is a good opportunity to think about investing. Whether you’re new to the game or you’re eager to expand or diversify your portfolio, it’s beneficial to be proactive in reducing risks. Key steps you can take in 2026 include prioritizing research, seeking expert advice, diversifying your investment portfolio, outlining clear, personal investment goals, reviewing your investments regularly, and keeping a close eye on your cash reserves. 

This is a contribute post.

This is the market-timer’s dilemma in real time – trying to outguess short-term moves instead of sticking with a long-term, risk-appropriate plan.

This week’s post dives into that very topic. Several reader comments landed in my inbox recently, and they all highlight the same challenge: the temptation to jump in and out of the market entirely, or to change strategies based on short-term noise.

Here’s why that approach is so dangerous, and why staying invested through the ups and downs is almost always the smarter move.

Honestly, I worry whenever I receive a bunch of emails from nervous investors. Worried that investors are going to abandon their sensible index funds at the faintest threat or whisper of adversity.

Here’s what a few of them said:

“We sold 70% of our (global equity) holdings in early September, since September tends to be a negative month for markets. We put the cash into a short-term GIC and now that it’s matured, we’re wondering if we should dollar-cost average back in or go lump sum. FOMO is starting to creep in since the market has been soaring higher.”

And they’re not alone. Another reader recently shared:

“With the unknowns surrounding Trump and tariffs I converted our savings to cash around the end of May and am currently earning 2.75%.”

Then came an email that struck a similar chord:

“I am wondering if one should add some gold ETFs to their portfolio to hedge off any downturn in the market? I read an article from Ray Dalio concerning having some gold—15% or so—in your portfolio.”

These are all versions of the same worry: maybe diversification isn’t enough. Maybe this time is different. Maybe a tweak or two will protect me from the next downturn.

Look, investing is hard. When markets are roaring, it’s tempting to chase the hottest stocks or indexes. Tech stocks, the Nasdaq, even the S&P 500 all look shiny when they’re leading the pack. Meanwhile, holding a global index portfolio feels boring and vanilla, even though returns have been strong and diversification quietly spreads risk across thousands of companies and dozens of countries.

I worry too. I worry that investors chase returns in rising markets. But I’m even more worried that they’ll abandon their risk-appropriate portfolio when markets fall.

And markets will fall. That’s not a flaw, it’s a feature of investing. It’s the very reason stocks offer higher long-term returns than cash, GICs, or bonds. The “risk premium” exists because investors have to stomach temporary declines along the way.

That’s also why I recommend asset allocation ETFs. You get globally diversified growth during good times, and that same diversification cushions (not eliminates) losses during downturns. Index funds aren’t magic. When markets fall, your portfolio will fall. That’s how it works.

The key is staying the course. It’s painful to watch your portfolio drop, but history shows that trying to time the market, selling and then figuring out when to buy back in, almost always leads to worse results than just holding your risk-appropriate mix and riding it out.

We saw this in 2022 when investors fled to 5% GICs, only to miss the sharp rebound from 2023 through 2025. Markets can recover faster than most people expect, and missing just a handful of strong days can derail long-term returns.

So yes, we’ve had a good run lately. The “Liberation Day” tariff scare from the spring feels like ancient history now. But eventually markets will drop 10, 20, maybe even 30%. Long-term investors in global index funds know this will happen and should not be surprised. Those drops are temporary. Over time, the line still moves up and to the right.

For retirees or near-retirees who’ve been flying a little too close to the sun with their equity exposure, now’s a good time to set up your 10% cash wedge to help facilitate future withdrawal needs. You can do that in a few ways:

• Sell a small slice of your ETF holdings while markets are high.
• Turn off dividend reinvestment and direct those distributions into a HISA ETF.
• Put new contributions into that HISA ETF until you reach about 10% of your portfolio in cash by the time you retire.

That small cushion will give you peace of mind when the next correction hits so you don’t feel tempted to abandon your plan.

Stay diversified. Stay invested. And most importantly, stay the course.

The original post was published here By Robb Engen

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Unfortunately, crypto trades are just as good at spitting new investors out of the fold, and they typically lead to heavy losses when they do. That’s because crypto remains the most volatile trade on the table, never mind its promise of high returns or new horizons. 

You’re especially liable to get burned if you jump in and get started without doing your due diligence. Such a mistake could easily lead to the following potentially catastrophic mistakes that are all too easy to make in your early crypto trades. 

Mistake # 1 - Rushing in Without Doing Your Research

While it’s great to get excited about cryptocurrency, rushing into a trade without doing any research whatsoever is guaranteed to get you into trouble. This is especially true considering how tricky crypto can be to understand for a total newbie: it’s all too easy to sign up for something you simply can’t even begin to understand. 

That’s why experts consistently highlight the need to do ample research long before you consider putting a trade on the table. As well as needing to know what’s what and who’s who in the crypto world, you’ll want to gain an understanding of everything from market research to trade transaction ledgers. You’ll also want to take the time to deep-dive into the community in question, to ensure that the right support, security, and standing are all in your trade corner. 

Luckily, all of this information is easily available if you know where to look for it. This is especially true when it comes to trade and transaction history, which are right there for everyone to see on the blockchain, and are easily searchable if you use a block explorer-as-a-service as offered by companies like Blockscout. You should also delve into crypto white papers, social sentiment, and market metrics before making any investment decisions. 

Picture Credit: CC0 License

Mistake # 2 - Losing Any Sense of Strategy

Leaping into any trade without a strategy is bad for business, but it’s especially problematic for volatile markets like cryptocurrency. In fact, leaping in without a plan drastically increases risks like overtrading, missed opportunities, and, of course, inevitable losses. 

To avoid all of that, you need to have a strategy from the get-go. In a lot of ways, this is the map that’s going to uncover your crypto treasure, and it ensures you never act too quickly or spend too much. Luckily, while there are more complex trading strategies to consider later in your journey, there are also great options for beginners, and they tend to hinge on simple concepts like trade analysis, risk management, and just basic self-discipline. 

In other words, you need to research, set clear price points, and always keep the bigger investment picture in mind. This is true even if a tempting-looking trade tries to lure you outside of those boundaries. Leave the risks to the wolves of Wall Street; you’re here to ensure returns. 

Mistake # 3 - Letting Your Heart Lead

Picture Credit: CC0 License

You might not think you would be an emotional trader, but it’s surprisingly easy to fall into this trap. After all, cryptocurrency trading is as exciting as it can be stressful, and it’s all too easy to get swept up in that. This can lead to what’s known as ‘emotional trading’, where you begin making impulsive decisions that entirely throw the rulebook out of the window. And that way is sure to lead to the most notable losses you’ll suffer. 

Emotional trading is especially liable during market dips and rises, yet these are pretty much part and parcel of crypto life. If you panic and sell your stocks as soon as a market starts to dip, then you’re sure to settle for a loss, while also facing higher repurchase prices when you reinvest. Equally, buying in a market on the rise has the potential to impact trade profitability if you jump in at the wrong time.

Hence, it’s crucial to lean into strategy and research far more than you should factor for any emotional trade elements. This is the only way to stick within reasonable trade limits, make wise choices, and avoid the inevitable fall that’ll come from letting your heart lead. 

Mistake # 4 - Falling into the Fraud Vacuum

The safety of cryptocurrency is one of its most lauded benefits, but that isn’t to say that you don’t still need to consider security elements during a trade of this nature. That’s because crypto scams are alive and well, especially in the trading world. From old hats like Ponzi schemes to trades that simply seem too good to be true, you’re sure to face it all when you get started. And, if that happens, you really will lose everything you put in. Luckily, the transparency possible with this currency means there’s no reason why you need to let that happen.

Securing your crypto assets is key to your success in this market, and it’s easier than you might think. Basic scam avoidance rules apply, including the need to thoroughly research every trade market, especially those that promise high returns. Equally, you’ll want to implement security steps like two-factor authentication and secure passwords on your crypto wallet, which scammers won’t be able to access without that information. It’s also worth simply using the block explorers mentioned, as these can help to highlight suspicious transaction activity, which can serve as an immediate red flag. 

Takeaway

Whether you’re a novice trader or you’re simply tempted by the allure of a different kind of investment, cryptocurrency holds an undeniable appeal. Yet, its promise can quickly become painful if you don’t tread carefully. As these mistakes reveal, cryptocurrency’s volatile reputation certainly isn’t unfounded. The best way to avoid losses is to step around these mistakes long before you ever consider making a trade.

This is a contributed post

Investing your money and time in 2025 is something that you should learn about and do with as much care as possible. Your money is earned with hard work and so where you invest and spend your own personal time, is important to get right.

So here are several helpful tips that will ensure you invest your money and time right in 2025 and beyond.

Get the finances in order

Before you go investing your money into anything in particular, you’ll want to get your finances in order so that you know exactly what you have available to spend. A lot of mistakes can be made by investing money that’s actually not your own to invest or it’s money that you need to use for fixed bills and debt repayments for example.

Getting your finances in order will certainly help you maximize the investment potential that you have when spending your money. A good budget spreadsheet is helpful to have in order to see what you have available to spend.

You should also look at what payments you can make towards your investment pot to begin with so that you always have something to play with. See your investment pot as another savings pot to put money into each money from your paycheck.
 

Learn about different investment types

There are a lot of different investment types and even more so since the dawn of the internet. Online investments have rocketed into popularity so it’s useful to get to know what a story protocol block explorer is and how digital currencies are becoming an alternative form of currency being used across the globe.

Every investment type is different and some are more complex than others. Some pose more of a risk whereas others can be fairly tame when it comes to the level of risk associated with it.

Therefore, it’s a good idea to do your research and to make sure you understand the ins and outs of the investment types available. By doing so, you’re going to find your experience with investing a lot easier and more enjoyable. If you don’t understand the investment you’re putting your money into, how can you expect to make a profit or even get your money back?
 

Set financial goals

Financial goals are good to have because they’re a motivator for your efforts when investing. It can be exciting to invest your money for the first time but often enough, you’re spending money and waiting for a return to come back on it.

Therefore, it’s worthwhile planning financially for the future and setting goals that you feel are either achievable or not too impossible to attain over a period of time. Some goals might be short-term options for the year ahead, while others can stretch to the latter years of your life when you’re looking to retire on the money you make.

Setting these financial goals is crucial in life, so you should look at ways in which you want to set yourself up in life financially. Are there certain investments that could increase your potential to hit those goals? All of this is good to think about as you start your investment journey.
 

Diversify your investment portfolio

Being able to diversify your investment portfolio is important, and it’s why it’s often harped on when it comes to the topic of investment in general. The more you can diversify your portfolio, the less risk you have across your investments. 

That’s because the investments you have can end up covering any losses that you might incur through investments that didn’t pan out.

Diversifying your investment portfolio takes time and again, it’s important to be aware of what investment types there are and which ones are best to add to your portfolio based on various criteria.
 

Track and monitor investments both short-term and long-term

To help with the success of your investments, you don’t want to just put away the money and forget about it. There are some investments that will allow you to do that to some degree but for the most part, you should be tracking and monitoring all of your investments for any subtle or significant changes that happen.

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You might need to make some decisions on certain investments in order to protect the money or profit you’ve made. At the same time, it might be that you have to suddenly pull out of an investment to save the money you’ve spent, so it’s good to keep an eye on all of your portfolio regularly.
 

Make use of tax allowances where possible

Tax allowances are certainly something to be mindful of when it comes to spending your money on investments. Certain investments will come with tax benefits, so it’s good to research and explore this area of investing as not everyone takes full advantage of it to help save themselves money.

From rental properties to donations, there are tax relief opportunities available but it’s not something that’s necessarily going to be shouted about from the rooftops. It’s important to know what these are as you investment in each asset.
 

Always be aware of the risks

Finally, as with all investment opportunities, there will always be risks attached to the investments so it’s good to know what these risks are and how low or high stakes it is. It’s also worth remembering that no investment is guaranteed to give you your money back, let alone make a return. That means you should be aware of how much money you can afford to spend.

Investing your money and time is certainly worthwhile if it’s done right. Make sure you’re investing your money wisely in 2025.

This is a contributed post.

There are good ways and bad ways to diversify your portfolio. Yes, you shouldn’t put all your funds into one stock. But the types of other stocks you choose and the amount of stocks in your portfolio matters too. Below are just a few important dos and don’ts to help you diversify efficiently.

The Dos of Diversification

DO spread your investments across different sectors

You’ll find companies from many different industry sectors in the S&P 500. A big mistake that some amateur traders make when diversifying is choosing lots of stocks from one single sector. A common example of this is investing purely in tech stocks (such as Microsoft, Apple, Nvidia, Palantir and Alphabet). The tech sector might be booming right now, but what if there’s one day a calamity that affects the entire tech sector? Investing into a few stocks from other sectors such as healthcare, consumer goods and energy could protect you from a sector-specific downturn. Your tech stocks might lose value, but your healthcare stocks could stay strong. 

DO invest in international markets

Beyond the NYSE and Nasdaq are a range of international stock exchanges that can also be worth exploring. These include Euronext, The Shanghai Stock Exchange, The Tokyo Stock Exchange, The London Stock Exchange and The Saudi Exchange. While it’s comforting to stick to familiar waters, investing in stocks from other countries could offer an extra layer of security. If there’s a domestic downturn, your European stocks or Chinese stocks might just come to the rescue. Just remember that foreign exchanges are open at different times of the day, so you might have to get up earlier or stay up later if you want to buy stocks, sell stocks or monitor what’s going on. Investing in international stocks also does mean keeping up with international politics. For example, knowing what’s happening in China will give you a better idea as to where Chinese stocks are going. 

DO rebalance regularly

You should ideally aim to keep a similar amount of funds in each stock you invest in. It’s unwise to dedicate more than 20% of your funds to a single stock - if that stock crashes, that’s one fifth of your funds gone. Modern trading platforms often allow you to visualise your portfolio as a pie made up of different slices for each of your investments. You should try to keep all of these slices a similar size. If one slice is much bigger than the others, consider rebalancing your funds. Don’t let one company guzzle all the pie! If one slice of pie is leaner than the others, you can similarly invest more funds into it if it’s making a return, or sell it and invest the funds elsewhere if it’s making a loss. 

DO remember your investment goals

The types of stocks you invest should be dependent on your goal. Looking to build your funds quickly? Aim to invest predominantly in high growth stocks - although higher risk, they will grow the fastest. Want to build some savings for retirement? Put some money into more stable stocks from older companies that have consistently proven to make slow but steady returns in the past. That all said, it’s still worth sprinkling in a couple high-growth stocks into a long-term portfolio to add some excitement, just as it’s still worth adding a few dependable slow-growth stocks into a short-term portfolio to add some stability. 

The Don’ts of Diversification

DON’T invest in things you don’t understand

While it’s important to invest in a range of sectors, you should be careful of picking stocks from industries that you know little to nothing about. Investing in random stocks just because they’re on the rise is essentially gambling. While you don’t need to be an expert in every company you invest in, you should ideally take some time to see what products and services they provide to get a better idea of how their price is affected. Some of the strongest portfolios are often made up of stocks that traders know and love - this can give you a much more intuitive idea of when and when not to invest. 

DON’T over-diversify

Diversification is all about balance. While you don’t want to just invest everything into one or two stocks, spreading your funds over 100 stocks isn’t sensible either. Known as over-diversifying or di-worse-ification, investing in too many different stocks often results in paltry returns. It makes it much harder to keep track of all the different companies you’ve invested in. As a result, you’re less likely to immediately notice which stocks are rising in value and which are falling unless you’re spending an hour per day trawling through them. Try to build a portfolio that is diverse but small enough to manage. Many experts recommend 20 to 30 stocks. Ideally, you should be able to name them all when asked to recall them. 

DON’T overlook quality

You could make an argument that even 20 stocks is too much. In fact, one of the most famous investors of all time, Warren Buffet, has long used concentration risk as a strategy: all of Berkshire Hathaway’s returns come from just 12 companies. The reason Berkshire Hathaway has such strong returns year on year is because Buffet has always focused on quality over quantity. Each of the companies he invests in is strong and well established with a proven track record of making steady returns. He doesn’t take a punt on new companies and avoids companies that have a history of volatility (even if they’re currently soaring in value). Choosing high quality stocks typically involves doing research into companies and not just choosing trendy stocks. Look at how well the company has performed over the years and heed the advice of seasoned investors.

DON’T make it too mathematical

It’s possible to take diversification too seriously and spend too much time and effort getting the percentages just right. Yes, you should try to invest a similar amount into each company. But you don’t have to precisely divide your funds into each. Yes, you should invest in different sectors. But you don’t have to maintain an even amount of stocks in each sector. Yes, you should invest in international stocks. But you don’t have to invest an exact equal amount into each stock exchange. Unless you enjoy approaching stock trading with mathematical precision, too many calculations will likely just turn trading into a chore. Aim to divide things up a little more roughly and trust your gut as to where to put your money. This will make building a portfolio more enjoyable. You also won’t have to check in as regularly - unless trading is your job, there’s no need to be logging in every day and tweaking things.

Conclusion

By following these dos and don’t, you can create a diverse portfolio that is profitable and protected against various different risks. The key is to maintain balance in terms of how you divide your funds and the types of stocks you invest in. At the same time, don’t let it become overly calculated to the point that it feels like you’re following a formula as opposed to following your gut. 

This is a contributed post.

While the past cannot guarantee future outcomes, it remains our most reliable resource for understanding market behavior. Previously, I outlined how Monte Carlo simulations can be used to estimate these probabilities. But relying solely on one method is limiting. Diversifying the ways we calculate probabilities adds robustness to the analysis.

In this article, I will delve deeply into three additional methods for calculating probabilities: Hidden Markov Models (HMM), seasonality-based probabilities, and implied probabilities derived from options prices. Each method has distinct advantages and complements the Monte Carlo approach, providing a comprehensive framework for assessing Credit Put Spreads.

1. Hidden Markov Models (HMM): Unveiling Hidden Market Dynamics

Hidden Markov Models (HMM) are a sophisticated machine learning technique designed to analyze time-series data. They operate on the assumption that observed data (e.g., ticker prices) are generated by an underlying set of "hidden states" that cannot be directly observed. These states represent distinct market conditions, such as bullish trends, bearish trends, or periods of low volatility.

How HMM Works

1. Defining Observations and States:
   • The observed data in this context are the historical closing prices of the ticker.
   • The hidden states are abstract conditions influencing price movements. For example:
     • State 1 (Bullish): Higher probabilities of upward price movements.
     • State 2 (Bearish): Higher probabilities of downward price movements.
     • State 3 (Neutral): Limited price movement or consolidation.
        
2. Training the Model:
   • The HMM is trained on historical price data to learn the transition probabilities between states and the likelihood of observing specific price changes within each state.
   • For example, the model might learn that a bullish state is likely to transition to a neutral state 30% of the time, and remain bullish 70% of the time.
      
3. Making Predictions:
   • Once trained, the HMM can estimate the current state of the market and use this information to predict future price movements.
   • It calculates the probability of the ticker being above a specific threshold on a given date by analyzing likely state transitions and their associated price changes.
      

Advantages of HMM in Options Trading

• Pattern Recognition: HMM excels at identifying non-linear patterns in price movements, which are often overlooked by simpler models.
• Dynamic Analysis: Unlike static models, HMM adapts to changing market conditions by incorporating state transitions.
• Probability Estimation: For a Credit Put Spread, HMM provides a probabilistic measure of whether the underlying will remain above the short strike based on historical market behavior.

By capturing hidden dynamics, HMM offers a more nuanced view of market probabilities, making it a valuable tool for assessing risk and reward in Credit Put Spreads.

2. Seasonality-Based Probabilities: Unlocking Historical Patterns

Seasonality refers to recurring patterns in price movements influenced by factors such as economic cycles, investor behavior, or external events. In options trading, seasonality-based probabilities quantify how often a ticker's price has exceeded a certain percentage of its current value over a specific time horizon.

How to Calculate Seasonality-Based Probabilities

1. Define the Threshold:
   • The threshold is expressed as a percentage relative to the current price (e.g., -2%, +0%, +2%). This normalization ensures the probability calculation is independent of the absolute price level.
      
2. Analyze Historical Data:
   • For a given holding period (e.g., 30 days), calculate the percentage change in price for each historical observation.
   • Example: If the current price is $100, and the threshold is +2%, count how often the price exceeded $102 after 30 days in the historical data.
      
3. Aggregate the Results:
   • Divide the number of times the threshold was exceeded by the total number of observations to calculate the probability.
   • Example: If the price exceeded the threshold in 70 out of 100 instances, the probability is 70%.
      

Applications in Credit Put Spreads

Seasonality-based probabilities answer the question: "In similar conditions, how often has this ticker remained above the breakeven?" This approach is particularly useful for ETFs, which often exhibit more predictable patterns than individual stocks. For example, certain sectors might perform better during specific times of the year, providing an additional layer of insight.
 

Limitations to Consider

• Seasonality probabilities rely entirely on historical data and assume that past patterns will persist. While this is often true for ETFs, it may be less reliable for individual stocks or during periods of market disruption.

3. Implied Probabilities from Options Prices: Extracting Market Sentiment

Options prices are more than just numbers; they encapsulate the collective beliefs of market participants about future price movements. By analyzing the prices of puts and calls across various strikes for a given expiration date, we can derive the implied probabilities of the ticker being in specific price ranges.
 

Steps to Calculate Implied Probabilities

1. Collect Options Data:
   • Obtain the bid-ask prices for puts and calls at different strike prices for the desired expiration date.
2. Calculate Implied Volatility:
   • Use the options prices to derive the implied volatility (IV) for each strike. IV reflects the market's expectations of future price volatility.
3. Estimate Probabilities:
   • For each strike, calculate the probability of the ticker being at or above that level by using IV and the Black-Scholes model (or similar methods).
   • The probabilities are then aggregated to construct a distribution of expected prices at expiration.
      

Why Implied Probabilities Matter

• Market Consensus: Implied probabilities reflect what the market "thinks" about the future, offering a forward-looking perspective.
• Dynamic Adjustments: Unlike historical methods, implied probabilities adapt in real-time to changes in market sentiment, such as news events or macroeconomic data.
   

Application to Credit Put Spreads

For a Credit Put Spread, implied probabilities can answer questions such as: "What is the market-implied likelihood that the ticker will remain above the short strike?" This insight helps traders align their strategies with prevailing market sentiment.

Conclusion

By integrating these three methods—Hidden Markov Models, seasonality-based probabilities, and implied probabilities from options prices—into my existing Monte Carlo framework, I’ve developed a robust system for evaluating Credit Put Spreads. This approach enables a comprehensive analysis of Out-of-the-Money (OTM) Credit Put Spreads among a selection of ETFs, filtering for:

• Gain/loss ratios within specific thresholds,
• Expiration dates within a defined range,
• A minimum credit of $0.50.
   

The result is what I like to call a “stellar map” of selected spreads:

accompanied by a summary table:

These tools provide clarity and actionable insights, helping traders identify the best trades—those offering the highest probability of success while maximizing potential returns relative to risk.
 

Looking ahead, the next step will involve calculating the expected value ($EV) of these trades, combining probabilities and potential outcomes to further refine the selection process.

The ultimate goal remains the same: to stack the odds in our favor—not by predicting exact prices, but by estimating probabilities with precision and rigor.

Stay tuned as I continue refining these methods and expanding their applications! 

1. Bitcoin (BTC)

Bitcoin was the first ever cryptocurrency (established in 2009 by Satoshi Nakamoto) and it is currently the world's most valuable. It is the coin most people think of when they think of crypto trading. Therefore, it’s no surprise that it’s also the most popularly traded coin. Bitcoin famously went through a boom in the 2010s, which resulted in many early investors getting rich. While many people continue to buy Bitcoin as an investment asset, it is also widely accepted as a currency and used to buy many products and services (more so than other cryptocurrencies). Companies ranging from Uber Eats to Adidas now accept Bitcoin payments.

2. Ether (ETH)

Ether is the second most popular cryptocurrency. It was introduced in 2015 and is traded on the Ethereum blockchain. Trading Ether is faster and more environmentally-friendly than Bitcoin, however there are added fees involved when trading Ether known as ‘gas fees’. These gas fees are paid to crypto miners and cover the cost of running the network. The price of gas fees is constantly changing, however you can track these fees using the likes of this ETH gas tracker. While not as commonly used as a currency as Bitcoin, it’s worth noting that Ethereum supports smart contracts, which makes it attractive to many businesses. 

3. Tether (USDT)

Tether was introduced in 2014 as a ‘stablecoin’ that has a fixed value equal to the US dollar. Stablecoins like Tether are less volatile than regular cryptocurrencies, and are therefore seen as less risky. Because of this low risk, Tether is the third most popularly-traded cryptocurrency in the world. It is becoming a more popular cryptocurrency for buying products and services, as well as being a popular option among investors. There are many other stablecoins that can also be looked into for those wanting a low-risk option. 

4. Solana (SOL)

Solana was founded in 2017 and is the fourth most popular cryptocurrency. Its creator Anatoly Yakovenko introduced a proof of history system when developing the Solana blockchain that allowed this cryptocurrency to be traded much faster than both Bitcoin and Ethereum. As well as being fast, Solana transactions are relatively affordable. Because of this, it is a very attractive cryptocurrency among traders. 

5. Binance Coin (BNB)

Binance Coin, which is more commonly known as BNB, was created in 2017. It is used to pay transaction fees on Binance.com, which is a popular cryptocurrency exchange. An increasing number of merchants have begun to accept BNB ranging from Shopify to Expedia. This is due to the fact that you get discounts on trading fees when you use this currency to pay for products and services. This has helped it to become the fifth most popularly traded cryptocurrency. This post delves more into the benefits of investing in BNB. 

6. XRP (XRP)

XRP was introduced in 2012 - making it one of the longest-running cryptocurrencies alongside Bitcoin. A company named Ripple is one of the main users of this currency and offers payment solutions to businesses that use XRP. Because of this XRP is sometimes referred to as ‘Ripple’ by crypto traders, however the currency is not controlled by this company. Other than being well-established, there are many benefits to using XRP that have helped it to become the sixth most popular cryptocurrency. It has very low transaction fees and takes seconds to trade. XRP also does not need to be mined, making it one of the most environmentally-friendly cryptocurrencies. 

7. Dogecoin (DOGE)

Dogecoin was created in 2013 as a joke. It was inspired by the Shiba Inu dog meme and is regarded as the first ‘meme coin’. Although created as a parody, Dogecoin attracted many traders for its silly premise and consequently turned into a wildly successful cryptocurrency - the 7th most popular in the world! Dogecoin has been used to fund many charity projects and business projects over the years including a SpaceX mission in 2021 and motorsports events. Since its boom, many other meme coins have been created and a lot of them have also become very popular. However, Dogecoin still remains the most popular meme coin, with a dedicated online community continuing to promote its use around the world. 

This is a contributed post.

In this article, I'll introduce Monte Carlo simulations, explain their relevance in trading, and describe a specific options trading strategy I've developed using these simulations. I'll also share backtested results to illustrate the strategy's effectiveness.
 

1. What Are Monte Carlo Simulations?

Monte Carlo simulations are a computational technique used to model the probability of different outcomes in a process that cannot easily be predicted due to the presence of random variables. Named after the famed casino, these simulations are especially useful in finance because they allow for the analysis of uncertainty and risk.
 

The process involves running thousands or even millions of simulations based on historical price movements, where each simulation projects a possible future outcome. The resulting distribution provides traders with probabilities of price ranges over a given time horizon.
 

2. How Are Monte Carlo Simulations Applied in Trading?

In trading, Monte Carlo simulations help to anticipate how a financial instrument, such as an ETF like SPY or QQQ, might behave over a future period. The process looks back over several years of historical price data and runs numerous simulations to project future price distributions. The outputs typically show a probability distribution of future prices, highlighting key metrics such as confidence intervals.Here is an example for SPY:
 



These simulations are invaluable for options traders because they offer insights into the probability that a stock or ETF will remain within above/below price bounds over a specific time frame. This information helps to craft structured options strategies, like Credit Put Spreads, which profit when an asset stays above a price threshold.
 

3. Example for a Credit Put Spread

Here for example is the result of 10,000 simulations carried out on SPY for a prediction of the movement in 15 days by asking the algorithm to calculate what percentage of data is above the $565 threshold. For example if we consider that this value is a support or that this value would be the break even of a Credit Put Spread strategy that we would have implemented. 
 

We see that there is a probability of 77% that the ticker is above this threshold value.
 

Recall that Monte Carlo simulations observe the past behavior of the ticker over many years, day after day, deduce a statistical distribution and perform random shots oriented like this statistical distribution in order to capture the pseudo-random nature of the market. It will be necessary to see how these predictions have come true in the past.
 

Note that to account for the historical distribution of a ticker, we need to adjust the Monte Carlo simulation approach in the code. Rather than assuming a normal distribution for price movements, I model price changes based on the actual historical distribution of returns. This technique, often called bootstrapping, samples historical returns directly instead of generating synthetic returns based on a fixed normal distribution.

This is then the kind of plot we get :

4. The Strategy: Using Monte Carlo Simulations for Options Trading

Using the break evens of an Iron Condor as threshold values is not interesting because the simulations showed that credits received on the Call part were not sufficient. 
 

So let's focus on the Put part via Credit Put Spreads. For a given ETF (we will leave out stocks because of the earnings), there are many expiration dates and many strikes, each with their own price. Which ETF to choose, which strikes to buy and sell and which expiration dates? 

For this, the program I wrote scans the most important ETFs, ['SPY','GLD','QQQ','IWM','EEM'], all their expiration dates between two numbers of days [min_days = 30 max_days = 120] and all strikes below the OTM strike that can form a Credit Put Spread. A point is thus given by, for example, [SPY, 2024-11-15, put bought=$577, put sold=$582]. 

For each point, the code then performs 10,000 Monte Carlo simulations, looking back 20 years and calculating the probability that the SPY close will be higher than the break even in 29 days (=number of days remaining between now and the expiration date). Then, the program displays all the points in the form of a graph with, on the abscissa, the perceived credit and on the ordinate, the Monte Carlo probability. Credit > $0.50 and gain/loss ratio above 40% are only selected.
 

The graph is divided into 4 quadrants, the one of most interest to us being the northeast quadrant (maximum credit and maximum probability). The program then detects the two points which, in this quadrant, have the highest probability or the highest credit.
 

Here is an example of display:
 

4. Backtesting Results

To validate this strategy, we performed backtests using historical data for the past 15 years. The idea was to simulate what would have happened if this strategy had been applied in the past with the break even corresponding to the probability computed in the chosen point. 
 

To use the example here above with the maximum credit,the backtest would answer this question: for the ticker QQQ at the expiration date of 2024-12-31 (corresponding to 74 days from now, the date of writing this article), the Monte Carlo simulations tell me that the Close of QQQ has a probability of 64.82% of being higher than the strategy's break even. If I had applied this strategy 15 years in the past from now, day after day with the Break Even at that time corresponding to this quantile, would the real value of QQQ have indeed been higher than this Break Even? And if so, how many times has it worked between 15 years ago and now, day after day?
 

To be more specific, during the backtest the algorithm displays the results of the step-by-step backtests very clearly:
 

Example of a screenshot during the backtest:

and the plot of the histogram to prove the consistency of the threshold value:
 

This systematic approach, with precise risk management, provides traders with a powerful tool to make informed decisions about structuring options trades. It's worth noting that the performance of each strategy can vary depending on market conditions, so consistent backtesting is key to keeping the strategy profitable in evolving markets.
 

The final result of the backtest, for that strategy, is:

This means that backtests give better results (83.64% win rate) than the probabilities announced by Monte Carlo simulations (64.82%) and the trade could be opened.
 

Conclusion

Monte Carlo simulations offer a scientific and data-driven way to project future price ranges in the often unpredictable world of trading. By applying these simulations, we can develop strategies that aim to capture value by accurately predicting price movements within specific time horizons. The backtests show that using this method, especially for long-term options strategies like Iron Condors, can significantly improve the likelihood of success.
 

This approach complements other options strategies and provides a robust framework for structuring trades with a high probability of profit, while carefully managing risk.

As is always the case, though, there is some flipside to that risk. When they go well, crypto trades enjoy benefits including the potential for highly profitable market swings and increasingly relevant inflation protection. 
 

For the traders who enjoy crypto success, risk management is key. But, how exactly do you manage risk in one of the highest-risk areas of today’s trading world? Keep on reading to find out.
 

The High-Risk Nature of Crypto Trading

Before we begin to understand risk management within crypto trades, it’s important to consider why cryptocurrencies are considered so high-risk in the first place. Truthfully, there are various reasons for this, with recent studies providing particularly damning evidence that, in a general sense, crypto’s high risk may not justify its reward. 
 

By far the prime reason for this high-risk tarnishing is simply the volatility we continue to see across cryptocurrencies. Few other financial areas are liable to fluctuate this much, making it difficult to accurately foresee volatility, or make wise investment choices. Along a similar vein, there are also market concerns about the long-term worth of crypto investments, which may not maintain their worth across long-standing portfolios. 

Picture Credit: CC0 Licence

Cryptocurrency Trading: The Benefits

If the situation for crypto trading is so bleak, why are high-profile investors still spending energy here? Because, for all that crypto’s risks are undeniable, many would disagree that crypto’s risks fail to justify themselves.

While current crypto markets generally aren’t the high-value areas they were at their dizzying heights a few years ago, crypto investment still opens the doors for benefits that, as well as potentially high earnings and protection from inflation, include diversification from traditional assets, high liquidity, and generally low transfer costs. 
 

Risk Management in a Cryptocurrency World

So, is risk management really possible in a world of cryptocurrency trades? Annoyingly, the simple answer is that it varies a great deal depending on your trade choices. However, there are some industry-standard ways to keep your crypto trades as secure as possible, and we’ll consider them here. 
 

# 1 - Delve into Diversification

Diverse trading portfolios are always the answer to avoiding big trade losses. Luckily, cryptocurrencies in themselves prove useful in this sense, allowing you to more easily diversify from things like cash trades. Taking things further, it’s also worth diversifying your crypto portfolio itself to cover a range of cryptocurrencies and traders. It’s particularly worthwhile to consider how those cryptocurrencies correlate, including each asset’s risk-return rates. This way, you can always ensure you’re off-setting more risky crypto investments like Crypto All-Stars, with cryptocurrencies that are more likely to maintain a stable price point, such as Tether (USDT). This ensures that, even if you do lose, you’re also more likely to win elsewhere in your portfolio. 
 

# 2 - Conduct Technical Analysis

Technical analysis (TA) is the process of studying the historical movements of a cryptocurrency to predict what it might do in the future. Popular technical indicators include moving averages, which use graphs to determine stock resistance levels, and relative strength indexes, which chart the historical strengths and weaknesses of a stock based on its past closing prices. There are also now plenty of risk management tools, including risk calculators that can conduct TA based on things like stock leverage and position size. All of which could lead to more informed, and hopefully more stable, crypto investments overall. 

As well as this, it’s always worth reading the latest crypto report to get an idea of the markets and keep yourself up to date on any major changes. 

Picture Credit: CC0 Licence

# 3 - Use Stop Loss Orders

You don’t need to be a crypto genius to appreciate the value of stop-loss orders in trade risk management. By ensuring that a security automatically sells once it reaches a specified level, stop-loss orders are always useful in the trading world. And, they’re particularly useful on highly volatile stocks like cryptocurrencies. 

# 4 - Use A Trusted Platform

One thing that really helps with risk management in crypto is to make sure you are using a trusted platform every time. If you are doing all of your transactions through a site like www.peakcrypto.com you are going to find that you have much more faith in it, and that you are therefore able to ensure you are keeping your risk as low as possible.

To avoid issues like accidental early exits, simply make sure that you never place stop loss orders too close to the current market value of a crypto investment. Remember, cryptocurrencies will always fluctuate, sometimes to extreme degrees. Instead, optimize your stop losses by considering things like historic market volatility, and the strength of your portfolio more generally. 
 

Takeaway

You can never take the risk out of crypto trading, but you can save yourself from losing big money when you put these essential crypto-based risk management must-haves in place. 

This is a contributed post.

Figure 1 TLRY iron fly on 13 September 2018

Options have infinite combinations but the classic hypothetical risk free trade is the credit spread with a wing width that is smaller than the credit collected. Naysayers will tell you that in this age of algos and massively automation driven trading such pricing differences and arbitrage are polished off immediately. The chart above – however – is a real one and the pricing of the TLRY spreads endured over a fairly extensive period, it seemed in fact a free lunch was available.

Others will argue that spread differences set by market makers make entering (or exiting) such positions at the theoretical profit an impossibility or just extraordinarily rare. This argument too must be rejected. Consider the chart below from a very recent NON OFFICIAL trade on Steady Options in the DJT:
 

Figure 2 DJT iron fly on 4th April 2024

Although less pronounced than the TLRY example one can see that the mid of this spread traded above 5$ which is the width of the spread – although bid/ask was rather wide there was a considerable amount of trading that occurred above this level. Whilst one might expect to see such differences at deep ITM or OTM levels due to skew, it is unusual but not impossible to find these kind of discrepancies.
 

Of course ‘haters are gonna hate’; and a chorus of voices will rise up to say that the above examples of mispricing are at once artifacts and on top of that will yield pennies only. Trading and capital costs will get you at best a special discounted menu at Taco Bell and never a proper dinner in the Ritz. That, however, would be untrue as well – options being leveraged instruments have this amazing ability to deliver outsized – infinite even – returns if you are right on direction. Sometimes it doesn’t take a genius to figure out that something is going to zero. The true story of LFIN and its meteoric crash with a business plan that was not far off the one of the South Sea Bubble: a promise of a future venture in crypto. At one point trading over $140 the stock reached a valuation of more than $6B. Correctly called by legions of retail investors on Reddit’s r/wallstreetbets; puts were bought by the bucket load and LFIN was trading near zero 6 months later leaving some traders with credible 5 figure returns and % profits of over 2000%.
 

Are you convinced yet? If you are you can buy us lunch!

In the article below we will dive into the three trades mentioned and conclude on some learnings aspects from them. Truly, there never is such a thing as a free lunch but that doesn’t mean there isn’t a buck to made if you are careful.
 

When everybody was getting high

Butterflies are common option instruments and often they are a bit of a toss-up between the net debit you incur in opening them (or the credit) and the width of the spread you have. A wide triangle of profit could be worth the risk of the stock ending under or over (depending on your spread and the side of the butterfly) your strikes. Normally due to call/put parity it is not possible to open a credit spread for more than the width of the strikes, the reason is simple. Market makers (or other market players) could simply buy or short the stock and create an opposite position that would effectively exploit this pricing difference and it would be immediately arbitraged away.
 

Yet back in 2018 an observant Steady Options member noted that a new stock, TLRY, recently quoted was making a meteoric rise on the market.
 

Figure 3 logarithmic TLRY stock from 07/2018 to 11/2018

Unsurprisingly this meteoric rise went hand in hand with exploding implied volatility – what’s more the IV differential between calls and puts also became insanely high. Figure 1 had a difference of no less than 70pts between the IV of the ATM call and ATM put. Near the close on Thursday 13th of September 2018 the ATM 5$ wide spread was trading at over 6$ - this was a function of the market closing however but several positions were opened anywhere between 25c to 50c over the width of the wings.

Figure 4 TLRY option spread ATM 13th September 2018 - 10mn before closing

The general presumption was that this mispricing could not endure. This proved to be far from the truth as the next day(s) it became clear that whilst it was possible to open this position – at a credit over the wing width – closing it for the spread width wasn’t working well. It was also noticed that the deeper in the money you would open a spread, the easier it was to do so for a decent credit. A particularly valiant trader opened 950 spreads over a multiple of strikes for such a credit. This wasn’t a trade to make the year – it was the trade to make retirement.

Doubts set in as surely there had to be some hidden flaw which indeed could be read in places that option traders rarely examine: the borrow rate for TLRY.

Figure 5 Borrow rates for TLRY stock on 13th September 2018

As can be seen from the stock price movement in figure 3 TLRY was moving really fast. Within a week you had to pay 20c for 400$ strike calls expiring in October and half a buck for the 50$ put in the same expiry. A 350% borrow rate translates at close to 1% per day or $120 for every ATM spread shown – the position is indeed guaranteed to yield the surplus over the wing width but you have to survive until expiry.
 

What people started noticing – beginning with ITM calls - was that short calls started getting exercised. This meant that you had multiple choices with tricky outcomes:

• Exercise your long call (if ITM) and just risk the stock not dropping to the put level;
• Borrow the stock and stay short at a cost of 1% per day;
• Close the whole position at a loss because you cant get a reasonable price for your puts and what’s more exercise happens outside of normal trading hours so the stock could be anywhere when you try this because of additional volatility.

A further risk was quickly identified even if you made it to expiry – with a stock moving so much there was a risk that your position would end between the strikes but that after market hours it would move out again effectively locking in your loss without enabling you to cash in on what should have been a positive position. Once again just the weekend cost of carrying a short in your account would wipe out any profits in the best of circumstances.

To say there was no free lunch was an understatement, the trader that opened 950 spreads in fact took on a 27M$ risk when doing so. He lost 4 digit level dollars on just a few spreads that were exercised over a weekend and even then he was lucky as the stock vaulted upwards afterwards. Some others with smaller positions did manage to get out – key was that they did so before expiry neared. The closer to a Friday one came – the more likely it was that ITM calls would be exercised – the chief risk coming from them.
 

The learning from this trade was not that it was fundamentally wrong but there are several things to be taken into account:

Options mispricing at this level are always an indication of an underlying phenomenon of some kind that is outside of normal stock trading. In this case it was:

• The agreement in June 2018 to legalise pot in Canada which was to come into effect mid October;
• The very recent IPO of TLRY meaning that it had a narrow free float and a lot of limitations;
• What we would now call ‘meme-like’ euphoria regarding the prospects of pot stocks;

The telling signs that could be deduced from options trading were:

• The extreme volatility of the options in question exacerbating price differences;
• Extraordinary skew between calls and puts making the mispricing more likely;
• The fact that simple observation of open interest of ITM calls indicated that massive exercising was occurring even if traders kept opening new spreads.

The position was only vulnerable to early exercise which is a characteristic of American style options that are universally used for stock trading. Anyone who was not way ITM came out more or less unscathed from the positions opened but this was very tricky by the time TLRY hit $300 on 09/19/2018. Its hard to give a correct estimate but its likely near 50% of ITM calls with more than a month to go before expiry were exercised. The weekly expiry of 09/21/2018 was exercised overnight from Wednesday to Thursday for even higher percentages. With the stock halving again by that Friday expiry anyone not agile enough would have been caught full in the cross fire.
 

Bill Gross called it: If you are bold you sell premium on DJT

On 29th of March 2024 DJT – the social media company of Donald Trump – launched on the stock market. Like TLRY it was a high visibility launch and the stock was both praised and criticised from the start. New Jersey businessman Mike Crispi embodied the bullish sentiment best:

Noone would want to deny Mike his day in the sun but a more interesting quote came from Bond King Bill Gross who stated that "A genius can have a high IQ or invest in the stock market during a bull market. A genius can also be an investor with the courage to sell DJT options at a 250 annualized volatility,". It turned out that Bill’s position likely had a lot of similarity to a credit spread like an iron fly or condor because Yahoo Finance found that:

Figure 6 Source Yahoo Finance/Reuters
 

DJT had huge volatility skew between puts and calls

Monthly options expiring in about 2 weeks had the ATM put 2.4 times more expensive than the ATM call.  This large skew up a feasible arbitrage scenario.   For example, with the stock ~$47.5,   the 47.5/42.5 call and put credit spreads should cancel each other out and make this a basically guaranteed break-even trade.   But in this extreme volatility skew, this combination of put and call credit spreads could be opened for a credit quite a bit over the $5.00 wing width (and the amount over the wing width would be a guaranteed gain at expiration).    On April 4, the following trade was opened using the April 19 expiration, it's called a Box combo.  Note how the ATM 47.5 strike put is so much more expensive than the 47.5 call, and the 42.5 call is close in value to the 42.5 put even though the call is around $5.00 ITM and the put is OTM.

This trade yielded a $5.65 credit on a box combo with a wing width of $5.00 (so the opening credit was 13% above the wing width).  This means that at expiration, letting any ITM legs go through assignment you'd wind up with a $65 profit at all stock price points.
 

But are there any potential pitfalls with this trade?    The answer is yes, and it’s all due to the early assignment possibility with American style options.   The extreme put vs call volatility skew that enabled this trade to be opened for a credit 13% higher than the wing width also created a trade which is delta negative prior to expiration.     Here is the PNL chart at trade opening:

Note how the thick blue line, which represents the profit at expiration, is $65 at all stock price points.  However, the thin wavy line is the current status which shows a delta negative trade where the position’s PnL improves if the stock price drops but shows a loss if the stock price rises (this is because in this scenario the OTM put credit spread holds onto much of its value because the put IV is so much higher than the call IV).   But why does this matter if a profit is guaranteed if you hold the trade until expiration?   

If the stock price rises enough to make the short 42.5 call have only a few cents of extrinsic value (time value) then there is a high probability of getting assigned on the short call.  In this case you'd have to close the call side for at or near the $5.00 wing width and hold onto the put credit spread and hope the stock price stays above 47.5 until expiration so the put side expires worthless.   There would be quite a bit of risk here as the stock price could very easily make a large downward move with such a high volatility stock.   If the stock price were to make a significant decline after closing the call credit spread for near $5.00, you could wind up having to close the put credit spread at a higher price and wind up with a losing trade.
 

In this particular trade, the stock price dropped (it moved in the right direction for this trade).   On April 15 (4 days prior to expiration) with the stock price under $30, it was able to be closed for a debit slightly under $5.00 thereby generating a gain of just over $65.  However, had the stock price risen by a few dollars after the trade was opened it would have turned into a much more difficult trade to manage.  In the end, it did turn out to be a free lunch trade – but only because the stock price cooperated and moved in the correct direction.

The lead balloon that was LFIN

One of options many pleasant aspects is that you can express a view on the market without betting the farm and yet with potentially infinite returns. For comedic value there is no replacement for the story of the option traders and crypto pioneer LFIN (though RIVN and their criticism by Hindenburg Research come a close second). Once again the mispricing that traders took advantage of and later suffered their utter discomfiture on, was based on events that rarely affect ‘normal stocks’:

• A meme-like enthusiasm for this new thing called crypto(?!?);
• A stock market launch ostensibly backed by NASDAQ’s strict rules that placed a stock with very limited (in fact insufficient) free float on the market;
• The announcement of the ‘master stroke’ investment in an allegedly successful (but in fact nascent) crypto platform;
• An extraordinarily rare dropping of the ball by FTSE Russel Index managers that co-opted the stock into their index without respecting their own rules.

All these elements put together boosted the stock from 5$ to over 140$ (intraday) and billions in stock market valuation. A critical issue was that the amount of stock required for the index funds was over half the alleged (inflated) free float. So a bona fide short squeeze occurred  and everybody started talking about LFIN as if they knew what these guys were doing.

As the madness hit its peak, the CEO  Venkata Meenavalli went on CNBC where every average Joe could follow the live train crash. As the interview progressed, LFIN’s price dropped some 16% in after-hours trading, with CNBC helpfully displaying this sharp downward trend in a chart next to Meenavalli’s face. If you ever did a presentation and thought your point did not come across, think of Venkata and you won’t think so poorly of yourself.

Figure 7 LFIN CEO interview on CNBC 18th December 2017, with live AMC prices as he speaks

A few classic statements were:

• Q:How many bitcoin transactions have you done?
  A: We own 140 bitcoins (one coin was worth about 10k);
• ‘We are a profitable company.’ And also ‘We are a GEICO of this world.’
• ‘We have a team of quants.’
• Q:’Is the 6B$ market valuation absurd?’
  A:’Yes.’
• No less than 11 times he repeated: ‘You have to understand that...’ followed by some unintelligible remark.

Needless to say the option traders piled in and the put buyers were seemingly quid’s in. Reddit fora were full of retail traders having positions between 10-100s of put options at strikes varying from 50$ to 2.50$. Here’s what happened with LFIN:

The insanity of this chart cannot be overestimated, LFIN had listed for 5$ on 15th December 2017 and hit 142$ (closing at $72.38) on December 18th 2017 when the CEO made his ill-fated interview. If ever there was a reason to buy puts on a company the whole sorry interview as well as multiple discoveries by i.a. Citron Research made it 100% plain this company was one big scam. Throughout late December and January people bought puts and they were cheap at the price. The vast majority chose expiries in April and May. As March came around the bells of doom sounded louder and louder for LFIN, not only was there an SEC investigation but FTSE Russel reversed its decision to include them in their index and multiple other agency lawsuits and NASDAQ investigations were triggered. Within the space of a few days the stock went from respectable to being at risk of delisting.
 

A T12 notice was issued end of March and this effectively delisted the stock. Now a trifecta of disasters faced put holders – some with deep ITM positions opened for 5$ at the 50$ strike for the April expiry:

• Institutional holders which had bought 45% of the theoretical free float had not finished unloading all their stock. With the halted trading they could no longer offload them;
• The CEO turned out to have lied about the free float in general and the NASDAQ stopped 26M shares from being circulated in violation of a lock-up;
• Short sellers and put holders held 250%+ of the free float – a kind of inverse short squeeze.

Having  taken millions of dollars in losses institutional holders realising the dearth of shares increased borrowing costs to 3000%. Simultaneously option holders – if they were lucky – had to exercise their puts and pray that trading would resume so they could fill their short positions thus created. Ominously no T12 trading halt had – up to that point – ever been lifted in less than 3 months. This would place all of the April, May and June put option holders in a dilemma.

For one they were required to put up the full sum of the value of the shares they had exercised puts against. This was very hard for any call holders that happened to be long strikes around the money or had sold credit spreads. Put holders likewise had to exercise and pay the extortionate borrow fees of 250$+ a day without knowing when they could cover the short. In the end trading OTC resumed on 05/28/2018 but it took another month before the stock traded below 5$ let alone near zero. This meant that anyone that had gambled and exercised 2.50$ strike puts were out of luck.

The general tenure in the reports of the retail traders about their experience is that even the ones that made 5 figures in the initial phase of the collapse, had doubled down so far after collecting their winnings that they were now out 6 figures. As the owner of this website famously wrote – position sizing is essential for successful trading.
 

What shall we have for lunch?

The stock market wisdoms that ‘there is no such thing as a free lunch’, ‘the market can stay irrational longer than you can stay liquid’ and so forth exist for a reason. Mispricing in options and opportunity for arbitrage exist – the above examples show that this occurs primarily in unusual situations where you have to take into account risks which do not exist when you trade established and liquid stocks. Black swan events like trading halts and their consequences are rarely understood until you are confronted with them.
 

Should you therefore shy away from trading these opportunities? Of course not, where is the fun in that?

However you should take into account that these trades are risky and size your position accordingly. Be prepared also to take a quick buck rather than wait for your ship to come in. if you are tempted to make a YOLO trade, remember the warning tale of the ‘Man who couldn’t lose’. It was a short tale of a man that always won in  casinos, on his deathbed when asked what his secret was, his answer was simple: ‘Observe the room until you find the guy that is about to lose everything, the house, the car, the wife, the kids on his last gamble. Then bet against him, because that guy ALWAYS loses.’ So it is with any YOLO or retirement trade, you will surely fail whereas if you were less greedy you could have joined us for lunch at Taco Bell.

Many thanks to our contributors @TrustyJules and @Yowster for this fascinating article.

Covered calls are popular among investors looking for a conservative way to generate additional income from their stock holdings. However, it's essential to understand both the benefits and risks before implementing this strategy.
 

Example of a Covered Call:

• Long Position: You own 100 shares of XYZ stock, currently trading at $50 per share.
   
• Sell Call Option: You sell a call option with a strike price of $55 for a premium of $2 per share.
   

Outcomes:

• Stock Price Below $55: The call option expires worthless, you keep the premium, and you still own the shares.
   
• Stock Price Above $55: The call option is exercised, you sell your shares at $55, keep the premium, and realize a profit from the stock's appreciation plus the premium received.

Understanding Greeks and Covered Calls

If this is your first parlay into covered calls, you also need to familiarize yourself with options Greeks.

Options Greeks are key metrics used to understand the behavior of options prices. They measure various risks and sensitivities in an options position. When using covered calls, understanding the Greeks can help investors make informed investing decisions.

Delta

Delta measures the sensitivity of an option's price to a $1 change in the underlying asset's price.

For a covered call, the delta of the call option is positive but less than 1. This means if the stock price increases by $1, the call option’s price will increase by an amount less than $1. As a result, the covered call position (long stock and short call) will experience a partial offset of gains in the stock by the losses in the short call.

Gamma

Gamma measures the rate of change of delta with respect to changes in the underlying asset’s price.

Gamma is the highest for at-the-money options. For covered calls, a lower gamma (typical of deep in-the-money or out-of-the-money calls) indicates less sensitivity to price changes in the underlying stock. This means the delta of the option will not change as dramatically with price movements.

Theta

Theta measures the sensitivity of the option’s price to the passage of time (time decay).

Theta is particularly important for covered call writers because it represents the premium decay over time. As the option approaches expiration, its value decreases, benefiting the seller. For covered calls, a higher theta means the option loses value faster, which is advantageous to the call writer.

Vega

Vega measures the sensitivity of the option’s price to changes in the volatility of the underlying asset.

Vega is important because it indicates how much the option price will change with a 1% change in implied volatility. For covered call writers, a decrease in volatility after selling the call is beneficial as it reduces the option’s price, making it more likely to expire worthless.

Practical Application in Covered Calls

1. Selecting Strike Prices: Understanding delta can help in choosing the right strike price. Higher delta options (in-the-money) have a higher chance of being exercised, while lower delta options (out-of-the-money) have a lower premium but less likelihood of being exercised.

2. Timing and Expiration: Theta helps investors decide the optimal expiration date. Shorter-term options decay faster, benefiting the call writer due to higher time decay.

3. Market Volatility: By monitoring vega, investors can choose to write covered calls when volatility is high to capture higher premiums while being aware of the risks associated with potential volatility decreases.

Example Scenario:

• Stock Position: You own 100 shares of XYZ stock, trading at $50.
   
• Option Selection: You sell a one-month call option with a strike price of $55.
   
• Delta: The option has a delta of 0.30, meaning the option price will increase by $0.30 for every $1 increase in stock price.
   
• Theta: The option's theta is -0.05, indicating it will lose $0.05 per day.
   
• Vega: The option has a vega of 0.10, so for each 1% decrease in volatility, the option price drops by $0.10.

Understanding the Greeks provides a comprehensive view of the risks and potential rewards associated with covered calls.

Who Should Use Covered Calls?

• Income-oriented Investors: Those looking for additional income streams, such as retirees, may find covered calls appealing. The premiums received from selling call options provide a regular income, which can be especially useful for those relying on investment income.
   
• Long Term Existing Stockholders: Investors who already hold a substantial position in a stock and do not plan to sell it soon can use covered calls to generate income. This allows them to monetize their holdings without liquidating their positions.

PROs of Covered Calls

• Income Generation: You earn the premium from selling the call options, providing additional income.
   
• Downside Protection: The premium received can offset some of the losses if the stock price declines.
   
• Selling at a Target Price: If the stock price rises and the call options are exercised, you sell your shares at the strike price, which is usually higher than the current price when the options were sold.

CONs of Covered Calls

• Limited Upside: Your potential profit is capped at the strike price of the call options sold. If the stock price soars, you won't benefit beyond the strike price.
   
• Obligation to Sell: If the stock price exceeds the strike price, you may be obligated to sell your shares at the lower strike price.
   
• Stock Decline: While the premium offers some protection, it doesn't eliminate the risk of a significant decline in the stock price.

The Bottom Line

Covered calls are a conservative strategy that helps investors generate additional income from their stock holdings. By selling call options on stocks you already own, you can earn premiums while maintaining a measure of downside protection.

This strategy is best suited for income-oriented and conservative investors who anticipate stable or moderately rising markets. However, it comes with the trade-off of capped upside potential and the obligation to sell shares if the stock price exceeds the strike price. Understanding the key options Greeks (delta, gamma, theta, vega) can further optimize the use of covered calls for effective risk and reward management.

Post by Adam Koprucki

What's the Difference Between SPX and SPY Options?

What Is SPX? 

SPX is the S&P 500 index, which is a stock market index that measures the performance of 500 large cap publicly traded companies in the United States. The S&P 500 index is widely regarded as one of the best measures of the overall performance of the U.S. stock market. 

SPX is a numerical value that represents the level of the S&P 500 index. It is calculated by taking the weighted average of the stock prices of the 500 companies included in the index, with the weights determined by the market capitalization of each company. SPX is often used as a benchmark for the performance of large cap U.S. stocks. 

The S&P 500 index is maintained by S&P Dow Jones Indices. It is one of the most widely followed stock market indices in the world and is used as a benchmark by investors, analysts and financial professionals. 
 

What Is SPY? 

The SPDR S&P 500 ETF Trust (SPY), also known as SPY, is an exchange-traded fund that tracks the performance of the S&P 500 index. The S&P 500 is a stock market index that measures the performance of 500 large cap publicly traded companies in the United States. 
 

SPY was introduced in 1993 and is one of the oldest and largest ETFs in the world, with over $375 billion in assets under management as of May 1, 2023. SPY trades on the NYSE Arca exchange and can be bought and sold like a stock through a brokerage account. 

Investing in SPY provides investors with exposure to a diversified portfolio of large cap U.S. stocks, making it a popular choice for those looking to invest in the U.S. stock market. Because it tracks the S&P 500 index, SPY is often used as a benchmark for the overall performance of the U.S. stock market.  
 

Dividends

Dividends are not normally paid to options holders. However, SPY pays a dividend every quarter. This is vital because if you trade with in-the-money (ITM) call options, you can exercise them to collect the dividend. To do this, you need to exercise your options on SPY before the ex-dividend date or own shares and place a call (called a covered call option).

It is important to be alert when trading ITM calls because most calls are exercised for the dividend on expiration Friday. Therefore, if you own these options, you cannot afford to lose the dividend.

The ex-dividend day for SPY is the third Friday of March, June, September, and December. If that day doesn't fall on a business day, it is pushed to the next business day.

Trading Style

There are two different trading styles, European and American. European style options can only be exercised on the expiration date, while American options can be exercised any time before the expiry date.

SPY options are American-style and may be exercised at any time after the trader buys them (before they expire).

Expiration

SPX options that expire on the third Friday stop trading the day before the third Friday (the third Thursday). On the third Friday, the settlement price is determined by the opening prices of each of the index's stocks. This price is the closing price for the expiration cycle. SPY options cease trading at the close of business on expiration Friday.

Settlement

SPY options are settled in shares. When you exercise your options, you'll buy (or sell) shares of the ETF. Cash is used to settle SPX options, so if you exercise and are in the money, you'll receive cash in your brokerage account.

Value

An SPX option is also about 10 times the value of an SPY option. For example, on April 9, 2020, SPX closed at 2,789.82 points, and SPY closed at $278.20.34

It's vital to grasp that one SPX option with the same strike price and expiration is approximately 10 times the value of one SPY option. Therefore, each SPX point was the same as $100.5

For example, suppose SPX was at 2,660 points, and SPY traded near $266. One in-the-money SPX option gives its owner the right to buy $266,000 worth of the underlying asset ($100 x 2,660).

One SPY option gives its owner the right to buy $26,600 worth of ETF shares (10% of $266,000). 

 

Liquidity

SPY has very "tight" bid/ask spreads. This helps planning because one has a pretty could idea of the execution price. It also enables the use of market orders which are easier and can execute much quicker than limit orders. When using market orders, many brokers (I know Fidelity does) offer price improvements that can result in favorable execution prices.

SPX, on the other hand, has a relatively wide bid/ask spread when compared to SPY. This means that limit orders are a must. That means some "bargaining" with the price and much slower execution. It is more time intensive, less precise and one never really knows if they received the best price.
 

Some traders prefer ETFs like SPY due to better liquidity. What they often forget is the fact that Index options are 10 times bigger product, so 20 cents spread on RUT is equivalent to 2 cents spread on IWM. For example, spread of 10.00/10.50 on RUT would be equivalent to 1.00/1.05 on IWM. The slippage on RUT is usually no more than 10-15 cents which is 1-1.5 cents on IWM.

Commissions

Buying less contracts means a significant difference in commissions. For example: if you buy one lot of 10 strike SPX Iron Condor, you will trade 8 round trip contracts. At $1/contract, that's $8 or 0.8% of the $1,000 margin. Buy 10 lots of 1 strike SPY Iron Condor - and the commissions jump to $80 or 8% of the $1,000 margin.

Tax Treatment Differences

Here there is a substantial plus to Index options. The IRS treats these indexes differently from stocks (or ETFs).

The Index options get special Section 1256 treatment which enables the investor to have 60% of a gain as long term (at a 15% tax rate), and the other 40% treated as short term (at the regular 35% short term capital gains rate) even if the position is held for less than a year.

By contrast, the ETFs are treated as ordinary stocks, and thus if held less than a year, all gains are taxed at the less favorable 35% short-term capital gains rate.

Thus the Index options can be better from a tax standpoint. You should of course consult with your tax advisor to see how these tax implications may or may not be significant in your situation.

Verdict: SPX tax treatment is significantly better than SPY. SPY has an advantage in LEAPS, but from a practical point of view, it can't even come close to the advantages offered SPX. Remember, it's not what you make it's what you keep that matters.

Which Is Right For You?

The assets within SPX do not trade, so there are no shares available to buy or sell. The options are written so that traders can bet on the S&P 500's price movements. SPX functions as a theoretical index with a price calculated as if it were a true index.

This means it has exactly the number of shares of each of the 500 stocks. So, while the SPX itself may not trade, both futures contracts and options based on the index do. This is why SPX options are settled in cash.

The SPY options are settled in shares because shares are being traded on an exchange. Therefore, the options contracts are written so that you take possession of shares when you exercise your option.

Which options are best for you depends upon your strategy and goals. If you want to take possession of shares to hold or trade again, SPY might work best. If you'd rather trade for value and receive cash in your account, SPX is an excellent choice.

Trading SPY options does bring some additional risk. For example, on the Monday following expiration, you end up owning shares. You'll owe the price of those shares at the expiry time, not the price on Monday. So if the price for the shares moves lower on Monday, you're paying more than they are worth on that day. However, if the price moves higher, you pay less than the current market price.

The Bottom Line

The two key differences between SPY vs. SPX options are that they are either American or European style, and SPY options are on an ETF while SPX options are on the prices of the index itself. You should understand the difference this makes for exercising your options. Additionally, the difference in value (and settlement) makes how much capital you have to buy the options important.
 

If you have more capital to spare and don't require dividends, SPX might be a good choice. On the other hand, SPY might be a better choice if you're a bit short on funds and can use the dividends.

Mark Wolfinger has been in the options business since 1977, when he began his career as a floor trader at the Chicago Board Options Exchange (CBOE). Since leaving the Exchange, Mark has been giving trading seminars as well as providing individual mentoring via telephone, email and his premium Options For Rookies blog. Mark has published four options trading books. His Options For Rookies book is a classic primer and a must read for every options trader. Mark holds a BS from Brooklyn College and a PhD in chemistry from Northwestern University.

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A few weeks ago we introduced a new strategy to our members. While a double diagonal spread is a well known strategy, we are trading it with a tweak. The double diagonal strategy is part of SteadyOptions service, along with straddles, strangles, calendars etc.

One of our members have mentioned that "I realize they are lower risk in the sense that they can be open longer without big losses, but feels to me like playing not to lose."
 

Here is a response from our contributor @Yowster who introduced the strategy:
 

Well... Lay me outline reasons why I like them (and I've been doing a ton more of them in personal trades in addition to the official ones, and are tracking even more of them).

• They are extremely low risk, of all the trades I've had on or tracked only one (a DE personal trade) was down by 10% or more at any given time provided I exit prior to T-0, and I wound up able to close that one for a small gain.   I've had many make gains of 15% or more (NVDA, SQ, PANW were recent trades I closed within the past few days that fall into this category).
   
• Of the trades I've placed since January (about 25 of them), roughly 75% of them have been winning trades with an average gain across winners and losers of ~5% (and there were a few large winners like BA and MRNA that I only tracked and didn't have on).   I compare the results to straddle trades since they have similar profit targets, although holding periods can be longer.   Compare a 75% win rate with ~5% average gain to our historical straddle results found here and these DD returns are very good.
   
• One of the common things heard from many members over the years is that the shorter duration straddle trades are difficult to manage when they can't be watching the market all the time.   DD's don't fall into this category as they can be open for longer periods of time, you can easily have GTC orders to close at profit targets and you don't have to worry about avoiding larger losses when RV suddenly spikes downward - so DDs are very good trades for people who can't be watching the market all the time.
   
• Regarding the "playing not to lose" comment.   Managing downside risk as much as possible is one of my primary goals with SO trades, as larger percentage losses can have a large negative impact on portfolio performance.   I look at DDs simply like this - I can have roughly 75% of trades be profitable (some smaller gains, but quite a few over 10% and some getting to 20%), but have almost all losses limited to below 10% (most losers below 5%) and that math works out very well over the longer term.

Currently, we have 4 DDs open as official trades and this will be the most you are likely to see at any given time - thereby leaving plenty of slots for other trade types. Members have different risk tolerances so not every trade type we use is a good match for all members.   But for people who can't be monitoring the market all the time and for some trades where you'd like a higher capital allocation because of the lower downside risk,  DDs can be a good match this category.

As one of our members mentioned:

"Regarding the "playing not to lose" comment.   Managing downside risk as much as possible is one of my primary goals with SO trades, as larger percentage losses can have a large negative impact on portfolio performance.   I look at DDs simply like this - I can have roughly 75% of trades be profitable (some smaller gains, but quite a few over 10% and some getting to 20%), but have almost all losses limited to below 10% (most losers below 5%) and that math works out very well over the longer term.

Many option forums or traders will report a win percentage, total percentage over a few years.  However, I will say that over long periods of time, the unlikely occurrence of a higher risk/higher return strategy  of will greatly reduce a portfolio.  The cost of the extra options easily is worth the alleviation of risk.  If you look at their historical performance.  This was once of there better performing trades over time.  
 

So thank you Yowster.  I also like that some trades are large enough stocks that you can exceed the recommended allocation without significantly effecting the float with a larger trade, as a straddle/strangle under a dollar needs is less desirable for me.  I completely respect this strategy is for a 100k portfolio.  I may be trading occasionally more, but that's a different topic that has been discussed I believe."  

My 2 cents:

To put things in perspective, we closed 9 DDs so far with average return of 5.1% and average holding period of 9 days. Only 2 losers, both 2-3%, and none of the trades was down more than 5% at any given time. Even when the stock doesn't move, the losses are minimal.

If someone believes that 5% is not a good return for options trades, I suggest reading Is 5% A Good Return For Options Trades? Yes, some options gurus will tell you that you should aim for at least 100% gain in each option trade, otherwise it is not worth the risk. What they don't tell you is the risk you will be taking. So I would say that on risk adjusted basis, those results almost too good to be true. They are also pretty easy to open, and because the holding periods are longer than straddles, members have more time to enter. Closing can be done with GTC order, and many times members get better results - just check the previous DD discussion topics. Commissions impact is negligible - in today's environment, many brokers have zero commissions, and even for people who pay 0.30-0.50 per contract (which is high by the current standards), the commissions impact is less than 0.5% per trade.

As for the statement "playing not to lose" - guilty as charged. Limiting losses is our main goal at SteadyOptions. And if you look at our track record, in the last 12 years we were able to produce triple digit gains while keeping the drawdowns very small.

I can only salute @Yowster for constantly coming with new variations of well known strategies in every market environment.

Another consideration is trade allocation.

Lets say you are willing to risk 2% of the account per trade.

If you know that the maximum risk is not likely to be more than 10-15%, you can easily allocate 10-12% per trade. But if your risk is 100%, your allocation should not exceed 2% per trade. So your overall performance will not necessarily be better with high risk high reward trades, but with much higher risk.

So yes, we are playing not to lose. Keeping your losers small is one of the key elements in trading.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

Join SteadyOptions Now!
 

This article will shows how this works, and how IV can affect your decision on what type of trade to open.

Directional Spreads

Let’s start with the simplest of options spreads, the put or call vertical spread which is often used as to place a trade for a stock to move in a certain direction.   Here’s a slightly OTM (Out of The Money) call vertical debit spread on AAPL about a month away from expiration (a popular spread to play for stock price to rise).  The stock price is $182 and the call vertical is long the 185 call and short the 190 call.  Note the highlighted Vega section that will illustrate some important points regarding IV:

• When the spread strikes are OTM (stock price is below both long and short call strikes) the trade is vega positive.   This means while the spread remains OTM, increasing IV will help it retain more of its value.
   
• As the stock price rises toward the spread strikes the degree of vega positive becomes less.   It eventually becomes vega neutral at roughly the break-even point for the spread at expiration.
   
• As the stock price rises even farther, approaching the higher short strike and beyond, the trade will become vega negative.   This means when the spread is ITM (In The Money), decreasing IV will help the value get closer to the spread width (the max gain).

How can this factor into a trade opening decision?   When opening a bullish call vertical spread when IV is elevated it may help to enter near the vega neutral position with the long strike ITM and short strike OTM.   This will be likely be a setup where the max gain is equivalent to the max loss.   If the stock price rises then you’ll hit the point where the spread becomes vega negative sooner, so any drop in IV won’t hurt.    Conversely, if opening when IV is lower you can start out with both legs of the call vertical being OTM.   This will give you a setup where the max gain is higher than the max loss, but you know that any further IV decline is less likely and therefore the downside risk due to dropping IV is not as high so it can be ok even though it will take more of a stock price rise to get to the point where the trade turns vega neutral and then vega negative.

Spreads for Minimal Stock Price Movement

I’m now going to focus on common spreads to play for minimal stock price movement.   The Iron Condor (IC) is one such spread and shown in the following chart, it consists of both an OTM put credit spread and an OTM call credit spread.   When the stock price is in the winning position between the wings it is vega negative meaning an IV drop will accelerate profit growth above the level that just time decay would generate.   Conversely, an IV rise will decelerate profit growth.   Also note that when the stock price gets to the losing zones within and beyond the wings, the IC becomes vega positive meaning an IV rise would help keep the losses smaller.

How can this impact a trade opening decision?    Opening an IC when IV is low means that you’ll have to use closer to ATM strikes to get the same opening credit compared to times when IV is higher when you can get the same credit with farther OTM strikes.   Also, when opening with low IV a further IV decline is less likely, so you won’t get the accelerated profit growth when IV drops.   Opening an IC when IV is somewhat elevated means to can go farther out with strikes (so a bigger stock price move is required to get to the losing zones) and any IV decline can accelerate profit growth provided the stock price doesn’t make a significant move.

Many people don’t like Iron Condors due to their risk vs reward where the max loss is higher than the max gain.   Let’s look at two other common spreads to play for minimal stock price movement that have more equal risk vs reward and how IV can factor into which one to use.    The first is the calendar spread, which commonly uses the ATM strike when playing for minimal stock price movement.  The primary gain catalyst is theta decay (and minimal stock price movement) but IV can also factor in.   As shown on the chart below, its vega positive everywhere meaning that rising IV will always help the trade.   Rising IV will both increase the gain potential and widen the profit tent.  Declining IV will lower the gain potential and tighten the profit tent.

The other common spread to play for minimal stock price movement is the butterfly spread.   Its PnL chart looks very similar to that of the calendar with a balanced risk vs reward and similar break-even points.   The primary gain catalyst is the same as the calendar, theta decay and minimal stock price movement.  But there is one important difference, the butterfly is vega negative when in the winning zone meaning that declining IV will allow gains to grow at a quicker rate.

How can this impact a trade opening decision.   When IV is lower, further IV decline is less likely so using a calendar is a good choice as any rise in IV can help the trade.   However, when IV is elevated and IV decline is more likely then a butterfly can be a good choice as any decline in IV can help the trade.

Spreads for Stock Price Movement in any direction

I’m now going to focus on common spreads to play for significant stock price movement, either up or down.   A long straddle or long strangle consists of only long legs, so they are always vega positive.    Rising IV will lessen the impact of negative theta, falling IV will add more price decrease to that of negative theta alone.    This is why straddles and strangles are typically used in the timeframe before earnings where you have the virtually guaranteed IV increase to counteract some of the negative theta.

A reverse iron condor (RIC) is the inverse of the iron condor. It consists of and OTM call debit vertical spread and an OTM put debit vertical.   How far away from ATM you go impacts the risk vs reward setup.   Note that the RIC is vega positive when in the losing zone between the put and call wings, so any IV decline will accelerate losses.    The trade becomes vega negative when the stock price moves into a winning zone, so if you get the stock price to move then you are guaranteed to have a winning trade regardless of what happens with IV.

There are certainly more complex trade setups to use in any of these scenarios, but I’ve covered some of the most popular trades and you can see how current IV can impact your decision to use one trade setup instead of another.

Insider Buying and Selling

In doing so we are competing with quant-based analysis that is poring hundreds of millions of dollars into similar things and rarely does the retail investor get a peek in with any edge. Courtesy of regulation, however, there are a number of things that we – the retail investor – can see as well (or as poorly) as anyone else and one of those things is insider buying. Due to grey zones in reporting and execution of trades, the exact timing is not what matters the most, it is simply a head’s up that insiders are buying.
 

Why is this meaningful, well to quote one of the old-time investment greats:

“Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.” —Peter Lynch
 

Insider buying is much more significant than selling because so many reasons can cause a person to require money that have nothing to do with the company in question, the most obviously ubiquitous one being DIVORCE! Buying is extraordinary because those doing it are actually increasing their exposure to the stock in question when usually they are already employed by the company and on top of that tend to benefit from share options or company plans. Occasionally a CEO/CFO has to make a public show of confidence in his own company by buying (avoid those situations) but by and large the run of the mill insider buyer really has no reason to buy except they think things are looking good for the stock. In betting terms, insiders buying is them doubling down on an already very large exposure to the success of the company in question.
 

Peter Lynch was very much a person who believed you should invest in stocks you understand. The example he gave of ‘unexpected’ insider buying (i.e. an unregulated one) was the 1950s fireman assuring fire safety rounds in an industrial area around Palmer Massachusetts who had to keep widening the walk of his round due to a particular company (Tambrands) expanding all the time. Without really knowing what they made, he bought shares in the company in question and retired a millionaire by 1970. In the same logic I invested (for my mother’s portfolio) in NVDIA back in April 2016 – why? My company pitched for their business (we didn’t get it) and their public RFP was the first document I ever read that made any sense to me as regards a strategy for AI (self-driving cars in fact). These two examples do have a warning inherent in them and Peter Lynch’s quote above is frequently cited but his second recommendation is more rarely reported:
 

“Finding the promising company is only the first step. The next step is doing the research.” —Peter Lynch
 

NVDA case

The NVDIA situation was a case in point, the investment made for my mother was based on her having a diversified portfolio and an understanding of semi-conductor stocks. A nice RFP itself wasn’t the only reason to choose to take the plunge, it was combined with other considerations and this is how you should approach all insider buying. There was a very interesting Reddit post about this which we shall shamelessly steal from use as research in this article. You see, not all insider buying always leads to success.

Figure 1 Source r/options on Reddit 02/25/2024
 

The above research by the redditor covered a 3-year period and provides sobering reading for anyone believing it is simply a question of blindly following insiders. Whilst the post was probably meant to get you to subscribe to insiderxtrade.com, it was quite enlightening. The period covers 3 years prior to Q2 2023 which was a particularly challenging stock market environment. One might conclude that the smallest cap stocks are only interesting in the shorter time frames and possibly that mid and larger cap stocks insider buyers are more on point about what they do. This analysis followed an older analysis that was less granular but likewise concluded that simply trading the S&P yielded more positive returns BUT insofar as the returns of the insider buyer were winners, they were larger winners than the S&P by some margin. So clearly whatever we do it cannot simply be to buy when insiders are buying.
 

Whom should you follow?

This brings us back to the same question: we should only follow the right insiders but the question is which ones?

The answer is that we should follow those where other things tell us that the stock in question could be of interest but that we are unsure about the general timing of entering an uptrend. Warren Buffet’s idea that what went up last year will go up next year is a truism that is hard to follow in practice when we inevitably pick the one stock that nosedives despite a stellar prior year. An example of a reasoned approach using insider buying is given below for two companies in the defense sector. In RED is Lockheed Martin (LMT) and in BLUE is German stock market quoted defense firm Rheinmetall (RHM.DE).
 

To understand the chart below, note that for both companies – as is usual for any quoted companies – they are subject to certain quarterly windows of buying and selling which are easily identifiable looking at the timing of purchases by insider.
 

• Points 1 & 2 in yellow are public events relevant to the two stocks in question – namely Russia’s invasion of Ukraine and the announcement by the German Chancellor of a “Zeitenwende” a fancy German term  that Bob Dylan stated more simply as: “The times they are a changing”. This coincided with a €100 billion defense spending package to upgrade the German armed forces. No prizes for guessing that both items are relevant for a defense stock but where the first event drove both of them; the second only drove up the German firm. Whilst US companies in defense make more money – the few remaining in Europe stand to grow faster as they start from a much lower base. This made them interesting to invest in.
   
• The little white dots is the insider buying in LMT – in fact it is one man: John Donovan who hasn’t had the best of luck in his choices to get in. This from amongst the 115,000 employees of LMT and a very large corps of people that must report insider trades. LMT reports about 30 insider trades a year – mainly executions and sales. John is the lone bull and combines his LMT director position with a director position at PANW;
   
• The reddish pink numbers are buys by Rheinmetall insiders – in fact in that whole period there are only two sales and they are from a single person who also acquired many shares. Every number there represents between ~3 to 6 insiders buying stock. When you consider Rheinmetall only has 33,000 employees and the fact they report about 10 transactions per year, the difference between LMT and them is even more remarkable.

The difference in performance is tremendous with Rheinmetall easily outpacing LMT but as one can see from (3) not all the purchases were necessarily perfectly timed. The meteoric rise of the stock in early 2022 led to a general pause in which not the company performance but the general market drove the stock, . Insiders kept buying all the time and this is where the combination of a company that is in a good place combined with sustained insider buying and hardly any selling makes the case compelling. Lonely John Donovan is not out of pocket but certainly the tightknit group of buyers in Rheinmetall have had the better of it. The differential is that in the Germans case there was so much more than just a regional conflict to drive the stock price that it was worth paying attention at what insiders were doing. Basically they confirm that the uptrend should last when you are an insiders and you know the end of a good thing is in  sight you sell and certainly don’t buy.
 

Trend Break Confirmation

This brings us to a third way to look at insider buying in a different light – as a confirmation of a trend break to the positive. So far we have examined insider buying as something stock based, secretly hoping that some magnificent epiphany is driving the insiders and that we can profit by association. Needless to say, trading on insider knowledge is not permitted and therefore it makes sense to look at insider buying at a more metalevel.

If you have been investing for a while you have been through a market downturn – my first exposure was the 1987 crash but many of you will recall the market collapse following COVID, dot.com, subprime or the government debt crisis and so forth. Warren Buffet always regales (and comforts us) with his quote that the flag goes out when the market goes down because in the House of Buffet it’s a good thing when ‘hamburgers’ get cheaper. The point is that we never seem to be able to be sure that the market will not go down further. Experience tells us that if you buy anywhere near the nadir of the market – in fact within quite a wide margin of the nadir – the recovery is extremely powerful. It’s a type of ‘buy and hold’ on steroids but our fear tends to drive us away from investing at the right moment and then looking back we bemoan that: ‘it was obvious this pandemic thing was going to go away one day.’ Or whatever equivalent new boom has followed the bust that made us skittish.
 

The analysis below is again ‘researched’ by Putnam but quite a good guide for a different way of looking at insider buying. They noticed the following in 2020 after the COVID Armageddon:
 

These were levels unseen according to them but what makes their analysis interesting is that on that basis they then made a choice about WHERE they would invest. They chose the heavy cyclical side of the market as the one that had been hammered the most and that tends to recovers fastest when a recovery sets in after the ‘doom and gloom’ is dispelled.
 

It’s too late now to look at the insider buying in the period – at least on the NASDAQ site – but one must presume that their choice stock FCX had its share of insider buying. It is also very sensitive to the copper price which itself is directly related to economic activity: there is no economic growth without copper and its price has been a bell weather for the total economy since electronics started dominating our lives.
 

Figure 2 FCX chart from 01/01/2020 to 04/2022
 

As you can see from the chart above, Putnam must have done well but frankly it didn’t take a genius to figure this out nor quantum access to data or even expensive tools. Certainly, you couldn’t possibly time the dip, but you could be more or less right: even a month or 3 would have been fine. What was key is the combination of insider buying and the insight into other drivers of a stock (in this case the realization the market was bottoming because of broad insider buying and the copper price bottoming out).
 

The bottom line

The conclusion of this post is that insider buying is not a direct trigger for investment but simply a useful contributing signal in certain circumstances. Options are ideal for making use of these signals because they can help play the market more subtly than outright share buys can. The approach to a duly researched insider buying scenario could be to buy a LEAP and sell some short options against all or part of the investment. This will give a little protection if the market goes down or sideways whilst making it possible to move the sold call up gradually if the stock picks up steam. The poor man’s covered call, as it is often called, is the option trader’s friend for insider buying strategies.

Ratio trading the earnings

Everyone knows what a ratio trade is right? A ratio can be found in many shapes, forms and directions, the SO beloved Hedged Straddle is a ratio whereby a larger number of long positions are offset (in part) with short positions that are closer in time. Its a more sophisticated version of the humble sell 1 short ITM (In The Money) and buy 2 long ITM (whether with calls and puts) for zero cash outlay (or even a minor cash+ or cash -) except margin.

This article is my own reflection of the use of this option strategy but inspired partially by what I learnt here on SO. I give it to you for criticism and suggestions - so agree or disagree with me, I look forward to the debate. The classic trade described above works both for calls and for puts, in the article I stuck to calls for illustrative purposes but it works just as well with puts.
 

Now you may ask why would you want to do a ratio trade ahead of earnings?

1. there is a large portion of stocks which will run-up in price ahead of earnings;
2. as we know from the SO long calendar, IV will rise ahead of the earnings announcement. An option that is ITM is less affected by IV rising than one that is ATM or OTM and so the mere rise in IV benefits the trade;
3. black swan protection - if the market were to tank really badly, the stock would end up below the short strike (if calls) and the whole trade would be a safe wash.
    

To put it simpler, the ratio trade ahead of earnings is a way to be in the market without risking your shirt - your losses tend to be mitigated if the trade is managed well. Anyone who has bought long calls before earnings will have known the joy of a 100%+ rise but of course also the bust of losing 100% when the market is adverse to you. Certainly if you are long and right on direction, nothing beats the simple long position however the ratio trade allows you to attempt this multiple times without losing your shirt if you are wrong. And you will be wrong occasionally even if you follow the process I describe below, the trick is to minimize the times you are wrong and the size of the loss whereas you rake in the profits when you get it right.

Now already some of you may be skeptical about the IV effect but believe me it is massive, below I will use AZO as an example. Why AZO? Well its a stock that seems to be rise before earnings but its not a perfect example and because its stock price is high the margin requirement makes it somewhat less practical to execute. Its an example and not meant to be followed, but it is a real live one, in any series of earnings a week there are never fewer than half a dozen potential candidates. Anyway, here is the schematic of an AZO 1:2 ratio based on 80 (short) and 60 (long) delta calls 15 March (i.e. after earnings which are unconfirmed for 29-Feb or 5-Mar).
 

Now I know that the IV of this position will rise to 112% the day before earnings so if I were to input that IV today you would see the position gain 10K right away:
 

That's pretty impressive eh? Of course its not really fair because that is the IV value right before earnings so lets bring the date forward to 1st of March - kind of a guess of the right date seeing we are not sure what the earnings date actually is.
 

See how cool that is? Even if the stock would not budge, theoretically under these parameters our position would have GAINED in value. Note that reality tends to be more fractious than the juicy look of these charts but the effect really is there. The increase in IV is a buffer against theta losses and meanwhile we could make a bundle if the stock moved in the right direction.
 

What do I need to choose my trade?

When we are looking for a stock suitable to trade we need to clarify the following questions:

• Is this a stock that rises before earnings?
• When should I enter and when should I exit the position?
• What are the ideal deltas of the short/long position to maximize profits (and what is that profit target)?
• What ratio should I use? (this is much related to the previous question as we will see)
• What will the IV be on the planned end time of my trade?
• What stock price would allow me to break-even at the planned end-date of the trade and what stock price would get me (theoretically) to the planned profit?

If we have the answer to all these questions we can make a trading plan and if on the day everything looks good then execute it and follow the plan. It also allows us to have a guideline to decide to take the winnings or cut our losses because we have set the most important parameters. So lets take these questions one by one, using the tools that are commonly used by everyone on SO - true some of these are paying tools but I think they are well worth it. A little hardwork with charting software can probably also get you to most of the outcomes without the need to use paying services.

Which stock rise before earnings?

Well you could just look at stocks and check back previous earning dates and find them - however thanks to SO I have found VolHQ really useful here - they have a return scanner matrix. To use one example that has worked very well in the past and that I have traded successfully consistently: SBUX. See the heat map that have:

This is the sort of heat map you want to see - as you can see there are a couple of crossings where there are substantial profits. I always start out looking at the 80D one because I need to have a stock that actually rises and the 80D option is pretty close to the actual stock value. To show you the reverse type chart see UAA:

UAA is not a good candidate for this strategy the few red bits notwithstanding, in fact UAA is a good candidate for a ratio put trade - but that's another story.
 

When should I enter and exit the position?

Now like I said we would look at AZO - the 80 Delta Return matrix of AZO looks like this:

This is actually pretty good - so we should check out the 60,40 and 20 D long call returns as well:

Now immediately you can see a sort of possibility here - somewhere between T-20 /T-16 opening and closing between T-12/T-8 seems to have the most consistent warm areas in the heat map. In fact when you look in detail there are probably several opportunities but the highest returns for all the options regardless of delta appears to be T-17 open and close T-9 (give or take a day depending on the option). Some other variants are conceivable and worth looking at - but this early one has the additional comfort that we have time to adapt if necessary before earnings hit us. That means presuming the earnings are announced somewhere in between the two dates currently mooted that we should open on or around 8th of February and close the trade on or around the 18th of February, In any case we shouldn't hold the position too long because it seems to worsen thereafter.

What are the ideal deltas for the options to be used in the ratio?

Here is where I think I can claim some originality - for a long while I presumed a one strike ITM, one strike OTM was the best approach or that possibly to be effective the ratio had to be 1:3 - but in fact nothing is further from the truth. It depends on the stock, the IV and the timing - there is no hard and fast rule though it is somewhat more common to have higher delta ratios being effective. This calculation is quite complex because you have to compare like for like. Practically speaking the comparison must take differences of capital outlay due to margin into account as well as the other parameters of option pricing. I made a spreadsheet for this and you need to fill the highlighted sections in yourself to get results (all other parts are filled automatically):

You need to determine the stock price corresponding to the 80/60/409/20 delta calls respectively for the option series ending soonest after earnings announcement. In this case as it was uncertain I chose the regular 3rd Friday expiry because this series would be more liquid and relevant in terms of option pricing. The relevant strike prices are not exactly corresponding but close enough for my purposes - stocks with lower prices the gaps tend be linear 5$ from delta to delta, but not here as they are 740/800/840/900$ respectively for the 80/60/40/20 Delta call series. I input these in the yellow highlighted section.

The orange section has the return as per volatilityHQ return matrix based on our timings above. The green section is simply last Friday's mid-price of the options in question. To determine which is the ideal delta combination with the above factors we look at the third and fourth set of table marked SPREAD and $2000 respectively. They are in fact the same except the first one gives a return in % and other the return based on a hypothetical 2000$ investment for each of the positions. In this case the 80 delta short and 60 delta long appears to be the winner as has the highest return of 65%.

What ratio should I use?

Well my excel sheet tells us that in the first section of the table marked PRICE - if we look at the 60 DELTA Call and match that against the column of the 80 Delta call we find a 2:1 ratio to be appropriate.

Great you will say, can I trade now?

Nope. There are a few more things to do and a few more caveats to address before you press that trade button.

What will the IV be at the end of the trade?

For this I return again to volatility HQ and let it run its normal calendar function. This is useful anyway because you can check at the same time whether the stock is suitable for a calendar. However I am looking at the third chart down on the calendar plots from vol.HQ:

So at T-9 - our proposed exit date for the trade IV would be ca. 41%, this we can now input into our option valuation as we have entry prices (admittedly based on today's option prices) and we know our exit date and the IV at that time.

What is my breakeven/target profit stock price at exit day?

It turns out our break-even price is today's stock price - that's pretty cool - even if nothing happens we should be okay(ish), the projection is for the exit date at T-9:

In terms of our profit - lets say we aim at 50% - for reasons I explain in the caveats below its better to be conservative and grab the money and run when you can. This would already be a great success - in this case the trade would have required 6K+ margin so I would look for 3K profit. As it turns out that is around the 871.50$ mark for AZO. Now you might say that is quite a climb but it is in fact only +7% compared to today - not at all out of the question and well within previous iterations of this stocks earnings run-ups.

Ok now we have a plan:

• we plan to enter the trade on 8th of February on 2:1 ratio of the 740/800$ 15-Mar call options;
• we plan to exit at the latest on 18th of February
• if at any time the stock should hit 870$+ we liquidate because that would be our end game if it was the final day of the trade as well;
• if during the trade the option threatens to stick below 814$ we might have to cut our losses. In fact for this particular ratio it doesnt look too problematic as the cushion of IV is very large.
   

Houston we might have a problem? (caveats)

Ok so what are the downsides and tricky things regarding this trade?

1. The black swan protection is a bit of a false security. Many people think that the trade will be ok if the stock tanks because in that case at expiry we would have the small credit (or debit) left over from the ratio. However this trade must NOT BE HELD THROUGH EARNINGS - therefore the IV will remain elevated and if the stock tanked you may find that the market prices your option well below the price at the end. Yes - WELL BELOW - even when the stock is ways under the short option. This is a real pain because unless you take the trade through earnings because the market tanked so massively it couldn't possibly pop up - it could just inconveniently rise to exactly your worst point (long strike). In that case you have the max. theoretical loss and no time left to adapt the position. There is no free lunch - the trade can lose money - certainly much less than an outright long but occasionally I have lost as much as 50% of the max. theoretical loss;
    
2. Finding the right stock is not so easy and the heatmaps on vol. hQ are averages - it is very important to hover your mouse over the crossing of entry date v. exit date and see what the average is based on:
   
   
    
3. Liquidity remains important - you cannot do this with stocks with very wide spreads. The ratio is more forgiving than the calendar in that there is no limit to do this on low value stocks but you cant have a spreads widening too much as you need to buy and sell twice;
    
4. This prep work that you do - you have to repeat it all over before you actually commit to the trade. Between then and now some of the parameters (not all) will have changed and therefore be prepared to have a long hard look before pressing that COMMIT button;
    
5. You have to watch these trades and adapt sometimes - do not forget to double check actual earnings dates - this is one reason why even very consistent but time narrow successful past experience is not enough. You could easily be a few days off and like I said whatever you do dont take the trade through earnings, the IV crush post earnings will wipe out even profitable positions pre-earnings that benefit from a post-earnings move in their direction. I am NOT KIDDING - I have lost money on Netflix going up 30$ over my long strike on a ratio trade held through earnings.
    

Ok you scared me - any soothing words?

No system is perfect and I am interested to hear feedback. However my experience has been very good so far and it is improving in particular as I have now nailed down better what sort of ratio to enter for every stock I go on. Including the periods when I was still finding my way (which included some clunkers I can tell you), I have roughly the following batting ratio:

1. profitable on target (or near enough/over - always more than 10% on average 18%): 26
2. on or around 0% (includes +5/-5% but most frequently just +1/-1%): 18
3. losers on average about -20%: 10

Since I started selecting the deltas more carefully my hit ratio has improved with no real losers at all but the sample size is too small in my opinion. Right now I am trading blocks of around 2-3K in value though I have gone over 6K on occasion. I think they are ok for the retail investor - it would be quite hard to open a 100 calls and short a 100 calls in most stocks that are suitable. Generally though for lower volumes you get good prices - institutionals in fact have bad prices because they buy so much volume they influence the market price directly.

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• Long Call Option Strategy
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• 4 Alternatives To Buying Call Options
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This skill is about blending analytical prowess with a dash of intuition. Think of it as chess, but the pieces are stocks, bonds, and the occasional cryptocurrency.

Via Pexels
 

The Art Of Calm And Portfolio Diversification

In asset management, not putting all your eggs in one basket isn’t just good advice; it’s a survival tactic. Diversification is your financial calm. It’s about balancing different asset types to mitigate risk. Imagine a tightrope walker juggling while crossing Niagara Falls; that’s you balancing equities, bonds, and alternatives. The goal? Not falling into the turbulent waters of market volatility.

Relationship Rodeo: Client Communication And Management

You’re not just managing assets; you’re managing people’s dreams and fears. Effective communication with clients is a delicate dance. You need the empathy of a therapist, the persuasion skills of a salesperson, and the patience of a saint. Remember, for every client who understands the stock market, there’s another who thinks NASDAQ is a type of medication.

The Sherlock Holmes Of Due Diligence

Asset management isn’t just about picking winners; it’s about not picking losers. That’s where due diligence comes in. You need to have the investigative skills of Sherlock Holmes, digging into financial statements, understanding business models, and sniffing out risks. Sometimes, it feels like you’re trying to solve a mystery where the butler, the candlestick maker, and the gardener are all suspects.

Risk Management: Playing Financial Jenga

Risk management in asset management is like playing a never-ending game of Jenga. Each investment decision can either stabilize or topple your financial tower. This skill involves understanding and managing various risks – market risk, credit risk, liquidity risk, and the occasional existential risk when your coffee machine breaks down.

Tech-Savvy: The Digital Wizardry

Gone are the days when asset management was done with just a pen, paper, and a phone. Today, you need to be a digital wizard. From algorithmic trading to blockchain, technology is reshaping the asset management landscape faster than you can say “Bitcoin.” Embrace technology, or risk being the financial equivalent of a dinosaur - and not the cool T-Rex kind.

GIPS Compliance: The Invisible Tightrope

And then, there’s GIPS compliance. Think of it as the invisible tightrope you walk every day. For the uninitiated, GIPS (Global Investment Performance Standards) ensure fair representation and full disclosure of investment performance. It’s like the referee in a football game - you don’t always notice them, but they’re essential for fair play.

The Financial Chef: Crafting Investment Strategies

Finally, crafting investment strategies is like being a chef in a high-end restaurant. Each client is a patron with unique tastes and dietary restrictions. Your job is to craft a menu (investment strategy) that delights yet adheres to their risk appetite. It’s a blend of creativity, precision, and occasionally dealing with the kitchen catching fire (market crashes).

In conclusion, mastering these seven skills will not only make you a competent player in the asset management space but also the life of every financial party. Remember, in this game, knowledge is power, diversification is your shield, and wit is your sword. Now go forth and conquer the financial world, one investment at a time!

This is a contributed post.

In both cases a (usually near the money) option is sold and used to partially fund the purchase of two (or more) out of the money options. Let’s see an example:
 

Let’s say Apple was $710 in the beginning of September and we thought it was going to rise in value, quickly. We might put on a call backspread:

• Sell 1 AAPL Sep 710 Calls
• Buy 2 AAPL Sep 720 Calls

It might cost us $50. Here’s the profit and loss diagram:



 

As you can see if we are correct, and AAPL rises, we will enjoy any rise over $720; for every $1 over $720 we make $100 profit. All for an investment of $50. So you can see how lucrative this can be.

Should we be completely wrong, and AAPL falls heavily, we will only lose our $50.

The risk is that AAPL stays around $710. There’s the potential to lose $1000.

Call Ratio Backspread vs. Put Ratio Backspread

A put ratio backspread is a bearish options trading strategy that combines short puts and long puts to create a position whose profit and loss potential depends on the ratio of these puts. A put ratio backspread is so called because it seeks to profit from the volatility of the underlying stock, and combines short and long puts in a certain ratio at the discretion of the options investor.

The put ratio spread is similar to call ratio spread, but instead of buying two or more call options and selling one call option to finance the strategy, you would buy several put options and sell one put option to help finance the purchase of the two puts.

If the stock goes down by a significant amount, the strategy earns money from the two puts to offset any loss from the one put that was sold.
 

Reduce Risk Of No Movement

We saw in the last lesson that backspreads can be used to exploit expected sharp moves in stocks. We looked at an example, a AAPL call backspread. We also found that the key risk at expiration is non-movement in AAPL. How do we counteract this?

The key to managing non movement risk is not to hold the position to expiration.

Look the profit and loss above again.

You will notice the dotted line. This is the profit and loss 2 weeks before expiration. Notice that any loss – how much the dotted line is below $0 – is small, and lower than the expiration worst point of $710, at this stage. Notice too that the upside has been earned by this time: the gap between the two lines is small as the stock rises over $710.

This is the key to trading backspreads successfully. It is possible to get most of the upside at minimal risk if we make sure we are out of our position well before expiration.

Before we detail the way to exploit this, let’s go through the (quite complex) Greeks of the backspread.

Backspread Greeks

Let’s go through the options greeks of the backspread, and how it might affect our strategy. We’ll use our AAPL call backspread example to illustrate this.
 

Delta

For most of the time before expiration the delta of a (call) backspread is positive (except if the underlying falls significantly when delta is flat or slightly negative).

Gamma

Gamma is positive where it matters most (as the underlying rises).
 

Theta

Theta is the key risk with backspreads. As we’ve seen non movement becomes more loss making with time. In other words if there is no stock movement the backspread will lose money; it has positive theta. It becomes more positive as time goes on; hence we avoid holding the position close to expiration.

Vega

Vega is positive. As volatility rises, the position increases in value.

This makes the call backspread our backspread of choice. Should we get the trade wrong, and the stock falls (we want it to rise), volatility will also rise. This would provide a bit of protection as the position would rise with vega being positive. Volatility provides a natural hedge.

Rho

Given the short time we plan to keep the position, rho isn’t really a key concern.

The key point then is that we want our stock to move quickly after we put the position on. Should it not move, or move in the wrong direction, we will remove the trade, well before time decay from theta hurts us.

Backspread Adjustments

General View Of Adjustments

We’re not a great fan of adjustments here at SteadyOptions.

In general adjusting a losing position in the hope that it comes good is similar to doubling down on a bad bet: eventually it will produce a too large to double-down-on loss. They tend to involve increasing a position and/or risk; a potential for disaster.

Backspreads Are A Possible Exception

Anyway, backspreads are a possible exception. Because the loss on a poor performing position stays small well before expiration, it is possible to close it for small loss and then put the backspread on at a different (lower for a call backspread) point.

The key, as always with adjustments, is to only do this if we would have been willing to put the resulting position on fresh.

A good example would be where we expected a strong positive announcement on a share which hadn’t yet happened. The share may have drifted down whilst the market waited. But we still believe the announcement to be imminent and hence want to adjust our position to continue to look for the big move. The call backspread adjustment allows us to do this.

When Would We Consider Adjusting?

Let’s use the call backspread example from 6.1. If you remember we put on the following trade for $50 about 30 days from expiry and with AAPL at $710 (and us expecting it to rise before the end of the month):

• Sell 1 AAPL Sep 710 Calls
• Buy 2 AAPL Sep 720 Calls

Suppose after a few days AAPL drifts down to $700. As can be seen from the P&L diagram this is not a disaster, even though the stock has moved in the wrong direction:

The ‘loss’ on the trade may be only $5-$10 or even less.

However the bigger issue is that stock has moved away from the profitability zone (currently about $705 and moving higher). In addition the stock would soon have to move through the trade’s highest point (around $710) to reach profitability. This reduces the profitability of success substantially.

And so what to do?

Well, we could just remove the trade for a very small loss. And usually we would recommend this. But adjusting back to something that looks like the original trade is quite cheap early on in the trade.

Possible Adjustment

How would we adjust? Well we could just remove the existing backspread and put on another one centered on $690:

Remove original backspread:

• Buy 1 AAPL Sep 710 Calls
• Sell 2 AAPL Sep 720 Calls
• Proceeds: $45

Set up new backspread:

• Sell 1 AAPL Sep 690 Calls
• Buy 2 AAPL Sep 700 Calls
• Cost: $50

The net cost is small ($5) – but may be much higher with commissions and slippage.

This last point is the key: you’ll have to weigh up whether the total cost is worth it to adjust. The though process is, as ever, would I be happy to put this position on fresh at this cost (including adjusting costs)?

Call Backspreads: Trade Plan

Let’s finish by putting everything we’ve learnt together and set out the full game plan for trading Call Backspreads…

Step 1: Choose Your Underlying

This is key.

You’ll only ever want to put on a call backspread if you believe a stock is about to shoot up in value quickly.

Step 2: Put on a call backspread ‘centered’ on the current price

Let’s say, for example you thought EBAY was going to rise from its current $52.

You could sell a 50 Ebay call and buy 2 52 Ebay calls (at the same expiry).

30-40 days out is perfect.

Step 3: Close if position loses or gains 20%

Our aim is jump in and out of these trades quickly. And to average more winners than losers.

Step 3 (alternative)

You could decide to adjust if the position loses 20% with there still being 20 days or more at expiry.

If so (i.e. you think the stock will still rise), close the position and go to step 2.

(Be careful: you can only ever hope to regain your loss using this method. It is only good to do if you are still sure the stock will rise quickly soon.)

 

The Bottom Line

In conclusion, backspreads can be an effective strategy for experienced options traders seeking to profit from significant price movements in the underlying asset while managing potential losses. By selling a certain number of call/put options and simultaneously buying a greater number of call/put options, traders can create a spread with unlimited profit potential.
 

However, it’s important to note that backspreads are a complex strategy that requires a good understanding of options trading and market dynamics. Traders and investors should carefully weigh the risks and rewards, including the maximum profit and loss potential, before incorporating this strategy into their portfolio. With proper knowledge and risk management techniques, backspreads can be a valuable addition to a trader’s options toolkit.

Another unique use of the backspread is Earnings Ratio Spread.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

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Related articles

• Options Greeks: Theta, Gamma, Delta, Vega And Rho
• Options Vega Explained: Price Sensitivity To Volatility
• Options Theta Explained: Price Sensitivity To Time
• Options Delta Explained: Sensitivity To Price
• Earnings Ratio Spread

Introduction To The Long Put Strategy

Options are used by investors to take advantage of a wide range of projections on the state of the market.
 

Unlike stock investing, where only a rise makes money, options can profit from falls in the market, and a range of other market movements such as changes in a security’s volatility.

One such simple strategy used in the long put, detailed here.
 

Description of the Long Put Strategy

The strategy involves the purchase of a put option.

Puts give the buyer the right but not the obligation to sell the underlying security anytime* between now and the expiry date of the option.

This is for ‘American’ style options – as compared to European options which can only be exercised on the expiry date, not before. Most options traded on the CBOE that we’ll cover are American options.

For example suppose a put option was purchased with a strike price of 140 and 3 months of time remaining until expiry. Anytime over the next 3 months we could exercise the option and sell stock for $140/share.

(If we didn’t own stock we could buy some immediately before exercising the option – brokers would just pay the difference to us).
 

Maximum Gain and Loss of the Long Put

The maximum gain is significant, but is theoretically limited to the strike price minus the cost of the option, if the stock drops to $0.
 

Your maximum loss is the amount paid for the option. If the stock is anywhere above strike A, you will lose the same amount of money.

When and how to put a Long Put on

A long put would be placed if we believed the underlying stock was to fall, and fall quite rapidly (as we will see the put loses time value).
 

A long put position is initiated when a buyer purchases a put option contract. Puts are listed in an option chain and provide relevant information for every strike price and expiration available, including the bid-ask price. The cost to enter the trade is called the premium. Market participants consider multiple factors to assess the value of an option’s premium, including the strike price relative to the stock price, time until expiration, and volatility.

Typically, put options are more expensive than their call option counterparts. This pricing skew exists because investors are willing to pay a higher premium to protect against downside risk when hedging positions.
 

Long Put market outlook

A long put is purchased when the buyer believes the price of the underlying asset will decline by at least the cost of the premium on or before the expiration date. Further out-of-the-money strike prices will be less expensive but have a lower probability of success. The further out-of-the-money the strike price, the more bearish the sentiment for the outlook of the underlying asset.

Pros of Long Put Strategy

Long puts are a capital efficient position – only the cost of the option which is likely to be a fraction of the price of the stock is required.

They are also one of the few ways retail investors can profit from falls in stock prices. The alternatives such as shorting a stock are often unavailable or too capital intensive to non wholesale broker clients.

The position is also pretty simple compared to other strategies and options spreads we cover.

Cons of Long Put Strategy

Long puts are theta positive. Over time they lose value, all things being equal, and so any move down needs to be reasonably rapid to counteract this.

Care with the strategy needs to be taken if the stock has taken a large fall recently. out of the money puts in particular are likely to be in demand, push up implied volatility and option price.

Should the stock rise back in value the puts will likely lose twofold: from the negative delta of the position and also the implied volatility falling back to normal levels. The put price is likely to collapse in this scenario.
 

Risk Management

As we’ve stated above, ensuring a long put position doesn’t have an elevated implied volatility on entry is the first risk management decision to make.

You should also consider reasonably long dated options – 30-90 days plus – to minimize the loss of time value. Theta on longer dated options is lower hence minimizing the effect of time decay.

Another alternative is to sell an out of the money put to reduce the net cost of the strategy, and minimize time decay risk. This would turn the strategy into a bear put spread.

Long Put Strategy vs. Shorting Stock

A long put may be a favorable strategy for bearish investors, rather than shorting shares. A short stock position theoretically has unlimited risk since the stock price has no capped upside. A short stock position also has limited profit potential, since a stock cannot fall below $0 per share. A long put option is similar to a short stock position because the profit potentials are limited. A put option will only increase in value up to the underlying stock reaching zero. The benefit of the put option is that risk is limited to the premium paid for the option.

The drawback to the put option is that the price of the underlying must fall before the expiration date of the option, otherwise, the amount paid for the option is lost.

To profit from a short stock trade a trader sells a stock at a certain price hoping to be able to buy it back at a lower price. Put options are similar in that if the underlying stock falls then the put option will increase in value and can be sold for a profit. If the option is exercised, it will put the trader short in the underlying stock, and the trader will then need to buy the underlying stock to realize the profit from the trade. 
 

Time decay impact on a Long Put

Time remaining until expiration and implied volatility make up an option’s extrinsic value and impact the premium price. All else being equal, options contracts with more time until expiration will have higher prices because there is more time for the underlying asset to experience price movement. As time until expiration decreases, the option price goes down. Therefore, time decay, or theta, works against options buyers.
 

Implied volatility impact on a Long Put

Implied volatility reflects the possibility of future price movements. Higher implied volatility results in higher priced options because there is an expectation the price may move more than expected in the future. As implied volatility decreases, the option price goes down. Options buyers benefit when implied volatility increases before expiration.

Conclusion

• A long put is a position when somebody buys a put option. It is in and of itself, however, a bearish position in the market.
• Investors go long put options if they think a security's price will fall.
• Investors may go long put options to speculate on price drops or to hedge a portfolio against downside losses.
• Downside risk is thus limited using a long put options strategy.

The Long Put strategy is great for being able to simply and easily profit on the fall of an underlying security. However more sophisticated traders may be more attracted to more complex strategies such as the bear call spread to similarly profit, but as reduced cost and theta risk.

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Related articles

• Options Greeks: Theta, Gamma, Delta, Vega And Rho
• Options Vega Explained: Price Sensitivity To Volatility
• Options Theta Explained: Price Sensitivity To Time
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Introduction to the Long Call Strategy

Although options trades can become quite complicated, sometimes simpler is better. One of the simplest positions available to both seasoned and novice options traders is the long call.
 

Description of the Long Call Strategy

A bullish long call option position is exactly that: a long option. Call options are derivatives that give the buyer the right, but not the obligation, to buy an asset at a specified price at a specified date in the future.

All options have an expiration date. On this date, the option will either be “in the money,” in which case it may be exercised or assigned, or “out of the money,” in which case it simply expires worthless.

A long call option is a simple, defined risk manner in which to express a bullish opinion of a market.

Here is an example: Suppose that you have been watching stock AAA, which is currently trading at $85 per share. The stock has been trending higher, but recently saw a five percent pullback. You feel that the recent decline represents a great opportunity to take a long position.

Instead of buying 100 shares of the stock outright, you decide to buy a $87 call option with 60 days until expiration. You pay a premium of $.50 for the option.

Now, suppose that the stock does in fact climb, and at expiration is now trading at $90 per share. In this case, the break-even of the option is calculated as the strike price ($87) plus the premium paid ($.50) for a break-even level of $87.50. Because the stock is now at $90, the profit is calculated as the break-even level of $87.50 plus the current price of $90 for a total profit of $2.50.

Every point that the stock price rises above the break-even level will result in a point-for-point gain on the call option.

Now suppose that your stock forecast was completely wrong, and the stock not only doesn’t climb but declines. If the stock is below the strike price of $87 at expiration, the option would simply expire worthless and the premium aid would be lost.
 

Long Call market outlook

A long call is purchased when the buyer believes the price of the underlying asset will increase by at least the cost of the premium on or before the expiration date. Further out-of-the-money strike prices will be less expensive but have a lower probability of success. The further out-of-the-money the strike price, the more bullish the sentiment for the outlook of the underlying asset.

When to put it on

A bullish call may be utilized if you believe the stock or asset price will climb in value prior to the expiration date. A bullish call option may also be suitable for a situation in which implied volatility levels have seen a significant decline, or are trading below key averages.

Although a call option can be purchased at any time, there are a few scenarios in which it may make the most sense. Purchasing a call after a market decline, as in the example above, may be a way to enter a long position in a market that is in a longer-term uptrend.

Another situation where a call may be appropriate is when a market has declined into a key support level. Markets that decline to such levels may see bargain hunters step in to buy, and thus can potentially be a bullish reversal point.

Pros of Long Call Strategy

A bullish call position can have several key advantages. Possibly the most significant advantage is the defined risk characteristics of such a position. When you purchase a call option, your risk on the trade is limited to the premium paid for the option plus any commissions and fees, regardless of what the market does.

A call option can also potentially provide a larger return on investment compared to an outright position in the underlying. Buying stock may require a large amount of capital, whereas an option may tie up less investment capital.

A long call can also potentially profit from a rise in volatility as well as higher prices.

Cons of Long Call Strategy

Although options have a number of potential advantages, they do also have some notable disadvantages. Because options have an expiration date, they will lose value over time with all other variables remaining constant. An option can also lose value, even if the market moves favorably, if there is a significant decrease in implied volatility levels.

In a nutshell, a long option holder must not only be correct about the market direction, but must also be correct about timing and volatility conditions.

Risk Management

There are numerous schools of thought when it comes to risk management of an option. A very simple, yet effective, method of managing risk is to simply cut the option once it loses half of its value. In one example, if you paid $1.00 for an option and its value declines to $.50, take the lump and move on to the next trade.

Another method may be to cut the option once it reaches a certain amount of time until it expires. For example, if you buy an option with 90 days until expiration, then cut the option when it reaches 30 days until expiration.

 

Payoffs for Call Option Buyers

Suppose you purchase a call option for company ABC for a premium of $2. The option's strike price is $50, with an expiration date of Nov. 30. You will break even on your investment if ABC's stock price reaches $52—meaning the sum of the premium paid plus the stock's purchase price. Any increase above that amount is considered a profit. Thus, the call option payoff when ABC's share price increases in value is unlimited.

What happens when ABC's share price declines below $50 by Nov. 30? Since your options contract is a right, not an obligation, to purchase ABC shares, you can choose not to exercise it, meaning you will not buy ABC's shares. In this case, your losses will be limited to the premium you paid for the option.

• Payoff = spot price - strike price
• Profit = payoff - premium paid

Using the formula above, your profit is $3 if ABC's spot price is $55 on Nov. 30.

Possible Adjustments

A long option can also be adjusted during a trade. For example, if a long call is showing a profit but is approaching expiration, you could sell the call back to the market and “roll” out by purchasing another call option of the same or different strike price for a later expiration.

You can even sell a short call against a bullish call once the position has become profitable. Doing so may lock in a profit, but will also cap the profit potential of the trade.

The bullish call option is one of the simplest, yet most powerful options positions you can put on. This trade carries defined risk, with unlimited profit potential. Long call options can be a losing proposition if not managed properly, yet can also potentially yield rapid and dramatic results if a market has s sudden and explosive move higher.

The bullish call is one of the easiest options trades to learn, and given its simplicity and risk characteristics should be a tool in any trader’s toolbox. That being said, any strategy will yield lousy results without proper and disciplined risk management techniques.

 

Time decay impact on a Long Call

Time remaining until expiration and implied volatility make up an option’s extrinsic value and impact the premium price. All else being equal, options contracts with more time until expiration will have higher prices because there is more time for the underlying asset to experience price movement. As time until expiration decreases, the option price goes down. Therefore, time decay, or theta, works against options buyers.

Implied volatility impact on a Long Call

Implied volatility reflects the possibility of future price movements. Higher implied volatility results in higher priced options because there is an expectation the price may move more than expected in the future. As implied volatility decreases, the option price goes down. Options buyers benefit when implied volatility increases before expiration.
 

Summary

• A call is an option contract giving the owner the right, but not the obligation, to buy an underlying security at a specific price within a specified time.
• The specified price is called the strike price, and the specified time during which the sale can be made is its expiration (expiry) or time to maturity.
• You pay a fee to purchase a call option, called the premium; this per-share charge is the maximum you can lose on a call option.
• Call options may be purchased for speculation or sold for income purposes or tax management.
• Call options may also be combined for use in spread or combination strategies.
   

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Related articles

• Options Greeks: Theta, Gamma, Delta, Vega And Rho
• Options Vega Explained: Price Sensitivity To Volatility
• Options Theta Explained: Price Sensitivity To Time
• Call Option Payoff
• Options Delta Explained: Sensitivity To Price
   

Definition of Delta Hedging

Delta hedging is a strategy in which an investor hedges the risk of a price fluctuation in an option by taking an offsetting position in the underlying security. That means that if the price of the option changes, the underlying asset will move in the opposite direction. The loss on the price of the option will be offset by the increase in the price of the underlying asset.

If the position is perfectly hedged, the price fluctuations will be perfectly matched so that the same total dollar amount of loss on the option will be gained on the asset.

In general, hedging is a strategy used to reduce risk. An investor hedges a position in a particular security to minimize the chance of a loss. The nature of a hedge, though, also means the investor will give up potential gains as well. For example, an investor with an options contract for Company ABC that benefits from the stock price falling would purchase shares of that company just in case the stock price rose.
 

Understanding Delta

Options Delta is the measure of an option’s price sensitivity to the underlying stock or security’s market price. It is the expected change in options price with a 1c change in security price (positive if it rises/falls with a rise/fall in market price; negative otherwise).

For call options, the delta ranges between 0 and 1, while on put options, it ranges between -1 and 0. For example, for put options, a delta of -0.75 implies that the price of the option is expected to increase by 0.75, assuming the underlying asset falls by a dollar. The vice-versa is the same as well.
 

Reaching Delta-Neutral

An options position could be hedged with options exhibiting a delta that is opposite to that of the current options holding to maintain a delta-neutral position. A delta-neutral position is one in which the overall delta is zero, which minimizes the options' price movements in relation to the underlying asset.

For example, assume an investor holds one call option with a delta of 0.50, which indicates the option is at-the-money and wishes to maintain a delta neutral position. The investor could purchase an at-the-money put option with a delta of -0.50 to offset the positive delta, which would make the position have a delta of zero.

Trade Example: Hedging Long Stock With Long Puts

In this example, we’ll look at a scenario where a trader owns 500 shares of stock. Being long 500 shares of stock results in a position delta of +500. If the trader wanted to reduce this directional exposure, they would have to add a strategy with negative delta. In this example, the negative delta strategy we’ll use is buying puts.

Since the trader is long 500 shares of stock, we’ll purchase five -0.35 delta put options against the position. Here is how the position looks at the start of the period:


 

As we can see here, buying five -0.35 delta puts against 500 shares of stock reduces the delta exposure by 35%. Let’s take a look at the P/L of each of these positions when the stock price falls:

 

Charts courtesy of projectfinance.com.

In the middle portion of this graph, the P/L of the long shares and the long puts are plotted separately. As you can see, when the stock price collapses, the long stock position loses money, but the long puts make money. In the lower portion of the graph, the combined P/L of the long stock and long puts is plotted.
 

The key takeaway from this chart is that the stock position by itself experiences a drawdown greater than $10,000. However, with the long puts implemented as a delta hedge, the combined position only experiences a $4,000 drawdown at the lowest point. By adding the negative delta strategy of buying puts to the positive delta strategy of buying stock, the directional exposure is less significant.
 

Pros of Delta Hedging

Delta hedging provides the following benefits:

• It allows traders to hedge the risk of constant price fluctuations in a portfolio.
• It protects profits from an option or stock position in the short term while protecting long-term holdings.

Cons of Delta Hedging

Delta hedging provides the following disadvantages:

• Traders must continuously monitor and adjust the positions they enter. Depending on the volatility of the equity, the investor would need to respectively buy and sell securities to avoid being under- or over-hedged.
• Considering that there are transaction fees for each trade conducted, delta hedging can incur large expenses.
   

What Is Delta-Gamma Hedging?

Conclusion

Delta hedging is an options trading strategy that aims to hedge the directional risk associated with price movements in the underlying. It uses options to offset the risk of a single holding or an entire portfolio. The goal is to reach a delta neutral state and not have a directional bias.

Delta hedging is a great way to manage the delta (price exposure) of both a position and your overall portfolio.  For premium traders, it is a particularly powerful tool to keep your delta neutral positions and portfolio… delta neutral.

There is more to cover on this topic.  It is important to note, that before using options to delta hedge, you need to fully grasp the dynamic delta behaviors of your hedges.  New traders should consider risk-defined (pre-delta hedged) positions at trade entry. It is important to match your strategy not only to your strategy’s criteria and objectives but also to your options trading ability and knowledge.

This strategy allows for a directional bet (bullish or bearish) while managing the effects of time decay.

A diagonal spread is a modified calendar spread involving different strike prices. It is an options spread strategy established by simultaneously entering into a long and short position in two options of the same type—two call options or two put options—but with different strike prices and different expiration dates.

• A diagonal spread is an options strategy that involves buying (selling) a call (put) option at one strike price and one expiration and selling (buying) a second call (put) at a different strike price and expiration.
   
• Diagonal spreads allow traders to construct a trade that minimizes the effects of time, while also taking a bullish or bearish position.
   
• It is called a "diagonal" spread because it combines features of a horizontal (calendar) spread and a vertical spread.

Types of Diagonal Spreads

Because there are two factors for each option that are different, namely strike price and expiration date, there are many different types of diagonal spreads. They can be bullish or bearish, long or short, and utilize either puts or calls.

Most diagonal spreads are long spreads and the only requirement is that the holder buys the option with the longer expiration date and sells the option with the shorter expiration date. This is true for both call diagonals and put diagonals alike.

What decides whether either a long or short strategy is bullish or bearish is the combination of strike prices. The table below outlines the possibilities:

In this article, we will use a call diagonal spread to explain the concept, but a diagonal spread can be used with puts as well.
 

Diagonal spreads are typically set up like vertical debit spreads, where the long option has a longer duration than the short option. This strategy is typically used to take directional assumptions on products in a defined risk way, while still reducing cost basis aggressively by selling a near-term option against the asset in the trade - the further-dated long option.

 

Diagonal Spread Strategy: How it Works

By re-centering their positions, traders can benefit from the inherent profit associated with being long gamma and continuously re-hedging their delta exposure.

What is Gamma Scalping?

The primary purpose of gamma scalping is to offset the effects of daily decreasing theta, which represents the cost associated with maintaining a long options position. As the value of theta consistently depreciates daily, traders buy and sell shares of the underlying stock to minimize any negative impact.

By understanding the relationship between an option's gamma and delta, traders can better predict how fluctuations in the underlying stock may affect the option's price and use this knowledge to their advantage when implementing a gamma scalping strategy.

Historically, gamma scalping has been considered a commission-heavy strategy due to the constant trading required. However, with advancements in technology and the availability of increasingly affordable trading platforms, this technique has become more accessible to a broader range of investors interested in maximizing profits and mitigating risks. Nonetheless, a thorough understanding of the options market and the intricacies of gamma scalping is essential for successfully implementing this advanced trading strategy.

Fundamentals of Gamma Scalping

Gamma scalping is an advanced option trading strategy that focuses on profiting from the changes in an option's delta as the underlying's price fluctuates. To understand the concept of gamma scalping, one needs to comprehend option greeks, how gamma is defined, and the concept of a delta-neutral strategy.

Option Greeks

Option Greeks quantify the sensitivity of options prices to various factors. The four main greeks are Delta, Gamma, Vega, and Theta. Each of these greeks measures the change in an option's price due to changes in underlying price, volatility, time decay, and interest rates, respectively. Understanding the options Greeks is crucial because they offer insights into crucial aspects of options trading, like risk management and optimal hedging strategies.

Gamma Definition

Gamma measures the rate of change in an option's delta concerning the change in the price of the underlying asset. Essentially, it reflects how much the option's delta will change if the underlying asset's price moves by $1. Gamma is highest at the money and decreases as the option moves further in or out of the money. As an option trader, being long gamma means profiting from the changes in delta as the underlying's price fluctuates.

Delta Neutral Strategy

A delta-neutral strategy aims to create a position with a total delta of zero. This means that any gains or losses from fluctuations in the underlying instrument's price are offset by changes in the options position. Gamma scalping usually starts with a delta-neutral position.

One common delta-neutral strategy is the long straddle, where an investor purchases a call and a put option with the same strike price and expiration date. Since the call has a positive delta and the put has a negative delta, the combined position's total delta will be close to zero.

As the underlying's price changes and the delta changes, a trader can perform gamma scalping by adjusting the hedge to maintain the delta-neutral position.

Implementing Gamma Scalping

Gamma scalping is an options trading strategy used to offset the theta decay on a delta-neutral long options trade. Its primary aim is to take advantage of changes in the underlying asset's price by utilizing the spot market for immediate delivery (Smart Capital Mind, InvestingFuse). Here are the sub-sections involved in implementing gamma scalping:

Choosing the Right Options

Selection of appropriate options is crucial to implementing a successful gamma scalping strategy. Traders should look for options that offer a high gamma and a low theta, as these will provide the greatest profit potential when adjusting positions in response to changes in the underlying asset's price.

Entry and Exit Points

Traders need to determine suitable entry and exit points for their gamma scalping trades. Entry points are generally based on factors such as implied volatility, market conditions, and price movements of the underlying asset. Exit points, on the other hand, are established when the profit target is reached or if the position becomes too risky to maintain.

Position Adjustments

As the underlying asset's price fluctuates, traders must continuously adjust their gamma scalping positions to maintain a delta-neutral stance. This process, known as dynamic hedging, involves buying and selling the underlying asset to offset changes in the option position's delta (Ticker Tape).

By carefully selecting options, defining entry and exit points, and regularly adjusting positions, traders can effectively use the gamma scalping strategy to offset potential losses due to theta decay on delta-neutral long options trades.

Advantages and Disadvantages Of Gamma Scalping

Profit Potential

Gamma scalping can offer significant profit potential for traders. It enables them to capitalize on small price movements in the underlying asset, which can lead to multiple profit-making opportunities in a short period. However, the profit potential is not without risks, as mentioned below.

Risk Management

Managing risk is an essential aspect of any trading strategy. With gamma scalping, traders can potentially neutralize their portfolio's price risk, as explained in this Quora post. Nevertheless, the strategy also comes with risks associated with large market moves, as outlined in this Seeking Alpha article. Traders need to be aware of these risks and utilize appropriate risk management techniques to safeguard their capital.

Time and Effort

Gamma scalping can be a time-consuming strategy, as it often requires traders to monitor the markets closely and make frequent adjustments to their positions. This can be both mentally and physically taxing. Furthermore, it may not be suitable for traders with limited time or those who prefer a more hands-off approach to trading. However, for traders who are committed to mastering the strategy, the potential rewards can be worth the effort.

Application in Different Market Scenarios

In this section, we'll explore how gamma scalping can be applied in various market scenarios, including trending markets, flat markets, and during changes in volatility. Understanding how this strategy functions in different conditions can help traders make informed decisions and optimize their risk management.

Trending Markets

In trending markets, where a clear uptrend or downtrend is present, gamma scalping can be an effective way to profit from price fluctuations. During an uptrend, traders can long gamma by buying at-the-money call options, whereas in a downtrend, they can short gamma by buying at-the-money put options.

As the market moves in the expected direction, traders can dynamically adjust their positions by buying or selling the underlying instrument, thus locking in profits through delta hedging. Gamma scalping can be particularly beneficial when the trend is strong and the position's gamma becomes increasingly positive.

Flat Markets

Flat, or range-bound markets, are where gamma scalping truly shines as a potentially profitable strategy. In these scenarios, the underlying instrument's price remains relatively stable, with minimal fluctuations or sideways movement. Traders can sell options, particularly straddles or strangles, to benefit from the lack of price movement. By gamma scalping, they can adjust their positions and take advantage of the small price changes to accumulate profits. Scalping gamma in a flat market requires close monitoring and quick position adjustments to ensure the option's delta remains neutral.

Changing Volatility

Gamma scalping can also be employed when market volatility is changing. Since gamma is directly influenced by volatility, traders can use this strategy to capitalize on anticipated increases or decreases in volatility. They can buy options with higher implied volatility if they expect it to rise or sell options with lower implied volatility if they believe it will decrease. With gamma scalping, traders can manage their positions dynamically, adjusting to changes in the market's volatility and capturing profits from the corresponding price movements. This strategy can be particularly useful for traders with a keen understanding of market volatility and its potential impact on option prices.

Conclusion

Gamma scalping is a sophisticated options trading strategy employed primarily by institutions and hedge funds. It entails adjusting one's delta exposure by buying and selling shares of stock incrementally to maintain a delta-neutral position. This approach exploits the inherent relationship between gamma and theta in options trading, capitalizing on short-term price fluctuations.

The success of gamma scalping lies in the trader's ability to balance these two option Greeks. Careful monitoring of market movements and timely adjustments to their position is crucial to profit from this strategy. It is essential to note that gamma scalping is not for every trader, as being actively involved in the market and having a deep understanding of options theory is required for success.

In summary, gamma scalping can provide a lucrative opportunity for experienced traders who are well-equipped to navigate its intricacies. The strategy requires dedication and a keen understanding of the options market, but it holds the potential for significant profits if executed correctly. Prospective gamma scalpers should thoroughly educate themselves on the subject and consider the inherent risks involved before diving into this complex trading approach.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

 

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Related articles:

• Options Delta Explained: Sensitivity To Price
• Options Theta Explained: Price Sensitivity To Time
• Options Gamma Explained: Delta Sensitivity To Price
• Options Vega Explained: Price Sensitivity To Volatility
• Options Rho: Sensitivity To Interest Rates

In a word, trading is really hard. Markets are extremely competitive. The smartest people in the world flock to financial markets looking to get rich. There are massive hedge funds set up solely to harness the talent of said smart people. Not only are they likely smarter than you, they have access to more money, information, and technology than you. A formidable opponent.

But the world is littered with millionaire traders with average intelligence. So what gives?

Most new traders enter the stock market with preconceived notions about how it works. Good trading isn't about predicting earnings numbers, finding the perfect technical pattern, or being the best analyst. In other words, new traders think that trading is like a big game of chess with fixed rules.

One of the biggest differences between successful and failed traders is grasping the "metagame" of how markets trade. While strategy development, risk management, and other fundamental trading concepts are vital, mainstream trading literature tends to gloss over these three factors that we'll highlight in this article.

So if you've had a creeping suspicion that markets are more than just a game of predicting numbers and finding the trading pattern, you'll love these three concepts that most new traders fail to grasp.

The Market is a Wicked Learning Environment

Getting good at most things is simple (not not easy).

Learning guitar starts with plucking the strings correctly. Then understanding the fretboard. Soon you're learning chords and playing songs. After that comes soloing and lead guitar work. With each hour of practice, you can feel yourself improving and progress is relatively linear. Learning guitar, like most skills, is a kind learning environment. There are predictable patterns to follow and feedback is instant.

Trading is different. There are no hard rules, and even when there are, following them can still lead to negative outcomes.

Imagine you create a trading strategy based on selling VIX futures after a large spike in volatility. After some backtests, you conclude this is a highly profitable strategy. You're ready to go - it's time to become a trader and print money.

But your first trade blows up in your face. So does the second, and the third.

You did everything right in your strategy development, avoided all the pitfalls when backtesting, and even forward-tested your strategy. And yet, the market punished you for it. You might feel tempted to go back to the drawing board. But that might be a mistake, too.

The market is a wicked learning environment. There's tons of randomness and unpredictability. Experience, education, and practice doesn't directly translate into improvement.

The "rules" of the market are dynamic and ever-changing.

Markets Are Extremely Competitive

Markets are a player versus player experience.

You're competing against everyone else trying to make money in markets. In every trade, there is a winner and a loser. For you to win, someone else needs to lose.

And your competition are some of the smartest people in the world. There are massive hedge funds set up solely to harness the talent of said smart people. Not only are they likely smarter than you, they have access to more money, information, and technology than you. A formidable opponent.

And just when you think you've figured out the strategy of the best players, the metagame changes. Just as it does in any competitive video game like Counter-Strike or DOTA.

Some successful traders try to fight the big hedge funds head-to-head using the same strategies. Although many fail.

But many traders carve out a niche of their own by playing a different game entirely. When HFT firms started to dominate scalping, the best scalpers adapted. They prolonged their holding periods and figured out how to continue to win using similar concepts but changing a few key factors.

The Market is a Beauty Contest

The stock market is a beauty contest. But not in the way that you think.

John Maynard Keynes, the legendary economist upon whom many presidents based their fiscal policies, came up with this concept called the Keynesian Beauty Contest. And in a word, he explained that traders and investors pick stocks based on what they believe others think is valuable, rather than their own analysis of the stock's value.

The 1990s dotcom bubble is a perfect example. Many smart traders make a killing buying stocks like Pets.com at ridiculous valuations. But they keenly sensed that most investors were hungry for internet stocks and would buy virtually anything. For many, it wasn't about Pets.com and Webvan's great business models, it was cynically deciding that investors were acting stupid and they could profit from that stupidity.

You can get a sense of the Keynesian Beauty Contest by turning on CNBC. Anchors are obsessed with "market reactions" to news and events, rather than the material of the events themselves. Because that's what drives markets.

The most obvious way to demonstrate this is showing you a payoff profile (the possible path of your P&L for the trade at different underlying prices):

Long Call:

Short Put:

There are immediate differences.

You buy a long call when you think the market will go up a lot. You're optimistic and willing to risk some cash in the hopes of making a multiple of that.

You sell a put when you think the market won't go down a lot. You're confident that the market won't go down. By selling a put to another trader, you're almost acting as a bookie, taking a fee to allow another trader to make a big bet. If he's wrong, you get to keep his bet. For him to be right, the market has to move enough to neutralize the cash value of his bet.

When To Use a Long Call

Reason #1: You Have Reason to Believe the Market Will Go Up. A Lot.

If you're bullish on a stock, there's a lot of things you can do to express that view.

●     You can buy the stock

●     You can buy calls on the stock

●     You can buy the stock and sell covered calls against it

●     You can buy the sector ETF or a basket of related stocks for a sympathy play

●     You can sell puts against the stock

●     You can enter any number of directionally bullish options spreads

All bullish outlooks, but very different P&L paths.

Buying a long call makes the most sense.

Reason #2: Other Traders Disagree With You (Low Volatility)

Professional options traders are fond of saying that anytime you trade options, you're making a bet on volatility, whether you intend to or not.

This is because option prices are inherently tied to the expected future price movement of the underlying asset. In other words, buying options is expensive when people think the market will move a lot, and vice versa. Hence, buying puts or calls on a stock like Tesla is much more expensive (as a percentage of the stock price) than a more tame stock like Johnson & Johnson. Tesla makes wild price moves all the time, while Johnson & Johnson remains stable most of the time.

In the options world, this idea of the market's expectations about future price fluctuations is called volatility. When options traders say a stock is "high volatility," they mean that traders expect the stock price to fluctuate a lot in the future and options on that stock are expensive.

Imagine Tesla is announcing earnings tomorrow, in the first quarter after the Tesla Semi is on sale. If the results are bad, the stock will tank. If results are good, it will skyrocket. All traders know this and hence buying puts and calls is expensive to account for the big move. There's no free lunch.

But while Tesla's baseline volatility is high compared to the average stock it has it's own ebb and flow cycle. Volatility is relative. You can't say Johnson & Johnson's volatility (i.e. option prices) are cheap because it's cheaper than stocks like Tesla. Both of them are priced the way they are for good reason.

Instead, volatility is relative to itself. So you should compare Tesla's volatility to the stock's own historical volatility. Is volatility cheap, average, or expensive today compared to recent history?

One way to do this is using a measure like implied volatility rank, or IV Rank. It measures how expensive a stock's options are as a percentile compared to the past 12 months.

When To Use a Short Put

Reason #1: To Capitalize on Expensive Option Prices

As we discussed, every option trade is an implicit volatility. Buying an option outright is taking the view that volatility (or the market's estimate of how much the market will move until expiration) is underpriced, and vice versa.

If you spend time in professional trading circles, you'll find that successful option traders tend to sell volatility far more often than they buy it. This is due to the "volatility risk premium."

This idea of a volatility risk premium comes out of academia. Scholars have essentially found that traders that sell volatility when it's high tend to make excess returns. And there's a good reason for that. High volatility indicates a high level of market stress.

And when investors are stressed, the first thing they want to do is protect what they have. Everyone doing this at once pushes up the price of protection temporarily until the market calms down.

When a stock declines quickly, investors will rush to buy puts and they'll become expensive--opening an opportunity to sell potentially overpriced options.

But it's not as simple as selling expensive options. Selling a put is a directionally bullish strategy--in other words, you need a compelling reason to be bullish on the underlying stock.

Reason #2: You're Moderately Bullish on a Stock

There are times when you're more sure that a stock won't fall than you are that it will rise.

There are plenty of situations like these.

A stock stuck in a long-term trading range with no evident catalysts.

Or perhaps a stalwart stock within a bull market. While Apple (AAPL) isn't the highest flying stock, it's rare to see its shares plummet in a stable bull market.

Some traders will even sell puts against takeover targets, surmising that there's a "floor" to their stock price due to the takeover interest.

Buying calls and playing for the home run isn't the right move for stocks like these. But you still have a market view you're confident in and want to profit from. Selling a put allows you to generate income as long as the stock doesn't decline a lot, which comes in handy in stable bull markets.


 

According to a 2022 survey, you need around $2.2 million to be considered wealthy and approximately $774,000 net worth to be economically comfortable. While it is undeniable that the earlier you start the better, the second-best moment is right now. With that said, here are twelve tips for building long-term wealth.

1. Have financial goals

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Your financial goals may be short, mid, or long-term. Saving for vacation could be short-term while paying off your student loan is mid-term, and investing for retirement is long-term. You will be on the path to enjoying financial security if you set financial goals and achieve them. The question now is, how do you go about it? You may begin by figuring out which goals are more important to you. For instance, you may be eager to pay off your student loan or want to retire comfortably. After identifying what matters to you most, you may set realistic goals to enable you to achieve them. Consider how much you earn and spend monthly and use a budget to determine where to cut your spending to enable you to reach your goals. Keep an eye on your progress and make adjustments when necessary. 

2. Understand time horizons

At some point, you need to invest. Other times you need to go into your savings. Yet how you recognise these moments will be crucial for building wealth. It would help to keep your savings or money aside to cover your expenses in something low-risk or with guaranteed returns. This way, you won't have to trade your investment at a loss when accessing your funds. You can take more risks when you save money for a long-term project. For instance, you may lose money in the interim when you invest in the stock market. However, you have enough time to see your money rebound by the time you need to withdraw. 

3. Consider index fund investing

Index fund investing offers extensive market exposure with usually lower charges than actively managing your funds. Regarding index fund investing, you won't have to worry about selecting the right stock. Instead, you may invest in a small percentage of all the index stock, spreading your risk and enabling you to tap into the success of the many large corporations. You may also participate passively in the whole market without requiring researching or trading actively. 

4. Spend consciously 

Spending consciously doesn't mean denying yourself good treats. For example, you can create a shopping list and stick to it at the grocery shop. This way, you won't spend on needless items simply because you can afford them. You can also compare prices before buying. Researching can help you find the best deals on the market since the same item and quality might be selling cheaper at another store. Also, know your spending limit for significant items, such as new furniture or TV. Give yourself a day or two to consider a purchase before heading out or swiping the credit card. 

5. Embrace the dollar-cost averaging approach

Everybody wants to buy low and sell high. But the reality is that you cannot achieve this consistently without a perfect investment approach. When building wealth, investing on schedule and consistently is the best approach. That may require investing a set amount at prearranged intervals, irrespective of prevailing market conditions. This dollar-cost averaging strategy can lessen the effect of market instability in the short term. Meanwhile, you can effectively reduce your average cost per share by investing consistently by buying more shares at lower prices and fewer when the prices shoot up. 

6. Downsize your housing 

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Downsizing is one of the principles for accumulating wealth beyond 50. Housing is one of the costliest budget items, and you might save a lot of money by downsizing or relocating to a less expensive location. Your children have most likely left home to live independently or attend college by now. It is time to relocate to a new place if you have vacant rooms and the house feels too huge for those living there. Downsizing does not mean getting smaller if it is not your best option. Consider moving to an area with a lower cost of living.

Meanwhile, first-time homebuyers can also use state-backed loans and grants to save significantly on home buying. For instance, the $25,000 first-time home buyer grant application can assist individuals in acquiring homes without reeling in the high-interest rates on the mortgage or housing market. 

7. Settle your high-interest debt

High-interest debt such as student loans, mortgages, credit cards, and pay loans can take up so much of your money, making it almost impossible to have anything left after taking care of your monthly bills and utilities. Create a plan to pay off your high-interest debt and free up more money for wealth-building through investment or savings. Paying these debts can also improve your credit score and reduce how much you pay in interest. You can tackle high-interest debt in several ways, including consolidation, debt snowball, and balance transfer. You may also speak to a credit counsellor to assist you in negotiating directly with your lenders. Take the time to research the various options to identify which approach is ideal for your situation. 

8. Find a new career

Aging is natural, and even with all the best self-care habits, you cannot continue working the same way as you do. Building long-term wealth is a lifelong activity, and even in retirement, you want to find new activities or engagement that pays and keeps you fulfilled at the same time. You can take up something part-time or an activity requiring less work to keep you thrilled and earn extra income to cover your daily expenses. Thanks to the internet, you can learn a skill or two or complete a course to make money even in your senior years. Imagine getting paid to do what you love and continue building wealth in retirement. Companies working with marketplace care partners provide opportunities for you to provide care, get paid for doing what you love and continue building wealth. That is because these organizations offer flexible and diverse job opportunities so that you can customize the type of work that you do. Finding such an opportunity may ensure a secure financial future and ensure earnings will continue even into retirement.

If you are in search of a new career path then you may have considered the many benefits of working abroad. If you decide to move and follow your dreams then you will need to have your finances in order. Depending on where you are heading to, Central America for example, make sure the exchange rate works in your favor. The last thing you want is to run out of funds while you are still setting everything up. However, the good news is you can ask friends and family to Transfer money to El Salvador should you need it. 

9. Automate your investing and saving

It takes discipline to consistently save and invest, particularly when you transfer a percentage of your income into investing. Doing so manually creates room to skip the undertaking, especially since there is great allure to spend. Fortunately, automating your investing and savings offers a more effective approach to staying disciplined and consistent. You can also use retirement accounts and brokerage platforms to automate the process by regularly transferring funds from your bank to your savings or investment accounts. Aside from eliminating manual transactions, automation enforces consistency and discipline in your saving and investment strategy. This also includes using the right platform for trading, such as Pocket Option, to help ensure that you are doing that right and making the most you can of it.

10. Stick to “boring” investing

It is common to see people treat investment like gambling. There is always that adrenaline to locate that stock set to peak in no time. It is okay to take such risks if you don't mind losing your money, but that is not the best approach for achieving long-term wealth. Gamble with money you can afford to lose, but you cannot grow money in a manner that triggers anxiety and excitement. Be patient if you want to build wealth; with time, you’ll reap rewarding results.

11. Protect your wealth

It is hard to make money but easy to lose it. And one way to keep your wealth intact and growing is to learn how to protect it. You can invest in property insurance to keep your home and belongings, health insurance to cover your entire family, disability insurance for any injury or illness that might prevent you from working, and life insurance for your family’s future. You can also sign up for care insurance if you or a loved one needs assistance or a nursing facility. Another way to protect your wealth is to diversify your investment and learn ways to reduce your tax burden. 

12. Work with a professional

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Working with a professional financial advisor is always the best unless you are comfortable making decisions about your money. Consulting a professional may be costly but worthwhile, depending on your situation. For instance, it is essential to learn how your financial advisor will be compensated if they assist you in making investment decisions. Most investment advisors are compensated based on a fraction of their client’s assets. The fee may vary from 2 to 5 percent, and they will be responsible for managing your assets. This approach is best if you want to transfer responsibility of your asset management to another person, although fees can accumulate significantly. 

You may also take the fee-only approach, where you pay a flat fee for an investment strategy you will implement yourself. These advisors know about various investment vehicles and advise you to trade yourself. 

The above are a few useful tips for building long-term wealth. You may explore and consider the ones that suit your situation. However, remember to begin now to make significant savings and investments to grow your wealth over time. 

This is a contributed post.

In addition, it’s also one of the most critical and essential things you can do to ensure you enjoy your golden years. Even with today’s technology, it is still highly likely you will get old and no longer be as productive as you were when you were young. That’s why it’s essential to ensure you have the financial backing and stability you need to maintain a reasonable quality of life. 

But what does that look like in practice? How do you actually go about creating a retirement savings plan for every age and income level? Well, you’re about to find out. 

Work Out Which Savings You Are Using

Generally speaking, there are two types of retirement savings options you can explore: tax-advantaged, and non-taxed-advantaged. 

The names are pretty self-explanatory. Tax-advantaged accounts are those that provide tax benefits, such as paying no tax when you draw the money, or none when it accumulates value. 

Non-tax-advantaged plans are those that don’t offer any tax benefits but provide other advantages, such as larger contributions or more flexibility. With these, you can usually take money out when you like without having to pay penalties or fees. However, you may still need to pay taxes if you earned significant income on your investments. 

Use Tax-Advantaged Plans

Tax-advantaged plans depend on where you live. 

In the U.S., plans include the 401(k), IRA, and SEP IRA. A 401(k) is a workplace plan that contributes some of your pre-tax salary to a retirement account. Employers will also sometimes match the amount you save as a job perk, which basically means you get free money. Unfortunately, there are limits on how much you can invest per year. But over time, the numbers add up significantly. 

An IRA is an individual savings account. You can find versions of these in practically all modern countries. These let you invest a certain allowance every year and deduct contributions from taxable income. However, you must pay taxes on withdrawals upon retirement. 

Why bother with an IRA? Because the initial capital you invest isn’t subject to taxation, and it can grow significantly larger over time with proper management. 

Roth IRAs are similar but they deduct taxation and source and not at retirement. You’ll need to discuss which option is best for you with your financial advisor. 

Finally, we have the SEP IRA. The idea of this type of retirement account is to make it easier for self-employed individuals to build up retirement savings. These let you contribute a significant chunk of annual income to a retirement account each year, deducting them from taxable incomes, though taxes are still payable upon retirement. 

Use Non-Tax-Advantaged Retirement Plans

Non-advantaged tax plans are usually for younger people who want to have more flexibility with their money as they get older. These are for individuals looking to build and withdraw money quickly, without working for decade upon decade. 

One option is a self-managed super fund (SMSF). The idea here is to invest in high-performance assets that grow wealth over time. These may be more volatile and include new asset classes, like crypto, but they may also be more lucrative, getting you to where you want to be faster. 

You can also experiment with a brokerage account. These are ideal for mutual funds, bonds, ETFs, and stocks. While a little old-fashioned, they let you access cash in your account at any time. These give you more flexibility over how you live your life and don’t require you to pay penalties, each time you encounter a situation requiring you to release cash. 

Savings accounts are another option. With rising interest rates, these have improved slightly in recent years. However, the interest rate on them is still incredibly low. You may also have to pay taxes on the gains you receive from these investments, pushing down the profitability further. 

Finally, if you’re looking for flexible guaranteed income streams at an older age, you might want to consider certificates of deposit. These pay a set sum of money on maturity. 

Income Level

As age rises, the amount of risky investments you choose to comprise your portfolio should fall. But you should also consider your income level when saving for retirement. 

Workplace plans are usually the best options for those earning regular salaries. As income rises, opportunities for investing in more active and diverse strategies, such as stock trading, also rise significantly. 

This is a contributed post

Navigating Investments in Retirement

Carefully Calculate Your Retirement Needs

The first step in preparing for retirement is to calculate how much money you will need in order to live comfortably during your golden years. This includes not only basic living expenses such as housing, food, and transportation but also healthcare costs. As you age, the cost of healthcare tends to increase significantly, so it's important to factor these costs into your retirement plan.

Considering the Impact of Inflation - Start Saving Early

One of the most important things you can do to prepare for retirement is to start saving early. The earlier you start saving and investing, the more time your money has to grow through compound interest. Even small contributions made over a long period of time can add up significantly by the time you retire.

Inflation can erode the purchasing power of retirement savings over time. Senior citizens should consider investments that have the potential to outpace inflation to protect their wealth. While stocks historically offer better protection against inflation than bonds, it's important to strike a balance between growth and risk tolerance. A diversified portfolio that includes assets with the potential for inflation-beating returns, such as stocks or real estate, can help seniors preserve their purchasing power in retirement.

Consider Contributing To An IRA or Other Retirement Plans During Your Working Years

If you are employed, one of the best ways to save for retirement is through an employer-sponsored 401(k) or other similar plans. These plans allow employees to contribute pre-tax dollars towards their retirement savings, which can help reduce their taxable income each year.

Determine Your Target Date For Retirement 

Another important aspect of preparing for retirement is determining when you want to retire and planning accordingly. This planning involves setting a target date for retiring and then working backward to determine how much money you will need to live comfortably throughout your golden years.

Flexibility and Liquidity

Senior citizens should maintain flexibility and liquidity in their investment portfolios. Unexpected expenses or changes in circumstances may require access to funds. While long-term investments like stocks and real estate can provide growth potential, retirees should maintain a portion of their portfolio in more liquid and accessible assets, such as cash or short-term bonds, to meet immediate financial needs without relying on selling long-term investments at unfavorable times.

Keep Track Of Your Annual Tax Rate And Tax Bracket 

Keeping track of your annual tax rate and tax bracket are critical to making a good plan for your retirement needs. This plan involves understanding how taxes will impact your retirement income and making sure that you have enough money saved to cover these costs.

Senior citizens should also be mindful of tax implications when investing. Certain investments, such as tax-efficient mutual funds or tax-exempt bonds, can help minimize tax liabilities. Additionally, retirees should explore tax-advantaged retirement accounts, such as Individual Retirement Accounts (IRAs) or 401(k) plans, to maximize tax benefits. Consider consulting with a tax advisor or financial professional to understand the tax implications of different investment strategies and make informed decisions.

The Importance of Diversification

Diversification is a critical principle in investment strategy. By spreading investments across different asset classes and sectors, seniors can mitigate risk and avoid overexposure to any single investment. A well-diversified portfolio may include a mix of stocks, bonds, mutual funds, and other assets. Diversification can help cushion the impact of market downturns and provide a more stable return over time.

Have Regular Portfolio Reviews

Seniors should regularly review their investment portfolios to ensure they remain aligned with their financial goals and risk tolerance. As retirement progresses, adjust the portfolio mix to reflect changing needs. Regular portfolio reviews can help identify underperforming investments, rebalance asset allocation, and make informed decisions regarding buying or selling investments.

Seek Professional Guidance

While it is possible to manage investments independently, seeking professional guidance can be beneficial, especially for seniors who may not have the time or expertise to monitor investments closely. Financial advisors can provide personalized investment advice based on individual circumstances, goals, and risk tolerance. They can also help seniors navigate complex investment products and ensure their portfolios are tailored to their specific needs.

Understand Your Retirement Account Options

Retirement accounts are an excellent way for senior citizens to save money and grow their wealth. They offer tax advantages that can help you maximize your savings over time. 

Tax-Advantaged Retirement Accounts

Retirement accounts provide tax advantages that can help you save more money in the long run. Traditional IRAs allow contributions to be tax-deductible, meaning that you won't have to pay taxes on the money until you withdraw it in retirement. On the other hand, Roth IRAs are funded with after-tax dollars, but withdrawals in retirement are tax-free. Roth IRAs are an excellent option if you expect your retirement tax rate to be higher than it is now.

SIMPLE IRA for Small Businesses

If you own or work for a small business, a SIMPLE IRA may be a low-cost option for saving money for retirement. This plan allows employers and employees to contribute pre-tax dollars into individual accounts. It's easy to set up and maintain, making it an ideal choice for small businesses.

Taxable Investment Accounts

While taxable investment accounts aren't technically considered "retirement" accounts, they offer flexibility that traditional retirement accounts don't provide. You can withdraw funds at any time without penalty and use them as you like. However, these accounts are subject to capital gains taxes when investments are sold at a profit.

Withdrawal Rules

Understand the rules around withdrawing money from your retirement account early. There may be penalties associated with early withdrawal, depending on the type of account you have opened. For traditional IRAs and SIMPLE IRAs, if you withdraw funds before age 59 1/2, there will typically be a 10 percent penalty plus income taxes due on the amount withdrawn.

Roth IRA contributions can usually be withdrawn at any time without penalty or taxes owed since contributions were made with after-tax dollars. However, earnings on those contributions may also be subject to a penalty if withdrawn before age 59 1/2.

Contribution Limits

Contribution limits exist for each type of retirement account. For traditional and Roth IRAs, the maximum annual contribution limit is $6,000 (or $7,000 if you're over 50). SIMPLE IRA contribution limits are higher at $13,500 (or $16,500 if you're over 50).

You can open an IRA at most financial institutions, such as banks or brokerage firms. Shop around and compare fees and investment options before opening an account.

Why and Where Should Seniors Invest Their Money?

As retirement approaches, seniors need to start thinking about how to grow and protect their wealth. Investing is a great way to do both. It's critical to choose the right place to put your money.

Investing for Growth and Protection

Seniors should invest their money for two main reasons–growth and protection. By investing in assets likely to appreciate over time, seniors can grow their wealth and ensure they have enough money to last through retirement. At the same time, investing in assets that are less risky than stocks can help protect seniors' wealth from inflation.

Choosing Low-Risk Options

Low-risk options are usually best for senior citizens. Bonds, CDs, and annuities are excellent choices because they offer a predictable return on investment without exposing investors to too much risk. These investments are also typically backed by the government or other large institutions, making them more secure than other investments.

Online Investment Platforms

In recent years, online investment platforms have become popular for seniors to invest their money. These platforms offer a wide range of investment options at low fees, making them an attractive option for those who want to manage their investments but don't want to pay high fees for professional advice.

Consulting with a Financial Advisor

While online investment platforms can be valuable tools for managing your investments, consulting with a financial advisor before making any major decisions about your retirement savings is a good idea. A financial advisor can help you determine the best place to invest your money based on your needs and goals.

Adopt Lower-Risk Investment Strategies for Stability

Managing retirement investments can be a tricky balancing act between risk and reward. While higher-risk investments may offer the potential for greater returns, they also come with a higher chance of losses. Adopting lower-risk investment strategies is critical for senior citizens looking to protect their wealth while still growing it. Here are some advice to consider when navigating retirement investments:

Trusts as a Tool for Managing Risk

Using trusts is one way to manage risk in retirement investments. Trusts allow investors to transfer assets into a legal entity managed by a trustee on behalf of beneficiaries. This legal entity can provide more control over how assets are distributed and protected from creditors or other potential risks. By including lower-risk investments within the trust, seniors can help ensure their wealth is protected while allowing for growth.

Bonds as Lower-Risk Investments

Bonds are another popular choice for those seeking lower-risk investment options. Bonds are loans made to companies or governments, with interest paid out regularly until the bond matures and the principal repaid. While bond yields may be lower than other types of investments, they also tend to be less volatile and offer more stability during market downturns.

While lower-risk investments may not offer the same potential for high returns as riskier options like stocks, they can help protect against declines in the market. Even with lower-risk strategies, some level of risk is involved with investing. Seniors should work closely with a financial advisor to determine an appropriate level of risk based on their individual needs and goals.

Diversify Your Portfolio Mix for Balanced Risk and Reward

Diversification is key. By diversifying your investment portfolio, you can reduce risk and increase reward. However, before selecting an asset mix, determine your risk tolerance. Asset allocation is the key to balancing risk and reward in your portfolio. A well-diversified portfolio should include a combination of different asset classes, such as stocks, high-yield bonds, and dividend-paying stocks. The right balance of these assets will depend on your individual goals and risk tolerance.

Stocks are a popular choice for investors looking for growth potential. However, they also come with higher risks than other types of investments. High yield bonds offer a higher return than traditional bonds but come with increased credit risk. Dividend-paying stocks provide regular income but may not offer as much growth potential as other stocks.

A balanced portfolio can help you compound wealth over time while providing steady distribution. Periodically review your asset allocation and make changes as needed based on market changes or your personal financial situation. For example, suppose you're nearing retirement age and have a lower risk tolerance. In that case, you may want to shift more of your investments into fixed-income securities such as bonds or cash equivalents that offer less volatility than stocks. On the other hand, if you have a longer time horizon until retirement and are willing to take on more risk for potentially higher returns, you may want to consider allocating more funds toward equities.

Protect Income from Market Volatility with CDs and Money Market Funds

Low-risk investment options, such as CDs and money market funds, are excellent ways to protect income from market volatility. These investment vehicles offer a fixed rate of return that is not tied to the ups and downs of the stock market, making them ideal for senior citizens who rely on their investments for income.

Money market accounts are an excellent option for cash reserves because they offer higher interest rates than traditional savings accounts. They are also FDIC-insured, meaning that your money is protected up to $250,000 per depositor per insured bank. Money market funds invest in short-term debt securities, such as government bonds, that provide stability and liquidity while still earning a competitive yield.

While CDs and money market funds can provide reliable returns, they may not offer significant growth potential compared to other investment options. Bond funds invest in a diversified portfolio of bonds with varying maturities and credit ratings, potentially generating higher returns than CDs or money markets over time. Index funds track the performance of a particular market index like the S&P 500, offering exposure to a broad range of stocks without requiring active management.

Traded funds (ETFs) are similar to mutual funds but trade like stocks on an exchange throughout the day. ETFs can provide instant diversification across different sectors or asset classes while being low-cost and tax-efficient. However, all investments carry some risk, so consulting with a financial advisor is essential before making any decisions.

Life insurance policies can be another way to protect wealth in retirement by providing tax-free death benefits or living benefits that can be used during your lifetime. Treasury bills (T-bills) are also considered safe investments because the US government backs them.

Monitor Your Spending and Withdrawals for Sustainable Income

One of the biggest challenges that retirees face is ensuring they have enough money to last throughout their retirement. To ensure sustainable retirement income, monitor your spending and withdrawals carefully.

Make Spending Adjustments to Align with Your Monthly Income and Essential Expenses

As a retiree, you must be mindful of your expenses and adjust your spending habits accordingly. You should keep track of your monthly income, including any pension or social security payments you receive and any other sources of income. Once you have a clear understanding of your monthly income, you can start to make adjustments to align your spending with your essential expenses.

Consider Diversifying Your Income Sources 

Having multiple sources of income can help create a steady stream of cash flow in retirement. For example, you might consider investing some of your savings in dividend-paying stocks or bonds that offer regular interest payments. Alternatively, you could look into rental properties or other real estate investments that generate rental income.

Track Your Checking Account, Yield Savings Account, and Taxable Income 

To maintain purchasing power over time, keep track of your checking account balance, yield savings account balance, and taxable income. Doing so lets you make informed decisions about how much money you can afford to spend each month without depleting your savings too quickly.

In addition to monitoring these accounts regularly, consider the impact of inflation on your purchasing power over time. As prices rise over time due to inflationary pressures in the economy (e.g., higher costs for goods and services), the value of each dollar decreases. Therefore, if you don't take steps to protect against inflation by investing in assets that appreciate at a rate higher than inflation (e.g., stocks), then the purchasing power of your savings will decline over time.

Tips for Successful Retirement Investing

Setting Clear Retirement Goals

Setting clear goals is one of the most important steps in successful retirement investing. Without a clear understanding of what you want to achieve in your retirement, making informed investment decisions that align with your long-term plans can be challenging. Start by considering factors such as your desired lifestyle, expected expenses, and any legacy you hope to leave behind. Once you have a clear picture of what you want to achieve, develop an investment strategy that will help you reach those goals.

Maximizing Retirement Savings

Another key aspect of successful retirement investing is maximizing your savings through tax-advantaged accounts. IRAs and 401(k)s offer significant tax benefits that can help grow your wealth faster than traditional savings accounts or taxable investments. By contributing as much as possible to these types of accounts each year, you can take advantage of compounding interest and reduce the amount of taxes owed on your earnings. Many employers offer matching contributions for employee 401(k) contributions, which can further boost your savings potential.

Diversifying Your Portfolio

While maximizing savings is important, it's equally crucial to diversify your portfolio to reduce risk and increase potential returns. Diversification means spreading investments across different asset classes such as stocks, bonds, and real estate rather than focusing all funds into one area. Diversification helps protect against market volatility by ensuring that losses in one area are offset by gains in another. It's also key to periodically review and rebalance portfolios over time to ensure they remain aligned with long-term goals.

Seeking Professional Advice

Seeking professional advice from a financial advisor can be invaluable when it comes to navigating retirement investments. A qualified advisor can provide personalized guidance on how best to allocate funds based on individual needs and goals while considering factors such as risk tolerance and time horizon. A financial advisor can also help monitor progress over time and make adjustments to ensure continued success.

You Need to Think About Estate Planning

It’s scary to think about this, but yes, when it comes to retirement, there’s a day where that retirement ends because, well, you know why. The last thing you want for your family is to stress over how they’re going to recover your estate, whether it be stocks, gold, cryptocurrency such as Bitcoin, land, basically, any type of investment you make, what’s going to happen when you pass away? 

Does your family know what to do? Do you have an executor? If you’re investing in cryptocurrency, does your family know how to access to recover your cryptocurrency? All of these things really need to be kept in mind and you have to have a plan. 

Don't Let Emotions Take Over

Retirement investing can be daunting, especially when you start to think about all the money you've saved over the years. Feeling emotional about your investments is natural, but it's important not to let those emotions drive your decisions. Instead, stick to a professional plan to help you grow and protect your wealth.

A trusted person or financial advisor, like Edward Jones, can help keep you on track. A financial advisor can provide guidance and support throughout the retirement investment process. A financial advisor can also help you create a personalized investment plan that aligns with your goals and risk tolerance.

Handing over control of your investments can be a smart way to avoid emotional decisions. When we invest our own money, we may become emotionally attached to certain stocks or funds. This attachment can lead us to make irrational decisions based on our emotions rather than sound financial advice.

Handing over control of your investments to an expert like Edward Jones enables you to take advantage of their knowledge and expertise without letting emotions cloud your judgment. You'll have peace of mind knowing that your investments are being managed by someone with experience navigating the ups and downs of the market.

Retirement can be an exciting time of life, but it can also bring financial challenges. As a senior citizen, you want to ensure that your wealth is protected and continues to grow throughout your retirement years. 

You can achieve a secure financial future by incorporating these strategies into your retirement plan. Remember to consult with a financial advisor if you have any questions or concerns about navigating investments in retirement.

This is a contributed post.

Are you diversified?

When considering the question, the first thought that comes to mind is the importance of having a diversified portfolio. Diversification is frequently emphasized as a key strategy to manage risk in investment portfolios. By spreading investments across different asset classes, sectors, and regions, investors aim to reduce the impact of adverse market movements on their overall portfolio.

These traditional ways to diversify include:

1. Invest in different industries: Allocate your investments across various sectors, such as technology, healthcare, finance, consumer goods, and energy. This helps mitigate the impact of sector-specific risks and allows you to benefit from the potential growth in different areas of the economy.
    
2. Consider market capitalization: Diversify your portfolio by investing in companies of different sizes. This can involve including large-cap, mid-cap, and small-cap stocks. Larger companies often provide stability, while smaller companies may offer higher growth potential.
    
3. Geographical diversification: Invest in stocks from different countries and regions. This helps you reduce exposure to the risks associated with a particular country's economy or political environment. Consider allocating funds to both domestic and international markets.
    
4. Asset allocation: Diversify your portfolio across different asset classes, such as stocks, bonds, and cash equivalents. This strategy helps spread risk and balance potential returns. Bonds, for example, tend to be less volatile than stocks and can provide stability during market downturns.
    
5. Include different investment styles: Consider blending growth-oriented stocks with value-oriented stocks. Growth stocks typically have strong potential for future growth, while value stocks are often undervalued relative to their fundamentals. By combining both styles, you can diversify your portfolio across different investment strategies.
    
6. Allocate across market sectors: Within each industry or sector, diversify your holdings across different companies. This helps mitigate the risk associated with investing in individual stocks. By holding a mix of stocks within each sector, you reduce the impact of any single stock's performance on your overall portfolio.

Do traditional diversification methods truly work? Let's examine the events of the 2020 market crash for some insights. During a market crash, a phenomenon known as correlation emerges, leading to a situation where all asset classes become closely intertwined. Even a well-constructed mix of traditionally uncorrelated stocks, such as GLD (gold), TLT (bonds), SPY (S&P 500), AAPL (big tech), BA (aerospace), TGT (retail), LUV (airlines), OXY (oil), and AMGN (pharmaceuticals), experienced a high degree of correlation from March 6 to March 19, within a mere two-week period.

Yes, but it might not help

The performance of these assets during that period was as follows: GLD -12.21%, TLT -11.19%, SPY -19.26%, AAPL -8.8%, BA -62%, TGT -5.4%, LUV -33%, OXY -60%, AMGN -6%. Despite representing different sectors, all of these stocks witnessed simultaneous declines. This phenomenon, which I refer to as "crash correlation," challenges the notion of proper diversification. In reality, being invested in these assets essentially amounts to a position that is short volatility.

This observation raises the question of whether this can be considered proper diversification. In my opinion, the answer is no. While an investor may have holdings across multiple assets, the common denominator among them is exposure to volatility. As a result, when a crash occurs, these assets tend to move in the same direction, leading to significant losses.

It is important to recognize that in a market crash, traditional diversification methods alone may not offer adequate protection. To mitigate the effects of crash correlation and volatility exposure, alternative strategies may need to be employed. These can include incorporating assets with true diversification potential, such as non-traditional or alternative investments, or implementing additional risk management techniques like hedging strategies.

During market crashes, there is an occurrence known as "crash correlation" that affects not only traditional diversification methods but also those who sell option premium. The popular method of selling implied volatility through short straddles or short strangles with naked puts can lead to significant losses during a crash. For instance, in the March 2020 crash, a $1 SPX put option skyrocketed to $90, resulting in potential losses of -$90 on a trade that aimed to earn $2. Thus, a $10,000 trade could have resulted in almost a million dollars in losses, causing immense financial stress.

Maintaining diversification in your portfolio involves a crucial factor: understanding a second-order Greek known as "vomma." Vomma is a derivative of Vega, which measures the sensitivity of an option's price to changes in volatility. When volatility is high, Vega increases, leading to a rise in option prices. Vomma, on the other hand, represents the exponential growth of Vega. In simpler terms, it signifies that Vega, or the price of an option, can experience significant exponential increases when volatility expands substantially, as seen in crash-type market conditions. By grasping the concept of vomma and its relationship with volatility, you can better navigate market fluctuations and strive to maintain a diversified portfolio.

Imagine a scenario where, during a market crash, you hold an asset that genuinely offers diversification. Envision the satisfaction of witnessing your $10,000 positions soar close to a million dollars. While this may be an exaggerated illustration, it highlights the potential gains that can be achieved by implementing the appropriate trade structure and capitalizing on the advantages of vomma. By focusing on trade strategies that consider vomma and its implications, you can potentially avoid the misconception of being adequately diversified while still being exposed to substantial losses due to the impact of vomma.

Another crucial factor in capitalizing on market crashes is the ability to exit trades efficiently through a single-order trade structure. During a market crash, it is essential to avoid "legging out" of trades, as this approach poses the risk of turning profits into losses. The process of closing one half of a trade while not simultaneously closing the other half can expose you to adverse directional movements in the market. I personally experienced this unfortunate outcome in early 2018, where a promising profit transformed into a substantial loss due to a legging-out scenario. To provide further insights into this matter, I have created this video. By understanding the importance of a consolidated trade structure during market crashes, you can aim to protect your profits and mitigate potential losses effectively.

Another critical aspect of maintaining proper hedging is being proactive in your approach. This means keeping your hedge in place at all times, as waiting can be detrimental. Since it's impossible to predict exactly when the market will crash, attempting to catch up by implementing a hedge after volatility has already spiked is a challenging and often unsuccessful strategy. Moreover, there is a high probability that volatility will revert to its mean before the hedge can be fully utilized if it is applied too late. To avoid such predicaments, it is crucial to adopt a proactive hedging stance, ensuring that your portfolio is consistently protected regardless of market conditions.

Bottom Line

Overall, achieving effective diversification and mitigating the impact of market crashes requires a comprehensive understanding of various factors, including vomma, trade structure, volatility dynamics, and proactive risk management. By combining these elements, investors can strive for a more resilient and successful trading system.


About the Author: Karl Domm's 29+ years in options trading showcases his ability to trade for a living with a proven track record. His journey began as a retail trader, and after struggling for 23 years, he finally achieved 
consistent profitability in 2017 through his own options-only portfolio using quantitative trading strategies.

After he built a proven trading track record, he accepted outside investors. His book, "A Portfolio for All Markets," focuses on option portfolio investing. He earned a BS Degree from Fresno State and currently resides in Clovis, California. You can follow him on YouTube and visit his website real-pl for more insights.

We’ll go through exactly what a covered call is, how it can be used, the risks and a few variations to mitigate these risk.

(We’ve also just published a post on choosing great stocks with which to trade covered calls: Best Stocks To Write Covered Calls)

What Is A Covered Call?

A covered call comprises purchased shares and the sale of a call option with the shares as the underlying. Let’s illustrate this with an example:

Suppose you bought 100 Apple(AAPL) shares at $430 each, a total of $43,000, in April. And then sold a AAPL 450 May call option for $10, or $1000 in total. You would then have paid a net $42,000.

So what happen for various expiry AAPL prices? Well if AAPL is less than $450 on expiry the call option would expire worthless and you’d be $10 a share better off than if you’d done nothing.

If the share price is above $450, however, the call option purchaser will exercise the option and your 100 shares will be ‘called away’. Suppose, for example, that AAPL has risen to $470.

Because you have sold a call option giving the purchaser the right to purchase shares at $450 you will, in effect, be forced to sell your shares at $450, rather than the $470 you could get in the open market.

You have therefore forgone the $20/share of profit you could have made (ignoring any premium you received originally) if you hadn’t sold the option.

Notice that in this scenario you’ve still made a decent profit. You have bought shares at $430, received $10 in premium from the sold call option, and then sold them at $450; a nice $30 total profit. It’s just not as much as you would have made if you’d simply bought the shares and sold them for $470 (ie $40).

Monthly ‘Income’ From Covered Calls

This trade off, foregoing large profits for premium received even if the shares don’t do well, is attractive to many investors.

Indeed most popular options trade is probably the sale of call options for premium on shares already held, or purchased with a view to the long term.

Let’s say you own 100 Apple shares and sell call options $20 above the current share price every month.

You’d receive $10 a month premium unless Apple rose over $20 in value when you’d be forced to sell your shares, but at a nice profit.

This seems like a heads I win, tails you lose proposition, and is certainly presented as such by many of the covered call option advisory services out there. Indeed covered calls are usually presented as a low risk options strategy.

However, as we’ll see later, this is not quite true. There are significant risks that need to be managed for the strategy to be successful.

What Could Go Wrong With The Covered Call Strategy?

Risk

And so what’s the catch? Are covered calls really low risk? Let’s look at a the Profit & Loss diagram for this trade:

Do you recognize the shape? It is exactly the same as a sold $450 put option. And because the P&L graphs are the same, it is exactly the same trade.

This is a good example of the ‘synthetic’ options phenomenon: often the combinations of shares and/or options can be used to ‘synthetically’ create another options position. In this case 100 AAPL shares combined with the sale of a $450 call is exactly the same as just selling a $450 AAPL put option.

Now, if I asked you whether you’d be willing to sell an uncovered put option what would be your answer? Well, hopefully, you’d be very concerned about the risk. Any uncovered options sale is inherently risky as it produces unlimited (or close to it) downside should the trade go against you.

The sale of a $450 put option expiring in 30-40 days would net you approx. $30 in premium.

However you could, theoretically, lose up to $450 should AAPL fall.

So do you still think covered calls are low risk? Hopefully I’ve convinced you that unmanaged they are actually very risky indeed.

Volatility

Before we look at ways of managing this risk, let’s look at implied volatility. No options trade should be evaluated without considering volatility but, in this case, it is less important than usual.

Investors usually hold sold calls to expiry and either just sell next month’s (if this month’s expired worthless) or give up their shares (at a nice profit) and then set up a new position (buy shares and sell next month’s option).

However volatility does affect the value of the trade during the month and so would affect the ‘buy back’ price should the investor wish to close the trade before expiry.

Risk Management

So how do you manage the risk of the trade?

Well, that’s the subject of the next section.

Covered Calls Risk Management

Recap

Previously, we’ve learnt what a covered call is, how it can be used and how it is, unmanaged, riskier than many people think. Let’s complete our covered call considerations, therefore, by looking at some risk management techniques:

Here are the key ways risk can be managed.

Stop loss

The first thing you could do is set a stop loss. Should your stock fall sufficiently to produce a 20% (say) fall in value, close the trade.

This has the advantage of being simple, and possibly automated depending on which broker you use. It also removes 80% of the risk.

Like all stop loss systems it could however produce losses needlessly. If your stock were to recover you’d have taken a 20% loss when, potentially, you’d need not do so. There’s nothing more annoying than being stopped out of a trade only to see it reverse into profitability.

Sell in the money call options

The above example, and the most common practiced covered call strategy, is to sell out of the money calls; $20 out of the money in our example.

An alternative is to sell in the money calls. Let’s say you were to buy AAPL at $430 and then sell a $410 call option instead of $450. You’d receive approx. $30.

In this strategy you would expect the shares to be called away most of the time (ie if AAPL expires above $410) for a ‘loss’ of $20. But you’ve received $30 and so have made a much lower risk $10 profit. Indeed the stock would have to fall to $400 for a loss to be made.

What you’ve forgone is any upside on the shares themselves. But many investors would be prepared to do this for a (in this case) 2% monthly gain.

Rolling down

Let’s say you’ve put on the above out of the money covered call (ie bought shares and sold a $450 call option) but the stock has fallen from $430 to $410.

Your sold $450 call is now, probably, worth very little ($2 say). You could take the opportunity to buy back this option and sell a $430 option (for $8 say) netting an extra $6 a share for the month.

The danger is, of course, that AAPL recovers back to over $430 and you are forced to sell at $430 rather than the potential profit up to $450.

Rolling Out

You could roll out instead of rolling down. So, in the above example, instead of rolling down from a May $450 call to a May $430, you instead roll to a Jun $450 call. This allows you to preserve the $450 strike price for your calls.

Dividend

This is a favourite tactic of mine: choose a stock with a dividend payable before options expiry (or more accurately: when the record date is before expiry). This adds to the income from the trade.

In theory the dividend should be priced into the call price – i.e. the call premium received is less – but I’ve found that often this isn’t exactly the case.

Covered Calls: Trade Plan

Let’s put everything we’ve learnt together and set out the full game plan for trading covered calls, the Epsilon Options way…

Step 1: Choose An Underlying

Choose a ‘boring’ stock with a dividend due within the next 2 months. The stock should be priced above $50 and have a historical volatility less than 25%. It should have an annual yield above 1.5% (2% is even better)

Stocks such as Walmart(WMT), IBM(IBM), Union Pacific(UNP etc are great.

Step 2: Buy 100 shares

Buy 100 shares (or multiples of 100 if you have a larger budget) in this underlying.

Step 3: Sell In-The-Money Call Option

At the same time sell a 1 call options contract per 100 shares bought.

Now for the tricky bit: The strike price for this call option should be the first strike in the money and be the first expiry after the dividend record date:

Let’s illustrate with an example:

IBM is $187 in October 2013

Its next dividend’s record date is 10 November 2013.

The strike price of the sold call is 2 strike prices below the $187. IBM options are in $5 increments ($180, $185, $190, $195 etc) and so the 1st strike price in the money (ie below $187) is $185.

The first options expiry date after the dividend is the November 2013 option.

Therefore we’d sell the Nov13 185 call option.

Tip: It’s best to put steps 2 and 3 on at the same time. This is called a ‘buy-write’; your broker should be able to help you with this.

Set Up Your Exit Plan

Remove the position if at anytime you have made a 20% loss

Remove the position if at anytime you make a 25-30% profit (a bit of wiggle room here: you can make your choice)

That’s it!

The aim is to do lots of these over the course of a year and make a few percent on each trade.

This should outweigh any 20% you may make along the way.

Unlike many options trades we should expect to hold most of these trades to expiry when the shares are called away (ie sold) at the strike price.

(NB We cover two alternatives to the traditional covered call:

The synthetic covered call here >>> The Synthetic Covered Call Options Strategy Explained

and The Covered Call LEAP >>> Covered Call LEAPs | Using Long Dated Options In A Covered Call Write )

Conclusion

We’ve seen from the three courses on covered calls that they can be used to obtain a small, but reliable income every month of 2-3%. This may be seen to be pretty small, but it’s repeatable and most investors would love to be able to bank annualized 40%+ gains.

This return comes at a significant risk, however, if unmanaged. Thankfully, there are several methods available to manage that risk, as we have seen.

The Epsilon Options covered calls method utilizes these methods (but not rolling down for the reasons suggested above).

 

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Related articles:

• The Synthetic Covered Call Options Strategy Explained
• In The Money (ITM) Options Explained
• Out Of The Money (OTM) Options Explained
• Uncovering The Covered Call
• Covered Calls –Does Rolling Forward Mean Higher Risk?
• Leverage With A Poor Man’s Covered Call
• 2 Tweaks To Covered Calls And Naked Calls
• Dangers Of The Covered Call
• Exercise Risk Of Uncovered Calls

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Some of the Market Chameleon features include:
 

Forward-Looking Tools and Data:

• Implied Volatility
• Risk Analysis
• Order Sentiment Analysis
• Put Protection
• Dividend Forecasts
• Earnings Forecasts
• Corporate Events

Present Time-frame Tools and Data:

• Intraday Market Data -- quotes and trades for market-traded securities and their options [15 minute delayed]
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• Analysis of today's biggest movers
• Volume Reports
• New listings and notable news announcements
• Press Releases from the world's largest companies

Historical Tools and Data:

• Historical Volatilities dating back over 3 years
• Historical Dividends and Stock Splits
• Historical Earnings and their price effects
• Equity Prices and Volumes dating back over 5 years

Market Chameleon has consistently received positive reviews and accolades from users and industry experts alike, highlighting its powerful tools and comprehensive options research capabilities.

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The truth is that investing is highly accessible, so pretty much anyone with some spare cash can get started. Of course, there are good and bad investments. So where should you be investing your money? Let’s take a look. 

A Good Savings Account

Putting your money into a good savings account isn’t an investment in the traditional sense, but it is valuable — and will help your money to grow. It’s worth looking at the interest rate that you’re currently getting if your money is with a traditional bank, as it’s unlikely to be as good as what you can find with an online savings account. This is a good option for people who are new to the financial planning world. Once you have 3 - 6 months' worth of living expenses in a high-yield savings account, you can begin to think about allocating money to other investments. 

Index Funds

Index funds should form a part of everyone’s long-term investing strategy. They won’t make you rich overnight, but that’s a good thing — it means there’s no volatility. Index funds such as the S&P 500 index fund offer a reliable way for younger investors to build good wealth over a long period. Of course, there’s no such thing as a guaranteed good investment, but if there was one, then index funds would be it. They routinely experience around a 7% return each year and have performed consistently well for several decades. If index funds ever fail, then there’d be big problems, so you can have relative peace of mind that if the ship does sink, then at least everyone will be going down with you. 

Investing in Real Estate

The wealthy have always known that real value lies in real estate. It’s one of the best investments that you can make, providing you get it right. Some markets do crash and there’s a possibility of losing the money. However, in general, most experts believe real estate to be a safe and reliable way to build long-term wealth. Historically, investing in the property market would mean buying a property and then selling it for a profit or renting it to get a fixed income. But there are other options, too. For instance, there’s real estate syndication, which offers a plethora of ways to earn money via property — take a read of the article ‘12 Ways You Can Earn Money as a Real Estate Syndicator’ to get a better idea of the options available to you. It’s worth keeping in mind that it’s often difficult to liquefy property assets, so it should be considered a long-term investment.  

Left Field Investments

There are many investment fields available to new and experienced investors, and not all of them are traditional. It’s also possible to make alternative investments which, over time, can yield a greater return on investment than other options. Examples of these alternative investments would be cryptocurrencies including greener crypto mining investment opportunities, as well as precious metals such as silver and gold. Even things like whisky and stamps can fall into this class. These types of investments are considered to be riskier than other options and require greater levels of understanding. 

Investing in Bonds

Investing in bonds isn’t for everyone. It’s usually best for people who have already earned their fortune and are looking to keep their fortune. So what are bonds? They’re essentially loans to a government or company. Since these entities are largely stable, so too are the bonds. In fact, the stability of bonds is what makes them such an appealing proposition for people looking to retain their financial health, because even during times of uncertainty, bond performance tends to stay the same. 

How Do You Choose What’s Right For You?

As we’ve seen, there are a host of different investment opportunities available to you. So how do you pick one which is right for you? This depends on a few answers. For example, will you need to access the money you’re investing in the near future, or are you planning to make it a long-term investment? You’ll also need to think about how much risk you’re willing to take, and how much help you need — some investments are highly beginner-friendly, while others will require the services of a broker. 

This is a contributed post.
 

We’re there going to go what they are, where they came from, how they are used and some of the theory (yes, sorry) that you need to know to understand them.

Also there’s more info on Options Greeks.

In the meantime let’s start with looking at exactly what options are…

What Are Options?

Options in their current form are recent inventions, but the basic options form has a long history. We’ll define exactly what an option is in a minute, but first let’s try a bit of a thought experiment.

Imagine an oil company about to invest in a new oil field. They have a good idea how much oil there is, how much it will cost to extract it etc, but unfortunately they don’t have certainty on the future price of the oil produced. This is a problem because they know they need to obtain at least $80/barrel for at least the next 3 years for the new field to be profitable.

How can this company mitigate the risk of a drop in the price of oil? Well, they could go out into the futures market and contract to sell oil at a pre-set price in the future. However they would have to enter several contracts spaced over the 3 years. And they would have to take whatever price was on offer now; which could prove costly should the oil price actually rise over the next few years. So this is unlikely to be a good choice.

But what if the company was able to purchase a $2/barrel insurance policy giving it the right to sell its oil at $80/barrel anytime in the next 3 years? Should the oil price rise they have only ‘lost’ the $2 premium on the, unused, insurance. Should price fall the company would know it could get the minimum price it needs to be profitable (less the insurance cost of course).

Well the above policy is actually an example of an option; it gives the right but not the obligation to sell at a predetermined price ($80) within a set period (3 years).

Stock options

Let’s concentrate now, and for rest of this course, on options on stocks. For a price (the ‘premium’) they give the right but not the obligation to buy/sell 100 shares at a predetermined price (the ‘strike’ price) within a set period (until ‘expiry’).

Options to buy stock are call options; options to sell are put options.

Here’s an example using Apple(AAPL): a Mar13 500 Call @ $40. For $4000 ($40×100) a trader could give themselves the option (pun intended) to buy 100 Apple shares for $500/share (ie $50,000) anytime between now and 20 March 2013.

Now, let’s say AAPL rises to $600 in March. Fantastic. The trader can ‘exercise’ their option, buy the shares for $50,000 and sell them back immediately for $60,000. A profit of $10,000 (less the original $4,000 premium). Notice here that the only upfront outlay was $4,000 to ‘control’ $50,000 worth of stock. Notice too that this $4,000 could all be lost, but no more – if AAPL falls below $5,000.

(We have a more detailed explanation of put and call options here).

This is an example of the ‘leverage’ available from options: they can be used to make huge profits on minimal outlay. But a trader can lose all their money.

Option selling

We have concentrated thus far on the trader who buys an option (either put or call). But for every purchaser there is a seller; which (subject to broker approval) could be you. Why would you want to do this? To receive the options premium. An options seller acts just like an insurance company. In our AAPL example they receive the $4,000 premium which they get to keep should AAPL be below $500 in March.

The risk is, of course, that it is higher whereby the option they have sold is likely to be exercised, requiring the sale of 100 AAPL shares for $500 (i.e. less than the market price) to the option purchaser (like our trader in the above example).

Either you have the shares already, and now have to give them up for a lower than market price, or you don’t, and have to buy them in the open market for more than the $500 you’d get on their sale to the owner of your sold call. There’s therefore unlimited risk: your loss is the market price (which, theoretically, could be infinitely high) less the $500 strike price (x100).

Elements of an Option

As we have seen, for every stock option, there are the following elements which need to be defined for each contract:

Underlying

This is the stock the options relate to (AAPL in the above example) Call/Put Does the contact give the right to buy or sell shares?

Strike Price

At what price can an option be bought/sold
 

Expiry

When do the option owner’s rights expire?

Monthlies/Weeklys

Most options, until recently anyway, were available in monthly series. There would, for example, be an Apple January series of calls/puts at different strike prices, and then another series for February, March etc. All options would expire on the same date in the month and so, should someone talk about January AAPL options, we would know they expired on 25 January (as per the CBOE’s options timetable).

This changed a few years ago. Monthly options still exist, and are still popular, but they have been joined by weekly options.

Highly traded stocks now have weekly options available with, as the name would suggest, shorter expiry times. Options expiring every week for the next four weeks are therefore now available for these popular stocks.
 

Therefore, in addition to the Jan/Feb/Mar etc series, AAPL has options expiring at the end of the week, and for the 3 weeks following. This has enabled several shorter term strategies, which will be covered in more advanced lessons. Most of the examples in these lessons will be using the monthly options, for clarity.

Using An Options Broker

Options are available to buy and sell at several options exchanges, such as CBOE (the largest), via options brokers. These options brokers, such as thinkorswim, tradeking and etrade, allow retail investors to buy and sell just like the pros.

If you haven’t yet set up an account yet google them, choose your favourite, and sign up. Most of them are very easy to use and used to beginners as well as more experienced traders.

A couple of tips:

Sign up for a paper trading or virtual account allowing you to trade without money changing hands. A good way to learn.

Don’t be put off by all the fancy tools brokers provide, they are for more experienced traders and are often not too useful anyway.

Options Chains

All brokers display options prices in a so-called options-chain. Let’s look at an example (from the yahoo website):options chainYahoo.com options broker chain

This is Microsoft (MSFT)’s call options chain for May 2023 (similar ones are available for other expiry dates too). Options chains usually include the last trade for each option, the bid and ask spread (ie the quoted sell/buy prices), volume and open interest. Some brokers also include the options Greeks. 

Other data such as this option’s open interest is there too. The actual process of buying and selling options is broker specific but as long as you can read an options chain you can, with the broker’s support, learn pretty quickly how to buy and sell options contracts. 

Options Pricing Models

Market Pricing

The prices for options are solely driven by supply and demand: what someone is willing to buy and sell them for.

Traders input the price they are willing to sell (the ‘bid’) or buy (the ‘ask’) the option. The best prices on the exchange are then displayed as the bid-ask spread; the bid always being lower than ask.

In our options chain above, we can see that the Oct13 108 BA put’s bid-ask spread is 0.62-0.67. In other words a trader could sell this option for 62c or buy one for 67c.

Black Scholes Model

Although prices are set by the market, traders have always been interested in knowing what they should pay for an option. And in particular how do various factors, such as movements in stock price and the length of time left on an option, influence this decision.

Up until relatively recently, the 1970s in fact, this was still largely an unknown question. Then work done by Fischer Black, Myrton Scholes and Robert Merton came up with a relatively simple method to come up with an option’s price. And here it is for a call option:

See, told you it was simple. OK, so we’re probably not that interested in the math.

Here’s an online calculator that uses the math to come up with an option valuation. Options brokers have them too. For our purposes at this stage I just want highlight the key inputs:

That is, a reasonable estimate of the fair value of an option can be determined by just the following factors: the stock price, strike price, numbers of days to expiry, volatility, interest rates and dividend yield. That’s it.

Perhaps the only tricky variable there is volatility; but for now just see this as a measure of how much the stock moves around.

Uses of an Option

So now that we know what an option is, what are its uses? Why would we want to buy and sell these things? Here are the main ones:

Insurance

The main use for options, originally, was as insurance. If you are exposed in some way to price of a stock or (more likely in the past) commodity, options can be used to insure partially, or fully, against this outcome.

We’ve already seen an example of this above.

The oil company used a bought put option – giving the right to sell oil at a pre-determined price – to ensure against a significant drop in the oil price.

Alternatively, an airline could insure against its rise by buying a call option – giving the right to buy oil at a particular price – to protect against its rise.

Similar examples could be constructed for other commodity producers/users; options can reduce or even eliminate the price risk of a key output/input (for the cost of the premium).

But what about stock options? What insurance uses do they have?

Their main use is to insure, via a put option, the value of a stock portfolio. Say you had 500 IBM shares at $200/share ($100,000), were approaching retirement but concerned about your exposure to the IBM share price before then.

You could, reasonably cheaply purchase 5 three month $180 put options, say, ensuring that whatever happened in the next 3 months, your shares could not fall below this $180.

Leverage

Options can be used to reduce the capital required to put on a trade.

Let’s say you believe Google (GOOG), at $750, will rise over the next month. You could buy 100 shares for $75,000 which, using margin, would require $37,500 of capital.

Or you could buy a 1 month call option, giving the right to buy the 100 shares at $750 anytime in the month for about $20/share.

This would require much less capital: $2,000. Now there are other pros and cons to this which we will cover later in the course – the $2,000 is completely lost should GOOG fall; but this is the most that can be lost even if GOOG fell heavily etc; the option’s value decays over time – but it is a great way to ‘control’ 100 shares for a small outlay. Finance professions call this ‘leverage’.

The percentage return, or loss, on capital is much more sensitive to the share price. A $50 rise in share price would result in $5,000 gain; a 13% increase on the $37,500 share investment.

But a similar rise represents a massive 150% gain on our $2,000 options outlay. Unfortunately this works in reverse. A $50 fall would result in a $5,000 (13%) share loss, but would cause a 100% options loss.

Speculation

This is the use we’ll be focusing on: options use in speculating on the direction of one or more financial variables.

One of these variables could be the share price, as above, but sophisticated traders can use options to ‘bet’ on other things such as volatility, time decay or the effects of earnings (we’ll look at these in more detail later on).

It is this flexibility that makes options so popular.

Think that a stock will fall? An option trade can be constructed to take advantage. Or that earnings will cause a stock to fall rapidly? Again options can be used.

Or even that a stock won’t move very much? Well, there are several options strategies that can profit from this.

Well respected options trader Jared Woodard likes to say that options are a sophisticated language that can be used to express more opinions on the market than any other financial instrument.

That explains it well: there are so many more ways to profit using options.

Common Options Trading Terms

Below are some of the common options trading terms that will make it easier to understand options:

Call option

The right to buy an underlying security with a specified timeframe

Put Option

The right to buy an underlying security with a specified timeframe

Exercise

Taking up the option to buy/sell a call/put option is known as exercising it.

Strike Price

The ‘specified price’ at which an security can be bought when exercised

Expiry

The last date an option can be exercised.

Implied Volatity

How much a security’s price moves up and down

In the money/Out Of The Money/At The Money

A call(put) option where the strike price is below(above) the current stock price is said to be In the Money.

A call(put) option where the strike price is above(below) the current stock price is said to be Out Of the Money.

An option where the strike price is at the current stock price is said to be At the Money.

Debit/Credit Spread

Option spreads are the combination of bought/sold options traded for a net cost (debit spreads) or credit (credit spreads).

Conclusion

Knowing how options work is vital to be able to learn how to trade them.

Now that we’ve learnt some of the basics we can look in more detail at some of the main types of options, call and puts, and some options spreads.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

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Options can be used to make directional bets on a market, to hedge a long or short position in the underlying asset and to make bets on changes in implied volatility. Options can also be used to generate income.

One of the biggest uses of options is to mitigate risk on a long position in a stock or other asset.

Description of the Protective Put Strategy

The protective put is a relatively simple trading or investing strategy designed to try to hedge the risk associated with a long position.

For example, if a trader or investor is long 100 shares of stock ABC, then he or she may look for ways to protect against a decline in the stock price.

The protective put strategy simply involves the purchase of a long put option that may potentially gain in value if the stock price declines. Here is a simple example:

Protective Put Example

Trader Joe is bullish on stock ABC and owns 100 shares at an average purchase price of $40 per share.

The company has a major earnings announcement coming up in a few weeks, and Joe wants to hedge his downside risk in the stock using protective puts.

With the stock currently trading at $45 per share, Joe decides to purchase the two month $40 put option (ie the strike price is $42) for a premium of $4.

If the earnings announcement is considered bullish and the stock price rises, the put option can either be sold back to the market at a loss or can be held until expiration.

If the stock price is above the option strike price of $40 at expiration, then the option simply expires worthless and Joe is out the $4 premium paid for the put.

If the stock price were to plummet, however, Joe's put could potentially gain in value and possibly offset some or even all of the losses on the stock.

If the stock price is below the option strike price of $40 at expiration, then Joe has the right to sell his shares at $40 regardless of how low the stock price goes.

For example, if the stock price declined all the way to $35 per share, Joe's losses would be limited to the $4 option premium paid per share.

When To Put It On

The protective put is used to try to mitigate downside risk on a long position, and can be used under a variety of circumstances. In the example used above, the trader wanted to try to hedge the downside risk that could come from a major earnings announcement.

In another scenario, a long-term investor might continually purchase long puts on a stock position that he believes could see a sharp rise in volatility. Long puts are also long vega.

In yet another case, a trader or investor could purchase a put if implied volatility levels are very low, thus making the options relatively less expensive.

Pros of Strategy

The protective put's primary purpose is to hedge downside risk of a long position in the underlying asset.

Options can provide a degree of protection for a long position as may also potentially produce a profit if the shares drop or if there is a significant increase in implied volatility levels.

Because the put option is purchased, the risk on the put position is limited to the premium paid for the option.

Cons of Strategy

The strategy does come with some cons as well. Because options have an expiration date, the option will lose value as time passes with all other inputs remaining constant.

Options that are close to the current share price may also be prohibitively expensive, forcing the trader or investor to purchase puts that are further away from the money.

Although puts that are further away from the money may provide a hedge against a major sell-off, the trader or investor is still exposed to a degree on the stock.

A put that is a few dollars out of the money may not gain enough value to provide a hedge against a minor to moderate decline in the stock.

Risk Management

Risk management for a protective put can be accomplished in various ways.

If one is hedging a long position, he or she may be willing to simply hold the option until it expires knowing that they will lose the entire premium paid.

Another way to manage risk may be to sell the put back to the market if it loses a certain amount of value. Some traders may decide, for example, to sell a put back to the market if it loses half of its value.

Another method of risk management could include rolling the put out to a later expiration date.

Possible Adjustments

There are several ways to adjust a long put position. The trader or investor could initially buy a put that is further from the money, and roll it closer to the stock price as expiration gets closer and the options become less expensive.

Another method could be to roll the long put out to a later expiration date using the same or even a different strike price. The trader or investor could even decide to spread the long option by selling an out-of-the-money put against it to lower the cost basis.

Using a put to protect a long position in the underlying is a relatively simple position, but it does come with its own set of risks.

Traders and investors must decide how much risk they are willing to assume on the stock price, and must also decide what they are willing to pay for the hedge.

Used under the right circumstances, the long put can provide a degree of protection for a long position, but that potential protection does come at a cost.

Bottom Line

Protective puts limit potential losses from owning stocks and don’t impact maximum gains from owning stocks. However, like other types of insurance, you have to pay a premium to buy protective puts. Over the long term, buying protective puts can drag down your investment returns.
 

Traders and investors must decide how much risk they are willing to assume on the stock price, and must also decide what they are willing to pay for the hedge.

Used under the right circumstances, the long put can provide a degree of protection for a long position, but that potential protection does come at a cost.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.


Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

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I experimented with various strategies that mainly involved long options, which would eventually depreciate and eat away at my capital.

How to start trading a small account

Starting to trade options with a small account can be a daunting task. I remember spending long hours at work thinking about how I was going to make a living trading, but I only had less than $5,000. Achieving my goal felt impossible, but I didn't have any other viable alternatives. I did not want to work until I was 80 which was my current path as I lived paycheck to paycheck and had credit card debt. I did not want to lower my expenses and live a minimalistic lifestyle, as my wife and I wanted to start a family. Starting a business was another option, but I enjoyed my job, which paid well and offered a flexible schedule. Besides, it was a family business, and I might run it one day, but that was too far into the future.

So, I decided to keep learning about options trading. I remember spending countless nights sitting at my desk, studying options until I fell asleep. I refused to settle for a mundane 9-5 job and retire at 65 with a regular income. I knew that if I could master options trading, I could create not just money but time. My ultimate goal was to be able to do what I wanted, when I wanted.

Through my experiences, I learned that until I could get my account to a higher level like $30,000 it's acceptable to take on higher risk. I could be long options as long as I had a way to finance them and hedge against potential losses. I aimed to maintain a good win rate and ensure that my winning trades were larger than my losing trades. In my search for an effective strategy, I scoured the internet and experimented with various ideas.

Strategies for small accounts

One day, I stumbled upon earnings-type strategies and was intrigued by the predictable upcoming events where options prices would depreciate differently than usual. This inspired me to delve deeper into the dynamics of option prices during earnings and consider the possibility of buying options before the event and selling them before the price depreciation occurred. After conducting thorough back tests and analyzing the data, I found a consistent way to exploit this edge and implement it in my real account. 

There are many strategies and techniques that traders can use to improve their chances of success, and one of them is to focus on maintaining a higher than 50%-win rate while maintaining larger winners than losers.

The key to success with this approach is to ensure that your winning trades are larger than your losing trades. This means that when you do experience losses, they are kept to a minimum, and when you do win, you maximize your profits.

Another important factor to consider is the ability to take advantage of surprise moves in the market. Many trading systems fail when unexpected events or sudden market moves occur because they are not designed to handle such situations. However, with a system that has an asymmetric reward structure, you can capitalize on these opportunities and potentially generate significant profits.

When engaging in liquid trading, finding a platform with low trading costs is very important in order to optimize profitability. High fees or spreads can have an enormous impact on returns for traders who conduct multiple transactions or operate with smaller margins. A lower-cost trading platform ensures more of your earnings stay in your account rather than being lost to fees. Such platforms often provide better access to high-liquidity markets, enabling you to enter and exit positions quickly without significant slippage.
 

One way to implement this type of system is by using options trading strategies that allow you to benefit from sudden market moves while limiting your downside risk. For example, you could use a long straddle or a long strangle strategy, which involves buying both a call and a put option.One thing I do is go long a strangle for a discount in order to move the probabilities up.

When an unexpected event occurs and the market experiences a sharp move in one direction, one of the options will likely expire worthless, but the other will generate a significant profit. This allows you to benefit from the surprise move while limiting your potential losses.
 

Useful tips for small accounts

Here are some thing I look for when trading a small account:

1. Risk management: Managing risk is essential when trading a small account. Avoid taking large positions that can wipe out your account in case of losses.
    
2. Liquidity: Always look for highly liquid options to avoid being trapped in positions.
    
3. Options strategies: Opt for options strategies that offer a limited downside risk and an asymmetrical reward profile.
    
4. Win rate: Aim for a high win rate, ideally over 50%, to ensure consistent profits over time.
    
5. Position sizing: Properly size your positions based on your account size to minimize risk and maximize returns.
    
6. Timing: Consider the timing of events such as earnings releases, as they can provide opportunities for profitable trades.
    
7. Market conditions: Keep an eye on market conditions and avoid trading during periods of high volatility or uncertainty.
    
8. Patience: Be patient and wait for high-probability trading opportunities to come along. Avoid forcing trades just to make something happen.

It is important to note that the method I use to grow my small account is not the only approach that can yield success. However, since January 2022, I have implemented a proven strategy that has yielded positive results. Therefore, I recommend using similar principles to those that I have deployed. The following numbers from my real account serve as evidence that these principles can work.

Since January 2022, I have successfully turned $5,000 into $9,200 by utilizing this earnings-based strategy with a good win rate of over 50% and asymmetric returns. This strategy like many other small account strategies comes with higher-than-normal risk as my account has drawn down from peak to trough over 46% since inception in January 2022.

Bottom Line

Growing a small trading account with options requires discipline, proper planning, and risk management. It is essential to focus on strategies that offer limited downside risk and an asymmetrical reward profile, maintain a high win rate, properly size your positions, and be patient. By following these guidelines, traders can achieve their goals and grow their small trading account with options.

About the Author: Karl Domm's 29+ years in options trading showcases his ability to trade for a living with a proven track record. His journey began as a retail trader, and after struggling for 23 years, he finally achieved 
consistent profitability in 2017 through his own options-only portfolio using quantitative trading strategies.

After he built a proven trading track record, he accepted outside investors. His book, "A Portfolio for All Markets," focuses on option portfolio investing. He earned a BS Degree from Fresno State and currently resides in Clovis, California. You can follow him on YouTube and visit his website real-pl for more insights.

(Most traded options are American options. The underlying can be bought or sold anytime . However 'European' options, which can only be exercised on contract expiration, exist too ).

However it is worth knowing that there are so called European options in existence too, which can only be exercised on contract expiration).

Options come in two main types: calls which give the right to buy and puts which give the right to sell.

Option Strike (Exercise) Price Definition

The strike (or exercise) price of an call option is the fixed price at which a holder can purchase the underlying stock or financial instrument sometime in the future. Likewise, the strike price of a put is the price at which a stock/instrument can be sold.

Options Quotes

Options are quoted via options chains on the Chicago Board Options Exchange (CBOE) and each by:

• Underlying Security (usually, but not always, a stock such as AAPL)

• Option Type: A Call (the right, but not obligation, to buy the underlying) or Put (the right, but not obligation, to sell the underlying)

• Expiry date: when an option has to be used before it expires worthless. Options are time limited as they can only be used up to this set expiry date.

• Exercise Price. Also known as the strike price, this is the price at which the underlying can be bought (call) or sold (put)

Let’s look at an example:

Suppose you see via your broker, via an options chain like the one above, an option quoted: Nov 20 200 Call   1.50

In other words the underlying is AAPL (Apple stock), this is a call option with an expiry of November 2020 and exercise price of $200. The price per option is $1.50.

Option contracts are usually in blocks of 100 and so one contract would cost $150 ($1.50 x 100) and allow you to buy 100 AAPL shares for $20,000 ($200 x 100) anytime between now and November 2020.

Why Is Strike Price Important?

Suppose in the above example you instead looked at the following option: AAPL Nov 20 180 Call

This is the same as before, but now the right purchased is to buy at $180.

Do you think this is more or less valuable to the owner? More valuable, of course, and hence we would expect the quoted value to be much higher than $1.50 (depending also on the current stock price and implied volatility).

Moneyness

Strike price is also relevant to the concept of moneyness.

An option is at-the-money if the strike price and the current stock price are the same.

It is in-the-money if the strike price is lower (for calls) or higher (for puts) than current price. It is out-of-the-money if the exercise price is higher (for calls) or lower (for puts).

So for example if Apple’s share price is $190 our AAPL Nov 20 200 Call is out of the money, but the AAPL Nov 20 180 Call is in the money.
 

• In the Money: In the case of a call option, the option is said to be ‘in the money if the market price of the underlying stock is above the exercise price and In the case of a put option, if the market price of the stock is below the strike price then it is considered as ‘in the money.’
   
• Out of the Money: In call option, if the exercise price of the underlying security is above its market price, then the option is said to be ‘out of the money, whereas in the put option, if the strike price is below the market price of the security, then it is said to be as ‘out of the money.’
   
• At the Money: If the exercise price is the same as the market price of the underlying stock, then at that time, both the call and the put options are at the money situation.
  
   

The Bottom Line

An option's strike price tells you at what price you can buy (in the case of a call) or sell (for a put) the underlying security before the contract expires. The difference between the strike price and the current market price is called the option's "moneyness," a measure of its intrinsic value. In-the-money options have intrinsic value since they can be exercised at a strike price that is more favorable than the current market price, for a guaranteed profit. Out-of-the-money options do not have intrinsic value, but still contain extrinsic, or time value since the underlying may move to the strike before expiration. At-the-money options have strikes at or very close to the current market price and are often the most liquid and active contracts in a name.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.


Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

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What Is Trading Volume?

Trading volume refers to the number of  options  contracts buyers and sellers are exchanging during any given period, usually a trading day. It is monitored for individual securities and can be summarized for stocks, sectors or entire markets as well. Trading volume for options is calculated by totaling the number of contracts that transact within a specific period. For example, if five investors collectively buy 2,000 of a specific put option contract that has the same strike price and expiration date, then the trading volume for that contract that day is 2,000. Join our options trading service to learn more.

Why Trading Volume matters?

Whether an option is bought or sold, whether it is a call or a put, when it trades on the exchange, it is considered volume. In short, option volume is the number of contracts traded in a security or an entire market during a specific time frame, usually one trading day. It is simply the amount of options that change hands from sellers to buyers as a measure of activity. If a buyer purchases 100 contracts from a seller or a market maker, then the volume for that period increases by 100 contracts based on that transaction.

Let's look at another example. Say Jim buys 100 calls for XYZ Inc. (XYZ) at the October 30 strike. On the same day, Bill buys 200 calls for the same strike and month. Total volume for XYZ's October 30 strike would then equal 300 contracts (100 calls + 200 calls = 300). This result would hold true regardless of whether the XYZ calls were bought or sold by either Jim or Bill. As you can see, option volume indicates the number of contracts traded at a particular strike for a particular option for a specified time frame.

Option volume is a useful tool for traders, as it can point out where traders are focusing their attention on an intraday basis. For instance, assume that XYZ Inc. reported strong earnings prior to the market open and opened higher when trading began. High call option volume could be the result of such an occurrence, as options traders try to take advantage of the underlying stock's move higher. Vice versa, a negative reaction to the same report could bring about a spike in put option volume. However, if you did not know that XYZ Inc. reported earnings, but saw the heavy option volume changing hands on the stock, you would know that options players were speculating on some event or move in the shares. As such, option volume can be an handy indicator for events (known or unknown) surrounding a particular stock.

What Is Open Interest?

Open interest measures the total number of open contracts for any specific option. That includes all long positions held by investors that have been opened but haven’t yet been exercised, closed out, or expired. Open interest is tallied for each option (puts separate from calls) and can be summarized by option type, expiration, exchange, or for the entire listed option market. Open interest is updated each night from all transactions, and posted for the next day. Thus, it does not change during the trading day.

Open interest will rise after an option begins trading as investors take on new positions. It will then either rise or decline on any given day as a result of new positions, positions closed, or options exercised the previous day.

Open Interest Example

Consider the following trade orders that are routed by two different traders, but on the same option contract:

Here, Trader A is buying-to-open 5 contracts to open and Trader B is selling-to-open 5 contracts. Both of these simple trading strategies are new positions.

If both traders are filled on their orders, the option’s open interest will increase by 5 because two traders have opened positions in that contract.
 

What happens when one of the traders closes their position while another trader opens a position? Consider the following trades:

As we can see here, Trader B bought 5 contracts to close while Trader C sold 5 contracts to open. In this case, open interest remains at 5 because there are still 5 contracts open between Trader A and C. However, if Trader A sells 5 contracts to close and Trader C buys 5 contracts to close, open interest will decrease by 5:
 

So, open interest represents the number of option contracts that are open in the market between two parties, though you don’t need to be concerned about the specific parties.

Why Open Interest Matters

When you are looking at the total open interest of an option, there is no way of knowing whether the options were bought or sold. That's probably why many options traders ignore open interest altogether. However, you shouldn't assume that there's no important information there.

One way to use open interest is to look at it relative to the volume of contracts traded. When the volume exceeds the existing open interest on a given day, it suggests that trading in that option was exceptionally high that day.

Open interest also gives you key information regarding the liquidity of an option. If there is no open interest in an option, there is no secondary market for that option. When options have a significant open interest, it means there are a large number of buyers and sellers out there. An active secondary market increases the odds of getting option orders filled at good prices.

All other things being equal, the bigger the open interest, the easier it will be to trade that option at a reasonable spread between the bid and ask.

For example, suppose you look at options on Apple Inc. and see the open interest is 12,000. This suggests that the market in Apple options is active and there may be a lot of investors in the marketplace who want to trade. The bid price of the option is $1 and the offer price of the option is $1.05. Therefore, it is likely you can buy one call option contract at the mid-market price.

On the other hand, suppose the open interest is 1. This indicates there is very little open interest in those call options and there is no secondary market because there are very few interested buyers and sellers. It would be difficult to enter and exit those options at good prices.

Image by wallstreetmojo.com.
 

The Importance of Option Liquidity

An option’s volume and open interest are very important to you as an options trader because you do not want to get caught trading illiquid options (low volume and low open interest). Illiquid options tend to have wide  bid-ask spreads , which can have a significant impact on your trading account. It will be more difficult to get the price you are looking for, thereby forcing you to accept a lower price for a sale or pay a higher price for a purchase than you might want. Furthermore, if your order for an option does not get executed in a timely fashion, the underlying stock might move in price, changing the parameters of your intended strategy. Active option traders view liquidity as a very important criteria in selecting and executing their strategies.

Additionally, it’s harder to get out of option positions at good prices when volume and open interest are low, which means losses may grow larger due to the inability to exit a position.

What are ideal levels of volume and open interest? At the bare minimum, the options you use for your positions should have volume in the hundreds and open interest in the thousands:

• Minimum Daily Volume: 100s, preferably 1,000s.
• Minimum Open Interest: 1,000s.

At this point, you understand the basics of volume and open interest, and why they’re important to you as an options trader. In the next section, we’ll go over which options on a stock tend to have the most of each.

Potential Trading Signals

Here’s an overview of some potential volume and open interest trading signals to watch out for:

• If prices are rising and call contract open interest is also rising, it could be a bullish signal that buyers are establishing new long positions.
   
• If prices are rising but call contract open interest is falling, it could be a bearish signal that traders are losing conviction in the bullish trend.
   
• If prices are falling but open interest in put contracts is rising, it could be a bearish signal that traders are opening new short positions.
   
• If prices are falling but call contract open interest is also falling, call holders may be getting forced out of their positions by margin calls, which could be a bearish short-term indicator but also an indication that a bottom could be near.

Bottom Line

Options trading volume and open interest are metrics that help investors better understand and interpret market action in both the options themselves and in their underlying stocks. They also provide a gauge on how liquid an options contract is and how easily it will be to favorably open or close a position in it. While both metrics have limitations, when combined with other data, they help investors understand options liquidity better and make better informed trading choices.

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For an investor that wants to bet on a market decline, one of the simplest ways to do so is with a bear put spread.
 

Description of the Strategy

A bear put spread consists of two options: a long put and a short put. The two options combined form the "spread." The idea behind such a put spread is to profit on the long put option while losing on the short put option. Because the short put is covered by the long put, the long put option will have more intrinsic value at expiration than the short put, producing a profit.

Here is a simple example: Suppose you have been watching stock XXX, which is currently trading at $25 per share. You believe that an upcoming earnings announcement will fall short of expectations, and the stock could see a significant decline. You decide that the best way to play such a potential move is with a bearish put spread.

With the stock price at $25, you elect to initiate a bearish put spread using the $24 and $21 strike prices. Therefore, you simultaneously buy the $24 put and sell the $21 put for a net premium of $.50. The options have 60 days until expiration. The maximum profit potential on this spread is calculated as the spread between strike prices ($24 minus $21 equals a $3.00 spread) minus the premium paid of $.50 for a maximum profit of $2.50.

The maximum risk on the position is the premium paid plus any commissions and fees. In the above example, therefore, the maximum risk is just $.50.

To produce the maximum profit, the stock price must decline to $21 or less at expiration. If the market declines, but not all the way to $21 or below, break-even may be calculated as the long option strike price of $24 minus the premium paid of $.50 for a break-even level of $23.50. Any movement between the break-even level of $23.50 and $21 would equal a point-for-point profit. If the stock was at $22 at expiration, for example, the profit would be calculated as break-even of $23.50 minus $22 for a $1.50 profit.

Of course, not every trade will go as planned. Now suppose for a moment that your forecast for the stock was completely off-base, and the stock doesn't fall but climbs. In this case, if the stock price is above the long strike price of $24 at expiration, you would stand to lose the entire premium paid of $.50.


Bear Put Spread Profit & Loss Diagram
 

When to put Bear Put Spread

A bear put spread can be used for either a bearish forecast on the stock or extremely low levels of implied volatility. If you believe that a stock or other asset class is due to fall, the bearish put spread can be a great way to play that opinion with limited risk and decent profit potential.

Because options are also affected by levels of implied volatility, a bearish put spread can also be used to express an opinion on IV levels. In this case, the market does not necessarily even have to move lower to produce a profit. The trade potentially profits from an increase in IV, which can lead to rising option values.

Pros of the Bear Put Spread Strategy

The bearish put spread has a number of potential advantages. Perhaps the biggest advantage to this type of spread is its defined risk. Regardless of what the market does, the investor cannot lose more than the premium paid for the position.

Selling the put option with the lower strike price helps offset the cost of purchasing the put option with the higher strike price. Therefore, the net outlay of capital is lower than buying a single put outright.

This type of spread may also potentially produce a higher return on investment, or ROI, compared to trading the underlying stock or contract. This is because selling stock short requires margin, and the investor may have to put up significantly more capital to sell short compared to buying an option spread.

Cons of the Bear Put Spread Strategy

Because the spread uses options, it is exposed to the numerous risks that come with a long-options position. Due to the fact that options have a limited lifespan and expiration date, they will lose value as time passes with all other inputs remaining constant. A bearish put spread can also lose money even if the market does decline due to a sharp drop in implied volatility levels.

Options are affected by several key factors, including IV levels, time and price. This means that not only does the trader have to be correct about the market direction, but they also have to be right about the timing and other factors as well.

Risk Management

There are many different schools of thought when it comes to managing a bearish put spread. The risk management techniques used can be based on price, time and value. For example, a simple method for managing risk is to close the position if it declines in value by half. Using the previous example above, if you bought a put spread for $.50 and it declined to $.25, you would close the position and move on.

Another method involves time until expiration. If you bought a put spread with 90 days until expiration, you might elect to close the position win, lose or draw once it has only 30 days left.

Appropriate risk management techniques may depend on the investor's risk tolerance, market conditions and other factors. Whatever method is chosen, the most important thing is to have a plan and then stick to it.

Possible Adjustments

A bearish put spread may also be adjusted as the trade unfolds. For example, if the market has started to move favorably, but the options only have a short amount of time left until they expire, you can elect to "roll" the position out. This involves selling the current spread and buying the same spread or even using different strikes for a later expiration date.

If you have seen a large percentage profit on a spread that still has a lot of time left, you could elect to take profits and buy a new spread that is further away (even lower strikes).

The bearish put spread is a simple, yet very powerful strategy that even novice option traders can use. With its defined risk and solid profit potential characteristics, it should be an important tool in any trader's toolbox.

 

The Bottom Line

The bear put spread offers an outstanding alternative to selling short stock or buying puts in those instances when a trader or investor wants to speculate on lower prices, but does not want to commit a great deal of capital to a trade or does not necessarily expect a massive decline in price.

In either of these cases, a trader may give him or herself an advantage by trading a bear put spread, rather than simply buying a put option.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.


Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

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Options may also possibly offer a better return on investment, or ROI, compared to making outright long or short bets using the underlying stock or derivatives.

As its name suggests, a bull call spread may be used when the investor is bullish on a market and wants to potentially profit from higher prices.

Description of the Bull Call Spread Strategy

The strategy uses two options: a long call and a short call to provide a limited risk/limited profit trade.

The long option is purchase closer to “the money,” which is the current market price of the underlying asset. The short option is sold at a higher price, or further “out of the money.”

The maximum profit potential of the trade is easily calculated. To determine maximum profit potential, simply take the difference between strike prices and subtract the premium paid for the spread, also factoring any any commissions or fees.

The maximum loss potential is even easier to calculate. The maximum amount of capital that can be lost is the total premium paid for the spread plus any commissions or fees.

For example: Suppose you are bullish on stock XYV, which is currently trading at $40 per share. You believe that the stock is likely to rise in the next 30-60 days, and want to take a bullish position in the shares. Rather than buying 100 shares of XYZ and hoping it moves higher, you decide to initiate a call spread by purchasing the $40 call and selling the $44 call for a net premium of $1.00. The options have 60 days until expiration.

If the price of XYZ were to climb to $45 at expiration, the bull call spread would reach its full intrinsic value of $4.00 (calculated as the difference between the two strike prices of $40 and $44). Because you paid $1.00 for the spread, your net profit would be $3.00.

Now suppose your forecast about the stock was wrong, and the share price declines to a level of $38 at expiration. In this case, both options would simply expire worthless and your loss would equal the maximum of the $1.00 premium paid.

In another scenario, suppose that the stock climbs, and is trading at $42 per share at expiration. In this case, the profit cold be calculated as the intrinsic value of the spread ($2.00) minus the premium paid ($1.00) for a net profit of $1.00.

The break-even of a bull call spread is calculated as the long call strike price minus plus the premium paid. Using the above example, the break-even would therefore be calculated as $41 ($40 long call strike price plus $1.00 premium paid).


Bull Call Spread Payoff Diagram

When to put it on

A bull call spreae may be out on at varying times based on the trader’s goals, risk tolerance and market conditions. There are, however, a few simple rules of thumb to consider. Because the spread is bullish, it is important to try to initiate it when prices are likely to continue rising or stage a bullish reversal.

A market that has recently broken out to fresh highs on strong volume could potentially be a good candidate for a call spread. Such a market move could potentially allow the trader to capitalize on an extended upward move or resumption of an uptrend.

Another potentially good place to initiate a call spread is when a market declines into previous support levels or pulls back within a larger uptrend. For a market that has been beaten down and declined to levels where it previously found buyers, bargain hunters could step in and fuel a reversal back to the upside.

For a market that has been trending higher on the longer time frames, a pullback into a support level may provide an opportunity to get long the market before it resumes the trend higher.

Pros of the Bull Call Spread Strategy

The bull call spread has several advantages. Perhaps the biggest advantage is the defined risk of the position. No matter what happens, a trader can not lose more than their premium paid.

Another major advantage may be a higher return on investment. The cost to put on a bull call spread may be considerably less when compared to the cost of holding an outright long position in the stock or contract.

Cons of the Bull Call Spread Strategy

There is no free lunch when it comes to options trading, and the bull call spread is no exception. The spread does come with some disadvantages as well that should be carefully considered. The biggest disadvantage of a bull call spread is the effects of time decay, known in the options world as “theta.”, one of the Options Greeks.

Because options have an expiration date, they will lose value with the passage of time all other inputs remaining constant. In other words, you not only have to be right about market direction, but you also have to be right about the timing.

The theta of the bull call spread would become positive if both options are In-The-Money. This would increase the probability of success, but also reduce the profit potential because ITM spreads cost more.

Bull call spreads may also require a sizable market move to turn a profit. Because of this, it may be best to only consider using a bull call spread when a substantial move is expected.

Risk Management

Managing a bull call spread is fairly straight forward. How you manage the risk is a matter of preference. One simple method for managing risk is to determine an exit point at which you will close the position. For example, if you paid a $1.00 premium for a bull call spread, you may simply exit the spread if the value falls to $.50.

This method is simple but can be highly effective, especially when profit potential on the spreads is at least four times the risk.

Possible Adjustments

For spreads that are not going according to plan, there are other adjustments that can also be made. Selling the spread back to the market and purchasing the same spread at a further expiration is one such method.

The bull call spread is a limited risk and highly versatile position that can be utilized by even novice traders. The spread can potentially provide significant profit potential with little stress. With its numerous advantages, the bull call spread should be a part of every trader’s arsenal.
 

The Bottom Line

The bull call spread is a suitable option strategy for taking a position with limited risk and moderate upside. In most cases, a trader may prefer to close the options position to take profits (or mitigate losses), rather than exercising the option and then closing the position, due to the significantly higher commission. 

It also offers great flexibility in terms of strike selection and expirations.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

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One way that you can choose to invest your cash is to invest in precious metals. They are prized investments the world over and yet so many people don't understand why this commodity still has huge value in the financial world today. The answer to that is that to invest in precious metals you end up with a recession proof and high appreciating investment. It is steady yielding, whether you invest in Hero Bullion gold, silver or other precious metals, you can guarantee that there will be returns on that investment. So, with this in mind, why should you invest in precious metals?

1. They are inflation proof if you want to invest in something that's not going to be affected too much by inflation, and almost every investment out there is subject to inflation overtime including bones, stocks and property. Precious metals contrast to that, because they are one of the most stable investments out there. This is a critical piece of information as it means that your investment is always going to be stable no matter what happens with the uncertainty in the economy.

2. It's a tangible asset. You can learn so much about investing in bonds or stocks but precious metals are a tangible asset which means you get Peace of Mind and huge relief. You can keep your gold safe, you can keep your silver safe, and it can't be hacked into in the same way that cryptocurrency can. It's an increasingly secure way to store your gold, so take advantage of this way you can.

3. The demand for precious metals is spiking. Metals are not common as a commodity and they are not abundant in nature. As the resources for precious metals are reducing the world over, this led to an increase in demand. There is a steady increase in the demand for metals, so you just need to make sure that you invest in them while they are still available. This way, you get access to high valued investments with huge profit margins because you bought when it was cheap to do so.

4. You have the option to diversify your portfolio. Investors will often have their hands in different pots when it comes to investments. If you currently have an investment portfolio, you'll be able to diversify into precious metals. This gives you far more options than you ever thought possible when it comes to figuring out how to earn more money, and it's something that you can really enjoy and rely on as a result. It will pay you dividends overtime and that's exactly what you should be looking for.

Description of LEAP Options

A LEAP option is essentially an option with longer terms than standard options. The acronym "LEAP" stands for Long Term Equity Anticipation Security and like standard options, LEAPS come in two forms: calls and puts.

These long-dated options are available on approximately 2500 securities and several indexes. Standard options are typically available in monthly cycles, and many are now also available in weekly cycles.

LEAPS, on the other hand, may extend out for a couple years and always expire in the month of January.

An investor may use LEAPS if they are bullish or bearish a stock or index, but think that there opinion may take some time to play out. For example, suppose that investor Bob is bullish on stock ABC which is currently trading at $40 per share.

Bob thinks the company has great fundamentals, and it is currently in the process of bringing several new products to market. Bob thinks the stock price could potentially go to $80 per share or even higher if the company is successful with the launch of its new products. Bob's understanding is that the products may take anywhere from 9-15 months to bring to market.

Bob could simply buy shares of ABC at $40 per share now and hope that the stock price does climb in the months ahead. That, however, could tie up a great deal of Bob's investment capital for a significant period of time. Bob makes the decision to purchase a LEAP call option that expires in one year with a strike price of $55 per share for a premium of $5.00

Bob's risk is now limited to the $5 premium he paid for the call option. His potential upside is technically unlimited. If the stock price is below the option strike price of $55 at expiration, Bob will lose the entire $5 premium paid.

If the stock rockets higher, however, Bob could potentially profit point-for-point once the share price rises above the break-even level of $60 per share. If the share price were to climb to $85, for example, Bob could potentially see a profit of $25 per share.

At that point, Bob could simply sell the option back to the market or he could exercise is options to obtain a long position in the stock at $55.

When To Put It On

LEAP options may be used to make long-term bets on a stock or index going up or down.

A call option can be put on when one is bullish the stock, but thinks their bullish thesis will take some time to develop. A put option can be put on if one is bearish on a stock, but again thinks that their bearish thesis may take some time to unfold.

In this way a high positive delta LEAP call is often used as a low capital required stock replacement strategy.

LEAPs may also be used to hedge a long or short position in a stock or index. If an investor owns shares in company YYY, which pays a handsome dividend, then he or she may look to purchase long-term puts to hedge their downside risk.

Pros of LEAP options

LEAPS may have numerous potential benefits. If LEAPS are purchased, then the maximum risk of the position is limited to the premium paid. LEAPs may also potentially allow for a better use of capital and higher ROI.

• The long timeframe of a LEAPS contract allows you to sell the option.
   
• You can use a LEAPS contract to hedge your bets against fluctuations in your overall long-term portfolio.
   
• The prices for LEAPS are not as sensitive to the movement of the underlying asset. If the underlying asset's price changes, the price for the contract won't necessarily make a big move itself.

Cons of LEAP options

LEAPs also have some negatives as well. if one is buying LEAP options, those options will lose value over time as the effects of theta, or time decay, take a toll with all other inputs remaining constant. Options can also be affected by changes in implied volatility, potentially fueling gains or losses. Due to the amount of time premium that may be built into LEAPs, they may also be cost prohibitive.

The prices for LEAPS are highly sensitive and subject to market volatility and interest rate fluctuations.

Risk Management

LEAP options can be managed just like standard options with some caveats. An investor could simply decide, for example, to cut their losses once the value of an option declines by a specified amount. Investors may also potentially choose to cut a position once the option reaches a certain amount of time until expiration.

LEAPs may be less liquid than standard monthly or weekly options, however, so risk management could potentially become more challenging. For investors that sell LEAP options, the risk is unlimited on the upside and only limited by zero on the downside (since a stock can go to zero).

Only investors with a solid understanding of options and the risks involved with selling options should attempt LEAP selling strategies. Even then, losses may not be avoided and investors must be willing to assume the unlimited risks involved.

Investors may, however, limit the risk of selling a LEAP option by purchasing another option further out-of-the-money, creating a limited-risk credit spread.'

Possible Adjustments

LEAP positions may be adjusted using various methods like standard options if liquidity is not an issue.

Strike prices may be adjusted as well as expiration dates. For example, if a LEAP is approaching its expiration date but the investor still believes a big run higher may be seen in the months ahead, he or she could sell their LEAP call option back to the market and purchase a new LEAP call option that expires the following year.

Used under the appropriate circumstances, LEAP options can be a useful tool for betting on market direction as well as hedging exposure in the underlying stock or index.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

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Call Options

Call options are the right to buy a share at a predetermined price sometime on the future.

The have a few key features and terms:

Underlying

All options are derivatives - i.e. they derive from an underlying other security.

In this case the underlying security is likely to be a share - Apple (AAPL) say - or index such as the S&P 500 (see below for more details).

A call option therefore gives the holder the right, but not obligation, to buy the underlying before the option expires.

Strike (Or Exercise) Price

This is the price that the underlying can be purchased.

So, for example, if an AAPL call has a strike price of 200, then the holder can purchase AAPL shares at this price any time before the option expires.

Expiration

The date at which a call option expires - ie the right to purchase the shares only lasts until this date.

Options Premium

The cost to purchase an option.

Thus, for example, a 3 month AAPL 200 call option (ie the holder can buy 100 AAPL shares any time in the next 3 month) might cost $15 a share (ie $1500 in total) in option premium.

Call Option P&L Diagram

Put Options

Puts are the opposite to calls in that they give the holder the right, but not obligation, to sell shares at a predetermined price sometime in the future.

They have similar features to calls:

Underlying

The security over which the put option holder has the right to sell.

Strike Price

The price at which the underlying can be sold in the future.

Expiration

The length of time the holder has to exercise (or use) the option before it expires.

Option Premium

The cost to buy the option.

Put Option P&L Diagram

Note that the put holder doesn't need to own the shares before buying a put.

The owner can simply sell the option in the open market just before expiry if it is in the money (see below).

Call And Put Options: The differences

The most important difference between call options and put options is the right they confer to the holder of the contract.

When you buy a call option, you’re buying the right to purchase shares at the strike price described in the contract. You’re hoping that the stock’s price will rise above the strike price of the option. If it does, you can buy shares at the strike price, which is lower than the current market price, and sell them immediately for a profit.

When you buy a put option, you’re buying the right to sell shares at the strike price outlined in the contract. You’re hoping for the underlying stock’s price to decrease. If the stock’s price falls below the strike price, you can sell the shares at a higher price than what those shares are trading for in the market, and earn a profit.
 

Call And Put Options: Other Terms And Considerations

Options Writing

Thus far we've concentrated on the purchaser of an option.

However one of the attractions (and dangers) of options trading is that you can also be on the other side of the trade, as the so called 'writer' of the options contract.

The writer of an option receives the initial options premium on the creation of the option. Thus, for example, the $1500 in the AAPL example above would be paid to the option writer (or seller as they are sometimes called).

One important concept to understand is that the P&L Diagram of option to its writer is the 'upside down' version of the P&L of the purchaser.

At The/In The/Out Of The Money

An option is said to be:

• in the money if, at the time, the strike price is lower than the current underlying's price (calls) or higher (calls)
   
• out of the money if, at the time, the strike price is higher than the current underlying's price (calls) or lower (calls)
   
• at the money if the strike price and current price are the same (for both calls and puts)
   

Mini Calls And Puts

In general one options contract relates to 100 shares in the underlying.
 

Thus, for example, one AAPL call option allows the purchase of 100 AAPL shares.

However in 2017 the CBOE launched so called mini options over five highly traded underlying securities: Amazon (AMZN), Apple (AAPL), Google (GOOG), Gold ETF (GLD), and S&P 500 SPRDs (SPY)

These options, designed for smaller retail investors, relate to only 10 shares.

It remains to be seen whether this new product will be as popular these will be: initial take-up has been slow.
 

Put Call Parity

A key theoretical concept that more advanced options traders need to understand is put call parity.

As this is an introduction to options we won't go into too much detail into this but in summary it is the idea that puts and calls are not as dissimilar as you might think.

In fact you can construct a put or call option by the purchase or sale of a combination of puts, calls and stock. Thus, for example, a sold put option is the same as a bought stock and sold call.

And because they are the same if you know the price of the call, you can deduce the price of the put (and vice versa).

Therefore, call and put pricing is connected - a connection call put call parity. We have a more detailed explanation here: Put Call Parity Explained.
 

Bottom line

Options do not have to be difficult to understand when you grasp their basic concepts. Options can provide opportunities when used correctly and can be harmful when used incorrectly.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

Join SteadyOptions Now!

What Are Options?

Options are contracts that allow an investor the option to purchase or sell stock at a particular price anytime before it expires.

An option contract generally covers 100 shares of the company; so, if you buy the right to buy Apple stock at a certain price, it is for 100 shares of the company.

Keep in mind that these contracts are distinct from the stock options employees may receive from their respective employers.

Call Options

If you buy a call option, you're buying the right to purchase at a certain price (the strike price) by a preset expiration date, although there is no obligation to do so.

When you sell a call option, you are agreeing to sell the stock at that price if the buyer assigns (or takes up) their option.

Put Options

Put options are a type of financial instrument that give the buyer the right, but not the obligation, to sell a stock at a specific price within a set timeframe.

Pros Of Options Trading

Options have the following advantages to a trader:

Limited Downside (For Buyers)

An option buyer can only lose the value of the bought premium (unlike sellers - see below).

(However, this is unlike owning stock where losing everything is rare).

Smaller Commitment

Options allow you to benefit from stock price movements without having to buy actual shares. Consequently, your potential returns could be much higher compared to what you initially put in. If things don't go your way, you're only out the contract premium.

Flexible strategies

Many more investment strategy can be achieved trading options than with stocks.

Depending on the type of option and whether you are the buyer or seller, options can be used to protect existing investments, provide supplemental income from existing stocks, or meet other investment objectives.

For example of you're bullish about a stock - you expect it to rise - you can use a long call or bull call spread to take advantage of any increase in stock price.

Similarly bears can trade long puts or bear put spreads.

Options can even be used if you believe a stock won't move much: options trading strategies such as calendar spreads and iron condors be traded profitably.

Cons Of Options Trading

However options do have several disadvantages

Complexity:

You must comprehend the technical language and regulations associated with options.

Therefore, it would be advisable to stay away from them until after you have obtained a decent amount of expertise in the stock market and have studied their operation.

Options sellers' risk is potentially unlimited

For example the seller of a call option with a $200 strike price is obliged to sell shares at this price at any time during the option's life.

But the share could potentially rise to any price forcing a trader to buy at this price but sell for the $200. The potential loss is therefore (in theory) infinite (although this can be mitigated by proper risk management).

Low Liquidity

Lower liquidity of some stock options can be a major challenge for traders looking to enter and exit the trade market.

Options Margin requirements can run up trading costs

One of the biggest costs associated with options trading is margin requirements, the amount of money that must be deposited with your brokerage in order to open an options position.

The amount of margin required depends on the type of option being traded, as well as the underlying security.

Commission Costs

Options trading costs more expensive as compared to future or stock trading, especially with a full-service brokerage.

You may be able to reduce these costs using discount brokers such as Robinhood to trade on lower commissions.

Bottom Line

When analyzing the pros and cons of option trading, there are many factors to consider.

The safety net of defining your downside allows you to speculate on short-term price movements while still preserving all of the upside. Moreover, buying options has a positive skew. In statistical terms, this means you’ll lose a small amount of money most of the time and make a large amount of money some of the time.

The trade-off is extremely beneficial because you only need a small number of trades to pay off to have a profitable month or year.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

Subscribe to SteadyOptions now and experience the full power of options trading at your fingertips. Click the button below to get started!

Join SteadyOptions Now!

However, it’s still worth knowing what rho means, as it does provide another dimension of understanding as to how the price of an option may fluctuate.

What Is Rho?

Rho measures how the value of an option is sensitive to a change in risk-free interest rates. The reason this makes it the least important Greek metric is because risk-free interest rates rarely see significant or unexpected changes.

Plus, even when interest rates do fluctuate, they only have a minor impact on the price of options. This means rho has a more long-term effect (much like vega) and has only a minimal impact on short-term options.

Bear in mind, you may also see rho used for a book of several options positions. In this case, rho is in reference to the aggregated risk of exposure to changes in interest rates.

No matter if rho is being used for a single option or a book of several option positions, it is a dollar amount that represents how much the option value will change if risk-free interest rates change by a single percentage point.

Options Rho Math

It's not necessary to understand the math behind Rho (please feel free to go to the next section if you want), but for those interested rho is defined more formally as the partial derivative of options price with respect to (risk free) interest rates.

 

The formula for the rho of a call option is below (some knowledge of the normal distribution is required to understand it). A similar formula for a put option also exists.

 

Calculating the Impact of Rho

To put the above into context, let’s say that an option has a value of $3.25, Rho is 0.5, and the risk-free interest rate is 1.5 percent. This means the price of an option will theoretically increase by $0.50 for every 1 percent increase in interest rate. Therefore, if interest rates increase by 1.5 percent to 3.5 percent, the theoretical increase will be:

$3.25 + 0.5 x 2 = $4.25

If interest rates dropped by 2 percent, we’d see a decrease instead:

$3.25 - 0.5 x 2 = $2.25

If the option has a negative rho of -0.5, the opposite will happen — the value will drop as the interest increases:

$3.25 + -0.5 x 2 = $2.25

But the value will rise when interest decreases:

$3.25 - -0.5 x 2 = $4.25

Why Do Interest Rates Affect Options?

It is easy to understand why the factors leading to sensitivity in the other Greeks impact the value of an option. For rho, it’s less obvious. After all, interest rates are for debt securities, whereas stock options are equities with no fixed interest.

To understand why interest rates affect options at all, it’s important first to be clear about what we mean by risk-free interest rates.

What Are Risk-Free Interest Rates?

In asset management, some types of investments are considered risk free. For instance, US government bonds are risk free because they’re backed by the institution of the government. As the government is unlikely to suffer severe financial troubles, there is almost no risk of savers seeing a default on their bonds.

In other words, if you purchase government bonds, you have a minimal risk of losing your investment. The risk-free interest rate is the minimum return you can receive on the money you borrow when the risk is zero.

Cost of Carry in Options

The main reason why rho matters at all is cost of carry. There’s a carrying cost of holding options because traders often borrow money to purchase financial instruments. In addition, even when a trader has money available without needing to borrow, there is a carrying cost. Traders could be investing this same amount in an account that yields interest instead. It is for these reasons that higher interest rates lead to a higher cost of carry.

As a consequence, the cost of carry is included in the price of calls — even though buying calls is cheaper than buying the underlying asset. Therefore, the cost of calls increases and decreases with the risk-free interest rate.

Rho for Calls and Puts

When rho is positive, its value increases with a higher interest rate and decreases with a lower interest rate (at least in theory). This, just like when using any of the other Greeks, assumes that all other factors remain the same.

Rho is positive for long options (long calls and short puts) but negative for short options (short calls and long puts). In other words, an increase in interest rate is generally good news for long options, whereas short options tend to benefit if interest rate decreases.

To understand why this is, let’s use an example. Imagine that ABC stock is trading at $35. To buy 100 shares would cost $3,500, but you could instead buy an at-the-money call for next month at $3.50. This means you could spend just $350 and the reward would be the same as if you bought the stock but the risk lower. Plus, if you invest the remaining $3,150 in government bonds, you’d be able to hedge your investment. If it turns out that interest rates do increase, the price of the call will also increase and become a good investment.

Furthermore, traders are more likely to buy calls when interest rates are high because of the greater savings from buying options compared to buying the underlying stock. This higher demand may also push up the price of options.

On the flip side, if interest rates are currently low, you may decide to forgo buying options and buy the underlying stock instead. This is because you’ll receive little interest keeping your money in your brokerage. Thousands of other investors will be thinking exactly the same way, meaning more people will be buying stock than call options. As a result, the price will drop for the call option.

Now let’s think about how interest impacts long puts instead. To play the underlying asset to the downside you can either short the shares or go long a put option. The first choice means you generate cash with interest. The second choice costs less, but it won’t add any more cash to your brokerage with interest. As a consequence, the first choice is more appealing when interest rates are high and it shows why high interest rates lower the value for long put options.

Does Volatility Impact Rho?

Volatility is a major factor for most of the Greeks, but it only has an indirect impact on the rho via the delta. How volatility affects rho will depend on whether the option is out of the money, at the money, or in the money.

Out of the Money

When options are out of the money, they have a strike price that is above (for calls) or lower than (for puts) the market price for the underlying asset. Rho has a particularly low value for options that are deep out of the money. You gain value if volatility increases, as this leads to a higher delta and subsequently a higher rho.

At the Money

Options at the money have a strike price that is close to the same (if not exactly the same) as the current market price for the underlying stock. They are little impacted by volatility. Any increase keeps the delta flat, meaning there is no change to the rho. However, looking at the rho can still be useful for at-the-money options, as it can provide an indication as to the future price trend of the underlying asset. If the option is receiving attention from investors, it is more likely to see profits.

In the Money

In-the-money call options have a strike price below market price and put options have a strike price above market price. An increase in volatility means a decrease in the delta, which translates to a decrease in the rho.

How to Use Rho

You can expect to see a higher rho for options in the money and a decrease in rho as the option moves out of the money. Rho is also higher for options that have a longer time until expiration. This is quite different from the other Greeks.

Rho will have a greater impact when interest rates change unexpectedly. This is because the sudden rate change will lead to increased market volatility in general, which causes higher option prices.

All the same, it is only really worth looking at the rho if the option has a long time until expiry — this goes for both calls and puts. This is because interest rates have a minimal impact on premium as options near expiration, due to the lower extrinsic value. For instance, rho can have an effect on long-term equity anticipation securities (LEAPs), as the expiration dates are usually at least two years.

Although rho is the least used of all the major Greek metrics, it is still worthwhile knowing what it means and how it works. Then you can decide if you want to pay attention to this metric or if you’d rather focus on the other four. If you have LEAPs, you’ll probably notice that rho does have some impact. If you trade in shorter-term options, however, you’re unlikely to notice rho making much difference.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

 

Related articles:

• Options Delta Explained: Sensitivity To Price
• Options Theta Explained: Price Sensitivity To Time
• Options Gamma Explained: Delta Sensitivity To Price
• Options Vega Explained: Price Sensitivity To Volatility

Options Theta Explained

Options Theta Math

It's not necessary to understand the math behind theta (please feel free to go to the next section if you want), but for those interested theta is defined more formally as the partial derivative of options price with respect to time.

 

The formula for a call option is below (some knowledge of the normal distribution is required to understand it).

 

Whether you’re an options holder or writer, you need to understand theta.

This Greek metric will help you make the right decisions and see a successful investment.

As theta has different meanings in other fields (including in economics, where it refers to the reserve ratio of banks), it is important that you learn what theta means in regard to options trading.

How Is Theta Different from the Other Greeks?

All the other Option Greek metrics measure how the price of an option is sensitive to a particular variable. For instance, vega measures how price is sensitive to a change in implied volatility by one percentage point.

Option Delta indicates how the price of the option is sensitive to every $1 change in the underlying asset and Option Gamma shows how a change of $1 to the underlying security affects the delta.

Finally, rho measures sensitivity to a change in interest rates.

Theta, unlike all the above, is not about price sensitivity. Instead, it measures time decay.

What Is Theta?

Theta measures how the value of an option deteriorates over the passage of time. Put simply, it’s the time decay of an option as represented as a dollar or premium amount. Whereas you can calculate the theta on a weekly basis, it is more common for theta to represent a day-to-day time decay.

When all other factors are constant, the option will lose value as it approaches its expiry date. For this reason, the theta is usually a negative value. However, you always need to bear in mind that a significant increase or drop in the price of the underlying asset or a change in implied volatility will also impact option price.

To calculate how theta impacts option price, let’s imagine that a call option is currently $3 and the theta is -0.06. This means that the option will drop in price by $0.06 per day. After one day, the price of the option will have fallen to $2.94. After one week, the price will be $2.58.

How the Passage of Time Impacts Theta

Longer-term options have a theta close to 0 since, there’s no loss of value on a daily basis. Options with a shorter term have a higher theta, since the time value is at its highest and there is more premium to lose on a day-to-day basis.

The theta is at its highest when options are at the money and lowest when they are out of the money or in the money. The theta value rises for options at or near the money as the option nears expiration.

However, in options that are deep in or out of the money, the theta value falls as the option approaches expiration.

Furthermore, when an option is out of the money, the time decay is particularly noticeable. Bear in mind that when an option is out of the money, the underlying asset is lower than the strike price in the case of a call and higher than the strike in the case of a put.

Therefore, when an option that is out of the money moves closer to expiration, the likelihood that it will ever be in the money diminishes.

Theta Curve

An important point to make is that, even if all the other factors do remain equal, time decay is not a linear descent. The theoretical time decay becomes greater (meaning the theta increases dramatically) as options near their expiration date because there is less time for the option to move when it is close to expiration. This leads to what is called the theta curve — where there is a gradual decay early on and an accelerated decay as the option approaches expiration.

Pricing models take weekends and trading holidays into account, either by adjusting volatility or time expiration. This means that you’ll see a decay over seven days, no matter how many trading days are actually in the week. It also means that you cannot cheat the system, such as by opening a new short position late on Friday and closing it early on Monday to collect two free days of time decay.

For the same reason, it can be a good idea to close a position on Friday if it’s showing a reasonable profit — you’re unlikely to see a greater payoff if you wait until Monday. Plus, it’s often possible on the Monday to reenter the position for almost the same price as you exited, should you change your mind.

Nonetheless, the lack of a standardized method of representing the time decay of options means that you may see a different time decay according to which model you use.

Why Does Theta Matter?

Theta gives a numerical value to the risk that options buyers and writers will face due to the passage of time. This risk exists because you only have the right to buy or sell the underlying asset of an option at strike price before the expiry date in options trading.

Therefore, in the case that two options have similar characteristics but one has an expiry date further in the future, the longer option will be more valuable. This is because there is a greater chance that the option will exceed the strike price due to the longer amount of time it has.

This is all down to the fact that the value of an option has intrinsic and extrinsic value. Intrinsic value refers to the profit from an option based on the difference between strike price and market price.

Extrinsic value refers to all the rest of the premium: the value of holding the option and the chance for the option to grow in value as the underlying stock price moves. When all else is equal, the extrinsic value of options will drop over time, leaving only the intrinsic value at expiration.

Volatility and Theta

Typically, an option with a higher volatility of its underlying asset will have a higher theta than a similar option with a low-volatility stock. The reason for this is the higher time value premium of high-volatility options, which means the potential loss each day is greater.

To put this into context, let’s use another example. This time, imagine that our call option is currently $5 and that the underlying stock is trading at $1,030 with a strike price of $1,045. Let’s also say that the option will expire in 10 days and has a theta of -0.5, meaning that the value of the option will decrease by $0.50 each day.

If everything remains the same, the option will already have lost $2.50 by the end of five days. However, if volatility leads the underlying stock to increase in price, this could offset the loss for the option holder that the theta calculated. In the above example, the price of the underlying asset would need to increase to at least $1,050 to give the option $5 in intrinsic value.

Positive and Negative Theta

We previously mentioned that theta is generally negative — it follows, then, that theta can also be positive. This is because both option buyers and option writers can use theta.

Theta is negative when you are in net long in a position. To see a profit as a buyer, therefore, one of two things is necessary: you can either respond quickly and be directionally right or you need implied volatility to be on your side. For the latter, you want to see implied volatility expand more than the theta is able to decay the value of your option.

Negative theta is a reason why it’s important to hedge your long options with short options. For instance, it is better to opt for calendar spreads, vertical spreads, and diagonal spreads than long naked options, as this will allow you to eliminate some (or perhaps all) of the time decay.

Theta is positive when you are net short in a position. Since option writers want their position to lose value, positive theta is favorable. In addition, it’s cheaper to buy back an option to close out a short position.

How to Use Theta

As we already mentioned, theta drops every day when all other factors remain equal. This means you lose money every day after you buy an option. When you choose to buy an option, then, you are expecting that factors will not remain equal — that the price of the underlying asset will move significantly.

Alternatively, if you believe that you’ll see little change in the underlying asset price, theta gives you a good opportunity to short the option. Time decay will bring you a profit, as the option’s value will drop.

Of all the Greeks, theta is the most indefinite. Since the calculation has to assume that implied volatility and price movement is steady (when, of course, it can be anything but), theta is often inaccurate.

For this reason, it’s necessary to consider theta as part of the bigger picture and never in isolation.

 

List of positive theta options strategies

• Short Call
• Short Put
• Short Straddle
• Short Strangle
• Covered Call Write
• Covered Put Write
• Long Calendar Spread
• Vertical Credit Spread
• Iron Condor
• Butterfly Spread

List of negative theta options strategies

• Long Call
• Long Put
• Long Straddle
• Long Strangle
• Vertical Debit Spread

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded epsilonoptions.com in 2012.
 

Related articles:

• Options Greeks: Theta, Gamma, Delta, Vega And Rho
• Options Delta Explained: Sensitivity To Price
• Options Gamma Explained: Delta Sensitivity To Price
• Options Vega Explained: Price Sensitivity To Volatility
• Options Rho: Sensitivity To Interest Rates

Options Delta Explained

For example, should a stock option price increase in price by 0.5c with a 1c increase in the underlying stock price then the option has a delta of 0.5.

Another way of looking at delta is as the probability of the option expiring in the money.

Some of the delta neutral strategies are ATM Long Straddle, Long Strangle and calendar spread.

Options Delta Math

It's not necessary to understand the math behind delta (please feel free to go to the next section if you want), but for those interested delta is defined more formally as the partial derivative of options price with respect to underlying stock price.

 

The formula is below (some knowledge of the normal distribution is required to understand it).

 

 

Delta is superficially the most intuitive of the options greeks. Even the newest beginner would expect the price of an option, giving the right to buy or sell a particularly security, to change with the security’s price.

Let’s look at an example with call options on a stock with $120 stock price as it rises higher (by $10 to $130, say).

In the money options – those with a strike price less than $120 – would become even more in the money. Thus their value to the holder would increase – the probability of them remaining in the money would be higher – and hence, all other things being equal, the option price would rise.

Out of the money and at the money options – those with an exercise price of $120 or greater – would also rise in value. The probability of, say, a $140 option expiring in the money would be higher if the stock price was $130 compared to $120. Hence its value would be higher.

Similar arguments can be used with put options: their value rises/falls with the fall/rise of the underlying (the only difference being put options have negative delta versus call options, whose delta is positive).

But the extent of this sensitivity – i.e. delta – and how it relates to expiration length, price, and volatility is quite subtle. Let’s look at it in more detail.

 

Delta for Short vs. Long Options

Options can be bought or sold. Depending on which side of an option trade an investor is on, the delta of that option will adjust accordingly.
 

For long options, delta values are positive for calls and negative for puts. A bought (long) call will have a delta between 0 and +1, rising as the option becomes more in-the-money. A purchased put option will have a delta between 0 and -1, with delta falling the further the put is positioned in-the-money.
 

The inverse is true for shorting options. When selling call options, delta scores will be a negative value, between 0 and -1. This is true because a short call option position will increase in value as the underlying security falls - the writer of a call option will benefit as the underlying security falls. The other way to look at this is to understand that a call option has a positive delta, but that the seller/writer of that call option has the inverse exposure.

Similarly, put options, which provide a delta exposure of -1 to 0 for the owner, expose the seller/writer of the put option to a positive delta between 0 and +1.

How Does Options Delta Change Over Time?

The effect of time on delta depends on an option’s ‘moneyness’.

In the money

All other things being equal, long dated in the money options have a lower delta than shorter dated ones.

In the money options have both intrinsic (stock price less exercise price) and extrinsic value.

As time progresses the extrinsic reduces (due to theta) and the intrinsic value (which moves in line with stock price) becomes more dominant. And so the option moves more in line with the stock, and hence its delta rises towards 1 over time.

Out of the money

All other things being equal, short dated OTM/ATM options have a lower delta than longer dated ones.

A short dated out of the money option (especially one which is significantly OTM) is unlikely to expire in the money, a fact that is unlikely to change with a 1c change in price. Hence its delta is low.

Longer dated OTM (Out Of The Money) options are more likely to expire in the money – there is a longer time for the option to move ITM (In The Money) – and hence their value do move with stock price. Hence their delta is higher.

At the money

There is no effect of time on the delta of an at the money option.

How Does Options Delta Change With Implied Volatility?

Again the effect of implied volatility changes on delta depends on moneyness.

In The Money

As we saw above in the money options’ value comprise both intrinsic and extrinsic amounts.

In general the higher the proportion of an option’s value that is intrinsic (which moves exactly in line with stock price) and extrinsic value (which doesn’t), the higher its delta.

Increases in IV increase the extrinsic value of an option and so, as intrinsic value isn’t affected by implied volatility, increases the percentage of the option’s value that is extrinsic. This resultant reduction in the intrinsic value as a proportion of the whole, reduces the option’s delta as above.

Out Of The Money

Out of the money options have only extrinsic value, which is driven by the probability of it expiring in the money.

A higher volatility suggests there is a greater chance of the option expiring ITM (as the stock is expected to move around more) and hence delta increases.

At the money

ATM options have a delta of approx. 0.5, which is unchanged as volatility changes.

Effect Of Changes Of Price On Delta

One of the other subtleties of delta is that it in itself changes value as the underlying security’s price changes.

The extent to which this occurs is another of the options greeks: gamma. This is the change in delta resulting in in a 1c change in stock price.

Gamma for long options holders is positive whereas it is negative for short positions, meaning it helps the former and penalises the latter. It is also at its highest absolute value near expiration. (See here for more discussion on gamma).

Conclusion

Delta is an important greek as it reflects an option holder’s exposure to one of the main variables: the price of the underlying security.

Whilst one of the easiest option concepts to understand, its behavior resulting from changes to other variables such as time, IV and underlying price is more complex.

It is vital for an options trader to understand these concepts.


About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded epsilonoptions.com in 2012.
 

Related articles:

• Options Greeks: Theta, Gamma, Delta, Vega And Rho
• Options Theta Explained: Price Sensitivity To Time
• Options Gamma Explained: Delta Sensitivity To Price
• Options Vega Explained: Price Sensitivity To Volatility
• Options Rho: Sensitivity To Interest Rates

The second-order Greeks are a bit more complicated. Rather than looking at the impact on the option itself, they measure how a change in one of the same underlying parameters leads to a change in the value of a first-order Greek.

An important second-order metric is gamma. In fact, it is the only second-order Greek that option traders use with any regularity. Gamma measures the rate of change of the delta with respect to the underlying asset.

As delta is a first derivative of the price of an option, gamma is a second derivative.

To understand what all this means, we first need to take a step back and define what is the delta of an option.

Understanding Delta

Options Gamma Math

It’s not necessary to understand the math behind gamma (please feel free to go to the next section if you want), but for those interested gamma is defined more formally as the partial derivative of delta with respect to underlying stock price.

 

The formula is below (some knowledge of the normal distribution is required to understand it).

 

Delta refers to the change of a price of an option in regard to the price of the underlying security. For calls, delta ranges from 0 to 1.

For puts, it has a value of -1 and 0. Delta expresses how much the price of an option has increased or decreased when the underlying asset moves by 1 point.

Usually, when options are at the money, you can expect to see a delta of between 0.5 and -0.5. When options are far out of the money, they have a delta value close to 0, and when they are deep in the money, the delta is close to 1.

This means that, typically, call owners make a profit when the underlying stock increases in price, as this leads to a positive delta. In contrast, as puts have a negative delta value, put owners see gains when underlying stock falls.

It’s important to note that this is not always the case: when another factor is large enough, it can offset the data.

Calculating the Impact of Delta

To use the above in an example, imagine a call has a delta of 0.5. If the underlying stock increases by $1, the price of the call should rise by around $0.50.

If the underlying asset decreases by $1, the price will drop by about $0.50. This assumes, of course, that no other pricing variables change.

Now imagine that a put has a delta of -0.5. If the underlying stock increases by $1, the price of the put will drop by $0.50. If it decreases by $1, though, the price will rise by $0.50.

Option holders will notice that the delta of an option increases rapidly at a certain price range — this is called the exploding delta.

For the buyer, this is great news, as it can lead to big profits. Of course, the opposite is true for sellers on the other end of an exploding delta.

In fact, an exploding delta is a major reason why selling unhedged options incurs such a high risk.

Bear in mind, though, that whereas delta hedging can reduce directional risk from movements in price of the underlying asset, such a strategy will reduce the alpha along with the gamma. We’ll now see why that matters.

What Is Gamma?

Gamma specifies how much the delta will change when the underlying investment moves by $1 (a unit of gamma is 1/$).

In other words, whereas the delta tells you at what speed the price of the option will change, the gamma will tell you at what acceleration the change will happen.

This means that you can use gamma to predict how the delta will move if the underlying asset changes — and, therefore, how the value of the option will change.

Gamma is important because delta is only useful at a particular moment in time.

With gamma, you can figure out how much the delta of an option should change in the case of an increase or decrease in the underlying asset.

Why Do We Need Gamma?

To emphasize why gamma matters and how it adds another level of understanding to options that goes beyond delta, let’s take an example. Imagine two options have the same delta but different gamma values.

There’s no need to even use numbers in this example: it’s enough to say that one has a low gamma and the other a high gamma.

The option with the high gamma will be riskier. This is because if there is an unfavorable move in the underlying asset, the impact will be more pronounced.

In other words, if an option has a high gamma value, there is an increased likelihood of volatile swings. As most traders prefer options to be predictable, the option with the low gamma is preferable.

Another way to explain this is to say that gamma measures how stable the probability of an option is.

How Gamma Changes with the Passage of Time

As the delta of an option is dynamic, the gamma must also be constantly changing. Even minuscule movements in the underlying stock can lead to changes in the gamma.

Typically, the gamma reaches its peak value when the stock is near the strike price. As we already saw, the maximum delta value is 1.

As the delta decreases as the option moves further into or out of the money, the gamma value will move closer to 0.

Using Gamma to Measure Change in Delta

Calculating a change in the delta using gamma is quite straightforward. As an example, imagine ABC stock is trading at $47. Let’s say the delta is 0.3 and the gamma is 0.2.

In the case that the underlying stock increases in price by $1 to $48, the delta will move up to 0.5. If, instead, the stock was to decrease in price by $1 to $46, the delta would drop to 0.1.

Long and Short Options with Gamma

For holders of long options, gamma means an acceleration in profits every time the underlying asset moves $1 in their favor. They are long gamma.

This is because the gamma causes the delta of an option to increase as the option moves closer to the money or as it becomes further in the money.

Therefore, every dollar of increase in the underlying asset means a more efficient return on capital.

This same concept means that when an underlying asset moves $1 against the holder’s favor, losses decelerate.

On the flip side, the gamma poses a risk for sellers of options — since, if there’s a winner in the equation, there also has to be a loser. Just as gamma accelerates profits for holders of long options, it accelerates losses for sellers.

Similarly, as it causes losses to decelerate for the holder, it leads directional gains to decelerate for the seller.

The Importance of Correct Forecasts

No matter if you’re buying or selling, having an accurate forecast is essential. As a buyer, a high gamma that you forecast incorrectly could mean the option moves into the money and the delta moves toward 1 faster than you expect.

This will mean the delta will then become lower more quickly than you predicted.

If you’re a seller, an incorrect forecast is just as problematic. As the option you sold moves into the money, a high gamma may mean your position works against you at an accelerated rate. In the case your forecast is accurate, however, a high gamma could mean the sold option loses money faster, yielding positive results for you.

How Volatility Impacts Gamma

The gamma of options at the money is high when volatility is low. This is because low volatility occurs when the time value of an option is low. Then, you’ll see a dramatic rise when the underlying stock nears the strike price.

When volatility is high, however, the gamma is usually stable across strike prices. The reason for this is that when options are deeply in the money or out of the time, the time value tends to be substantial.

As options approach the money, there is a less dramatic time value. In turn, this leads the gamma to be both low and stable.

Expiration Risk

One more aspect to take into consideration is the expiration risk. The closer an option is to expiration, the more narrow the probability curve.

The lack of time for the underlying assets to move to far out-of-the-money strikes reduces the probability of them being in the money. The result is a more narrow delta distribution and a more aggressive gamma.

The safest way to use understanding of gamma to your advantage is to roll and close your positions at least seven (or perhaps as many as 10) days before expiration.

If you wait longer than seven days out, there’s a greater chance you’ll see drastic swings — where losing trades convert into winners and vice versa. Buyers may be able to benefit from this trend, but it is particularly risky for sellers.
 

List of gamma positive strategies

• Long Call
• Long Put
• Long Straddle
• Long Strangle
• Vertical Debit Spread
   

List of Gamma negative strategies

• Short Call
• Short Put
• Short Straddle
• Short Strangle
• Vertical Credit Spread
• Covered Call Write
• Covered Put Write
• Iron Condor
• Butterfly
• Long Calendar Spread

Summary

• Gamma measures the rate of change for delta with respect to the underlying asset's price.
• All long options have positive gamma and all short options have negative gamma.
• The gamma of a position tells us how much a $1.00 move in the underlying will change an option’s delta.
• We never hold our trades till expiration to avoid increased gamma risk.
   

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.
 

Related articles

• Options Greeks: Theta, Gamma, Delta, Vega And Rho
• Options Delta Explained: Sensitivity To Price
• Options Theta Explained: Price Sensitivity To Time
• Options Vega Explained: Price Sensitivity To Volatility
• Options Rho: Sensitivity To Interest Rates
• Gamma Risk Explained
• Why You Should Not Ignore Negative Gamma
• What Is Gamma Hedging
• Market Neutral Strategies: Long Or Short Gamma?
• Estimating Gamma For Calls Or Puts
• What Is Gamma Hedging And Why Is Everyone Talking About It?
• Short Gamma Vs. Long Gamma

The strategy seeks to make a profit from a large move in either direction of the underlying asset. It has a large profit potential with the risk limited to the price paid for both premiums.

A long strangle option is the most common and involves buying an out of the money call option with the strike price above the current market price and buying a put option with the strike price below the current market price. 

A long strangle is an options spread that involves purchasing a put option and a call option at the same expiration date and a different strike price. The strategy is long volatility and market-neutral with infinite profit potential and limited risk. A strangle is similar to a straddle but uses options at different strike prices, while a straddle uses a call and put at the same strike price.
 

What is a Long Strangle?

The long strangle is quite similar to the popular straddle spread, the only difference is that the straddle involves buying a put and call at the same strike price, while the strangle uses different strike prices.

The trade is theta negative, vega positive, gamma positive and (typically) delta neutral.

Let’s look at an example in SPY options.

• SPY (underlying) price: $414.00
• BUY (1) 19 MAY $405 PUT @ $3.67
• BUY (1) 19 MAY $420 CALL @ $2.30
• Total trade cost: $5.97 (net debit)

In this case, you’re hoping for a large price movement in either direction, as your break-even price is often pretty far from the current underlying price. So you’d want to buy a strangle when you expect substantial market volatility, but when you’re relatively agnostic about the direction of that volatility.

An example of such a situation is if there’s an important upcoming Federal Reserve meeting that you think will shock the market, resulting in dramatic price action.

Here’s the payoff diagram for this position:

The position becomes profitable, or in-the-money, when the price of SPY trades outside of the dotted blue lines at expiration. With this specific spread expiring in 29 days, you’re playing for a pretty significant market move, in this case, you’re expecting SPY to move up or down roughly 3.6%.

Elements of a Long Strangle

Market Neutral

Strangles make no attempt to forecast the direction the underlying price will move in the future. A standard strangle has roughly equal exposure to both increases and decreases in price. Instead, you’re taking a view on the magnitude of price movement.

The Long Strangle is a Bet on Increased Volatility

The long strangle is a Vega positive options strategy. When you buy a strangle, you’re betting on a significant price move in the underlying stock and/or increasing implied volatility.

Think of it this way. The price of an at-the-money straddle (the “sister” spread to the strangle) is basically the option’s market expectations of how much price will move until expiration.

You can think of it like a spread in sports betting. If the Giants are +140 to beat the Vikings, then the bookies are giving the Giants a 41% chance of winning. If you think those odds are substantially higher, then you should bet on the Giants.

The same is true in the options market. For instance, if an ATM straddle in SPY costs $13.84 when SPY is trading at $414, the options market is pricing in a roughly 3.3% move. If you think it will move substantially more, then you should buy a long volatility spread like a strangle or straddle.

The Strangle is Negative Theta

Because the strangle is a long premium options strategy, you’re working against the clock. Due to theta decay, the value of your options will slowly lose value with each passing day, meaning the market needs to make a big move in a relatively short time to make up for theta decay.

The Strangle Has Unlimited Profit Potential

Because options are worth their intrinsic value at expiration and there’s no theoretical limit to how high a stock can go, a strangle has unlimited profit potential on the upside, with the profit potential on the downside only limited by the underlying stock going to zero.

Here’s a zoomed-out payoff diagram for a visual:

The Strangle Has Limited Risk

The strangle involves only buying options, meaning that the most you can lose is the net debit, or the total cost of the options. In this case, the trading costs would be the combined cost of both the put and the call.

Recalling our SPY strangle example from earlier in the example:

• SPY (underlying) price: $414.00
• BUY (1) 19 MAY $405 PUT @ $3.67
• BUY (1) 19 MAY $420 CALL @ $2.30
• Total trade cost: $5.97 (net debit)

The most we can lose in this case would be $5.97, the net debit or total cost of the trade.

How to Create a Long Strangle Spread

A long strangle is a very simple trade structure: a put and a call at different strike prices with the same expiration date. The width between the strike prices can be as narrow or wide as you like. You structuring the strangle trade to fit your specific market view is where the “special sauce” of options trading comes in.

Let’s visualize a strangle on an options chain:
 

Above is the same SPY long strangle example we’ve been using throughout the article. You’re basically buying out-of-the-money (OTM) options that will benefit from huge price moves in either direction. The market move needs to not only be large enough to put one of your OTM options in-the-money, but also pay for your net debit.

So perhaps you conclude the structure we have above is a little expensive for your taste. You’d rather pay less for a spread and have a smaller probability of making a significant return on your capital.

You can simply widen the spread to fit this view. See the table below:
 

This spread will cost substantially less at $2.52, however your probability of profiting on the trade is far lower as the market needs to make a much bigger move to put your trade in the money.

Like any options trade, the long strangle is about tradeoffs. You’re trying to find the right balance between risk and reward. The longer expiration you choose, the longer you give yourself for the trade to work, but the more you pay for the spread. If you widen the width between your strikes, your risk/reward is higher, but your probability of profiting on the trade declines.

For this reason, there’s a number of considerations to make when structuring a long strangle spread.

Strike Width and Strike Selection

Strike selection is a key component of options trading, it’s often what defines a profitable or losing trade. The decision largely comes down to the balance between reward/risk ratio and probability of profit.

As a rule, wide strike widths have high reward/risk ratios and low probabilities of profit, while narrow strike widths have comparatively lower reward/risk ratios and higher win rates.

As a point of demonstration, let’s compare the strangle examples we referred to earlier in this article. If you recall, the first one is:

• SPY (underlying) price: $414.00
• BUY (1) 19 MAY $405 PUT @ $3.67
• BUY (1) 19 MAY $420 CALL @ $2.30
• Total trade cost: $5.97 (net debit)

And the second spread is:

• SPY (underlying) price: $414.00
• BUY (1) 19 MAY $394 PUT @ $1.95
• BUY (1) 19 MAY $434 CALL @ $0.58
• Total trade cost: $2.53 (net debit)

While both of these spreads are long-volatility spreads aiming for big wins, the second spread has a far higher reward/risk by virtue of the much smaller capital outlay. But the first spread has a much better chance of expiring in-the-money. The first spread has a probability of profit (POP) of 56%, whereas the second spread has a POP of just 25%.

Expiration Date

A very similar tradeoff is at play when selecting an expiration date for your options. In an ideal world, you’d always select the longest expiration date possible. But of course, the longer an option has until expiration, the more time value it has and in turn, the more expensive it is.

So we’re constantly looking to strike the perfect balance between buying ourselves enough time to be right, but not overpaying for time value so much that it hurts our reward/risk ratio.

Theta is the primary factor to keep in mind here. The following chart from Investopedia displays the rate of theta decay based on the time to expiration:

While this is only a rough guide and theta decay will be slightly different for each option, the concept stands. As you get closer to expiration, the rate of theta decay accelerates.

For this reason, many traders prefer to pick longer-dated expirations when buying premium. But again, you’re paying for that extra time value.

What Are Market Expectations?

In financial markets, obvious things are priced-in. Buying a high-quality company like Apple typically comes with a heftier valuation than a lower or mid-tier company. Everyone knows that Apple is a good company and the price reflects that. The same is true to a more severe extent in the options market.

The best analogy for this concept is in sports. The Boston Bruins just broke the NHL record for most wins in a season at 65. If the Bruins were facing the Anaheim Ducks with only 23 wins on the season, it’s pretty obvious who’s going to win. You’d never bet on the Ducks with 50/50 odds. But with 1/99 odds? Suddenly that seems like a good bet.

To relate the concept to options, everyone knows that a Federal Reserve meeting or earnings report will create volatility. So the options market, just like sportsbooks, set “odds” on what is most likely to happen. In the same way that sportsbooks reflect that the Bruins should beat the Ducks, the options market does this to reflect publicly available information. This is why buying pre-earnings options is expensive, because everyone knows that there will be increased volatility.

The best way to see what the option market thinks will happen is pricing out an at-the-money (ATM) straddle.

For instance, let’s say we were interested in betting on earnings on Apple. We’d look at the expiration following the company’s earnings date on May 4, 2023 and sum the price of the ATM call and put, giving us a net debit of $8.03. This means the options market expects the price of Apple stock to move plus/minus about $8 on the release of earnings.

You can look at the ATM straddle as the “moneyline” in sports betting. Rather than thinking in terms of “the Bruins are the better team, I think they’ll win,” you think more in terms of “I think the Bruins’ probability of winning is higher/lower than the odds.”

So before entering a long strangle, you need to ensure that you are bullish on volatility relative to market pricing. It’s not enough to think that prices will be volatile, you need to think they’ll be more volatile than what the market is already expecting. This is a key concept that many novice traders take a while to learn.

Long Strangle Payoff and P&L Characteristics

Long Strangle Breakeven Prices

The long strangle has two breakeven prices, an upper breakeven and a lower breakeven. Calculating them is easy.

• Upper Breakeven Price = Call Strike Price + Net Debit
• Lower Breakeven Price = Put Strike Price - Net Debit

For instance, here’s an example for an Apple strangle:

• $175 Call
• $160 Put
• Net Debit: $2.60
• Upper Breakeven = $175 + $2.60 = $177.60
• Lower Breakeven = $160 - $2.60 = $157.40
   

Long Strangle Maximum Loss/Risk

The maximum risk for a long strangle is the net debit paid for the spread. The net debit is simply the combined cost of both the put and the call you purchase. Limited risk trading strategies like the long strangle are often the building blocks for new traders to cut their teeth on, allowing them to learn without taking on unlimited risk they might not understand.

Long Strangle Maximum Profit

The long strangle has unlimited profit potential because there is no limit to how high or low the underlying stock price can go. The only theoretical bound is the stock going to zero on the downside.

Long Strangle Market View and Outlook

Matching Market View to Options Trade Structure

One thing we're trying to nail home in this primer is the importance of matching your market view to the correct options spread. As an options trader, you're a carpenter, and option spreads are your tools. If you need to tighten a screw, you won't use a hammer but a screwdriver.

So before you add a new spread to your toolbox, it's crucial to understand the market view it expresses. One of the worst things you can do as an options trader is structure a trade that is out of harmony with your market outlook.

This mismatch is often on display with novice traders. Perhaps a meme stock like GameStop went from $10 to $400 in a few weeks. You're confident the price will revert to some historical mean, and you want to use options to express this view. Novice traders frequently only have outright puts and calls in their toolbox. Hence, they will use the proverbial hammer to tighten a screw in this situation.

In this hypothetical, a more experienced options trader might use a bear call spread, as it expresses a bearish directional view while also providing short-volatility exposure. But this trader can be infinitely creative with his trade structuring because he understands how to use options to express his market view appropriately.

The nuances of his view might drive him to add skew to the spread, turn it into a ratio spread, and so on.

What Market Outlook Does a Long Strangle Express?

The long strangle is delta-neutral, meaning traders buying a strangle take no position on price direction. Instead, they’re betting on the price magnitude, whether up or down. Put simply, a strangle profits when the underlying stock makes a big price move in either direction.

Positions like the long strangle or long straddle are often described as being long volatility, which might sound weird. To most, volatility is simply a calculation or an adjective used to describe chaotic trading. How can you “buy volatility?”

When you buy an option, you’re making a bet on price direction, time, and volatility. So if you buy a call, not only are you betting that the stock will go up, but that it will go up prior to expiration, and that it will go up more than the extrinsic value in the option cost implies. That third part is the volatility aspect of the equation.

Because a strangle involves buying both a put and a call, the directional aspect of the trade is neutralized, leaving only the time and volatility aspects of the trade.

So the long strangle trader is bullish on volatility and neutral on price. He is expecting a large price move.

When To Use a Long Strangle

Earnings

Speculating on earnings is the most popular use for strangles, which involves making a bet that a stock will or won’t make a big move following its earnings report.

A trader might observe that a specific stock tends to habitually make big moves on earnings, buyers of strangles profits quarter after quarter. Acknowledging this, a trader might buy a strangle prior to the following earnings report, so long as it doesn’t look like the market is adjusting to reality and making earnings options more expensive.

Here at SteadyOptions, we prefer to trade earnings volatility differently than the traditional style. We trade pre-earnings strangles and straddles. In other words, we both enter and exit our earnings volatility trades before the earnings event ever occurs. This might seem entirely counter-intuitive but I promise, it makes sense.

Because implied volatility tends to rise in the lead-up to earnings, we exploit this phenomenon. Essentially, as earnings get closer, traders and investors begin buying protection in the form of puts and buying speculative calls, pushing implied volatility up.

We tend to buy strangles and straddles 2-15 days before an earnings release and sell before earnings are even released. In this way, not only do we harvest many of the benefits of earnings volatility trading, but we also avoid the grim reaper of long volatility earnings trades: implied volatility (IV) crush, or the phenomenon for IV to plummet immediately following the release of an earnings report as the uncertainty that made the IV expensive is now gone.

Furthermore, the quick turnover also mitigates negative theta, or theta decay, the primary risk of buying options.

Other Market Events and Catalysts

While earnings is the main domain for volatility trading, several other events present similar trading opportunities. Some of these are:

• FDA trials for biotech stocks
• Significant economic releases like Federal Reserve meetings, nonfarm payroll, etc.
• Impending court decisions for companies in litigation
• M&A takeover speculation
• SEC and federal investigation outcomes

The general concept stands. When there is a catalyst that will significantly impact a company’s stock price and the market knows the date of the catalyst, the same uptick and crush in implied volatility will occur as it does with earnings releases.

Certain catalysts are more up in the air and don’t have a definitive date of resolution as earnings or a Federal Reserve meeting do. The SEC’s ongoing fight with Coinbase is one such example. In this case, you might see the implied volatility of such a stock’s options elevated for a prolonged period, as the market can’t pinpoint exactly when the catalyst will resolve. Such catalysts are much harder to trade and are better left to specialists.

Volatility Mean Reversion

We explained earlier in this article how the long strangle is more than anything, a volatility trade. You’re making a bet that the underlying stock’s volatility will be more than what the option market expects. In other words, the stock will make a bigger move than the market thinks it will.

So just as many traders might systematically buy stocks after huge declines, betting that it will revert back to a historical mean, the same concept exists in volatility trading. As a matter of fact, true mean reversion is much easier to observe in the volatility trading world than it is in the stock trading world.

For instance, take a look at a long-term (12 weeks) moving average of the S&P 500 Volatility Index (VIX), which is a measure of implied volatility for the S&P 500.

The above chart is a 12-week moving average of the VIX over the last 15 or so years. As you can see, the chart more resembles an EKG than a stock price, featuring semi-predictable peaks and valleys.

The behavior of volatility mean reversion is a well-known and accepted phenomenon in the quantitative finance world, with GARCH models being the standard way to model volatility.

With this in mind, many traders aim to play these peaks and valleys of volatility. Buying when it’s cheap relative to its historical mean, and selling when it’s expensive.

We at SteadyOptions do a fair bit of volatility trading and we prefer to approach it using long-volatility positioning, allowing us to benefit from significant spikes in volatility and not expose ourselves to the potentially catastrophic losses of selling volatility.

Long Strangle vs. Long Straddle

Strangles and straddles are very similar. They’re both delta-neutral, long-volatility strategies that aim to capture a significant price move in either direction. Both are used to speculate on volatility related to earnings and other market catalysts.

The primary difference is that straddles involve buying a put and call at the same strike price while strangles involve buying a put and call at different strike prices.

In practice, while a strangle and straddle have very similar market outlooks, their P&Ls behave differently throughout the trade.

The practical differences are as follows:

• Straddles tend to have more premium than strangles and cost more to initiate a position
• Straddles tend to have a higher probability of profit than strangles
• Strangles tend to require a larger move to breakeven on the trade

The best way to represent these differences is through each trade’s payoff diagrams.

A strangle features a more U-shaped payoff diagram:

As you can see by the flat line, a strangle is more of a “do or die” type of trade. It either works, or you lose almost all of your premium.

On the other hand, the straddle’s V-shaped payoff diagram means that very rarely will a straddle trader reach their maximum loss at expiration:

Bottom Line

The long strangle is a simple option spread. It involves buying a put and a call at different strike prices and the same expiration date. Long strangles are betting on a big price move and/or IV increase. 

To enhance the gains, traders might also consider gamma scalping.

Related articles:

• Long Straddle Options Strategy: The Ultimate Guide
• How We Trade Straddle Option Strategy
• Straddle Vs. Strangle Options Strategy
• Exploiting Earnings Associated Rising Volatility
• What Is An Implied Volatility Crush

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What Are Options Greeks?

Financial derivatives can be volatile and sensitive to factors such as changes in the pricing of the underlying asset. Each character denotes the of sensitivity of an option’s price to the change in some attribute of the underlying asset, such stock price and volatility.

These attributes are components of risk that a trader needs to control if he/she is to manage the risk of their portfolio.

The Greek characters are easy to calculate and are a popular tool amongst derivatives traders, especially since the letters are very useful in portfolio hedging, which enables the investors to protect their investments from adverse changes within the market.

Not only that, the Greek alphabets allow an investor to determine how much risk their portfolio is facing and from which area is the risk the greatest.

The 5 related Greek Characters are: Delta, Gamma, Vega, Theta and Rho. (Vega is a bit of cheat: there is no such greek letter. Often epsilon is used instead).

We will look at each in turn and, in particular, how we will use them to control our trades’ risk.

Options Greeks: Delta

What Is Delta?

Delta measures option price sensitivity to changes in the price of the underlying asset.

 

Option Delta is perhaps one of the most vital measurement methods of all, as it can investigate the level of sensitivity that an option’s price will move, if there is a change in the underlying stock price.

 

(As with all the other options Greeks, we assume that all other of the options parameters don’t change when looking at delta).

 

If the option has a delta of 1.5, it means that there will be a price movement of 1.5 cents for every cent the underlying stock moves.

 

Therefore, this shows that an option with a high delta reading will increase or decrease in value more considering the direction of the price change.

 

As compared to another option with a low delta which will not move as much from changes in the price of the underlying stock.

Delta signs for long and short options:

 

How is Delta Used?

The importance of the information that the Greek Delta can provide is indispensable. This is especially the case where, in the real world, investors rarely hold options until maturity.

 

Knowing how much profit that can be reaped or the potential losses that will be incurred from a single movement in price will be one factor an investor uses to determine whether they should still hold the option or sell it.

 

Complication

Unfortunately there is a complication with delta: it also moves as the price moves. So that 1.5 delta option may move 1.5 cents higher for 1 cent move in the underlying, but then the delta may have changed to 1.6.

 

Hence any further increase in share price will cause an even bigger increase in the price of an option. This effect is an example of positive gamma – to be explained in our next lesson – and can be thought of as the price ‘accelerating’ higher.

 

Click here for more on the greek: options delta.

 

(NB We have recently published a post on the related concept of Position Delta).

 

Options Greeks: Gamma

What is Gamma?

We saw above that the Greeks are an important measure of risk to used by options traders to assess the impact in changes of certain variables on the price of an option.

 

In particular we looked at one of these, delta: the sensitivity of option prices to changes in the price of the underlying security.

 

Unfortunately, again as we saw, the relationship between stock price sensitivity (delta) and the stock price is not linear.

 

For example if a stock moves up, call options will become even more sensitive to further changes to the stock price. This effect is called gamma. It measures the change in delta, i.e. sensitivity to stock price movements.

 

Positive gamma means that as a stock rises the option’s price will more sensitive to further stock changes. Negative gamma means the opposite: stock price rises cause stocks to be less sensitive.

 

Why should we be concerned about Gamma?

Gamma is the key enemy of many of the options strategies we use. It tends to rise as an option moves closer to expiration. Hence in the last week of an option’s life small changes in stock prices cause large, and accelerating, swings on options prices.

 

This is unfortunate as many of our favorite strategies – such as the iron condor or calendar spread – rely on time decay. They relay on time passing to make money.

 

Often a trader has to weigh up the potential profits, from time decay, of leaving a strategy on versus the increasing risk of the stock moving and wiping out those profits.

 

It is for this reason that most experienced options traders rarely keep a trade on until expiration. We take a particularly risk averse line: we tend to remove our standard time decay exploiting trades at least 2 weeks before expiration.

 

For example, look at our trade rules for putting on this calendar spread. Notice the last ‘Trade Management – Exit’ rule. We would get out of the trade within 2 weeks of expiration to avoid the gamma risk.

 

Such is the power of gamma that trading with positions with large gamma – expiration week trades for example – is known colloquially as ‘riding the gamma bull’. Not for the faint hearted.

 

Uses of Gamma

We’ve seen that Gamma is often seen as an enemy. But this is usually only relevant to those trades, admittedly the most popular, that relay on time decay to profit.

 

Some trades, however, take the opposite course: they take advantage of the accelerating price sensitivity from gamma to make money from expected changes in stock prices.

 

One good example of this is the simultaneous purchase of an at-the-money put and call, called a long straddle, Let’s say a stock was $650.

 

We expect significant stock movement, from a product launch for example, over the short term and so buy a $650 call and a $650 put.

 

Such a purchase has strong gamma. Stock movement not only increases the price of the spread, these price changes are increased the more the stock changes, either way.

 

(Don’t worry too much about the mechanics of this: we will have a more detailed course on straddles later).

 

The catch, and key risk, is time, the opposite of the trades mentioned above.

 

Time decay works against us here: if there is no stock movement then the spread will gradually lose money. Indeed the spread loses value every day – all things being equal – and so there is an amount of stock movement required each day just to break even.

 

The trader has to be sure that the stock move, and move quickly, for the trade to be profitable.

 

(This example is taken from a real life trade here. We used an APPL straddle to exploit expected movement from the iphone5 launch. Ignore, for now the discussion on increases in implied volatility: this will be part of the Vega lesson).

Gamma vs. time:

 

 

Gamma scalping

One advanced use of gamma is ‘gamma scalping’, something you may hear about from experienced traders.

 

It’s pretty complex – it takes advantage of the ‘boost’ in option price changes from excessive stock movement whilst managing delta risk (I said it was complex) – and I may include it in a later advanced post, but I suggest that most of you don’t worry about this strategy at present.

 

Click here for more on the Greek: options gamma.

 

Options Greeks: Vega

What Is Vega?

Vega is a measure of an option’s sensitivity to changes to implied volatility (IV). As we’ve seen earlier, implied volatility is the market’s estimate of the volatility (measured by standard deviation) in the future.

 

It’s an input into the standard options pricing models and hence any change in this expectation, in other words any change in implied volatility, will affect the price of options.

 

How does it affect the price?

In general bought options, either calls or puts, increase in value as IV increases. This makes sense: an option seller would want to be compensated more for the increased future risk, as priced by the market, of the option moving in the money.

 

Stocks expected to be more volatile, and hence have higher IVs, have higher options prices, everything else being equal.

 

Short options decrease in value, the higher IV is for the same (but opposite) reasons. Things get interesting once options are combined in a spread. Some combinations such as a Calendar Spread increase in value as IV increases. Others, such as the Iron Condor, decrease.

 

Uses of Vega

Many options strategies rely on picking the way volatility moves. For example should be believe that we are to have a market correction we would, of course, be interested in the effect of stock price falls on our options positions.

 

But we’d be also interested in what the associated increase in IV would have on the position. There are some trades that rely solely on Vega: volatility trades.

 

IV tends to be mean reverting and so any short term deviation could produce a correcting change in the near future.

 

For example many traders look for the difference between historical volatility – how volatile the market is right now – to implied volatility – a future volatility prediction.

 

There is some evidence to say if these two indicators diverge than they will soon get closer together. This can be traded if you know the volatility effect of IV on an options trade. In other words, Vega.

 

Click here for more on the Greek: options vega.

 

Options Greeks: Theta

What Is Theta?

Theta is a measure of the time decay of an options, or option spread. As we have seen elsewhere in the courses, options are a decaying asset: they reduce in value over time.

 

All things being equal an option is worth more the longer it has to go until expiry; an option with 60 days of time left to expiry will be worth more than one with only 30 days.

 

The expected drop of an option value, again all things being equal, in the next 1 day is Theta (expressed as a negative).

 

For example, at the time of writing, you can buy an ATM June 13 445 APPL call with 23 days until expiration for about $12. It has a Theta of -0.24, meaning it will lose $0.24 in the next 24 hours if nothing – share price, volatility etc – changes.

 

Uses of Theta

Theta is the basis of many of the standard options trades we use in this course. Strategies which involve selling options – or at least there are ‘more’ sales than purchases – have positive theta (ie they rise in value over time).

 

If we were to sell the above AAPL call options for $12 and nothing changed, we could buy them back at $11.76, the next day for $0.24 profit. If nothing else changed of course.

 

This rather simplistic example shows the way to more (and much less risky) ways we can profit from theta. Take the vertical spread. Let’s say you thought Apple wasn’t going to rise in the next 23 days.

 

You could sell a 450 call and buy a 480 call and receive a net credit of $4.70. The 450 call has a theta of -0.24; the 480 call a theta of -0.14 and hence the net theta is -0.10. We have reduced our risk (of a significant share price increase) but are still making $0.10 a day all things being equal.

 

Effect of time on Theta

Theta is the effect of time on options pricing. However it too changes with time. In general theta increases as expiration nears. Another way of saying this is that the time decay accelerates closer to acceleration.

 

You can see this from our sold AAPL 445 call above. It will lose $0.24 between day 23 and day 22. If theta was constant it would only lose 23x$0.24=$5.52 of its value between now and expiration. But it is worth $12 – which must all be lost by day 23.

 

Hence Theta must increase at some stage this to happen. Here’s a graph of what happens:

 

 

Notice how the value of the option (time value) accelerates near the end of its life. This is the theta increasing.

 

Gamma and Theta

So why don’t you wait until the last few days to sell your options? All that nice accelerating time decay should reduce your option price quick only for to buy them back or let them expire for a quick profit. Easy.

 

Well, unfortunately not. We have been looking at Theta in isolation. But we know from our last course that another of the Greeks increases with time: gamma. This is the acceleration of the effect stock price has on the option price.

 

Increasing time decay is matched with increasing sensitivity for price changes and so any time decay could be wiped out by an adverse move in the share price.

 

This is a good example of the interplay between the Greeks. In general strategies that exploit theta have to contend with gamma and vice versa. We will see more interrelationships later. In the meantime though we will look at the last of the major Greeks, Rho.

Click here for more on the greek: options theta.

 

Options Greeks: Rho

What Is Rho?

Rho is a measure of the sensitivity of options prices to changes in interest rates. It is defined as the increase in price of an options, or options portfolio, as a result of a 1% increase in interest rates.

 

Relevance

Rho is often ignored by options traders as interest rates are unlikely to change (much) during the course of most options spreads. Hence changes in interest rates are usually ignored.

 

However there are times where more notice should be taken of Rho. Long term options, such as LEAPS, are more sensitive to changes in interest rates, ie have a higher Rho.

 

At the time of writing an at the money AAPL call option with 32 days to go has a Rho of 0.3 (a 1% interest rate rise would produce a small, 0.3%, increase in the options price). However a LEAP with 578 days to go has a Rho of 2.2. Hence any LEAP strategy, such as our LEAP Covered Calls, would be affected somewhat by a change in interest rates.

 

The other time Rho should be at least considered is, of course, when interest rates are changing. At the time of writing, for example, there is a strong possibility that the Fed will remove its QE program thus causing, amongst other things, an increase in interest rates.

 

Hence, all things being equal, may be see an increase in options prices over the next few months/years.

 

In conclusion Rho can be an important factor in certain circumstances – when interest rates are expected to change and/or we are looking at long term options – but in general Rho is a far less important Greek than Delta, Gamma, Theta and Vega.

 

Click here for more on the Greek: options rho.

 

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded epsilonoptions.com in 2012.

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Related articles:

• Options Delta Explained: Sensitivity To Price
• Options Theta Explained: Price Sensitivity To Time
• Options Gamma Explained: Delta Sensitivity To Price
• Options Vega Explained: Price Sensitivity To Volatility
• Options Rho: Sensitivity To Interest Rates
   

The Costless Collar Explained In Detail

The simplest protection method is to purchase puts – usually placed out of the money – enabling the sale of the stock at a predetermined price.

However this insurance comes at a cost: the put option premium paid. To offset this an out of the money call can be sold for a similar price, thus creating the ‘zero’ (net) cost collar.

However there is a payoff – as ever in options trading – as the sold call limits the upside to be enjoyed from the stock held.

Zero Cost Collar Example

Suppose an investor owns 100 IBM shares, valued at $140 per share. Here’s their profit and loss:

They are concerned about the risk of their position – their potential loss is, in theory, 100% – and so decide to limit this risk by purchasing a 130 put option contract for $5 per share.

Here’s the new P&L:

Notice how this limits their loss to $15 a share (if the stock falls below $130).

But the $5 put premium has caused the position’s breakeven to rise from $140 to $145. In other words the stock has to rise from its current $140 to $145 to cover the cost of the option protection.

To offset this cost they decide to sell an out of the money 150 call option for $5 (this is a simplified example).

This offsets the purchased put option cost – but means that should the stock rise above $150 it will be ‘called’ away. In other words they would not enjoy any gain above $150.

The new P&L is:

This is the zero cost, or costless, collar. Both the upside and downside have been limited, to $10 either way.

Pros Of Zero Cost Collars

The downside of a stock position can be protected at zero net cost.

Collars are particularly popular with Company Executives with large portfolios of stock held in trust (ie they can only access it after several years). A costless collar can be used to ‘fix’ the future value of the stock to within a narrow band, thus providing certainty of future payouts.

Unlike many other options spreads an investor will still receive dividends given they own the stock.

Cons Of Zero Cost Collars

The main downside is the limited upside of the stock position once a collar has been put on.

The spread is also complex and involves two options position – this, potentially, incurring significant transaction costs.

It is also unlikely that premiums of suitable puts and calls will be equal as in our example. Indeed out of the money puts often have relatively high implied volatility and hence price and therefore there may be small cost to the position after all.

Conclusion

‘Moneyness’ considers the strike price of an option versus the current stock price.

If exercising the option produces a ‘better’ result than if the option holder traded in the stock (if by exercising a call they obtained a discount versus current stock price) then the option is said to be in the money.

(This is as compared to at the money when strike price equals the stock price, or out of the money when call/put strike prices are higher/lower than stock prices).

In The Money Call Options

For example, consider a 130 IBM Call Dec 20 call option. This allows the option holder to buy IBM stock at $130/share anytime between now and Dec 2020.

 

Let’s suppose that the stock price is $134. The option allows the holder to exercise the option and buy the stock at a lower price – $130 – and hence this is said to be in-the-money.

 

 

(In reality they are unlikely to do this. As we shall see below, the option is likely to be valued at more than the $4 discount and hence it would make more sense, should they wish to own the stock, to sell the option and buy the stock at $135 – at a net cost of less than $130 – rather than exercising the option and buying at $130.)

 

In The Money Put Options

Alternatively, let’s look at a 140 IBM Dec 20 put option at the same time. As the option holder is able to sell IBM shares at a premium – $140 – to the current $134 stock price this option is in-the-money per the above definition.

 

Intrinsic Value

Intrinsic value is the amount of discount (call options) or premium (put options) that would be enjoyed if the option was exercised.

 

In the above examples, the call option has $4 ($134 less $130) of intrinsic value and the put has $6 ($140 less $134).

 

Effect On Options Valuation

Intrinsic value is the lowest an in the money option can be valued.

To see this consider if this was not the case. For example suppose the 130 IBM call Dec 20 above was valued at $3, despite its $4 of intrinsic value.

 

Well that would be a great deal if true. All a trader would have to do is buy the call for $3, exercise the option, buy the stock for $130 and sell immediately for $134, thus making a $1 risk free profit.

 

These risk free profits are called arbitrage and efficient markets price them away. In this case all the demand for the $3 options would increase their price until, at the very least, no arbitrage would be possible (ie above the intrinsic value of $4).

 

(A similar thing would happen if the put was valued at less than its $6 intrinsic value: an arbitrageur could buy the put and make a profit by buying stock, exercising the option and selling for a net $6. If the put was valued less than $6 they would, again, make a risk free profit).

 

In the money options will generally be valued at greater than intrinsic value before their expiry date.

We’ve already shown that they can’t be less than intrinsic value. But why not equal to it?

 

Again let’s look at the example above. It’s easiest to consider the put: suppose the 140 IBM Dec 20 was valued at exactly $6, its intrinsic value, with 3 months to go before expiry.

 

A crafty trader could buy the put and stock at the same time (a protective put) for $140. Should the price rise above $140 at expiry – to $150, say – they would let the put lapse and sell their stock at a $10 profit.

 

Should it be below $140 the 140 put would be exercised thus ensuring no loss. The resulting profit and loss diagram would therefore be:

 

 

Notice that at no point can the trader lose. The worse that could happen is for the stock to be below $140 and they not lose money. If, however, it was over $140 they would profit, at no risk of loss.

 

This is, again, would be traded away in the market. The put option would rise in value at more than the $6 to ensure the above risk free profit could not occur.

 

(The amount over intrinsic value is called extrinsic value and depends on several factors such as implied volatility and time to expiry).

 

In the money options’ values are therefore a mix of intrinsic and extrinsic value.

 

What Happens to ITM options at expiration?

If an option is in the money and approaching expiration, it is in its owner’s best interest to either sell or exercise the option regardless of whether they made money on it. Occasionally, however, an investor might be unavailable at the time or forget to do this.

 

If an investor does not resell or exercise an expiring option, the investor’s brokerage (or the Option Clearing Corporation) usually exercises the option automatically on the investor’s behalf. In the case of a call option, this means purchasing 100 shares of the underlying stock at the strike price. In the case of a put, this means selling 100 shares.

 

If the investor does not have enough money in their account (or enough shares in their possession) to exercise, the contract may be automatically exercised on margin (money borrowed from the brokerage), or the brokerage may attempt to contact the investor.
 

Conclusion

“In the money” and “out of the money” are phrases used to describe the intrinsic value of an option. As an options buyer, you want the contracts to be in the money (have intrinsic value). As a seller, you want options to expire without being exercised, so you want the contract you sell to be out of the money.


About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded epsilonoptions.com in 2012.

 

Let’s look at a couple of examples:

Out Of The Money Call Option

Suppose a trader owns a 140 IBM Call Dec 20 call option allowing them to buy IBM stock at $140/share anytime between now and Dec 2020.

This call is said to be out of the money if the stock is less than $140, at $134 say.

There would be no point exercising this option, and buying the stock at $140, as it is available on the market for $134.

Out Of The Money Put Option

Likewise the owner of a 130 IBM Put Dec 20, allowing them to sell IBM stock for $130 anytime between now and Dec 2020, would not exercise this option as they could get a better price, $134, in the open market.

Hence the put is out of the money too.

Intrinsic Value: OTM Options

Out of the money options have no intrinsic value (unlike in ITM Options).

A call’s intrinsic value is defined as the discount to the stock price enjoyed by the owner of these options. As, by definition, there is no such discount (out-of-the money calls’ strike price is higher than the stock price) there is no intrinsic value.

Similarly the intrinsic value of a put, any premium of exercise price over the stock price, is zero too.

(Intrinsic value cannot be negative).

Extrinsic Value Of Out-Of-The-Money Options

Extrinsic value is defined as the option price less intrinsic value. As an OTM option has no intrinsic value (see above) all its value is extrinsic.

Options beginners struggle with this. Why, they ask, does an option that is, say, $6 out of the money (such as the 140 Dec 20 call above) have any value if a buyer could just buy the stock for a lower price. Wouldn’t the fair value of an OTM option be zero?

Extrinsic Value Example

Well, again looking at above call example, what the owner of the option is buying is the chance that it will move to be in the money (ie above $140) sometime between now and Dec 2020.

Suppose the stock price rose to $150 at expiry (for simplicity). The option holder would profit by $10 – they could exercise their $140 option and sell at $150. Indeed their upside is unlimited – the stock could be even higher.

Their downside is zero (excluding the cost of the option) however. No loss would be made If the underlying stayed below $140 as there is no obligation to exercise the option.

Optionality & Option Valuation

This ability to enjoy unlimited upside but no downside has a value – the call’s so called ‘optionality’. This value is what powers an OTM option’s price.

But how to quantify this value? How would we price the 140 Call, with the stock at $134? That’s for the market to price. But in general its value is mainly determined by:

• The amount it is out of the money: you’d pay less for a 150 call, $16 out of the money, than the closer to the money $140 call for example.
   
• How volatile the stock is. The IBM share price is likely to be much steadier than, say, a start-up. Hence it is much less likely to jump up to the $140 before Dec 2020. Therefore the IBM call option is likely to be worth less. The market’s view of a stock’s future volatility is called implied volatility. 
   
• How long to expiry. If there is a long time between now and the option expiration date then it is more likely to cross $140. Therefore, all other things being equal, it is more valuable than a shorter dated option.

(There more on how options work here)
 

Behavior Of OTM Options On Expiry

Following on from the last point above, the option has no extrinsic value if there is no time left to expiry as there is no optionality (the stock can never rise to be in the money).

Because it has no intrinsic value either (see above) OTM options expire worthless on expiry.

This makes sense. If the above option, for example, expires with the stock price below $140, the option holder will be able to buy stock at $140.

But they can buy it for less, $134, on the market and so the option has no value to him/her.

An option will expire worthless if it is out of the money as (per the above examples). The market will provide a better price for both buying (call) and selling (put options).

Conclusion

Out of the money call/put options are those that are above/below the strike price and have no intrinsic value.

They do have extrinsic value – caused by a holder potentially making money if the stock moves.

The market’s view of the stock’s future volatility (i.e. its implied volatility), how far the strike price is from the stock price and time to expiry are the main factors that influence an option’s market price.

If an option expires out of the money it is worthless.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

(We have similar post on the opposite trade: Buy To Open vs Buy To Close)
 

What Is Sell to Open In Options Trading?

An open position means that you’re entering a trade when you place an order. Selling to open means you are selling an options contract to open a position.

You need to use a sell-to-open order whenever you want to open a new short call or short put.

Let’s put this into real terms. Imagine you want to sell a call option where the underlying stock is trading for a $1.30 premium and the expiry date is two months in the future.

Let’s say the current stock price is $50 with a strike price on the call of $55. To sell this call option through your brokerage, you would need to use a sell-to-open order.

When the time comes to exit the position, you’ll need to use a buy-to-close order.

You can do this at any time — even the day after you use the sell-to-open order. In the above example, you may choose to buy to close if the underlying stock price increases to perhaps $57 before it reaches expiry date. When you use a buy-to-close order, the open short option position becomes closed.

Bear in mind that a sell-to-open order may not always execute. This can happen when an exchange limits to closing orders only during certain market conditions. One example of such a market condition is when the underlying stock for the option you are trying to sell to open is scheduled for delisting. Another reason could be that the exchange will not be trading the stock for some time.
 

What Is Sell to Close?

As you saw above, sell to open (and buy to close) applies to short calls and puts. For long positions, you have sell to close (and buy to open). In other words, you need a sell-to-open order to establish a new position with short calls and puts.

To be able to sell to open, you need collateral for the position. This can be in the form of the corresponding stock shares or the equivalent value in cash. In the case you have the shares, you’ll be sharing a covered position. If you don’t have shares, you are shorting the option or selling a naked position.

Then, as we have seen, when you want to close the position, you’ll need to use a buy-to-close order.

Selling to open is simple enough. Let’s look in greater detail at what we mean by selling to close.

First, you need to remember that, in options, buying long means buying a contract from an options writer. Your aim is to see the underlying stock price rise (for calls) or fall (puts), which will bring you a profit when the trade closes.

The trade will end when it reaches maturity, with you selling the position. You will make a profit if the sold price is more than the bought price.

When you sell to close, you exit a short position that already exists. Put another way, you have an open position for which you have received net credit. By writing that option, you are closing that position.

Sell to Open vs Sell to Close: When to Use Each

Now that you understand the difference between sell to open and sell to close, all that’s left is to be clear about when to use them.

When Should Investors Sell to Open?

Whenever you want to sell a call or put to benefit from a change in price of an underlying asset, by receiving options premium, you can sell to open. 

When Should Buyers Sell to Close?

As an option buyer, time decay is in not in your favor. All the same, there may be times when you’ll want to close the position before it expires.

One instance of when this could be true is in the case of a price change in a favourable direction to the underlying asset. When this happens, selling to close may enable you to access profits earlier.

For example, imagine you have purchased at-the-money calls that last 3 months. Then, after two months, the underlying asset increases by 30 percent. You could use the opportunity to sell to close and access the majority of your profits immediately before time decay hits.

Alternatively, selling to close could reduce your potential losses. Let’s return to the same scenario above of buying at-the-money calls.

However, this time, instead of the underlying asset increasing by 30 percent, let’s say it decreases by that amount. You could decide to sell to close at this point to avoid even greater losses that you may incur by waiting longer.

The key rule of thumb for deciding whether to hold on to an existing position is, “would I put this position on from scratch”. If the answer is yes, keep holding on to the trade; if not, close it.

Long and Short Options in the Same Position

Some option spread strategies allow you to carry both a long option of an asset and a short option of an asset at the same time. This is useful for giving you the opposite position without needing to close the original open position. In other words, you gain when the underlying asset price moves in the right direction, but you also reduce risk compared to just selling a single option.

Whereas you could sell your long and short options separately, if you’re using a brokerage that specializes in options, the chance is you can enter the strategy as a single trade.

So, when you have a strategy that contains multiple long and short options, what should you use? Should you sell to open (and sell to close) or sell to close (and sell to open)? The answer is: it depends.

For strategies like a bull put spread, bear call spread, short straddles, and short strangles, you’ll use sell-to-open orders. This is because you open these strategies with net credit, meaning you are receiving premium to open the position. You’ll also use sell-to-close orders — it’s just like with long positions.

Deciding when to sell to open and sell to close sounds simple enough. However, like everything in options trading, it does involve some calculating to predict how the price of the underlying asset is likely to change.

This is further complicated when you have an option strategy that includes both long and short options. In these cases, you’ll need to consider your overall position to ensure you make the right decision.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

This approach can be used to manage risk and leverage market movements more strategically.
 

Options spreads involve the purchase or sale of two or more options covering the same underlying stock or security. These options can be puts or calls (or sometimes stock too) and be of different options expiries and different strike prices. Each combination produces a different risk and profitability profile, often best visualized using a profit and loss diagram.

Options Spreads Combinations Explained

For example a trader may sell one AAPL 170 call and buy one AAPL 160 call, a type of call spread as defined below.

In all such strategies, a trader uses the chosen combinations of puts and calls to make a profit should a forecast outcome occur.

This is usually that the underlying stock moves a particular way – up in the case of the call spread above – but in more complex trades can be an expected movement in volatility, or to take advantage of the passage of time (we will see how later).

There are three main types of basic options strategies:
 

1. Vertical Call and Put Spreads

So called because options with the same expiry date are quoted on an options chain quote board vertically.

Hence, vertical spreads involve put and call combination where the expiry date is the same, but the strike price is different.

Examples of vertical options spreads include bull/bear call/put spreads as discussed below, and backspreads discussed separately.

Bull Call Spread Strategy

A Bull Call Spread is a simple option combination used to trade an expected increase in a stock’s price, at minimal risk.

It involves buying an option and selling a call option with a higher strike price; an example of a debit spread where there is a net outlay of funds to put on the trade.

So let’s say that IBM is at $127.

It might be possible to buy a June 125 call for $5.50 and sell a June 130 call for $3.00, a net cost of $2.50 per contract:

• Buy IBM June 125 Call 5.50
• Sell IBM June 130 Call 3.00
• Net Cost: $2.50

Should IBM rise and be above $130 at expiration the spread would be worth $5, thus doubling the invested amount.

Of course, if it is lower, the spread is worth less, with the worst case being if IBM falls below $125, whereby the spread is worthless and all money is lost.

The trade is therefore a risk adjusted ‘bet’ that IBM will rise moderately over the next three months.

We’ve covered the bull call options spreads in more detail here.

Bear Call Spread Strategy

A Bear Call Spread is a similar trade used to trade an expected fall in a stock’s price, at minimal risk. It involves selling a call option and buying another with a higher strike price.

Note that this is a credit spread: ie that we receive money for a trade and, if we are correct and the stock does fall, we get to keep this if both options expire worthless.

So, again, with IBM at $127 we might sell the $160 June call and purchase the $165 June call (ie the opposite of before).

It might be possible to sell a June 125 call for $5.50 and buy a June 130 call for $3.00, a net credit of $2.50 per contract:

• Sell IBM June 125 Call 5.50
• Buy IBM June 130 Call 3.00
• Net Credit: $2.50

If IBM falls below $125, as hoped, both options expire and we get to keep the $2.50.

However, should IBM rise and be above $130 at expiration, the spread would have to be bought back at whatever value IBM is above $130. The breakeven point for the trade is $127.50.

The trade expectation is therefore that IBM will fall moderately over the next three months.
 

Bull Put Spread Strategy

The put version of the bull call spread: i.e. a credit is received for ‘betting’ that stock will move in a particular direction (up, as compared to the bear call spread where the ‘bet’ was for the stock to fall). For example:

• Buy IBM June 125 Put 4.00
• Sell IBM June 130 Put 6.50
• Net Credit: $2.50

The full credit is kept if IBM is above $130 at expiration.

Of course should IBM be between 125 and 130 at expiration, the spread would expire with some value (equal to the stock price less $130). Hence if this value is more than $1.50 – ie the stock price is below $127.50 – the strategy has lost money.

This $127.50 is the break even point of this trade.

Bear Put Spread Strategy

This is the put version of the bull call spread: ie an amount is paid up front which rises in value should the stock will move in the right particular direction (‘down’, compared to ‘up’ for the bear call options spreads). For example:

• Sell IBM June 125 Put 4.00
• Buy IBM June 130 Put 6.50
• Net Cost: $2.50

Should IBM fall below $125 at expiration, the spread is worth $5 (a significant increase from the original $2.50) investment.

However, if the stock is above $127.50, the final value of the spread would be less than the $2.50 paid, and the trade would have made a loss.

We covered the bear put spread in more detail here.

2. Calendar (Horizontal) Spread Strategies

Calendar spread is so called because of options with different expiries being displayed horizontally on an options chain quote board.

They, therefore, involve buying and selling options with different expiry dates, but the same strike price (and, of course, underlying). A calendar spread is a good example or horizontal call or put spread (see more here).

3. Diagonal Spreads

Diagonal spreads are a combination of the two and are complex trades involving options of different strike prices and expiry dates. An example is a LEAP covered call spread detailed later.
 

Covered Call

One popular strategy that doesn’t really fall into the above categories is the covered call which involves the purchase of stock and sell of a call option. More details on the covered call are available by clicking here.
 

Advanced Options Combinations: Complex Put and Call Trades

Options have a lot of advantages; but in order to enjoy those advantages, the right strategy is essential. If traders understand how to use all the trading strategies, they can be successful.

We already been through some basic options combinations; now it’s time to go through some more complex strategies.

In particular, we’ll look at some strategies such as the iron condor and butterfly spread (including when to put on and the related options greeks).

Strangle Strategy

This strategy is a neutral one where an out-of-money put and out-of-money call are bought together simultaneously for the same expiration date and asset. It is also called “Long Strangle”.

When Would You Put One On?

When the trader believes that in the near short term, the underlying asset would display volatility, the strangle is apt.

When Does It Make Money?

In this Option strategy, unlimited money is made when the underlying asset makes a volatile move. It could be downwards or upwards, that doesn’t matter.

• Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
• Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

When Does It Lose Money?

The spread loses money when the price of the asset on expiration is between the Options’ strike prices.

Loss = Underlying Asset Price = Between Long Call’s Strike Price and Long Put’s Strike Price

Options Greeks

The Delta is neutral, the gamma is always positive, Theta is worst when the asset doesn’t move, and Vega is always positive.

Illustration

Assume that Apple Stock is currently trading around $98. A strangle could be a good strategy if the trader is unsure about the direction in which the stock will go.

So, the trader will buy a 97 put and a 99 call. Let us assume they have the same expiration date and value = $1.65. If the stock rallies past $102.3 (3.3+99), the put would have no value and the call would be in-the-money. If it declines, the put would be ITM and the call would have no value.
 

Straddle Strategy

This strategy is also called Long Straddle. When a put and call are bought for the same asset, with the same expiration date and same strike price, it is called a straddle.

When Would You Put One On?

When the trader believes that in the near short term, the underlying asset will display significant volatility, a straddle strategy is used.

When Does It Make Money?

Money is made by the strategy no matter which direction the underlying asset moves towards. The move has to be pretty strong, though.

• Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid
• Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

When Does It Lose Money?

If the price of the underlying asset during expiration is same as the strike price of the bought call and put, the options spread loses money.

Loss = Underlying Asset Price = Long Call/Long Put’s Strike Price

Option Greeks

The Delta is neutral, the Gamma is always positive, Theta rises during expiration, and Vega is always positive.

Illustration

Take a new example and assume that Apple stock is currently around $175. Straddle would be a good strategy if the trader thinks that a huge move would be made on either side. A call and put with the same expiration date as the stock would be bought by the trader. Assume that the 175 Call and the 175 Put cost $10 each. If the stock rallies past $195, the call would be ITM by at least $20 and profits will pour in. If the stock falls below $175, the cost of the straddle would be covered. There is a 50/50 chance of being right about the direction because the cost of the straddle is the maximum loss a trader can incur.

Butterfly

In a butterfly spread strategy, there are three different strike prices. Two calls are bought – one ITM and one OTM. Two ATM calls are sold.

When Would You Put One On?

When the trader believes that the rise or fall of the underlying stock would not be a lot by expiration, a butterfly options spread is the best.

When Does It Make Money?

When the price of the underlying stock does not change at all during expiration, this strategy achieves its maximum profit.

Profit = Underlying Asset Price = Short Calls’ Strike Price

When Does It Lose Money?

When the price of the underlying stock is less than or equal to the strike price ITM long call OR when its price is greater than or equal to the strike price of OTM long call, this options spread loses money.

• Loss = Underlying Asset Price lesser than or ITM Call Strike Price
• Loss = Underlying Asset Price greater than or ITM Call Strike Price

Option Greeks

Delta is always positive, Gamma is lowest at ATM and highest at ITM and OTM, Theta is best when it remains in the profit area, and Vega stays positive as long as the volatility is not too much.

Illustration

Assume that Apple stock is trading at $90. Assume that an 80 call is purchased at $1100, two 90 calls are written at $400 (x2), and a 100 call is purchased at $100. The maximum loss would be the net debit = $400. If the price of Apple at expiration remains the same, the 40 calls and the 50 call would have no value and the profit would be $600. If, however, the stock trades below $80, all the options would be useless. If it trades above $100, the loss from the ITM and OTM calls would be set off by the profit from the ATM calls.

Iron Condor

In this strategy, one OTM put with lower strike is sold after buying one OTM put with strike even lower, and one OTM call with higher strike is sold after buying one OTM call with a strike even higher.

When Would You Put One On?

When the trader believes that low volatility is to be expected, the Iron Condor is chosen.

When Does It Make Money?

When the price of the underlying asset is between the strike prices of the sold call and put, this strategy makes money.

Profit = Underlying Asset Price = Between Short Put Strike Price and Short Call Strike Price

When Does It Lose Money?

This options spread loses money when the price of the stock falls below purchased put’s strike price or rises above purchased call’s strike price. Loss can sometimes be greater than profit.

• Loss = Underlying Asset Price greater than Long Call Strike Price
• Loss = Underlying Asset Price lesser than Long Put Strike Price
   

Option Greeks

The Delta is neutral, the Theta should stay positive, Gamma shouldn’t be too large, and negative Vega should be minimized.

Illustration

Apple Stock is trading at $45, Iron Condor would be – buying 35 Put at $50, writing 40 Put at $100, writing 50 Call at $100, and buying 55 Call at $50. The net credit ($100) is the maximum profit. If the expiration value is the same, all long and short options would be useless and maximum profit would be realized. If it falls to $35 or rises to $55, only the 40 Long Put would be useful and the maximum loss of $400 would be realized.

Conclusion

Spread trading can be a valuable component of an investing strategy. In many cases they can significantly reduce the risk compared to calls and puts strategies. It’s important for those considering options spreads (or any investing strategy) to also consider how well options fit within their portfolios. Some will want to use a combination of approaches, but they must first understand the potential risks.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded epsilonoptions.com in 2012.

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It’s important to know what these terms mean. In addition, you should know under what circumstances you should buy to open and when you should buy to close.

(We have similar post on the opposite trade: Sell To Open vs Sell To Close)

What Is Buy to Open?

The term “open” comes from the fact that you are opening a position when you enter a trade. Buy to open, therefore, means you are buying an option to open a position.

You need to use a buy-to-open order whenever you want to purchase a new long call or long put. This may indicate to other participants in the market that you’ve spotted potential in the market, especially if you’re making a large order. However, if you’re only making a small order, it’s equally possible that you are using the buy-to-open order for spreading or hedging.

Let’s put this into real terms. Imagine you want to purchase a call option where the underlying stock is trading for a $1.30 premium and the expiry date is two months in the future. Let’s say the trading price is $50 with a strike price on the call of $55. To buy this call option through your brokerage, you would need to use a buy-to-open order.

When the time comes to exit the position, you’ll need to use a sell-to-close order. You can do this at any time — even the day after you use the buy-to-open order. In the above example, you may choose to sell to close if the underlying stock price increases to perhaps $57 before it reaches expiry date. When you use a sell-to-close order, the open option becomes closed.

Bear in mind that a buy-to-open order may not always execute. This can happen when an exchange limits to closing orders only during certain market conditions. One example of such a market condition is when the underlying stock for the option you are trying to buy to open is scheduled for delisting. Another reason could be that the exchange will not be trading the stock for some time.

What Is Buy to Close?

As you saw above, buy to open (and sell to close) applies to long calls and puts. For short positions, you have buy to close (and sell to open). In other words, you need a sell-to-open order to establish a new position with short calls and puts.

To be able to sell to open, you need collateral for the position. This can be in the form of the corresponding stock shares or the equivalent value in cash. In the case you have the shares, you’ll be sharing a covered position. If you don’t have shares, you are shorting the option or selling a naked position.

Then, when you want to close the position, you’ll need to use a buy-to-close order.

Selling to open is simple enough. Let’s look in greater detail at what we mean by buying to close.

First, you need to remember that, in options, selling short means writing a contract to sell to another buyer. Your aim is to see the underlying stock price drop, which will bring you a profit when the trade closes.

The trade will end either when it reaches maturity, with you buying back the position, or with the buyer exercising the option. (Exercising the option involves converting it into stock, which is rare.) You will make a profit if the selling or shorting price is higher than the purchase or cover price.

When you buy to close, you exit a short position that already exists. Put another way, you have an open position for which you have received net credit. By writing that option, you are closing that position.

Sell To Open And Buy To Close Example

Let’s put all this (both sell to open and buy to close) into another example. Say you decide that ABC stock is likely to increase in price and want to use the opportunity to make a profit. Therefore, you need to sell to open a put contract for $1.50. In this scenario, let’s imagine that you are right: the stock does increase. This results in making the put worth $0.75. Your profit would therefore be:

$1.50 – $0.75 = $0.75

Now, let’s say the position will not expire for two weeks. You want to secure your profit, meaning you need to close the position. This means you’ll need to use a buy-to-close order. And that’s it. You receive your $0.75 profit.

Buy to Cover

One thing to note: buy to close is not the same as buy to cover. The difference is buy to close is usually for options and sometimes for futures, whereas buy to cover is only for stocks. However, they both result in buying back the asset you originally sold short, meaning you end up with no exposure to the asset.

Buy to Open vs Buy to Close: When to Use Each

Now that you understand the difference between buy to open and buy to close, all that’s left is to be clear about when to use them.

When Should Investors Buy to Open?

Whenever you want to buy a call or put to benefit from a change in price of an underlying asset, you should buy to open. Taking buy-to-open positions is useful for hedging or offsetting risks in your portfolio. It is particularly effective if you use a buy to open a put option that is out of the money at the same time as purchasing the underlying stock.

Overall, buying to open gives the opportunity to see significant gains. Plus, if there are losses, these will be minimal. Of course, there is always the risk that the buy-to-open position will become worthless by its expiration date due to time decay.

When Should Sellers Buy to Close?

As an option seller, time decay is in your favor. All the same, there may be times when you’ll want to close the position before it expires. One instance of when this could be true is in the case of a price increase to the underlying asset. When this happens, buying to close may enable you to access profits earlier.

For example, imagine you are selling at-the-money puts that last 12 months. Then, after two months, the underlying asset increases by 15 percent. You could use the opportunity to buy to close and access the majority of your profits immediately.

Alternatively, buying to close could reduce your potential losses. Let’s return to the same scenario above of selling at-the-money puts. However, this time, instead of the underlying asset increasing by 15 percent, let’s say it decreases by that amount. You could decide to buy to close at this point to avoid even greater losses that you may incur by waiting longer.

Long and Short Options in the Same Position

Some strategies allow you to carry both a long option of an asset and a short option of an asset at the same time. This is useful for giving you the opposite position without needing to close the original open position. In other words, you gain when the underlying asset price moves in the right direction, but you also reduce risk compared to just buying a single option.

Whereas you could buy your long and short options separately, if you’re using a brokerage that specializes in options, the chance is you can enter the strategy as a single trade.

So, when you have a strategy that contains multiple long and short options, what should you use? Should you buy to open (and sell to close) or buy to close (and sell to open)? The answer is: it depends.

For strategies like a bull call spread, bear put spread, long straddles, and long strangles, you’ll use buy-to-open orders. This is because you open these strategies with net debit, meaning you are paying to open the position. You’ll also use sell-to-close orders — it’s just like with long positions.

On the flip side, any time you received net credit for your strategy, you’ll need to use sell-to-open and buy-to-close orders — just like with short positions. Strategies that fall into this category include bull put spreads, bear call spreads, short straddles, short strangles, and iron condors.

Deciding when to buy to open and buy to close sounds simple enough. However, like everything in options trading, it does involve some calculating to predict how the price of the underlying asset is likely to change. This is further complicated when you have an option strategy that includes both long and short options. In these cases, you’ll need to consider your overall position to ensure you make the right decision.

About the Author: Chris Young has a mathematics degree and 18 years finance experience. Chris is British by background but has worked in the US and lately in Australia. His interest in options was first aroused by the ‘Trading Options’ section of the Financial Times (of London). He decided to bring this knowledge to a wider audience and founded Epsilon Options in 2012.

The answer is the Synthetic Covered Call.
 

What Is A Synthetic Option Strategy?

A synthetic covered call is an options position equivalent to the covered call strategy (sold call options over an owned stock). It consists of a sold put option.

Synthetic options strategies use bought and sold call and put options to mirror the payoff, risks, and rewards of another strategy, often to reduce complexity or capital requirements.

For example, suppose a stock, ABC, is trading at $100. Buying 1000 shares would be expensive ($100,000 or perhaps $50,000 on margin).

The same risk and rewards can be achieved by buying an at the money call option (strike price 100) and, simultaneously, selling an at the month put option (exercise price 100).

How do we know these are the same trade? By looking at their pay off diagram. It is a fundamental point of options theory that if the payoff diagrams of two strategies are the same, over time, they are the same position.

Here’s the stock pay off diagram:
 

And the ‘synthetic stock’:
 

These are identical and don’t deviate over time (in fact the payoff diagrams don’t change at all over time – both positions are theta neutral) and so are the same.

But why would you put on this synthetic position? Because it potentially requires much less capital: owning a call option (just the premium) and being short a put option (just any margin requirement) requires less cash up front.

What Is A Covered Call?

We’ve covered this elsewhere, but a covered call is one of the most popular option strategies.

It involves a short call option – usually out of the money – against an owned long stock position.

It’s popular with stockholders wishing to generate income on their portfolio. Selling, say, monthly out of the money (OTM) call options against their stock positions for option premium is attractive, particularly in these low yielding times.

Their only risk that their stock gets called away – the stock rises above the sold call strike price on expiry. But even in this scenario the stockholder would still profit – but not by quite as much as if they had not sold the share.

Let’s look to an example.

An investor owns shares in XYZ, trading at $50 a share, and decides to sell 1 month call options with a strike price of $50, over this holding, receiving premium of $5 a share. This is the classic covered call.