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Retirement Strategies for Senior Citizens to Grow and Protect Their Wealth
Kim posted a article in SteadyOptions Trading Blog
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. 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. -
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There is an issue with Twitter, we are looking into it.
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The individual payoff diagram of each seagull spread will vary based on strike selection, however, below are rough ideas of bullish and bearish seagull spreads: Bullish Seagull Spread: Bearish Seagull Spread: The goal of the trade is to reduce the risk of a vertical spread while still allowing the trader to participate in some directional upside potential. The addition of a third leg (the short put/call) provides a level of protection by using the premiums received to offset potential losses. The strategy tends to be more popular in the Forex world, but it does sometimes come up in the stock and index options world should it fit a trader’s specific market outlook. Seagull Spread vs. Vertical Spread A seagull spread is nothing more than adding a short leg to a vertical debit spread. While it does dramatically alter the payoff profile, the directional market view remains the same. Seagull vs. Vertical Spread Profit Potential The Seagull option strategy is a way of hedging a vertical spread. Like many hedges, it’s really a game of tradeoffs. The short leg of the Seagull spread helps to reduce the cost of the debit spread, and if properly structured, can bring the net debit of the trade to zero. The premium collected from the short leg offsets some potential losses from the debit spread, making the trade’s probability of profit higher than a vanilla debit spread. However, the short leg acts as a double-edged sword. While it can improve the likelihood of making a profit from the trade, it creates a scenario of potentially unlimited losses from the short leg. To illustrate this, let’s pretend we’re trading the following Bullish Seagull Spread in Intel (INTC): ● Buy 27 Call ● Sell 28 Call ● Sell 26 Put The payoff diagram would look like this: As you can see, the debit spread provides no protection against the potentially unlimited risk of the short put with a strike price of $26. On the other hand, let’s look at the same debit spread without the short put leg. Which would be: ● Buy 27 Call ● Sell 28 Call The payoff diagram looks like this: The two options offset each other, leaving the trade to have a defined risk and defined profit potential. However, as you can see, you reach the maximum loss threshold much faster in this vanilla debit spread than you do with the Seagull Spread. When To Use the Seagull Spread: Market Outlook The Seagull Spread is a “safer” way to get a vertical spread-like payoff profile. Selling the third option gives the trade much more room to breathe before you reach your max loss level. In effect, the two spreads are expressing somewhat similar market views, but the Seagull Spread has a short volatility component, so the trade benefits from the passage of time, or is close to being theta-neutral. So a trader should stick to the vertical debit spread when implied volatility is low and they expect a significant move. On the other hand, a Seagull Spread makes far more sense if you think implied volatility is high yet you still have a directional view on the stock price. How to Create a Zero Cost Seagull Option Spread The addition of the third leg of the Seagull Spread enables a trader to turn a vertical debit spread into a spread with a net credit, or close to zero cost. This is dependent on strike selection, but if the premium in the short option outweighs the net debit of the vertical debit spread, the trade can be entered for near-zero cost. Let’s return to the Seagull Spread we created in Intel (INTC), which is: ● Buy 27 Call @ 1.47 ● Sell 28 Call @ $0.95 ● Sell 26 Put @ $0.61 In this trade, we collect $1.56 in credit for selling the call and put, and we pay out $1.47 in net debit, leaving us with a net credit of $0.09. This means that we will collect $0.09 to enter this trade. You can alter your strike selection all you’d like to create a spread with a higher net credit or a small net debit. You should never structure a Seagull Spread solely based on the “net credit” number on your screen. Instead, everything should be driven by your market view. If you don’t have a market view, why are you trading? Bottom Line The vertical spread is the backbone of many options trading strategies. Many strategies rely on simply altering and repositioning a series of vertical spreads. The Seagull Spread expands on this very idea. The addition of a third short leg to a vertical debit spread allows a trader to further shape their options trade structure to fit their market view or risk tolerance. Sometimes you have a market outlook that roughly fits that of a vertical spread, but you want more leeway, which you can give yourself by adding a short option. 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!
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Thanks, we'll check in to it. Right now please follow the trades/contributors to get the notification by email.
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Question I just noticed that over the last two or three weeks I am not receiving Twitter alerts for the new trades and closing trades for steady option trades… I have gone over all the set ups a few times I cannot find where the issue is… Any ideas? And just an FYI I have been receiving them perfectly over the last two years.
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Well merited @tooriginalwhat your contributions lack in originality they have too in spades. 😉
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It's well deserved. When I see a post from you I try to look at it immediately. I appreciate your help and trade suggestions. Thanks @tooriginal.
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Happy to be MOM again. Just trying my best to keep to the conversation going. There are so many tickers-- the buffet threads have been great reminders of what I've been missing. Q4 of 2022 earnings were a difficult time. Q1 of '23 shaped out really well. Here's to a productive Q2 starting in July!
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Member of the month award for May goes to @tooriginal for his continuous contribution of trading ideas and analysis.
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We are trading the index options on the VIX futures, not the futures themselves. No futures trading account is necessary. Yes, I have made the membership aware of the 1256 contract qualification.
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Scott, you and Kim have made it clear that SteadyVol is composed of trading options utilizing VIX futures only; no trades on the spot market. The other day I was looking over some reviews pertaining to Firstrade. A main point made on all the reviews was that Firstrade did not offer a trading platform for futures, and the forex. One of the reviews also stated "Firstrade offers no forex, futures or futures options trading." Since the VIX is an index, and not an equity, is this the reason why Firstrade allows option trading on the futures? Furthermore, regarding the VIX, because it is a cash-settled index option, it would be classified as a 1256 Contract, meaning the SteadyVol trades would have a tax advantage at year's end over equity options trades. Any profits at the end of a trading year would be taxed at 60%(long term) and 40%(short term), which is a plus for those trading the service.
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The Surprising Secret to Proper Portfolio Diversification Revealed
Karl Domm posted a article in SteadyOptions Trading Blog
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: 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. 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. 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. 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. 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. 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: P&L: Covered Call 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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Chartaffair.com - RV Charts & Backtesting for Steady Options
Christof+ replied to Christof+'s topic in Promotions and Tools
@rigulator, a message like this has been reported to me a couple of times over the months. Unfortunately, I am unable to resolve it, I have not experienced it on my machine. Sorry that I cannot be of more help here. I know for sure that the calls to the API follow the rules and are correct. I heard in one case that it helped to install the IB API in the root of C:. But that is more guessing than knowing. -
Chartaffair.com - RV Charts & Backtesting for Steady Options
poseidolginko replied to Christof+'s topic in Promotions and Tools
Great, thanks @Christof+. All's well with SNOW. -
Chartaffair.com - RV Charts & Backtesting for Steady Options
Christof+ replied to Christof+'s topic in Promotions and Tools
@poseidolginko Thanks for the headsup. SNOW is fixed. Please let me know any other symbol with missing data you may come across (Indeed, need to see where the feedback button went. Anyway, it is always fastest to reach me by mail at: chris@chartaffair.com) -
Chartaffair.com - RV Charts & Backtesting for Steady Options
poseidolginko replied to Christof+'s topic in Promotions and Tools
Hello @Christof+. Would you mind looking at SNOW? The straddle & calendar graphs are missing all of the 2022 cycles. Also, what happened to the feedback tab? It's not on the earnings chart any more. Thanks. -
Options Trading Strategy: Bear Put Spread
Chris Young posted a article in SteadyOptions Trading Blog
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! Join SteadyOptions Now! -
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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, 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.
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How Options Work: Trading Put And Call Options
Chris Young posted a article in SteadyOptions Trading Blog
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! Join SteadyOptions Now! -
I'm pleased to announce that our long term mentor @TrustyJules will become a contributor and start posting official trades. He is likely to start with his famous SPY IC "boring trade", but might add other strategies over time. SteadyOptions has now four official contributors: @Kim @Yowster @krisbee and @TrustyJules I recommend following all of us, it will save you time to follow each trade individually. We become better and better over the years!
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Protective Put: Defensive Option Strategy Explained
Chris Young posted a article in SteadyOptions Trading Blog
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. Protective Put Example 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! Join SteadyOptions Now! -
Thanks for clarifying and laying it out for me. Yes, I am aware of the options, just not sure which one to take! I chose to let it sit overnight and I'll see where it's at in tomorrow's final trading day before expiration. I'll probably let it get assigned unless I can roll some of them at a very reasonable price. Thanks
