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Thread: Dr. Dave's Options Thread

  1. #1
    billhart22 is offline
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    Dr. Dave's Options Thread

    Dr. Dave's Options thread is a new thread for those interested in learning options and sharing options experience.
    Last edited by billhart22; 08-19-2009 at 12:22 AM. Reason: A better title

  2. #2
    Dr. Dave is offline
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    Options school 001

    First - just reposting edited versions of stuff from the other thread:

    An options call contract is basically a contract between 1 person that holds 100 shares of a company, and is willing to sell ("sell to open") a contract - for a slight premium to someone who wants to buy a contract for the right (not obligation), to buy 100 shares of the company from him/her (the seller) at a certain price (strike price) by a certain date (options expiration which is the third friday of each month - but you can select contracts - provided they exist for forward months).

    #Why would you want to be a buyer?
    1) you'd rather wait to see if the stock develops in price and then you get your shares at a lower price - maybe you are waiting on news, etc. If the news isn't what you expect, you would just lose the premium you paid (the contract price, which could be a nominal fee as compared to holding a stock that tanks), and that's that. Example, say you didn't want anything to do with SIRI unless it was trading at $3/share by Jan 2010. You could pay just $5 + commissions for a contract to buy 100 shares at the $1 strike price for Jan 2010. If it isn't in your price range by then, you're out $5 + comm. But say it was trading at $8 per share before the expiration date, you have the ability to buy 100 shares at $1 a piece from the person who sold you the contract. You could even turn around that day and sell them at $8 a share and make $700.

    2) hedge your current stock - the opposite of a call contract is a put contract, here the buyer expects the price to go down, and that person gets to buy shares at the strike price to later sell at the open market price. Example, say you thought that earnings wasn't going to be so hot for a stock because you read that over at the hub and you actually believed it, but you have a lot of shares of the stock, and you want to hold out for tax purposes. You could buy a put contract, which will go up in price if the stock goes down in price. Once the downturn (if it ever occurs) is over, and provided the expiration date has not come, you can sell the contract and keep the gains to offset the downturn in stock price.

    3) Just buy contracts and sell them later, pocketing the difference in price. Since they move much more quickly in price, you can say, gain 50% or more in a day, ie. my last trade I made 113% in a day. Meaning you can put less money down, keeping your account more open. Also, you shorten the time frame such that you don't have to go thru the waiting period to get the same move. Example, I paid about $420 for my contract (if I remember correctly), and to get the same gain, I would have had to say, put down roughly $2000 and wait for the stock to move 25%, which honestly, I don't think will happen without a market downturn. On the flipside, you can lose just as much too, and actually, when buying options contracts, you will a little money as each day passes anyway. More on that later.

    Note, selling calls and puts is another game, in fact, selling puts is so risky, that you likely won't be approved for that the first time around. I don't do either.

    #What stocks have options?
    Now, there aren't a lot of these contracts floating around, someone has to have the shares to sell, and most companies (stocks) that do have contracts are your big board established companies - even many stocks tooted by cramer or the fool or whatever don't have option contracts available. So, we are talking tickers like GS, AAPL, AMZN, MSFT, and the likes. You won't find them for say BEHL, or even companies that are mainstream.


    #See if you're interested and can trade them.
    1) Are you interested in option 3 above - just buying and selling contracts? That's all I'll be really talking about.

    2) Do you qualify by your broker to do trade? - if you don't know, I'll tell you some guidelines, so if you think you fit, then add this to your yes list... note, every broker will screen you, its subjective and usually taken on an individual basis. This is what they will be looking at:
    a) how long you have been trading (ie. you can wipe out your account pretty fast, so unless you are funded like $10-20K, I don't see how they would clear someone with under a year of experience.
    b) you're net worth, who knows, they may run another credit check, but they likely did that when you set up a margin account
    c) if you already have a margin account
    d) your balance (you can likely get away with $2k, but I'm no expert on how your brokerage operates)
    If I reviewed your account, I'd likely give a thumbs up to someone with 5 years of experience and 2K in a margin account, but not someone with less years, likewise, if you had 20K in your account, then I'd say 2 years of experience is ok. Like I said, every brokerage is different

    These are just questions from me - I'll put more energy into it if we are on the same page.
    3) Do you and are you comfortable day/swing trade(s)?

    4) Have you traded the big boards (and by this I mean, bought and sold a bunch - not say bought SIRI 5 years ago and averaged down, never sold, still hoping).

    Note, I'll say right now, this is for experienced traders. You should be able to maintain an account without big losses realized or not.

    5) Do you have access to real-time quotes and charts (I guess charts is optional)

    6) Do you have the ability to watch the trade all day - or put in a conditional order while you step away. I've lost a lot of money because I was either asleep, driving to work, etc.


    Some general links to look at:

    http://en.wikipedia.org/wiki/Option_(finance)
    http://en.wikipedia.org/wiki/Call_option
    http://en.wikipedia.org/wiki/Put_option
    http://www.cboe.com/
    Last edited by Dr. Dave; 07-28-2009 at 05:34 AM.
    Positions: Change so often, it's no longer useful to update this...

  3. #3
    Siriusowner is offline
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    Quote Originally Posted by Dr. Dave View Post

    Note, selling calls and puts is another game, in fact, selling puts is so risky, that you likely won't be approved for that the first time around. I don't do either.
    Why ? Because of the leverage ? If you use them properly they are not more risky than owning the underlying (selling puts). Besides, it has been proven that most options expire worthless, therefore if you sell them, you pocket the premium. Do not follow your broker recommendations.

    If you think selling options is risky then start by selling the puts only (selling the calls is a bit riskier). As a beginner, sell them covered not naked. Let me know if you need more help.

    Visit these websites for more information:

    www.cboe.com
    www.ise.com
    www.optionseducation.org
    Last edited by Siriusowner; 08-10-2009 at 07:02 PM.

  4. #4
    Siriusowner is offline
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    Let me explain my philosophy a little bit more:

    When selling puts, the hope is that they will expire worthless, so the max profit is equal to your execution price. Max profit occurs if [ticker] is above [strike price] on expiration day.

    If by any chance [ticker] is below [strike price] on expiration and you do not trade the option, you then become the proud owner of [ticker].

    This is why I recommend selling put options "covered"... in other words, have the money available to buy the underlying in case you get the shares put to you ... Afterwards you can sell calls against your asset and still emulate selling puts. Try it, sell one put for OSIRIS... Sell the September 10 Put for $2.375. Remember, options contracts represent 100 shares of the underlying so you will pocket a $237.50 premium minus commision. (why am I recommending this option ? The probability for the underlying to go below $10 is almost zero AND volatility is quite high... when you sell options you want volatility to decrease and the options to expire worthless...

    If you want to risk more, which I assume most of you penny traders want to do, sell naked puts then... if you want more risk, sell naked calls then...

  5. #5
    Dr. Dave is offline
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    Thanks for the input - I don't have any experience selling contracts. When I was talking about risk, I meant uncovered selling. Some brokerages it seems will turn you down if you have little experience. Anyway, any input you have is more than welcome. So far I have only been involved in some intermediate term buying of calls and puts, but lately, have been just doing them as 1-5 day trades. It's much easier for me to deal with and my record so far has been pretty good, and who can complain with getting a few 100% gains in 1 day, lol.
    Positions: Change so often, it's no longer useful to update this...

  6. #6
    Dr. Dave is offline
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    002

    Anyway, on with the show... again, I'm kind of new to this, but its making me money...

    Info on contracts -

    To get a feeling on what the pricing is - I usually just go to yahoo finance - we'll use AAPL for the examples:

    http://finance.yahoo.com/q?s=AAPL
    Then click options on the left

    That will bring you to here -
    http://finance.yahoo.com/q/op?s=AAPL

    Note, from here, they have a "get quotes" button on the left, but a "get options pricing" button on the right.

    There are tabs you can click for the options expiration. Example, the default is the current month, so this month it is Aug 09. Next months contracts, which you may also trade, are Sep 09, etc.

    *Tip - before you go in, always look on the calendar - the third friday is always options expiration, unless its a holiday. That way you know how many days there are left for expiration, which you may use in certain calculations. Though there are no trading days on the weekends, they will count in these calculations, I believe.

    The symbol is the options contract symbol. In scottrade, they use a dot before the symbol. You also use just the 5 letters usually, so some brokerages (I have more than one - so I know they don't use dots) will use
    QAAHO for the top contract on that list (ignore the X usually for most brokerages)
    .QAAHO will be what scottrade uses

    Options are leveraged, and the tickers represent 100 shares, so going across the top... for QAAHO

    75.00 means the strike price is 75.00 - that means if you had bought the contract, you have the right to buy 100 shares of AAPL from the seller of the contract (who has 100 shares) at $75.00 a share. You can then hold them forever, or sell them on the market - which they are trading near $89.05 today... or, you could sell the contract likely at the ask - but the market is closed, so the numbers will change on monday (we'll the numbers except the strike)

    Symbol is the symbol of he contract

    Last is just like stocks - that was the last price - but it's leveraged so in reality 89.05 means $8905.00 per contract is what will be deducted from your account, but when entering prices for the trade, you would have set a limit at $89.05 likely, if you were the one who placed the last trade. *These prices will certainly differ once tomorrow's open occurs.

    Bid, ask and vol are the same.
    *Tip: Usually you only get the ask or just shy of the ask when buying, so plan on that accordingly if shit starts hitting the fan.
    Volume as you can see is pretty low.

    *Tip: Therefore when scouting out trades, you want to see a decent amount of volume and open interest - like in the upper hundreds/thousands. If you are going to flip a contract, you don't want to see numbers like vol = 1, open interest = 30.

    Open interest, this is how many contracts are open - note, it's tough to guage how many are newly formed contracts and how many have been traded multiple times. There is a discussion about it in John Murphy's book http://stockcharts.stores.yahoo.net/teanoffimajo.html
    You can get this at the library, and decide if you want to buy it - I think its one of the best. Note though, its great for discussion, but after trying my hand at mechanical trading systems, I say don't try to buy and sell macd crossovers etc.

    For the trades, we are (rather I am) doing, you don't have to look up that open interest thing, just be aware of the numbers.

    The yellow background are those contracts that are in the money - ie. where the strike for a call is below the current market price...
    ie I can tell by looking at this chart that the shares of AAPL are between $155 and $160. In the money means if you had the $155 contract, you could "exercise" (meaning buy the 100 shares) and you'd be ahead if you turned around and sold them that instant - ie. if AAPL was $159, you'd make $4 a share instantly if you dumped them, for a profit of $400. Well, once you have the shares, you could sell how many you wanted, so say you sold half, you'd have $200.


    APVHO, for example, is "out of the money" meaning, if you exercised that, it would be pretty dumb, as you could have bought AAPL in our example on the open market for $159, so why pay the $175 a share?????

    "At the money" is when you are right on the line - some will have a small buffer. They don't show that here.. but you can figure it out.

    Things to note - many brokerages will automatically exercise the option contract at the close on the expiration date if you are in the money - so if you don't want 100 shares of something - you need to tell them not too - but on the other hand, you'll also lose the entire thing - ie. the $7335 for QAAHQ if you don't sell the contract by the close.

    Also, take a note at the liquidity - if you were the QAAHQ guy, hopefully there is a rich buyer on the other line - I'm sure there will be, but if you are doing this for some other less thinly traded stock (thinly traded in the option sense) maybe you could miss out -

    You can also call your broker ahead of time and say don't exercise these for me - in most cases (we'll at least for the two brokerages I've used for these).

    Puts - that's everything in reverse...
    Positions: Change so often, it's no longer useful to update this...

  7. #7
    Dr. Dave is offline
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    http://www.volatilitytrading.net/optioncalculator.htm
    http://www.ivolatility.com/

    I finally figured out those calculators.

    We don't need to go over this more complicated stuff early on... but I found some links that we will discuss later. I have been trading without this info up until now - we'll at least for 1-5 day trades.

    http://www.investopedia.com/articles.../04/121604.asp
    http://www.investopedia.com/terms/d/delta.asp
    http://www.investopedia.com/terms/t/theta.asp
    If you are some hardcore math geek:
    http://en.wikipedia.org/wiki/Greeks_(finance)

    Though I'm not a fan of paper trading - at investopedia, you can set up a paper account, and you can trade options there. They make you create or join a game when you do, we could always create our own game. I have an account there already, just have to remember my user name.
    Only drawback, is all trading is overnight daily trading, kind of like the chartgame, which I still like, and I'm thinking of practicing more now, but with certain candles keeping track myself with wins/losses a day ahead of time. ie. to represent buying in the morning, and selling in the afternoon based on the previous day.
    Positions: Change so often, it's no longer useful to update this...

  8. #8
    Dr. Dave is offline
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    Ok, just an example using the trade (for better or worse), that Bass and I made on JPM puts.

    I wasn't looking for anything grandiose, just an example to get in and out of a contract to show that they trade pretty much like stocks. Hopefully, we'll clear enough to get a chicken dinner on this one.

    Anyway, I expect JPM to head down in price. Likely below $40. Just so we could go (hopefully) from out to in to the money, we chose the following contract:
    http://finance.yahoo.com/q/op?s=JPM&m=2009-09
    JPMUH, the first out of the money contract put contract.

    The strike is $40. So that means that if we had 100 shares of JPM, and the price of the stock goes below $40 at any time between now and the third friday of September, we could sell those shares to the person who sold us the contract for $40 a share. So if the price becomes $35 on friday, that day we could sell it and profit $5 a share. However, we are just going to resell the contract, hopefully for a profit. So, for now, we are looking for a drop in the price from where we bought the contracts. Now, what confuses most is that there is a decay in the value of the contract as time goes on. So tomorrow, I'll discuss that a little more. As of late, most of my trades have been for one day, so as long as the expiration of the contract is 3 weeks or more from the expiration, I don't bother looking up what the decay rate will be.

    Anyway, tomorrow, I'll run some numbers using contracts for different expirations for the same strike, then also some with different strike prices, so you can see how these calculations work.

    If I get any of this wrong (I've been doing the calculations on my own), Siriusowner, you're more than welcome to chime in.

    Info on puts:
    http://en.wikipedia.org/wiki/Put_option
    Last edited by Dr. Dave; 08-18-2009 at 05:23 AM. Reason: add link
    Positions: Change so often, it's no longer useful to update this...

  9. #9
    Siriusowner is offline
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    Don't get too complicated trying to explain simple stuff.

    Look, here's a good options education site:

    http://www.interactivebrokers.com/en...&ib_entity=llc

    Remember the CBOE ? sign up for the free CBOE site. They have an agreement with optionsxpress in which optionsxpress provides about 12 to 15 free courses about options. Heck, open an account with optionsxpress just for its educational material. They are expensive so, open it with $2000 and place 1 or 2 trades every few months to keep it open.

    Delta, Gamma, Vega, Theta, otherwise known as the greeks, and volatility constantly change and therefore the direction of the trade (left, right, left, right...) so instead of overtrading, place a trade and forget about it. Just manage it but do not overtrade...if you get bored post on this site, etc ...

    BTW: Try not to trade options just on price, that is one of the cardinal sins. Always, always look at the option volatility (not the stock BETA, BUT the option volatility). If it is too high, the option is expensive, if it is too low, the option is cheap.

    The holy grial of trading options is: How to know if volatility is high or low ? There's 2 volatilities I use: Implied volatility and historical volatility. Compare one to the other to get a feeling but usually when implied goes above historial then it is high and therefore the options price is high. Thinkorswim has all this information readily available in one place so you do not have to use sites like ivolatility.com. Thinkorswim also has probability analysis, the greeks, volatility analysis, prophet (go to prophet.net to learn about it), charts, spread scan, MarketWatch from WSJ, risk profiling, etc ....

    Obviously, the best broker to trade options ? Thinkorswim. It is expensive but their platform worths its every penny. Everything in one place. I vote optionsxpress #2 and interactive brokers #3.

    SOMETHING VERY IMPORTANT: If you insist on buying options only, never buy them out of the money (I'll probably be selling them to you)... The probability of them expiring worthless is too high...
    Last edited by Siriusowner; 08-18-2009 at 11:54 PM.

  10. #10
    bassmaster is offline
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    nice info siriusowner and thanx for sharing your strategy

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