Archive for the ‘Options’ Category

Options: Learning About Volatility   Leave a comment

In October, I was watching the QQQQ climbing for several days. I wasn’t willing to bet that it would continue to rise, but I was willing to bet that it would change and I had a hunch that it might also move more than normal due to the elections coming up. I decided to open a long straddle.

Here’s a chart now (November 8th):

Effectively, instead of betting on the value of the underlying changing, this position is betting that the QQQQ will change more than it has recently. Antithetically, each day that ticks by has a cost that diminishes the value of the contracts. Hopefully, an uptick in the volatility of the QQQQ will offset the time decay of the long contracts, right?

Considering loss control was my first concern. My loss tolerance on this trade was 25%. Using January $52 contracts and an end-date of November 19th insures that I will not exceed a 25% loss. (I did not fill in the numbers for targets, so ignore the last 3 lines in the graphic)


The $52 call was selling for $2.22. The greeks are recreated below. Note the volatility of the call – At the time, this didn’t really seem elevated compared to the QQQQ’s roughly 18% volatility. I would have been much better off if it was below the historical volatility of the QQQQ, but the likelihood of that happening is pretty slim.

Today, the IV of the calls is 22.28% and QQQQ’s historic volatility sits at 22.26%. The small bid/ask spread also makes the QQQQ good for trading.

The price of the underlying has not moved enough to get into the green on this trade. At this point, while I was right in guessing that the volatility of the QQQQ would rise, it has not risen nearly enough to offset the cost of time in the contracts. As time passes, that decay will accelerate.

Here is the profit/loss graph of the position at expiry. The red line marks its position today.

I’ll probably close the trade this week and limit the loss. However, in the interest of improving my strategies when trying to use volatility, I’ve started to read The Volatility Edge in Options Trading by Jeff Augen.

To date, I haven’t done much with trades based solely on volatility but I am definitely interested. Clearly, a sharp increase in volatility could have created a nice profit on this trade. For example, if volatility doubled to 36%, the position would yield about a 50% gain at today’s closing price. With such a big election “event”, I expected a little more movement in the market.

Hope you enjoyed the article.

(All of the images above were taken from OptionsOracle, Fidelity Active Trader Pro and Calc)


Posted November 8, 2010 by jeffkeith in Investing, Options

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Limiting Investment Risk with Derivates – Collars   Leave a comment

So the RIMM position didn’t work out, but I’m still holding the stock so the show’s not over.

The ability to buy and sell put contracts in your investment account lets you employ another options strategy called a Collar. A Collar is a position in which you both sell calls against a stock and buy puts on the stock.

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RIMM Position Outcome   Leave a comment

The May options expired on May 22nd. As a call writer, I get to keep the premiums I received initially. Since the stock closed below the strike of $70, I also get to keep the shares. By writing calls against the stock, I was able to reduce the cost of each share to $68.14. Unfortunately, the stock is at $59.23.

When a short call expires, no additional transaction fees are taken from the options premiums received or applied to the cost of the stock held long. If the stock had been called away (“assigned”), I would have incurred an additional transaction fee for the sale of the shares.

Here’s a quick spreadsheet to show the position calcuations:

The reduction in the cost of the positions from the premiums received for writing the calls offset about 23% of the loss, but the position is still in the red pretty badly.

Here is a 3-month chart as of the close today:

Real Buy-Write Examples: RIMM update   Leave a comment

The last options post explained the RIMM position I setup on April 22nd. The market has taken quite a dive since then and here’s a one-month chart of RIMM:

one month chart of RIMM

One month chart of RIMM against NASDAQ

The blue line overlaying the stock price is the NASDAQ composite. I’ve changed the red horizontal support line to show my cost on the chart, which you can see is above the recent range for the stock.

As of today, the position is down 5.38% or about $1,100. This is not good and definitely not what I want, so I wanted to cover the potential options I have for the position.

Let’s start with a couple basic “risks and obligations”. Remember that I am long 300 shares of RIMM and I am short 3 May 22 $70 calls. Since I’m using a cash account, while I have an open short call position on RIMM, I must maintain a long stock position to cover the obligation I have entered into by writing the May $70 calls. If I want to sell the stock, I have to close the options by entering a “buy-to-close” order for three May $70 calls on RIMM.

So what are my options with this position? (prices below are as of the close today)

  1. I can leave the position open and hope that the stock rises back above my cost and potentially higher. If the stock gets above my breakeven cost of $68.14 by Friday, I can potentially make a profit. If I let it ride I will get to keep the $958.75 I received in option premiums by selling the calls in the first place. This was my intent when I sold the calls and should always be the intent when you setup a buy-write.
  2. I can close the position and take a loss. Going from today’s prices, I would have to “buy-to-close” three May $70 calls at a cost of around $0.11/call with fees. I can then sell my shares at about $65.39. Here is how that works in actual numbers: sell-and-close calculations(Note that a stock-only position would lose $1,792 (8.4%) under the current conditions if sold.)
  3. I can roll the position forward by closing the May options and writing calls further out on the calendar. However, since the stock is below my original breakeven price of $68.14, I will not get as much protection from the calls because the premiums will be lower.  For example, a June $70 call is now bid at $1.41. I also want to make a certain amount off of the investment each month or my money may be better used elsewhere. I would want to write for June to leverage the time decay as much as possible. However, June is also the end of a quarter, and the option chain has price increments of $2.50. I can write calls at $65, $67.50, $70 and so on. The number one consideration for the next write will be to not write it any lower than my cost, which would include the options written in May and the potential June options. The next consideration would be maintaining some type of profit potential and lastly to ensure a decent level of protection. Here’s a little spreadsheet to rough it out:rolling forward analysis
    • You can see that at $60 and $62.50, I can obligate myself to lose money. This would be a huge mistake, because if the stock advances, it will cost even more to undo the trade.
    • The $65 call gives me very little protection and would cost money after brokerage fees.
    • The $67.50 calls give me some very limited cost offset (I would still be in the red) and doesn’t allow for any better profit than the original position in exchange for holding the stock for another month.
    • The $70 strike gives me a good profit potential for the two months but doesn’t really help much in the way of cost offset – I’m still underwater if I write June $70 calls.
    • The $72.50 and $75 strikes offer good potential profit margins but very limited cost offsets.

So I’m not impressed with any of the June calls, except maybe the June $70, which gives me a good monthly rate of return but is disappointing in terms of offering any additional downward protection.

We’re not talking about buying put protection on this position, but that is another option that I could explore. Long puts increase the net cost of the shares in the position but can limit losses to a fixed known value. Ultimately, If I had expected such a pullback in the market or RIMM stock, I would not have purchased the stock. What pullback I expected has been exceeded and now we’re in a bad position.

So what to do? Part of this game is patience, and I’m going to let it ride. I still like the news I’m hearing about RIMM’s activities in markets and partnerships around the globe, and I’m still positive on the market. Once the May options expire, I’ll re-evaluate the position.

Next time I’ll either say what happened with RIMM or describe a position I have open for May expiry in Intel Corp (INTC). The INTC position is a Collar, which has a fixed max loss and fixed max profit.

Thanks for reading!

Real Buy-Write Examples   Leave a comment

So now that you’ve seen how to calculate your breakeven and your potential max profit, let me show you some examples and talk about some of the scenarios you would want to anticipate.

First, let’s reiterate a couple points –

  • When I talk about a “Buy-Write Position”, I am describing a set of transactions that consist of the purchase of stock in even 100-share lots and the sale of an equivalent number of covered call option contracts. You sell one option contract for each 100 shares of stock you own. I’ll refer to the sale of the calls as the “write”.
  • My primary criteria for a trade are based on:
    • My expectations of what the stock might do in the period of time I want to “write” it for – usually the next month but sometimes I’ll write it two months out.
    • My desire to make at least a certain minimum percentage profit if the stock remains unchanged
    • My desire to avoid foreseeable losses by selling off some of the value of the stock in return for time premium. In other words, having every trade result in a win.

Research In Motion (RIMM)

On 4/21 I noticed that RIMM closed just below it’s 50-day moving average and it looked like it was going to bounce back to trade in it’s higher March range around 74-75.

Knowing that I’m frequently, if not always, wrong about these bullish feelings, I also looked at what the reasonable potential downside the stock might have. Clearly, the April 5 low stood out at around $67 and coincided with the highs on 1/14 and 1/15. From this, I established that I would want protection to about the $67 level.

Here’s a six month chart of RIMM as of today. Click the chart to see it full size

With that criteria established, I looked at the option chain for a call that would get me to that level of protection. So, looking at options that had an intrinsic value of around $4.60 (the 4/1 close price of $71.60 minus the $67-level protection I was looking for).

Unfortunately, in order to really make that work, the option chain would have to have an option for every dollar increment in the stock’s price. The RIMM option chain trades in $5 increments at this level. So I had a choice between a $70 and a $65 call.

The $70 call closed at $3.20, and the $65 call closed at $7.10.

Writing the May $70 would put my protection level to $68.40 (The stock price of $71.60 minus the May $70 call premium of $3.20 = $68.40). This was a bit higher than my initial protection target at $67.

Writing the May $65 would put my protection level to $64.50 (The stock price of $71.60 minus the May $65 call premium of $7.10 = $64.50). This was better in terms of protection.

In terms of potential profit, the $70 write would yield $1.60 or 2.34% if assigned, whereas the $65 write would yield $0.50 or 0.78%. These calculations were all just a quick spreadsheet job and did not include brokerage fees.

Here’s where judgement and risk taking come in. My expectation was that the stock would return to trade in the $74-$75 range, and I expected it to trend toward the upward-moving 50-day average. In addition, I noticed that the Chande Momentum Oscillator (the blue line below the stock plot in the chart above) was moving up. With this in mind, I decided to go with the May $70 write and try to capture a larger profit with a little less protection.

On 4/22, RIMM opened a little lower. I modified my spreadsheets and put in my multi-leg order for a buy-write on RIMM that executed something like this:

  • Buy 300 shares of RIMM at $71.31/share
  • Sell 3 May $70 calls for $3.23/contract

If you’ve been watching the market over the last week or so (or turned the news on lately), you’ve seen how the market took a big dive. Since I still had some level of confidence in the market, I left the position on.

Had I just bought RIMM stock and held it through today’s close, I would be down $1,044 or 4.88%. This would have exceeded my stop-loss and I would have simply lost money on the position. This is a profit/loss chart of a straight long-stock position of the 300 shares of RIMM I bought without the offsetting options. Click the chart to see it full size.

Long 300 shares of RIMM by itself

Because of the time left on the options and the increase in the stock’s volatility due to the recent market turmoil, the position is down about 1.8% or $371.46. Here is a chart showing my current position, as of the close today. Click the chart to see the full-size version.

Buy-Write of RIMM, today's value

At expiration, if RIMM remains unchanged (RIMM closed at $67.83 today) I would be down about $93 or 0.45%. You should be noticing the difference in the today chart above, and the expiration chart below – this is how you leverage the time and volatility value in options to offset risk.

Buy-Write of RIMM at expiration

The bad thing about this position is that it has not yet met one of my primary objectives – which is to not lose money. Fortunately, I’ve been able to offset a great deal of the market’s dive with the premiums I received for the calls. You can see, however, that the stock did dip into some seriously negative territory, even with the options premiums received.

Assuming the bottom doesn’t drop out of the market (again lol), we’ll see what happens at expiration on May 22nd.

The next post will talk about some of the potential scenarios that might occur and how I might either adjust or extend the trade to attempt to fix the position and move it back into the green.

Posted May 11, 2010 by jeffkeith in buy-write, derivatives, Investing, Options

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Reading a Profit-Loss Chart   1 comment

Figuring out your breakeven point and potential profit are important calculations. Options generally use what’s called a profit and loss chart/graph to visually represent the potential gains or losses, based on the closing price of the stock at expiry. Because a number of factors affect an option position’s breakeven, the profit-loss graph is only useful at a specific time for a specific underlying’s behavior and price.

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Buy-Write Options Positions – Calculating Breakeven   Leave a comment

To calculate the lower breakeven on a buy-write, you deduct the amount received for calls you write (the “premium”) from the cost of the shares. At expiration, you will get to keep the option premiums you received (by obligating yourself to the call buyer when you wrote the call option contracts). If the stock price is higher than the strike price of the option at expiration, you will also have to sell your stock to the call buyer. This is called “assignment”, and it means that the long option holder is forcing you to sell your stock to them at the strike price of the contract. Regardless of what the stock price is, you have to sell your stock at the previously-agreed upon strike price.

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Posted May 9, 2010 by jeffkeith in buy-write, Investing, Options

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