Stock Market Logic Series #7Options Spreads strategy, let us talk about it.
If you want to buy high-probability spreads, there are specific places where you have the advantage.
And, there are other specific places where it is just pure gambling.
And, we don't gamble, EVER.
We take calculated risks, where the probability of success is much higher than the probability of loss.
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In spread options, what matters the most is where the price will be at the expiration date.
WHY?
Because your profit can only be realized near the expiration date unless the price moves dramatically into your favor and far away from the spread strikes.
So, if what matters is where the price is at the expiration date, you want that in this future date, the price of the stock to be away from it, with HIGH PROBABILITY.
As you can see from the drawing on the chart,
the blue channel signifies the probability area of where the price should be in the future.
So if in the future, you are in the probable zone, as seen in the RED spreads, at the expiration date, the price could be below or above your strikes, and thus be successful or not successful, so your odds are more 50-50.
since the price can just stall there, and oscillate in this area, since it is the probable area where the price should be.
But if you look carefully at historical data, you can see that in the GREEN (MONEY ZONES), the price gets immediately rejected...
WITH THE HELP OF T-I-M-E
And when you buy spreads, you want TIME to be on your side...
So now you can easily see... how to make TIME which is a HUGE factor in spreads, on your side!
The trend is your friend... IF... you let it TIME to help you...
When you use options, and trading options in general you need to know which strategy fits which scenario, and where your HIGH probability trade waiting for you.
Just in case you don't know what options spreads are...
In simple words...
You choose 2 prices of the stock (aka strikes):
------$100
------$90
and you speculate that
if the price in a month will be above $100, you profit 1 point.
and if the price in a month will be below $90, you lose 1 point.
So it is a 1:1 risk-to-reward strategy.
So your advantage comes from knowing where are the pivot points.
But not all pivot points have the same advantage...
As I just showed you in this post...
Options
How to use call option buy or sell indicatorHello Traders,
Exciting news! We've just released a detailed video guide on how to harness the full potential of Chobotaru Brothers Option Indicators. In this short tutorial, we cover everything you need to know to use the indicator, specifically focusing on out-of-the-money call options.
Here's what you'll discover in the video:
1. Adding the Indicator to Your Chart:
Learn the simple steps to seamlessly integrate Chobotaru Brothers Option Indicator into your trading view for a clear and concise analysis.
2. Finding Option Parameters:
Navigate through your broker's option chain on platforms such as Interactive Brokers to locate all the essential parameters needed for effective trading decisions.
3. SEE the Lines of Profit:
Gain a deep understanding of the meaning behind each line of profit displayed by the indicator, empowering you to make informed choices based on market movements.
4. Utilizing Lower Timeframes (Example of 5m and 30m):
Explore the versatility of Chobotaru Brothers Option Indicator by discovering how it can be effectively applied to lower timeframes like 5 minutes and 30 minutes.
5. LIVE Example: Out-of-the-Money Call Option:
Follow along with our real-time example using an out-of-the-money call option, providing practical insights into how EASY is the indicator's functionality and application in a live trading scenario.
We've designed this tutorial to be beginner-friendly, ensuring that traders of all levels can seamlessly integrate Chobotaru Brothers Option Indicators into their trading arsenal. Watch the video, enhance your trading skills, and unlock the potential for greater success in the options market.
If you find the video helpful, don't forget to like, follow, and share it with your fellow traders. Happy trading, and may your profits soar!
Best regards,
Chobotaru Brothers
Option TradingOption Trading work based on a contract that gives the buyer the right to buy or sell a certain asset, at a predetermined price (strike price) within a certain time period.
A very simple task, but is there a clear technical analysis method that can provide consecutive wins?
This post is not trading advice, just a statistical hypothesis test. I will try in 100 candles, and stop if the win rate is below 70%
If you are an options trader, or are interested in learning the system I use, please follow this post.
the Bull Put SpreadIn the world of options trading, there are numerous strategies available to help investors mitigate risk and maximize profit potential. One of my favorite strategies is the bull put spread which I use when I have a bullish outlook on a particular stock or market.
What is a Bull Put Spread?
A bull put spread is a defined-risk, vertical options spread strategy that involves the simultaneous purchase and sale of put options on the same underlying asset with different strike prices. It is typically employed when an investor anticipates a moderate upward movement in the price of the underlying security.
How Does It Work?
To initiate a bull put spread, an investor sells a put option with a higher strike price and simultaneously purchases a put option with a lower strike price. Both options have the same expiration date. The premium received from selling the higher strike put option helps offset the premium paid for buying the lower strike put option. As a result, the strategy is implemented at a net credit, reducing the upfront cost and risk.
Profit Potential:
The bull put spread strategy profits from two scenarios. First, if the price of the underlying security remains above the higher strike price until expiration, both options expire worthless, and you keep the initial net credit received. Second, if the price of the underlying security experiences a moderate increase, the spread narrows in value, allowing you to buy back the short put option at a lower price, realizing a profit.
Risk and Loss Potential:
While the bull put spread strategy offers limited risk compared to naked put selling, it is not without its downsides. If the price of the underlying security falls below the lower strike price, both options may end up in-the-money at expiration. In such a case, the investor incurs a maximum loss equal to the difference between the strike prices minus the net credit received. It is crucial to assess the risk-reward ratio and have a clear exit plan in place to manage potential losses.
Picking your Spot
When you decide you want to try this strategy, the question becomes what stock should I choose? Choose an asset that has sufficient liquidity and options volume. Stocks or ETFs that are actively traded and have a large market capitalization tend to meet these criteria. I have done well with several tech stocks in the past.
Strike Prices: For a bull put spread, you will sell a put option with a higher strike price and buy a put option with a lower strike price. The difference between the two strike prices (less the credit received) will define the spread's width (and the $$ you are risking). Consider strike prices that are below the asset's current price but still provide a comfortable buffer. The specific strike prices will depend on your risk tolerance and profit target.
Implied volatility: Implied volatility reflects the market's expectations of future price fluctuations. Higher implied volatility generally leads to higher options premiums, making it more attractive for option sellers. However, excessively high implied volatility might also indicate heightened risk or uncertainty. Evaluate the implied volatility levels of the options you plan to trade and assess whether they are within a reasonable range.
Time to expiration: The time remaining until options expiration can impact the premium you receive and the potential risks. Shorter time frames generally result in lower premiums but also limit the trade's duration and potential profits. Longer time frames provide more room for the underlying asset's price to move favorably but come with increased exposure to adverse market events. Consider your desired trade duration and how it aligns with your outlook on the underlying asset.
Benefits of a Bull Put Spread
Limited risk: Unlike naked put selling, the maximum loss potential is known upfront, allowing for better risk management.
Lower capital requirement: The strategy is implemented at a net credit, reducing the upfront capital required to initiate the trade.
Profit potential in multiple scenarios: The bull put spread can generate a profit if the underlying security remains above the higher strike price or experiences a moderate increase.
Considerations and Trade-offs
Time decay: The passage of time erodes the value of options, benefiting the strategy as long as the underlying security remains above the higher strike price.
Market volatility: Higher levels of volatility can increase option premiums, potentially improving the initial net credit received.
Margin requirements: Some brokers may require a margin account to implement this strategy, as it involves short-selling options.
Risk Management
Risk is a very personal thing, so you will need to determine the maximum loss you are willing to accept for the trade, and then set appropriate stop-loss orders or exit strategies. Consider the potential loss if the underlying asset's price falls below the lower strike price of the spread. If you're new to options trading or want to validate your strategy, consider paper trading or backtesting your bull put spread using historical data. This can help you assess the performance and risk of your strategy under various market conditions before committing real capital.
The bull put spread strategy can be an effective tool for traders who hold a bullish view on a particular stock or market. By combining the sale and purchase of put options, investors can define their risk, reduce capital requirements, and profit in multiple market scenarios. However, it is crucial to thoroughly understand the mechanics, potential risks, and market conditions before implementing this strategy. As with any investment strategy, proper research, risk management, and ongoing monitoring are key to successful implementation.
📊 Exploring Basic Options StrategiesOptions are contracts that grant buyers the right, but not the obligation, to buy or sell a security at a predetermined price in the future. Buyers pay a premium for this privilege. If market conditions are unfavorable, option holders can let the option expire without exercising it, limiting potential losses to the premium paid. Options are categorized as "call" or "put" contracts, allowing buyers to purchase or sell the underlying asset at a specified price. Beginner investors can employ various strategies using calls or puts to manage risk, including directional bets and hedging techniques.
🔹 Buying Calls (Long Calls)
Trading options offers advantages for those who want to make a directional bet in the market. It allows traders to buy call options, which require less capital than purchasing the underlying asset, and limits losses to the premium paid if the price goes down. This strategy is suitable for traders who are confident about a specific stock, ETF, or index fund and want to manage risk. Additionally, options provide leverage, enabling traders to amplify potential gains by using smaller amounts of capital compared to trading the underlying asset directly. For example, instead of investing $10,000 to buy 100 shares of a $100 stock, traders can spend $2,000 on a call contract with a strike price 10% higher than the current market price.
🔹 Buying Puts (Long Puts)
Put options provide the holder with the right to sell the underlying asset at a predetermined price before the contract expires. This strategy is favored by traders who hold a bearish view on a specific stock, ETF, or index but want to limit their risk compared to short-selling. It also allows traders to utilize leverage to capitalize on declining prices. Unlike call options that benefit from price increases, put options increase in value as the underlying asset's price decreases. While short-selling also profits from price declines, the risk is unlimited as prices can theoretically rise infinitely. In contrast, if the underlying asset's price exceeds the strike price of a put option, the option simply expires without value.
🔹 Covered Calls
A covered call strategy involves selling a call option on an existing long position in the underlying asset. This approach is different from simply buying a call or put option. Traders who use covered calls expect little or no change in the underlying asset's price and want to collect the option premium as income. They are willing to limit the upside potential of their position in exchange for some downside protection.
🔹 Risk/Reward
A long straddle strategy involves purchasing both a call option and a put option simultaneously. While the cost of a long straddle is higher than buying either a call or put option alone, the maximum potential loss is limited to the amount paid for the straddle. On the other hand, the potential reward is theoretically unlimited on the upside. However, the downside is capped at the strike price. For example, if you own a $20 straddle and the stock price drops to zero, the maximum profit you can make is $20.
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Using Put options in SPXU to trade the SPXDisclaimer
All TRADING involves high risk and YOU can LOSE a substantial amount of money, no matter what method you use. All trading involves high risk; past performance is not necessarily indicative of future results.
For Educational Use Only – Not To Be Utilized As Trading Advice
Strategy
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SPXU is inversely correlated to the SPX.
Trade SPXU weekly put options for cheaper premiums and expecting a larger move.
Purchase the weekly SPXU put options contract to trade upside in SPX. (A short term trading strategy to reduce capital outlay)
Use Level 2 Tape Reading to see the supply/demand of the market, including the
Pros
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Less capital outlay so much more efficient
There is a tracking error in the SPXU which can help in getting a better price into the put option (the option pricing will change based on the buyers and sellers in the options market). This can help in time delay for trade setup before the move comes into the SPXU instrument.
SPXU provides (-3x) exposure to a market-cap weighted index of 500 large- and mid-cap US companies selected by the S&P Committee. This -3x exposure can help speed up the change in price of the underlying, which can help move faster towards breakeven and above into profitability in the options contract.
Cons
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Options have an expiry date so some timing does come into question.
There could be a change in the negative correlation between SPXU and SPX due to tracking error.
The trade does not move enough in the direction of the put in SPXU over and above the breakeven that the premium
Premium decay in the option for short-term options which can result in Theta decay.
Put options tend to move slower (shorter deltas) than call options (larger deltas).
Summary
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This strategy is only meant for reducing the capital required to get exposure to the SPX via leveraged instrument such as option.
Trading Options - CALL optionsIt is my logic to trade options, CALL option
Steps:
Crawl options data to get "date change" every day
I will focus on the third expiration, ex: this week 01/07/2022 then expiration to trade: 01/21/2022
I will alert as overchange of 5 days of any strike over +150% then I will follow this one
Setting up indicators: EMA5, EMA10. If price > EMA5 and EMA5 cross up EMA10 then I will CALL
I tried and won some cases.
The above logic is an example very simple to trading CALL options.
How to crawl history price or options from TD Ameritrade API?I crawl options data from Yahoo Finance but actually, Yahoo returned fake data if I send a thousand requests.
I research and use TD Ameritrade API to get options, both github.com and github.com is a good rating. However, every time I send a request a new token is generated then the TD Ameritrade API team noticed me. I like tdameritrade package than td-ameritrade-python-api because of the handled tokens.
======================
Major changes in the v0.1.0 update to the way tokens are handled.
You will still need the original authentication instructions, but the TDClient now takes the refresh token and client id, not the access token. A new session class handles token expiration and will automatically call a new token as needed.
======================
And I used Redis to keep tokens in 30 minutes, then my project works smoothly.
You have a job similar please reference github.com you can download source code and use (the package I am testing)
I hope this source saves your time.
Understanding OptionsTo gain a grasp on options it is essential to understand profit/loss diagrams for the various options whilst also understanding why they display such diagrams. Understanding profit/loss diagrams can help you gain insight into arbitrage trading(which is beyond the scope of this post) and will help you hedge various types of positions. We will first discuss the difference between being long from short, and will conclude why the diagrams are the way they are.
LONG OPTIONS
When you are long an option, you are paying a specified amount of money upfront. What does this mean? This means you can only lose the amount of money that you used to initiate the trade. This is known as having limited loss. Upon paying this premium you have the opportunity to gain infinite profits and will reap such profits if the underlying asset goes in your desired direction, hence you are paying a premium to acquire greater opportunity.
SHORT OPTIONS
Being short options is quite different than being long options. Instead of paying money upfront for the opportunity of large profits, you actually receive money upfront. This is also known as having limited profits. Once you place a short position you already have your max profits set in place. If I receive money upfront then how do I make a profit? Your endeavor as an option seller is for the person on the other side of the trade to be at a loss. Options are a zero-sum game. There are those that profit off of a trader's loss and there are those that acquire that loss. When you are selling an option there is someone on the other side of the trade that is long the option. This is important because as we have learned earlier, long options have infinite profit potential. This means that as an option seller you technically face the probability of having unlimited losses. For example, if you are selling a call there is someone that has purchased the call that you sold. If their call becomes unprofitable then you can buy back the call to offset the call that you have sold, acquiring a net profit. But if their call becomes profitable then you will have to offset the call that you sold, hence buying back the call at a larger price for a net loss.
APPLYING KNOWLEDGE
Lets now take a look at the option's profit/loss diagrams above. The Long Call displays a diagram in which the underlying asset must rise for you to make a profit, with the benefit of having limited losses. The Long Put displays the need for an asset to go down to reap a profit with the added benefit of only having a limited amount that can be lost. The Short Call displays the acquiring of a limited amount of profit with the desire for the underlying to not rise or else an infinite amount of loss will be faced. The Short Put displays the acquiring of a limited amount of profit with the desire for the underlying asset to not go down or else unlimited losses can be faced.
p.s A great way to remember these diagrams is to picture them forming a diamond shape. The image above depicts that of a diamond formation which can help you form new profit/loss diagrams for advanced strategies. It is also very helpful to understand the rights and obligations that the various type of options have.
Explaining The Greeks: DELTAIn case you prefer to read the blog version of the report, it is listed below. I have included an example as well.
What is DELTA?
Delta is one of the four major risk measures in options trading. It measures the amount an options price is affected by a $1 price change in the underlying stock. DELTA is measure on a scale from 0.00 to 1.00 for call options, and 0.00 to -1.00 for put options. Delta is the main component in measuring leverage. This can be done by: (delta/option price)*current stock price. Remember a delta of 0.45 results in a 45 cents change in options prices, which is a $45 change in options value, with every $1 move in stock price. The leverage through this can be huge. As expiration approaches, the delta for in the money options will approach 1.00, whereas, for out of the money options, the delta will approach zero. Delta unofficially is also the probability that the option will expire in the money.
EXAMPLE:
CASH: $100
Current Stock Price: $25/share
Call Option: Strike: 26, Cost: 0.50, DELTA: 0.80
Before expiration the price of the stock rises to $26 per share
If you would have out right purchased shares, it would have costed you $100 for 4 shares.
If you would have bought two call options it would have costed you $100, and you have the right to 200 shares of stock
At expiration your shares, if purchased, would be worth $26 each, or a $4 P/L.
At expiration your contract would be in theory worth 1.00, or $100 each, $200 P/L.
We can calculate your leverage at purchase to be (0.80/0.50)*25 = 40X leverage
PLEASE NOTE: The numbers listed above are extremely unrealistic numbers, I used them for simplicity's sake.
PLEASE NOT: You must have sold your option prior to expiration in order to cash out on your gains.
Asset Classes - Part 3 - For beginnersToday we prepared for you 3rd part of our paper on asset classes for beginners. Purpose of this paper is to concisely detail futures contracts, forwards, swaps and options.
Asset Classes - Part 1 and 2 - For beginners
Feel welcome to read part 1 and part 2 if you have not yet.
Derivative
Derivative is a type of financial asset which derives its value from an underlying asset or group of assets, or benchmark. Underlying assets for derivative contracts can be, for example, stocks, commodities, currencies, bonds, etc. Derivatives are traded on a stock market exchange or over-the-counter (OTC). They can be used as investment vehicles, speculative vehicles and even as hedge against the risk. Additionally, derivatives often allow for use of leverage. Most common derivatives are futures contracts, options, forwards and swaps.
Illustration 1.01
Illustration 1.01 shows the daily graph of gold in USD.
Futures contracts
Futures contract is a standardized derivative that is publicly traded on a stock market exchange. It binds two parties together which are obligated to exchange an asset at a predetermined future date and price (without regard to current value). Expiration date is used to differentiate between particular futures contracts. For example, there may be a corn futures contract with expiration in April and then another corn futures contract with expiration in May. On a day of expiry, also called delivery, the exchange of an asset between the two parties is enforced. Underlying assets for futures contracts can be stocks, commodities, indexes, etc.
Forwards
Forward contract is a derivative contract between two parties to buy or sell an asset at a specified price on a future date. Unlike futures contracts, forward contracts are not standardized. They are customizable and traded over-the-counter rather than at a stock market exchange.
Illustration 1.02
Illustration above depicts the daily graph of continuous futures for gold. It is clearly visible that the gold chart in USD and gold continuous futures chart are resemblant.
Swaps
Swap is another form of derivative contract that binds two parties to exchange cash flows. There are currency swaps and interest rate swaps. Currency swap is defined as the exchange of an amount in one currency for the same amount in another currency. Interest rate swaps are defined by exchange of interest rate payments.
Illustration 1.03
Picture above shows daily graph of S&P500 continuous futures.
Options
Option is a type of financial asset that gives a buyer the right to buy or sell an underlying asset at a predetermined price and date. Options differ from futures contracts in that they do not oblige parties to exchange an underlying asset. There are European-style options and American-style options. European-style options can be exercised only on a date of expiry while American-style options can be exercised at any time before this date. Options that give a buyer the right to buy an underlying asset are called call options. Contrary to that, the put options give a buyer the right to sell the underlying asset. Options are very complex as they involve option risk metrics, so called greeks.
DISCLAIMER: This content serves solely educational purposes.
Options flow predicting moves on Derivatives (Futures)Options have been and are an important instrument on the financial market for a trader trading Intraday Futures. Therefore, while exploring the mechanics of the option market over the last several months, as a result of work, indicators were created that load data from Quandl and then look for patterns that may herald a change of direction on the derivative market - in this case Futures Contracts. There are two main types of Options:
CALL - allow their owner to buy a given product in the future at a predetermined price (Strike Price)
PUT - allow you to sell this product at a predetermined price (Strike Price)
By observing the market volumes of both types of Options, we can observe the sentiment of investors. The key factors are which volume (call or put) prevail in the volume and the dynamics of the volume - what is the trend on volume, whether the difference between them increases or decreases. In addition, the Put / Call Ratio analysis allows you to confirm or negate the signals from the Option volume. The Ratio indicator behaves inversely to the price movement - in the case of a bearish sentiment, we expect the ratio to increase, and in the case of bullish sentiment - the indicator should decrease. If the Ratio follows the price in the same direction, it is an anomaly.
Of course, the mere observation of the Option volumes and the Put / Call ratio is not sufficient, as the Options Market is a much more complicated activity. It is worth including in the calculations such factors as Expiration Date, Bonus Amount, option type (In the Money, Out of Money or At the Money). Not each of the factors is equally important, therefore the key is additionally the appropriate selection of the weighting factors. For this purpose, due to the multitude of data, it is worth using Machine Learning, which I also do by saving the resulting data in a dataset in Quandl and displaying the data in TradingView using Pine Script.
Below are some additional examples from recent sessions on ES showing the predictive nature of the Option sentiment, often preceding major movements in the ES index (during the spot session):
First, from the left, the session from November 15 is shown and an opportunity to play Short. On the right, the session from November 16 and an opportunity to play the Long position this time.
Session from November 10, where we first got the Bull's signal, and at the top we got a warning signal of traffic reversal and the possibility of entering Short:
And one of my favorite moves on November 3:
How Does Implied Volatility Effect Premium Selling Strategies?In this video I address a question from a member of my social media. I wanted to answer this for them and educate others on why paying attention to Implied Volatility is important to your probability of success and your strategy returns if you are employing Premium Selling Strategies (Iron Condors, Credit Spreads, Straddles, Strangles, Butterflies, etc.)
LEARN TO TRADE THE FOREX WITH OPTIONSForex Trading Alternative Using Options to trade the Forex Market.
Hey traders here is in my opinion the best way to build up a small forex account. By trading options on the forex. This strategy will give you staying power in the forex market. It is a great alternative to trading on margin accounts exposing yourself to unlimited risk with a traditional forex broker.
Enjoy!
Trade Well,
Clifford
What is a Call option ?How Do Call Options Work? What Is a Call Option?
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Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.
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How Do Call Options Work?
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Since call options are derivative instruments, their prices are derived from the price of an underlying security, such as a stock. For example, if a buyer purchases the call option of ABC at a strike price of $100 and with an expiration date of December 31, they will have the right to buy 100 shares of the company any time before or on December 31. The buyer can also sell the options contract to another option buyer at any time before the expiration date, at the prevailing market price of the contract. If the price of the underlying security remains relatively unchanged or declines, then the value of the option will decline as it nears its expiration date.
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Use Of Call Options
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Investors use call options for the following purposes:
🔵 Speculation
Call options allow their holders to potentially gain profits from a price rise in an underlying stock while paying only a fraction of the cost of buying actual stock shares. They are a leveraged investment that offers potentially unlimited profits and limited losses (the price paid for the option). Due to the high degree of leverage, call options are considered high-risk investments.
What's the Probability of SPY 500 End of Year?This is not a forecast of AMEX:SPY getting to 500... this video will instead demonstrate how we can answer this question using Options Delta to assess the probability the market expects for an event to happen. I use a backtest of NASDAQ:TSLA Weekly Options to demonstrate.
the chalk or the longshot - pick your poisonUVXY traded upward 20% on 3 January 2020. that was the day the Iranian General, Solemani, was - pick your characterization basd on your politics - murdered assassinated etc. In February 2018 UVXY rose 110% in one session. In March 2020 The Covid spike was $12 to $130 in two weeks. Absent these outliers, UVXY has dropped from over $30,000 in 5 years with the most recent reverse split to $28 today. Along the way there are always these short term interuption of the downward bias based on fear. Fear fuels the spikes. whether it is SPY fear, volatility in all world markets or the spectre of Iranian oil market retaliation. The portfolio of UVXY is completely available cash and the purchase and sale of short dated volatility instruments that are rolled every month. Time decay erodes the portfolio until the spikes occur.
Yesterday UVXY Net asset value dropped 10%.
Those who thing that some volatility should be in a portfolio for the downside protection,r for the gain on instability can today buy the risk on cost to hedge for 48 days at $2.50 with unlimited upside gain. It is possible to reduce that cost with a put vertical that has a lose $2.15 and gain $15 hedge that expires in mid September with a complete loss.
A larger portfolio that has a dividend aristocrat leaning will likely sell the common or buy a September $29/$15 put veertical for $704 to earn $698.
Why the discrepancy? The pricing tells the story. A trend that is inexhortably downward yielding less, or a guess as to the upward spike in volatility.
the chalk is downward. the longshot is the volatility spike for any narratice the investor chooes to believe.
Option Greeks and Implied VolatilityThere are many reasons why an investor or trader trades options. The main reasons, as with other derivatives markets, is to hedge another position or to speculate on the performance of the underlying security.
1) Hedging: A hedge is like an insurance policy in that it can help mitigate risk for a small fee. For example, a portfolio manager buys a large position in Company A stock for its long-term price appreciation potential but is worried that the next earnings report will show short-term issues. He or she can buy put options on that stock that will increase in value if the price of the stock falls on its earnings news.
2) Speculation: Options allow both buyers and sellers to capitalize on their market forecasts, whether they are bullish, bearish, or neutral. However, because options prices depend on many factors, including market volatility, traders can profit from increases or decreases in those factors as well.
While traders can look at individual options data, a very widely used display called an “options chain” lists all options, or a subset, available for a given expiration month. Options traders also look at derivatives of the price that measure how fast their prices decay over time, how fast their prices change with a given change in the price of the underlying, and more. These derivatives are designates with Greek letters such as delta and gamma, so traders call them “the Greeks” .
I. Delta – measures how much an option price changes for a one-point move in the underlying. Its value ranges between 0 and 1 for calls and between -1 and 0 for puts.
II. Gamma – measures the rate of change in delta. It is essentially the second derivative of price.
III. Vega – measures the risk from changes in implied volatility. Higher vol makes options more expensive since there is a greater change than the underlying security price will move above the strike price for a call.
IV. Theta – measures the rate of time-value decay and is always a negative number as time moves in only one direction.
V. Rho – measures the impact of changes in interest rates on an option’s price.
Implied volatility (IV) is the estimated volatility of a security’s price and is critical in the pricing of options. Although not a guarantee, implied volatility tends to increase while the market in the underlying security is bearish. Conversely, when the underlying security is bullish, implied volatility tends to decrease. This is due to the common belief that bear markets are riskier than bull markets.
The most important is that implied volatility is an estimate of the future volatility, or fluctuations, of a security’s price. While levels of implied volatility are associated with bullish and bearish markets in the underlying security, it really does not predict market direction. It only forecasts the sizes of potential price swings. Implied volatility is not the same as historical volatility, also known as realized volatility or actual volatility. Historical volatility measures past market changes in the price of the underlying asset.
Trade with care.
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Basic Options TerminologyOptions or options contracts are agreements to give the holder the right, but not the obligation, to buy or sell a specific amount of the underlying security at a specified price at or until a defined time in the future.
Options are derivative instruments because their value depends on the value of the underlying asset. Further, options are “decaying” assets because, all other things being equal, their value will decline over time until they expire. All assets depend on some definition of value , which is then modified by demand-supply forces established by the market players. However, options depend on many other variables, the most notable being the strike price and the time left until it expires.
In the following paragraphs, we will explain some basic options terminology.
1. Call options: A call gives the holder the right, but not the obligation, to buy a defined amount of the underlying security at a certain price at or by a certain date.
2. Put options: A put gives the holder the right, but not the obligation, to sell a defined amount of the underlying security at a certain price at or by a certain date.
3. Strike price: This is the price at which the holder of the option may buy or sell the underlying security. For example, a call option with a strike of 100 gives the right to the holder to buy the underlying stock at that price no matter what the price of the stock may be at that time.
4. Expiration: The date at which the holder no longer has any rights and the option no longer has value.
5. Premium: The price paid for the option
6. Open interest: The number of options contracts outstanding per strike/expiration combination.
7. Exercise: Using the rights acquired under the option to buy or sell the underlying security.
8. In-the-money: A call option with a strike price below the price of the underlying; a put option with a strike price above the price of the underlying.
9. Out-of-the-money: A call option with a strike price above the price of the underlying; a put option with a strike price below of the underlying.
10. At-the-money: An option with a strike price at or very close to the price of the underlying security.
11. Implied volatility: The calculated expectation of future volatility
12. American style: Options that may be exercised at any time up to and including their expiration date.
13. European style: Options that may be exercised only at expiration.
Option prices contain both an intrinsic value and a time value . The intrinsic value is the value the option would have if it were to expire now. The more in-the-money the option is, the higher the intrinsic value. Out-of-the-money options don’t have any intrinsic value.
Time value is the speculative component. The longer the option has until it expires, the greater the chance that it will move into profitability. This is why a call option with a strike price of 100 has some value even if the underlying security is trading at 50. If there is time left before expiration, there is still a chance the security could rally enough to make the option profitable.
Trade with care.
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