Let's talk about options

[torero]

willd, you can post it in the Articles category http://www.traderslaboratory.com/forums/f43/

It would be a great read for everyone, including me.

[RhodyTrader]

It's threads like this that scare most people competely away from trading options. It is made to sound like it is incredibly complicated. While that certainly can be the case, it doesn't have to be at all.

A while back I completely shifted away from actually trading stocks themselves to using a very simple and straight forward option strategy to position trade stocks. No spreads. No worrying about B-S and getting all tied up in Greeks (and yes, I am very familiar with option pricing models and methods). The options give me a fixed downside and don't use up nearly as much of my capital as holding the stock would.

[TinGull]

	Quote:	RhodyTrader
	It's threads like this that scare most people competely away from trading options. It is made to sound like it is incredibly complicated. While that certainly can be the case, it doesn't have to be at all. A while back I completely shifted away from actually trading stocks themselves to using a very simple and straight forward option strategy to position trade stocks. No spreads. No worrying about B-S and getting all tied up in Greeks (and yes, I am very familiar with option pricing models and methods). The options give me a fixed downside and don't use up nearly as much of my capital as holding the stock would.

Hi Rhody,

I do agree that it can be made to be very easy. As for fixed downside, how are you fixing that? What strategies are you using?

For example of easiness, I had just bought a few calls of CROX right after Christmas and recently it had broken out to new highs and I sold the calls after making 44% on them. Not bad for a few weeks of holding.

Buying calls can work good, but you have to understand volatility and how it's going to play into that option youre buying. If not, you could buy into a winning stock, but the option could hardly move compared to the underlying if the volatility is just getting sucked out of it.

[wsam29]

your net delta is pretty important as well.

There is no sense having a position on if your net delta is less than +50 if you are long spread or -50 if you are short spread.

For those that do not understand the greeks, just think of delta as how much your options will change in price relative to the stock it derives its price on.

example.

ABC bull call spread, long at 1.00, delta +30

ABC stock goes up 1.00, your bull call spread would be at 1.30 now because the +30 delta. Mind you the greeks change in value depending on how close to the money they are. Once they get In-The-Money (ITM) your delta changes even faster, but that all depends on the Gamma, which is the rate of change of the Delta.

That is why and where people get confused.

There are just too many variables that need to be factored in.

Not to mention the underlying market conidtions will be a major factor to your spread.

[RhodyTrader]

	Quote:	TinGull
	Hi Rhody, I do agree that it can be made to be very easy. As for fixed downside, how are you fixing that? What strategies are you using?

You fixed downside is the cost of your options, plus commissions of course. That assumes you are long the options. If you were short, and unhedged you would have an unlimited upside risk. I stick to just buying calls as proxies for long trades in the underlying stocks.

[RhodyTrader]

	Quote:	wsam29
	ABC stock goes up 1.00, your bull call spread would be at 1.30 now because the +30 delta. Mind you the greeks change in value depending on how close to the money they are. Once they get In-The-Money (ITM) your delta changes even faster, but that all depends on the Gamma, which is the rate of change of the Delta. That is why and where people get confused. There are just too many variables that need to be factored in. Not to mention the underlying market conidtions will be a major factor to your spread.

Here's a very simple way to determine whether an option is too pricey, meaning there is too much volatility built in to the price. Figure out what the intrinsic value of the option would be if the price of the underlying stock were to move by 10%. Compare that to the current price of the option. If it's not at least 50% higher, the option is too pricey.

Let me break that down a bit.

XYZ stock is trading at 51. The 50 Call is currently at 3.50. A 10% increase in the price of XYZ would put the stock at a bit over 56. The intrinsic value of the option - which is stock price minus strike price - would be 6. That would represent an increase in the 50 Calls by 2.50, which is more than 50%. By my personal trading rule, that makes it worth buying. If the option were at something like 5, though, it would be too expensive.

To provide parameters for my option trading I don't hold options into their final month and I always trade at-the-money strikes.

Naturally, the 50% measure is just a guide. And yes, I realize that the option would actually be worth considerably more than the intrinsic value if the market were to rise 10%. I just use this rule of thumb as a very conservative method of identify option trades with real potential.