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WEEK III - FINAL

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WEEK III - FINAL Powered By Docstoc
					WEEK III
• Placing the Buy order for CALLS & PUTS

• I. Before you buy or sell an option you need to know • 1. The STOCK • 2. The EXPIRATION MONTH • 3. The STRIKE PRICE • 4. The TYPE • 5. The PRICE you are willing to buy or sell the option for.

How do I tell my broker which Options I would like to Buy or Sell

• 6. The STOCK OPTION SYMBOL

How option symbols are constructed.
• 1. Getting an option quote can be a little tricky • 2. All option symbols are created by taking the option symbol for an underlying stock and adding a two-letter symbol to represent the MONTH and STRIKE PRICE. • 3. The Option SYMBOL cannot be greater than 3 characters in length ( for listed securities the Stock and the Option trading Symbol are generally the same. ) ( the exceptions we will learn about latter ) • 4. NASDAQ symbols will normally be different than the NASDAQ stock symbols • 5. To find a quote for options trading on a NASDAQ securities like -XZZC ( fictitious ) its option symbol will be changed to 3 characters like XZC - which means to find a quote for option trading on XZC, you must begin with its option trading symbol XZC.

n

SYMBOLS FOR MONTH & STRIKE PRICES MONTH CALLS A B C D E F G H I J K L MONTH PUTS M N O P Q R S T U V W X STRIKE PRICE 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100 STRIKE SYMBOL A B C D E F G H I J K L M N O P Q R S T

T6

n n n n n n n n n n n n n n n n n n n n n
n

MONTH JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC

ODD STRIKE PRICES AFTER SPLITS U, V, W, X, Y, Z

Option Symbols

Now that I have my options and the Option Symbols What next ?
• 1.Tell your broker which options you want to trade. ( if an on-line broker be sure you have the
correct option symbol.)

• 2. Be sure you know the option symbol of the option you wish to sell ( that way you will be sure you have the right option ) • 3. Always give your broker a maximum entry price ( called a LIMIT Order ) ( we will touch on types of orders shortly )

Placing your option order
• You also need to give your broker, one other piece of information.
– OPENING Transaction – CLOSING Transaction

Placing your option order OPENING TRANSACTIONS
• OPENING Transaction = initiates the trade ( it does exactly what it states it opens the trade • EXAMPLE: • BUY 1 XYZ APRIL 65 CALL @ 3 to OPEN • BUY 4 IBM APRIL 110 CALLS @ 4.50 to OPEN • SELL 2 UAL MAR 55 PUTS @ 2.40 to OPEN • SELL 2 WMT JUN 60 PUTS @ 2.40 to OPEN

Placing your option order CLOSING TRANSACTIONS
• CLOSING Transaction = consummates the trade. ( it closes or completes the trade. • BUY 1 XYZ APRIL 65 CALL @ 3 to CLOSE • BUY 4 IBM APRIL 110 CALLS @ 4 .50 to CLOSE • SELL 2 UAL MAR 55 PUTS @ 2 .40 to CLOSE • SELL 2 WMT JUN 60 PUTS @ 2.40 to CLOSE

PLACING AN OPTION TRADE OPENING & CLOSING
• WHENEVER YOU INITIATE AN OPTION POSITION IT IS AN OPENING TRANSACTION. • WHENEVER YOU TERMINATE AN OPTION POSITION IT IS A CLOSING TRANSACTION.
• CAVEAT: YOU MAY HAVE A BUY OR SELL TO OPEN • CAVEAT: YOU MAY HAVE A BUY OR SELL TO CLOSE

PLACING AN OPTION TRADE ( OPENING & CLOSING )
• REMEMBER: Your initial transaction is ALWAYS an OPENING TRANSACTION.
– ( Example if you SELL 2 ABC JUL 50 CALLS to OPEN – THEN YOU MUST BUY 2 ABC JUL CALLS TO CLOSE (unless the – ABC calls expire worthless. )

You’ve selected your option You know the Description You know the Symbol You know how much you want to pay for your option • You know how many contracts you want to purchase • You know that this is an OPENING POSITION because you are initiating the option trade. ( like a door you are OPENING it)

• • • •

IT’S FINALLY TIME TO PLACE YOUR FIRST OPTION ORDER !

• “I would like to BUY

HERE is how it should sound!

5 XYZ CORP. FEB 55 CALLS TO OPEN (Symbol XYZBJ) @ 4 /12 LIMIT for the DAY” • TRANSLATION: • I would like to “ BUY 5 XYZ CORPORATION FEBRUARY CALL OPTIONS, TO OPEN EXPIRING ON THE THIRD FRIDAY BEFORE THE THIRD SATURDAY OF FEBRUARY, FOR A PRICE NOT HIGHER THEN $450 PER CONTRACT, FOR THE DAY”

After you have placed your Order
• 1. Your Broker should read back your order to you exactly as you gave it to him, be sure your listen carefully, especially to the symbol and the Option description • 2. It does not hurt to ask you broker after he repeats your order back to you...What the current price is for the option you wish to purchase. Options can move away form you a lot quicker than stock.

After you have placed your Option Order
• Your broker will confirm your order when it is filled , just as he does when you buy a stock. This should be done over the telephone, but if you have entered your trade by the internet, an email confirmation will be sent you as soon as the trade is completed. • Once your order is filled, be sure to log it in your blotter or position record • You will get a confirmation within several days. • Options unlike stock settle the next day ( meaning they must be paid in full if you are buying them.)

• Let’s start trading Long Calls and Long Puts! • We will be learning many other uses of options in the upcoming weeks, but there is nothing like getting started using the background we have and getting use to a simulation where we can see how it actually feels. The only difference is that THE MONEY ISN’T REAL.

• http://www.cboe.com/tradtool/virtualtrade.a spx
http://www.cboe.com/tradtool/virtualtrade.aspx

T4

1. Selling Calls
1. Covered Call Writing Strategy - ( Very Conservative ) 2. Uncovered Call Writing ( Very Very Risky)

COVERED CALL WRITING

T5

1. Selling Puts
1. uncovered puts / naked puts)

Put Writing

PUT WRITING
• 1. Put stock to you at a lower price • 2. Cover a short position

1. Two Option Strategies that will come in handy in managing your stock portfolios 1. The Collar 2. The Repair

1. THE COLLAR
80

1. You originally purchase a stock at the price of $25 nearly 2 months ago

25

Stock original purchase Price

1. THE COLLAR
80

76 Current Stock
Price

25

Stock original purchase Price

1. The stock now has moved up in price to $76 a share. 2. You want to hold on to the stock because you feel it has some more upside potential . 3. But you don’t want to lose all the profit you have made in the stock.

1. THE COLLAR
80

76 Current Stock
Price

25

Stock original purchase Price

1. The Collar would work like this: 2. Buy 1 XYZ Mar 70 Put @ 3 1/2 = $350 Debit. 3. Sell 1 XYZ Mar 80 Call @ 6 1/2 = $650 credit. 4. This gives you a NET CREDIT of $300 to your account.

1. THE COLLAR
THE MARKET CAN ONLY DO ONE OF THREE THINGS OVER THE COURSE OF ANY SPAN OF TIME.

1. 1. GO UP 2. 2. STAY THE SAME 3. 3. GO DOWN

1. THE COLLAR
Let’s examine all three scenarios

80

1. THE COLLAR Stock Moves up to 82
76

1. The Stock moves up.
Previous Stock Price

2. The Stock is exercised from you at the price of $80 which is the price of the XYZ MAR 80 Call option you sold. 3. The XYZ MAR 70 Put you purchased for 3 1/2 expires worthless with the stock trading above 70.

25

Stock original purchase Price

4. NET PROFIT IS $83 ( $80
for the stock and 3 1/2 credit for net option premiums

1. THE COLLAR
80

1. The Stock stays the same.

76 1/2 Current 2. The XYZ MAR 80 Call option you sold for $650 expires 76 Previous worthless with the stock trading Stock Price below 80 3. The XYZ MAR 70 Put you purchased for $350 also expires worthless with the stock trading above 70.

25

Stock original purchase Price

4. NET PROFIT IS $300 for the NET CREDIT between the option PREMIUMS.
PLUS you still own the stock at

76 1/2

1. THE COLLAR
80

1. The Stock price goes down

25

2. You can sell the stock for the price of $70 eventhough the stock is selling at $40 because you bought a Mar 70 Puts @ Previous 76 Stock Price 3 1/2 3. You also keep $300 in Stock Price drops premium which is the difference between the Mar 80 Call you sold for 6 1/2 Credit and the Mar 70 Put you purchased for 3 1/2 for a 40 Current NET CREDIT of $300. Price 4. NET CREDIT is $70 a share for the stock & $300 for Stock original Option premiums . purchase Price 5. NET RETURN $73 a share

1. THE COLLAR SUMMARY
1. LOWERS THE INSURANCE COST MORE THAN OUTRIGHT PUT PURCHASE 2. REDUCES MARKET RISK AND PROTECTS STOCK PROFITS 3. REMOVES DOWNSIDE RISK 4. ALLOWS FOR SOME UPSIDE POTENTIAL

1. Stock Repair Strategy using Call Options
1. 20 -30% down from your original purchase price 2. would like a chance to at least get even or make a small profit. 3. reduce your current paper loss 4. very little of no additional out-of-pocket expense

1. Stock Repair Strategy
1. XYZ is NOW trading @ $60 a share.
2. So, What do we do to attempt to repair this disaster? ( without
spending more money ) 1. You recently purchased XYZ @ 80 on the expectation that XYZ was going to have a great earnings report. The report comes out and its not what the street expected. THE STOCK DROPS

1. Stock Repair Strategy using Call Options
1. Buy 1 XYZ FEB 60 Call Option @ $5 2. Sell 2 XYZ FEB 70 Call Options @ 2 .50 ( The reason I can sell 2 Feb 70 Call Options is because I am Long 100 shares of XYZ and also Long 1 XYZ FEB 60 Call Option, so I can sell 2 short FEB 70 against my 100 shares XYZ and my long XYZ FEB 60 Call. 3. The Net cost to me is ZERO ( except for commission costs ). 4. I pay $5 for the XYZ FEB 60 Call = DEBIT $500 and I receive $5 for the 2 XYZ FEB 70 Calls = $500 Credit = ( 2 X $2 1/2 ) O

1.

1. THE USE OF LEAP OPTIONS What are LEAPS?

2. Long Term 3. Equity 4. AnticiPation 5. Securities
6. In short, these are LONG TERM OPTIONS usually 1,2,3 years in time 7. Not all stocks have LEAP Options only the most widely traded stocks
1. ( e.g. CSCO, IBM, MSFT, HWP, T, etc. )

1. THE USE OF LEAP OPTIONS
PRICE CHART OF XYZ

160 140

STOCK PRICE

$125

120 100 80 60 40 20 0

1. THE USE OF LEAP OPTIONS
1. 2. 3. 4. 5. Buy a short term option: ( example ) XYZ = $125 XYZ $130 MAY Call @ 5 Breakeven = $135 Risk = $500

1. THE USE OF LEAPS
1. XYZ Trading @ $125 2. 2 - 1/2 Year LEAPS - XYZ $130 Call @ 35 3. Breakeven at Expiration = $167 4. Risk = $3,500

1. Greater time than short term options 2. Leverage - ( for 30% you can participate in the upward movement of the stock for the next 2 1/2 years while only risking $3,500 dollars. 3. Frees up capital to buy other LEAPS for diversification 4. Place difference in a 2 1/2 year fixed income vehicle generating income to reduce the cost of the option even more

1. THE USE OF LEAPS

1. THE USE OF LEAP OPTIONS LEAP Option Regular Option
Cost of Option
Time in Market Cost per day

$5
3 months (90 days) $ 5.55

$35
2-1/4 years (821 Days) $ 4.26

1. THE USE OF LEAP OPTIONS
1. The Movement of an option does not move
point for point with the underlying Stock. 2. The further an option strike price is away from the price of the stock, the less the option will more 3. The further away the option is from the stock price the more speculative it becomes for the buyer of that option 4. As a buyer of options you want an option that is at or more favorably IN- THE - MONEY

1. THE USE OF LEAP OPTIONS
1. The reason that an IN-THE-MONEY option will perform like the underlying stock is due to a factor called its DELTA. 2. DELTA measures how much an option will move in relationship to the underlying security. 3. DELTA is measured in terms from 0 to 100.

1. THE USE OF LEAP OPTIONS
1. IF an option had a DELTA of 80 and the price of that option was 5. 2. Then for every 1 point move in the underlying security that particular option would move 80%. 3. IF the DELTA on an option was 80 and that option was selling for 5. 4. If the underlying stock moved 5 points the option price would increase 4 points. ( 5 X 80% = 4 ) 5. As the price of the underlying stock and option change so does the DELTA. DELTA is ever changing

1. THE USE OF LEAP OPTIONS
Buying a LEAP Call that is at least 20% in the money will make your LEAP act more like the actual STOCK because its Higher DELTA because the LEAP is in the money.

1. 2. 3. 4. 5.

XYZ Trading @ $125 2-1/2 Year LEAPS - XYZ $100 Call @ 50 Breakeven at Expiration = $150 Risk = $5,000 This option is more expensive but offers you movement close to the actual price movement of the underlying security.


				
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posted:10/25/2009
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