Options, understandings and tacticsAlan – We open here a forum for discussing options. It might be helpful to open the discussion with a copy of the paragraphs that I wrote 4/24 about options. I don’t know how to cut-and-paste that material.
Before I opened this discussion forum, I noticed a question about choosing a stock that might perform well as an option. I’ve already briefly addressed the subject…and would appreciate knowing about the thinking of others.
I have years of experience, but could not pass myself off as an ”expert.” I prefer that this discussion forum be a gathering of investors with an interest in options…with all of those with greater experience contributing things that they have learned. Our goal is to benefit one another.
This is a discussion topic or guest posting submitted by a Stock Gumshoe reader. The content has not been edited or reviewed by Stock Gumshoe, and any opinions expressed are those of the author alone.
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Greetings, Kevin! I think that we were talking about three things at once here. But on the subject of options, you could check out the assignment that we will address Monday.
You’ll find it written out at #9. Then at #10, I again tried to draw three charts in a row. Third try was at #15.
My three failed attempts led to our discussion about the role of failures in playing with options…or in any of life’s endeavors.
I soon meet a friend, so need to get going. I’ll do our assignment when I get back home, so I’ll be ready to benefit from our gatherings tomorrow here for our option forum. I’m looking forward to learning how The Blind DayTrader analyzes MSFT, the stock he chose for us to consider as an option play.
Lol, wait, how did I get to be the chooser? At the time, I thought I was just suggesting a possibly interesting one for analysis if anyone was looking to analyse something. But okay, if I was looking at it today:
I would start by recent performance, very basic stuff. 21, 50, and 200 day moving averages. I would consider it bullish, if it was above both the 21 and the 50, or maybe if just above the 21 depending on other factors (which is often the more likely case).
The big questions, however, are how fast is it moving, and what is its daily volitility like? Again, this is all on the underlying. I would be looking at the high, low, open, close data for the last several days to weeks, to get some idea of what it’s performance has been like lately. As an aside, given the “blind” part in my name here, you didn’t think I was looking at charts, did you?:) But charts would be the better way to do this. However I also dabble in automated trading (see the “day trader” part of my name), so I have easy access to high-low-open-close data. If I could look at real charts, I would, and I suggest that as the way to look back at stocks for options purposes (or any other). An obvious suggestion, but I wanted it in as a disclaimer.
I would also be considering news about the company (MSFT just came out with good earnings, better than expected). It had been flat for a while, then started moving a little up, then the earnings.
For me, one thing I like to do, is “get to know” a stock. How does it move when certain things happen? Looking at a short circuited version of the above (because I already had LEAP calls on MSFT which had appreciated this year), I decided Thursday that I didn’t think it would stay much above $40 for any length of time, and probably wouldn’t go too far back down. So I placed orders to sell calls at $40, turning my LEAP position into what is called a “bull call spread”, or just a “call debit spread”.
I didn’t get filled on Thursday or Friday, but I’ll try again, although it appears I may have been right, and it didn’t hold $40+.
So, that’s one rather crude way to analyse a stock. There are better ways by far, that involve, for example, looking at supply and demand levels and other things, but I am less competent at those methods, and look forward to any discussions of that here.
Bull Call Spread: http://www.optionseducation.org/strategies_advanced_concepts/strategies/bull_call_spread.html
The Blind DayTrader – Many Thanks!
When I next am considering some stock for its suitability as an option’s underlying stock, I am going to look at it differently. I will pay a lot more attention to the stock’s actions of the past week, and learn whether earnings were better than expected.
I’ve never understood the meaning of “moving averages.” That was the first thing that you addressed, and may be the first thing that you look for when analyzing a stock. Time for me to know what it means.
Margaret – post 22
http://www.investopedia.com is a GREAT site for learning the basics of investing. It covers just about any topic you can think about, and I have yet to see anybody say anything bad about it. Almost all of the information is free.
Introduction to moving averages
http://www.investopedia.com/university/movingaverage/
Trading with moving averages:
http://www.investopedia.com/forex/news/dailyfx/tradingwithmovingaverages.aspx
Pitfalls of moving averages
http://www.investopedia.com/articles/trading/11/pitfalls-moving-averages.asp
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I have created charts for the 30+ stocks that I follow.. Each chart shows the 20, 50, and 200 day moving average. I update the charts manually every day. (If anyone knows how to automate the process, PLEASE let me (us) know !) I have seen no benefit to looking at the moving averages. I’m sure that this is due to the type of price fluctuations of the stocks that I follow, not the validity of using moving averages,
It appears to me that moving averages work best for mid- and long-term investors, and that they are not useful for low-priced speculative stocks.
By the way – I am working on my homework. The sad fact is that, when it comes to options (maybe investing in general), I’m don’t even qualify for Pre-K school. I will have to ask Pastor Liz to pray for me before she moves to Italy.
I’ve charted the past two years of MSFT, and now I’m trying to pick out a put and a call whose combination might be profitable.
The general trend is very positive. The price has remained well above the 200 day moving average since mid-April of 2013. The 20 day moving average dropped below the 50 day at the beginning of 2014 and then rose above it in mid-February. The 20 day is rising somewhat faster than the 50 day. This is a case where the moving averages are saying “buy”. However, the Williams pitchfork is indicating that it is overbought ( it’s probably above its true value ).
Getting back to options — I use Scottrade. I was surprised to learn that (a) their puts and calls go out only to May 30th, and (b) that you can short options. Gee Whittikers! I did not realize that options are this complicated !
Maybe I misunderstood u about auto graph drawing with MA, but Yahoo is constantly updating. I have 20 and 50 periods set as standard overlays for every graph I view.
Hi Pockets: https://uk.finance.yahoo.com/q/ta?s=MSFT&t=3m&l=on&z=l&q=l&p=m50%2Cm20&a=&c=
Hello Margaret, I am not an options trader, however i believe I am ready. I have been an investor for 15+ years and have a similar initial analysis prior to an investment. I use TDA as my broker and enjoy their advanced graph analysis. I use 1 hour for acute timing, 10 day for a recent trend and 6 month for current trend analysis. I further use FINVIS (terrific analytical tool with screening ability and current news articles to measure news hype and Seeking Alpha Pump & Dump). I raise all this process and very much more DD prior to an investment to see how I can take my experience into options trading. I am not looking for an individual review, but just raising simple tools that everyone can use for their analysis. I hope this may be helpful, if not, I am sorry for the intrusion.
Welcome Warner!
Yes, you surely do sound ready. I don’t come anywhere near the depth and breadth of your analysis. And FINVIS sounds really useful.
Tomorrow we will discuss how to analyze stocks….and how to choose an underlying stock for an option play. I gave out an assignment at #9. But my row of 3 charts collapsed into a mess. For a good laugh, take a look at my attempts to get that row of charts to shape up (see #10 and #14).
So you can analyze those 3, plus MSFT. The Blind DayTrader chose MSFT for us, and will lead analysis of it. I am looking forward to learning what he/she has to say about choosing a good underlying stock.
Across time, we’ll want a list of stocks to screen and to analyze. For me, a good underlying stock for an option is difficult to identify…maybe is difficult to find for even very skilled option players. So while you are doing your own screening or analysis, how about jotting down stocks that you think might hold an up-trend for at least 1 month. Also find us some stocks that you think will, with strong probability, be at a higher price in April 2015 for a long-term play. I’ve never gone out more than a year-and-a-half, but you could with options.
Your enjoyment of analysis will serve you really well when choosing and managing option plays. I want to be sure you know that a tactic for stopping losses is more important with options than with stocks. I view stop-loss tactics as vital with options.
For 7 years, I’ve watched only the options share price. Just yesterday, I learned from Blind DayTrader that I will do better if I, instead, watch the price of the underlying stock and cut losses when they are between 5%-10%. So a tight stop.
I’m guessing that you will discover, within not too long, whether your temperament, personality, preferences, comfort level make a good fit for using options. I really enjoy them. Not everyone has a good experience.
Given the old saying Sell in May and Go Away! It may be better to look to either Buy Putt spreads or Sell Bear Call Spreads – look for stocks that are near the top of their recent range that you believe are more likely to correct downwards. Look I am off to golf so I will just post (as my contribution to the education) a Butterfly spread that my share broker recently advised
Enter new Butterfly Spread – EXPE
Expedia, Inc., together with its subsidiaries, operates as an online travel company in the United States and internationally. It provides travel products and services to leisure and corporate travellers, offline retail travel agents, and travel service providers through a portfolio of brands, including Expedia.com, Hotels.com, Hotwire.com, Expedia Affiliate Network, Classic Vacations, Expedia Local Expert, Egencia, Expedia CruiseShipCenters, eLong, and Venere.com. The company’s travel offerings consist of airline tickets, hotel rooms, car rentals, destination services, cruises, and package travel provided by various commercial airlines, lodging properties, car rental companies, destination service providers, cruise lines, and other travel product and service companies on a stand-alone and package basis. It also facilitates the booking of hotel rooms, airline seats, car rentals, and destination services from its travel suppliers; and acts as an agent in the transaction, passing reservations booked by its travellers to the relevant travel provider. In addition, the company provides various media and advertising offerings to travel and non-travel advertisers.
EXPE is scheduled for their earnings announcement on Thursday the 1st May, After Market Close (AMC). Historical price activity shows us that Implied Volatility increases ahead of the earnings announcement (as uncertainty towards the results increases), and on release of the announcement IV will decrease significantly. It is this change in IV that we are entering a Butterfly position for.
This neutral strategy will benefit from the share price remaining at or around the sold strike level ($72.50), however, will also benefit from a decline in IV. Therefore, if the share price gaps on the earnings announcement, which is a reasonable probability, we can still benefit from a change in option values on a regular event occurrence.
The position we will be entering is to Sell the 2x May 72.50 Calls, and to buy the May 62.50 ITM and May 82.50 OTM calls. We will be placing this order at a Limit of $3.55 per share, GTC. This calculates our breakeven levels at $78.95 and $66.05. Our Risk is that the share price gaps through the bought strikes, but that would require a 13.7% price shift in either direction for this to occur %u2013 a relatively low probability.
To manage this position, we will use the cost of the trade as our maximum potential Risk %u2013 that is $3.55 per share. Therefore, if the share price gaps outside of the butterfly spread, the position will be left to run through to expiry.
Following the earnings announcement, we will look for the opportunity to close the trade. Particularly if it is in a profitable position. We have a 50% of maximum potential return profit target, however, we will also look for the opportunity to close the trade should the markets provide an opportunity to adjust the trade. As we cannot be sure of what that adjustment might be at this stage, we will require authorisation for any adjustment outside the parameters of the standard exit plan.
Our expectation is to reduce Risk or exit the trade within 2 days following the earnings announcement.
Latest stock price $72.48
Upper Bought Option May 82.50 Call
2x Sold Option May 72.50 Call
Lower Bought Option May 62.50 Call
Entry Order Buy Limit $3.55
Maximum potential gain $6.45 per share or 181.6%
Upper Breakeven $78.95
Lower Breakeven $66.05
Earnings Date 1st May 2014 After Market Close Position
Management Exit Stop = 100% of Risk
Close position on breach of Breakeven levels
Profit Take following earnings announcement: close trade up to 2-days following earnings
announcement; Take profit if at 50% of expected potential return Evaluate position adjustment; if gap in stock price, buy/sell option positions to reduce Risk of position.
ANNOUNCEMENT TO EXPERIENCED AND SKILLFUL – The next post speaks your language.
See # 24, contribution of Ken Clifton.
Funny for my “announcement” to land AFTER Ken’s post.
So now I thank you, Ken.
Move over Aristotle, Plato, Socrates, Kant, Heidegger, and Sartre! Make room for Margaret Kittelson, philosopher extraordinaire . . . . I too am a collector of wise (and sometimes famous) sayings that capture positive values. My all-time favorite is Winston Churchill’s “Never Give Up” – a phrase that (uttered 3 times with intervening pauses for effect) comprised the Prime Minister’s entire speech given to the graduating class at Eton at a critical point in English history – a few years before the end of WWII. Every time that I turn my cell phone on, that phrase pops up to remind me that perseverance (coupled with good judgment) pays large dividends. A balancing principle is a caveat that I choose to interpret in a positive way as underscoring the critical value of planning: “To fail to plan, is a plan to fail.” In that context, I subscribe to a plan of cutting investment losses to ensure preservation of capital to enable funding of better (profitable) investments. Since I do believe that option trading is a great risk management vehicle, I am committed to working hard to learn how to use the tools of the trade to generate a reasonably predictable income. Semi-regrettably, family vacation plans will preclude my extensive involvement in this new thread for the next 3 weeks – but I will return refreshed and ready to roll!
Lawrence – Ahhh, Such company you put me in!
I wonder what that group would be saying about perseverance. Often, I think that it is the virtue second to only compassion (not pity, but the attitude that compels a person to action). But as a human virtue, maybe I do most value perseverance. When 10 people are struck down by the same affliction, and only one rises up and trudges on, there in that one I honor perseverance.
I think that perseverance also serves investors well. So what about that…a virtue that benefits the virtuous!
I’m glad that you dropped by before leaving for your family vacation. Do have a great time. And I leave with you the first saying I set aside to save.
Don’t wrestle with pigs in the mud. The pigs love it. And you get dirty.
I note that several say they have never shorted a stock. Have you ever taken a profit?,,,,,sold stock,,,,closed a position? If so you shorted that stock by those actions ,,, you shortened or reduced [perhaps to zero] the amount of stock you held. You probably had perfectly good reason for doing so therefore the act of shorting is not bad or wrong.
Everyone that sold QRX after their apparent fraudulent actions engaged in shorting it & further driving down the already crashing price. Was that wrong ?,,,I think not,,,,Just too bad we did not do it sooner.
Same thing when you buy stock you go long or lengthen/increase your holding with the hope you will gain some return for the use of your money. No different than charging for the use of your property of any kind.
Options have a slightly different concept In that while you buy a “Call” to purchase
the stock at a later date,,,,,,you buy a “Put ” to SELL a stock at a later date. Neither action obligates you to complete the purchase of the stock since you are merely buying the right to do so if you choose. That leads to more questions I know. I will continue later if any find this useful.
Very useful information, Frank. Please continue with the lesson.:>)
Frank, Very, Please continue!
There is zero wrong in shorting. It helps the market.
Banning shorting is a dangerous practice.
A successfully shorted stock or index has to be bought back to close the trade and take a profit. Without this, the market could fall to zero with no buyers.
If the market goes up, the shorts lose and are forced to buy out by hitting stops or by choice.
Ken Clifton and The Blind DayTrader are going to find this boring. I currently have 9 different call stock options in my portfolio. I will mention 3 of them here. I am breaking all the rules by buying ‘out of the money’ calls with the maximum expiration (7 are Jan 2016 and 2 are Jan 2015). You have to wait awhile, but I have had fairly good success with this approach.
Since Dr. KSS has glowing reports about Gilead Sciences (GILD), I have purchased some calls in that company. On April 21, 2014, I bought GILD Jan 15 2016 75.0 Calls for 11.30 each (for a cost of $1,130 each plus commisions). Here is the current option chain for Jan 2016;
http://finance.yahoo.com/q/op?s=GILD&m=2016-01
One point that we should stress for the novices; never enter a market order. The bid and asked spread is just too great.
Another thing that I like about options is that they can cure seller’s remorse. On March 27, 2014, I sold pre-split Google (GOOG) at 1107.95 for a nice profit. I felt a void, so on April 23, 2014, I bought post-split GOOG Jan 15 2016 600.0 Calls for 43.50 each (for a cost of $4,350 each plus commissions). Here is the current option chain for Jan 2016;
http://www.nasdaq.com/symbol/goog/option-chain?callput=call&money=all&dateindex=7
Allan; coincidentally, I also have Apple (APPL) calls. On December 12, 2013, I bought AAPL 620.00 JAN 16 WK3 Calls for 66.00 each (for a cost of $6,600 each plus commisions). Here is the current option chain for Jan 2016;
http://finance.yahoo.com/q/op?s=AAPL&m=2016-01
Right now, I am not feeling that confident about Apple. My option now sells for 41.81. The stock hasn’t done much for the past 6 months.
I have only been trading options for the past 1.5 years even though I have a lot of investing experience ( 40 years). My big gains Facebook (FB) and 3D Systems (DDD) calls more than make up for my big loss, Priceline Group (PCLN) put. I do not use charts; but mostly go with gut feel. I usually go with stocks that are volatile and popular.
MONDAY, APRIL 28…OUR FOCUS IS ON
________________________________________________________________
STOCK ANALYSIS
_________________________________________________________________
IDENTIFYING GOOD UNDERLYING STOCKS
FOR OPTION PLAYS
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In preparation for today’s focus on stock analysis, we all have in front of us our sketches of charts for………CBST…………….ARNA…………..DRTX…………….MSFT
We have drawn the trend-lines for these stocks, and noted the volume (including whether volume recently fell or increased). We made note of the 2014 performance of each stock.
Each of us can refer to our research, so that we can follow along with any discussion of these 4 stocks.
Some of you, knowing what the topic of discussion would be today, will suggest analysis of some other stocks. I think that we need to have a chart in front of us in order to grasp the significance of comments about any given stock.
_________________________________________________________
So I recommend that people provide us with up to 3 stock-symbols,
and NOT make any comments at all about those stocks.
____________________________________________________________
Each of us can then sketch the chart’s trend-line, and note volume and any other pertinent information that we will want to have during discussion about the stock. Tomorrow, we will engage with one-another in analysis of those stocks.
Today,tell us how you choose a stock for your portfolio. What is the most important factor for you? What do you put on paper as you screen stocks? What are favorite sources for finding stocks that you might consider buying?
Tell us also what you think makes a good underlying stock of options.
These are rock-bottom fundamental issues. Being fundamental, these issues engage us regardless of whether we have used options for many years, or only now consider maybe using options to increase gains.
There are no correct and incorrect positions regarding stock analysis. There are, instead, preferred and not preferred positions. There may, of course, be more effective (financially profitable) approaches. Regardless, we can honor individual differences even while making a spirited presentation of our own methods of analysis.
I mentioned to some of you that I was looking forward to learning the sort of approach used by The Blind DayTrader for stock analysis. And I am hoping that others of you will tell us your own process when analyzing stocks.
…………………………………..MONDAY’S DISCUSSION FOCUS……………………………….
_________________________________________________________________________
………………………………………WAYS WE ANALYZE A STOCK………………………………….
…………………………………CHOOSING AN UNDERLYING STOCK………………………….
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I want to add these cautions, for anyone (considering) trading any kind of option spreads, especially credit spreads. I am no expert, but maybe someone can learn from my mistakes.
First, always exit early. If you have a profitable position, and a few weeks or days left to expiration, ask yourself the question: “would I open a new position, if all I was getting is what is left to get in this position?” If the answer is no, close it.
I can’t tell you how many times I’ve seen those go bad at the last minute, and usually because someone was trying to catch an extra 10-20%. These days, I generally try to get out at the 75% of possible profit mark, give or take a few percentages.
The second one is this:
Always. Know. When the next earnings release is likely to appear!
I had some very well performing Debit spreads on, and neglected to notice that an earnings release was expected mid expiration month. It hit, and my nicely profitable call spread went ~$40 in the money in the after hours session. I had to do a huge amount of fancy footwork (trading in and out of crazily risky positions to catch intra-day moves for the next two days), and at the end of the week I only managed to save a few thousand of what was a significant loss. I learned some very weird and creative ways to recover partial amounts from failed credit spreads, but those were lessons I really could have lived without. I also learned not to trade Priceline any more.:)
The Blind DayTrader – Delighted that you are here!
Yesterday, I told many people that I looked forward to learning your approach to analyzing MSFT. I gave it a bit of a try. I’ll bet others did, too, because it was our assignment.
Your message here about closing a trade with nice gains, rather than trying to squeeze out everything you might get, surely hit home with me. I learned the lesson years ago, but did not learn the lesson well. So just last month I disregarded the lesson.
My holding was PLUG. At 8:45 AM, PLUG options were up more than 400% on the day. I did not sell. Surely it will keep rising, I said to myself. When I next pulled up my portfolio, PLUG options were -200% on the day. I rapidly sold, and a good thing that I did. PLUG has been down most days ever since. I got a really fine gain of more than X10 on those options. But think of what it would have been if I had done the wise thing.
That experience, and your caution of today, might both help me make better decisions in the future. Thank-you.
It was great to be outside playing golf, but 29 stableford points was a bit disappointing LOL.
I agree with all the caution expressed, really I don’t think that it is possible here to do more than encourage education on options. I would suggest tastytrade.com as a good starting point and look at Sink or Swim software on options. There is also numerous YouTube and other free sources on Option trading.
What would be good IMO would be to do as suggested earlier and for everyone to look at MSFT and the possible option trades that could be done with a view to each of us expanding our knowledge. I am now using a broker that gives recommended option trades on the Aussie and the USA stocks, and the more I learn from their trades the more I realise I do not know and that going it alone against others that have much more knowledge than I have is probably a very mismatched event.
Have a look at million dollar lady option trader http://www.youtube.com/watch?v=cXy9HoWX0es
Hi Ken! ‘Appreciate the recommendation of tastytrade.com and million dollar lady option trader.
log
Earlier on this thread (#9), you can find things I said about my approach to screening stocks, and creating pages with charts that are all from one sector.
For our topic of stock analysis, I favor two trend-line patterns. I’ll mention those in another posting. My search for a good stock does not focus on stocks, but on sectors. So I am giving you my understanding of my favorite sectors.
When I sell an equity or option, so have available investment funds, I decide first which sector I will buy into. For me, it is always sector first. If the solar sector is moving into an up-trend, I will sell 5 or 6 holdings so that I can replace them with solar stocks.
I lost a lot of fun times when the solar sector fell ill, a consequence of malignant abuse. When the abusers were being ridiculed, solar’s lights became visible again. During the past three up-trends of the Solar sector, leading the pack was CSIQ. Others that out-performed the sector were SUNE…SCTY…JKS. I have liked each of these for option plays also. And I have a fondness for one of the solar babies, that was all aglow a year ago, wee HSOL.
I always keep an eye on the Gold/Silver Sector, too, that glittered last fall. This sector is full of immature characters, self-focused and impulsive. In the sector is a group of ballerinas that leap high, and land down hard, hurting tender footsies. They all run into the basement then, where you might find them slumped in chairs to recover. Some in the sector are moody characters who race up the mountainside, then turn around and race back to the cabin in a funk over something, and won’t budge until they get over their grudge.
I like this sector. But the investor needs to be nimble, quick to sell out at the first wail from a drama queen. If you are inclined to hold on to a stock in decline, go find some other sector. Oh…Stay away from solar stocks. Prima Donna’s there, too.
I was going to talk about the shipping sector. Just thinking about shippers, I feel sad. For five whole years. their record’s been bad. But if they should recover, as they surely shall one day, you buy into some shippers and make yourself some hay.
An understanding of the sector’s characteristics is helpful when choosing a stock to buy, then for deciding how to best handle the stock that you are holding..
Here is another link to free information on Options – they will give offers to subscribe but that is your decision, otherwise take advantage of the opportunity to educate yourselves about options
http://www.wyattresearch.com/article/probabilities/
Ken
Ken – Thank-you for giving us this link. Information gives us material for forming a good foundation for our investing. And free information, that I like!
Some of you may have missed a thoughtful post by Jim Skelton, The Blind Squirrel. You can find it in the thread of comments under #20.
Jim’s observation during years as a financial advisor was that clients who used options had many more losing options than gainers. Jim did also observe that options that did well often provided exceptional gain.
These observations certainly have been mine, as well. So I stressed that we have no basis for buying an option with “conviction” or with strong confidence of this option doing well. Statistically, only 1 our of ever 4 options finishes “in the money.” The rest lose money or expire worthless. However, the gains statistically are greater than losses. And carefully chosen underlying stocks for options will provided gains with 2 of every 4 option plays, or for 3 of every 4 option plays.
Our focus today is on choosing with care the underlying stock.
Margaret; The primary reason so many options “expire worthless” is that they were bought to serve as insurance. If you buy Puts you can cut your losses on a stock when the floor falls out from under it. Same idea as buying fire insurance you hope you never use.
Frank…Thank-you for addressing the reason so many options “expire worthless” or lose money. Using options as insurance serves an investor well. Those options make gains as the underlying stock is losing money.
Most of the time, the underlying stock does fine, so the put options lose money. But those put options were in place “just in case”…like our fire insurance is.
Your comment reminds me of a tactic that is enjoyed by many users of options. This tactic is to buy both a call option and a put option at the same time on the same underlying stock.
An example is needed, and I’m not thinking of a stock that fits it. So we’ll call this stock XXX. XXX is a pharmaceutical company with a drug in Phase III that is coming up on an AdCom with the FDA process.
Odds are that the ADCom rejects the drug of company XXX. So you buy put options on XXX with a strike price at about its current price (with expiration for the month after the scheduled FDA review). If the review favors acceptance of XXX;s drug, then XXX;s share price will soar. So you also buy call options on XXX with a strike price at about its current price (with expiration a month out).
These put options and call options will likely play out very quickly in the days after the FDA review. So be alert. Be prepared to sell all of the options very soon after the FDA review.
These options are a play on an event. Following the event, the underlying stock will either rise a lot or fall a lot. But the underlying stock will soon move toward its actual value. You want to sell your options prior to that move of the underlying stock.
This is a fun play. And you do well, whether the vote went for or against the drug of the underlying stock.
There may be nuances to this play that I omitted. So I invite others to add thoughts about using options as insurance, and using options for gains related to events.
I must be misunderstanding??
So you buy both put and calls and because they are leveraged, whichever way it goes, on avg you win. That sounds almost like cheating or to good to be true.
Alan; You have it right ,,,options work because of the leverage. Unfortunately if your strategy is wrong you can guarantee you will lose. That is why you need to develop your own strategy instead of relying on another’s that you might get wrong. At basis all options are “forward contracting” IE ,,,,I will give you $100 to hold that price til Friday ,,,if you find a great price on a Bentley & payday is Friday. You do that because you can rip your ex wife’ s new honey for double the money on Saturday. $100 call & $200 Put or maybe more depending on how sloshed you can get him.
I use dollars because my evil machine refuses to type in Sterling.
Frank – post 38 re pound sterling symbol –
If you use Windows, try holding down the “Alt” key and entering “0163”.
If you use a Mac, try holding down the “Option” key and pressing “3”.
You’re welcome, Alan!.
Alan, It does sound too good to be true. And you do not profit “on average”…You profit ALWAYS .
The situation is a company with a drug in Phase III at the point when the committee recommends that the FDA accept or reject the drug under consideration. You have bought put options on the company. And you have bought call options, also.
A recommendation that the FDA accept the drug ALWAYS results in a rise of the stock-price of the company that developed the drug. Then your call options ALWAYS rise, and may rise 500% or more on the day after the recommendation.
A recommendation that the FDA reject the drug ALWAYS results in a drop of the stock-price, that is typically a severe drop. Then your put options ALWAYS rise, and may rise 500% or more on the day after the recommendation.
You do, of course, want to take SWIFT action to sell the options that are now falling in value. So if the committee recommended acceptance of the drug, you want to swiftly sell your put options.
The amount of gain also depends on the nature of the drug under consideration. In the case of a drug that has generated a lot of interest, the rise (or fall, if the drug is rejected) is much greater. Why? Because a lot of people are invested in the outcome…and a lot of people will be buying both stock and options immediately after the event. Therefore, drugs that generate a lot of interest are the best for profiting through using options.
The same tactic of buying both call and put options can be employed when a large company is coming up to revealing earnings. Revelation of earnings will initiate a move of the company’s stock-price, either to the up-side or to the down-side. A big earnings “surprise” will initiate a big move that much increases the value of either your call options or your put options. As is the case following the FDA decision, you are motivated to sell the losing options right at the opening bell.
Buying both call options and put options in advance of a large company’s report of earnings will likely increase your investment capital (make you money). Buying both call options and put options for FDA outcomes will increase your investment capital…ALWAYS.
So whats with all the analysis? If you can buy both sides and win 10x what you risk, just bet on anything and youll be a 90% winner. Im obviously missing something or we’d all be millionaires.
So if three out of four options expire worthless, who makes more money: the people who buy the one out of four that made money? Why no, it’s the person who sold those worthless three.:)
Whenever you buy an option, you’re buying it from someone. But who? It’s not your broker. No, it’s somebody just like you, who decided to bet the other way. So all those puts that expire worthless when a stock goes up, were none the less paid for. And the people who sold that “insurance”, were the ones who ‘got paid’!
(Market Makers are probably outside the scope here, so I’m pretending they aren’t involved.)
There is always an option play, if you have some good idea of what a stock is likely to do. If it’s going to go up, you could buy a call. If it goes up, your call probably makes money (depending on how far up, and how long it took, and what the volitility was when you bought it). But Instead of buying something, you could just as well sell a put. You get paid right away, and if the stock goes up, and that option expires worthless, you keep what you got paid.
Of course, there is one big ‘honkin problem with this–what if the stock goes down? Well, if you bought the call, you could lose everything you paid for the call. But if you sold the put what happens?
What happens, is that put becomes very valuable to the person who paid you for it. For every dollar the stock drops below the put’s strike price, the put is worth another dollar (approximately).
If the stock recovers, no harm done. But if not, and you let the option expire, you now own that stock, and you paid the strike price for it. Another good reason never to let a short option expire. (A short option is any option you sold instead of bought. Like a put you sell, or a covered call. However, it is okay to let covered calls expire)
Note: I didn’t start this to suggest that selling options is better than buying them (although I think it often is), or to suggest that we should get into a discussion of selling. I am writing it because of all of the talk about three out of four options bought expiring worthless, and to respond to Jim’s point about time being your enemy (or not your friend). Because in options sales, “ti-i-i-ime is on your side, yes it is”.
So, an example.
ABC trades at $100. Bob thinks it is going down, so he buys a put at $95 for $2.00 ($200). Alice doesn’t think ABC is going down, so she decides to collect Bob’s $2, by selling the put to Bob.
If ABC is at $95.01 or more when the option expires, Bob loses his $2, and Alice keeps $2.
However, if ABC falls to $90.00, Bob’s option is now worth more than $5 (probably more like $5.25, but that is beyond the scope of this post).
Let’s say it’s trading at $90, a week before expiration.
Bob paid $2 for his option, but it’s now worth over $5 (let’s say $5.25 to keep it simple). He could sell that put for $525–a $325 profit.
Meanwhile, Alice received $2 for a put which is now worth $5.25. She might buy the sold put back for $5.25 ($525), taking a $325 loss. She may also hang on to it, hoping the stock will rise again, and the option will get cheaper.
If they hold their options until expiration, with ABC at $90, the options expire “in the money” ($95 strike puts, are in the money if the stock is trading at $94.99 or less). So Bob’s puts are exercised, and since he had the right to sell, he sells 100 shares of ABC at $95 each ($9,500). Meanwhile Alice’s puts are “assigned”, and she is forced to buy 100 shares of ABC at $95 each. She spends $9,500. She can hang on to them, or sell them for $90 ($9,000), which, subtracting the $200 she received for selling Bob the put, gives her a loss of $300. Of course, if the stock falls further before she can sell it, she will lose more.
Bottom line: selling puts can be a rewarding business, especially in an up market. But always pay attention to the stock, and buy them back before you lose much!:) A common piece of advice, is to only sell puts on a stock you wouldn’t mind owning.
BDT; Good analysis/explanation. I often enter or increase a position by selling Puts at or below market to effectively lower entry price.
Blind DayTrader – This is so VERY well-done!
Many people like selling options. So I had some motivation to learn what that means. Until now, I seemed to have a mental block as I tried to follow along. But you explained clearly. And when you also provided illustration, I got caught up in the story. When your story ended, I realized with surprise: I understand now!! Thank-you.
Ok, I’m completely new to options, so I will ask a few stupid questions.
I’m unclear on the final part of your example:
“If they hold their options until expiration, with ABC at $90, the options expire “in the money” ($95 strike puts, are in the money if the stock is trading at $94.99 or less). So Bob’s puts are exercised, and since he had the right to sell, he sells 100 shares of ABC at $95 each ($9,500). Meanwhile Alice’s puts are “assigned”, and she is forced to buy 100 shares of ABC at $95 each. She spends $9,500. She can hang on to them, or sell them for $90 ($9,000), which, subtracting the $200 she received for selling Bob the put, gives her a loss of $300. Of course, if the stock falls further before she can sell it, she will lose more.”
1) To be clear, any action Bob takes must be before the put expires, otherwise he’s out his $200. Correct?
2) In order for Bob to take his profit he can either:
a) sell the put, in which case he would make a $325 profit
b) exercise the put, in which case he would have to buy 100 shares of ABC @$90 (9000) and sell them @$95, whereby his profit would be $300.
Do I have it right?
Yes, you have it right. If it expired out of the money, Bob’s “insurance policy” of the bought put, would expire worthless, and he loses his $200. If it expires in the money, his right to sell 100 shares of ABC at $95 will convert automatically (well, his broker does it) into a transaction of selling his 100 shares at $9,500.
As an aside, if he had paid $100 for those shares, he still books a loss, but only of $700 (The $500 between $95 and $100, minus the $200 he spent on the puts). If it was at $90, and he had to sell into the market without the put, he would lose $1,000 instead.
Of course, if he bought months ago, when it was trading at $80, he effectively locked in most of his gains; although to me a stop limit order might be preferable in some circumstances to paying for a put, unless he was using a sold call to pay for the put (a collar, in other words).
Here’s another one of my long messages, to provide an important caution.
Something I left out of my first post on puts, that I believe I really do need to clarify.
What happens if Bob holds his in the money $95 put through expiration? If the stock is trading at $90 (really, anything less than $95), his broker will (probably–there may be some who do something else, but this is the majority case) allow his put to be exercised. Bob will sell 100 shares of ABC at $95 each, for $9,500 cash.
All fine, but what if Bob never planned to exercise that option, and doesn’t actually have 100 shares of ABC? In fact what if he has zero shares of ABC when that option is exercised?
Well, his broker will sell it anyway. The option closes in the money on Friday. On Sunday, 100 shares of ABC go to the option’s counterparty, and Bob’s broker takes 100 shares out of his account, just like would be the case normally.
However, because Bob doesn’t have any shares of ABC, his broker will borrow them on his behalf.
So on Monday morning, Bob will find that he owns negative 100 shares of ABC. In other words, although unintentionally, he has now shorted 100 shares of ABC.
If this is an IRA or some other kind of cash account, Bob has a problem. You can not hold short positions in cash accounts, at least not for any length of time. Bob must buy to cover (to close the short), 100 shares of ABC in the open market. If ABC has kept falling by the time Bob notices this state of affairs, and has now reached $85 or something, Bob’s in a pretty good position. He buys 100 shares, spending $8,500, and pockets a nice $800 profit ($9,500 received, – $8,500 spent, – $200 for the put).
But what if ABC snaps back up, and jumps to $97 by late Monday when Bob checks his account? Well, he still has to buy it, and now he has to spend $9,700–not too good for Bob.
What if Bob doesn’t notice his short? I have only ever had this happen with my current broker, OptionsHouse, never with Ameritrade or Scottrade (where I ran former accounts), so I only know the OH process.
Late Monday, or possibly Tuesday morning, Bob will get an email alert (or phone alert) from his broker, saying that he has a short position in a cash account, and that if he doesn’t do anything, the broker will do something for him, which he probably won’t like. In the OH case, they will probably do that Tuesday morning at 10:00 Eastern.
If all of this happens in a margin account, and Bob can hold short positions of the given size, there may be no real problem. However, given the number of shares that can be controlled by a relatively small options position, the short could be quite massive.
I looked at an account after 3:00 PM EST one Monday, to find a $360,000 short position on in a $54,000 IRA. Oh baby, the adrenalin rush that prompted was not a good thing to experience! Someone had early exercised part of a short call position I had (as part of a butterfly) on good ol’ MSFT, and I had to scramble to make some things happen in a hurry, as nobody wants a margin call in an IRA (or in anything, really). That was not because of expiration exercise, but it has the same effect. (and yes, ultimately it was still a profitable position, but I had to play around and take unintended risks to get it that way)
I have had expiration exercises into short positions before, but most times I knew they were coming, and was planning for them.
Another good reason not to let an option expire–it’s not just the short ones that can get you!
To read more on all of this (a professional writeup), click here (it’s about long puts as a strategy in general, but it covers this).
Hope this helps someone.
Well it certainly helped me…..to realise that playing options is not for someone who has a day job. My heart is beating 10 to the dozen and I havent got $1 invested.
This was a great post and is how I make money on options. Since something like 70% of options expire worthless, the odds are stacked with you if you are short put or short call (covered call) options.
This day is not such a good one for a focus on choosing an underlying stocks for option plays. WHY? Because I can’t find a sector that I like.
So the hunt for some good underlying stocks has not surfaced much for me. Did it for you?
We had our assignment of analyzing 4 stocks. I noticed….No one dared set forth here their analysis. So I’ll give you mine on CBST, for a start.
CBST – This is a biotech, specializing in antibiotics, liked by Dr. KSS. The trend-line shows us a jagged up-trend line rising 30% between September 2013 and January 2014. Nice gain. Investors who had bought 100 shares saw their investment of $6,500.00 rise to $8, 212.00.
CBST stock then plummeted. It plummeted in a dreaded waterfall pattern. WHOOSH down. It dropped 38%.
Investors using a stop-loss tactic [for preventing loss of investment capital] sold after CBST dropped about 10% below its high of $82.12. So they sold at a price near $73.91 for $7,391.00. Across 6 months, they gained $891.00 and re-invested the $7,391.00 2 months ago in some other equity.
Investors using a buy-and-hold approach did not sell their CBST shares when they were falling in price. They still hold CBST, with shares now worth less than they paid for them.
Is CBST now a good buy? It has a trend-line that rises to a peak, then falls into a low valley. This pattern has a lot of appeal to me. Following a break-out from that low valley, there is strong probability of a fairly rapid return to the previous high. However, CBST has not yet broken out. Friday it fell 5.67%.
I would need to see several days of gains before I would consider buying shares of CBST. At that time, I will buy options on CBST. As is my preference, I will choose a strike price lower than the current price.
On some unknown date, no one knows how far into the future, CBST will break out into a new up-trend. I also do not know when my favorite sectors will again post strong gains.
When leaders of my favorite sectors make good gains, I will perk up and start scrutinizing all of the stocks in those sectors. At such a time, I am sure to find many stocks that I will want to buy. That sort of situation is good for buying call options, too.
Here is my thought for the day. [Yes, one thought is my allotment. One, and no more.] Here it is: Keep your powder dry. When sectors are not trending up, keep your powder dry.
Listen as the market talks to you, To me, the market right now is saying, Just sit tight. Wait a bit. Be watchful. Don’t make any buys right now, of either stocks or options. Things are too tippy. And we can’t figure out which way they will end up tipping. Up? Down?
Margaret, please keep the lessons coming….no one wants to raise their hand yet, but we are paying attention in class.
Analog68 — Thanks for the encouragement. I’ve surely benefitted from things people have contributed here, too.
Thoughts of others spur our own thinking. And learning about tactics used by other investors spur us to try new ways of managing risk or increasing gains.
I’ve very much appreciated and valued the little community we form here.
Meg; If I read you right you are talking about buying calls into a rising market. That is a good strategy especially if you have knowledge that they have a good product. I feel you have good instincts about what the market tells you. You can never have complete assurance of action but when everyone is unsure there is opportunity as well as great risk.
I sense the whole world dithering & waiting for USA elections since the $ is the reserve currency by default. There are great forces in play to change that,,to what I do not know.
Exactly, Frank. Great uncertainty, maybe.
I like the way you put it: The whole world dithering and waiting.
I do not buy a stock that is not trending up. I do not buy options on a stock in a see-saw pattern, because that stock is not trending at all. And this market is difficult to buy into because it is similar to the see-saw pattern.
The stock in a see-saw pattern is consolidating, and will break out either to the up-side or to the down-side. Statistically it breaks in the direction it had been heading just prior to consolidation. So if it had been trending down, the odds favor a break to the down-side.
Last week, I thought that gold/silver had broken out. But gains were brief, followed by a drop. I also thought that solar had broken out of its doldrums. Monday, most solars were down 9% to 11%. And I am holding a bunch of them.
The top-gaining stocks Monday were brave representatives from many sectors. From them, I got no messages about where strength resides in this market. Directionless. And I agree…some great force, maybe currently in play, will change that. Change it to what? As you said, “I do not know.” Until I know, I don’t go.
Rather than buy calls, I would sell puts into an uptrend…
ARNA was another stock for us to analyze. Arena Pharmaceuticals has a weigh- loss drug that is widely viewed as safe, without the threat of heart problems that occurred with some previous weight loss medication…a situation that scared people. So ARNA got a lot of attention when its weight loss drug was in FDA trials.
The strong interest in ARNA spurred a lot of buying, and my ARNA shares multiplied my investment many times over as the share price rose. That experience inclines me to buy other stocks that are in Phase III of the FDA approval process. Then came the AdCom. Not approved. ARNA’s share price dropped a lot.
In this sort of situation, options are so valuable to an investor. They cancel the risk of great loss of investment capital . I had call options on ARNA, and I had put options on ARNA. I lost money on my call options, because the underlying stock-price fell. I gained a LOT of money on my put options.
During a second AdCom, ARNA’s weight loss drug was approved. Again, I had both put options and call options on ARNA. This time, my put options lost money, because the underlying stock-price rose. This time, my call options gained money.
The final approval of ARNA’s weight-loss drug did not propel the stock to gain a great deal. And the years since approval have been disappointing for investors. ARNA has been range-bound. The stock-price moves up to near $8.00, then reverses direction. Up. Down. Up. Down. I will not hold on to a stock that is forming this pattern. But I will happily hop on to ride such a stock while it is moving up.
Currently ARNA is rumbling down…now down 22.59% from a $7.70 peak. Many people buy ARNA at this sort of low point of its up-and-down trend-line pattern. They then ride ARNA up to the next peak for a 20% gain, and sell ARNA at this point (while those committed to a buy-and-hold approach start the ride down that will erase all gains made).
So let’s look at the outcome for people who buy ARNA at a low point, and sell at a high point. Four to five times each year, for 3 years, they have been riding ARNA up to a peak (for a 20% gain each time). That is a gain of 80% to 100% each year. And if they use options, their gain is much greater. A great outcome.
So I make a case to buy options on ARNA now. It is at a low point. I am watching for an entry point. A stock-price gain, plus volume increase, are my signals to buy. Volume will increase from its current 4.7 M, typically being at 8 M during each up-trend time. As ARNA draws near a stock price of $7.50, I will become watchful and ready to sell out of this range-bound stock.
Brilliant sleuthing Margaret.
One of the newsleter guys I follow says he like stocks that are cheap, hated, and in an up-trend. If you see a good entrty point based on past experience, let us know. Let’s try this one.
Don -Will do. You watch, too. Let’s see if we can catch that start of a new up-trend for ARNA.
Thanks for your ARNA observation,,,Pattern had eluded my observation,,,I am tempted to follow your lead. As a cautionary buy into an uptrend on a stock you think will ultimately
rise because of good product/prospect sell into downtrend for obverse. I have in the past made money on ARNA but I deemed them to have flatlined.