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Options Trading
A Primer
Answer: D – All of the above (start small, learn paper trading, interview several brokers before choosing the one that best suits your needs). Going long: purchasing securities, options or futures with the intention of profiting from an increase in the price of the asset.
The Big Picture
FOREX
If most investors think the company's earnings will disappoint the Street, then prices will be. If you believe that corn prices will fall during this period, you can contract corn futures for three months hoping to make a profit.
HOLDRS
HOLDRS
Discussion: The basic economic rule of supply and demand is used daily in the stock market. For example, if the market price of an option rises without a change in the price of the underlying stock or futures contract, the implied volatility will increase.
Option Basics
The exercise price of the option compared to the current market price (intrinsic value). Discussion: Validity refers to the option's strike price relative to the price of the underlying asset.
Basic Trading
True or False: With a long call strategy, when the price of the underlying asset rises, you make money; when it falls, you lose money. True or False: With a long call strategy, when the price of the underlying asset rises, you make money; when it falls, you lose money. Discussion: Call options appreciate in value as the price of the underlying asset moves higher.
Discussion: If the value of the underlying asset at expiration is equal to the strike price minus the premium, the long put price is equal. Discussion: Selling the put is a bullish strategy that profits when the price of the underlying asset moves higher. As we can see, the risk curve of the long call is sloping up to the right.
Introducing Vertical
At-the-money (ATM): When the strike price of the option is equal to the current price of the underlying instrument. A call option is in the money if the strike price is lower than the market price of the underlying security. A put option is in the money if the strike price is higher than the market price of the underlying security.
A call option is out-of-the-money if the exercise or exercise price is higher than the current market price of the underlying security. A put option is out-of-the-money if the exercise or exercise price is lower than the current market price of the underlying security. The intrinsic value of a put is calculated as the amount by which the market price of the underlying asset is below the strike price.
Demystifying Delta
By dividing the change in the premium by the change in the price of the underlying asset. By dividing the change in the price of the underlying asset by the change in the premium. Multiply the change in the premium by the change in the price of the underlying asset.
Multiply the change in the price of the underlying by the change in the premium. Answer:A—Dividing the change in the premium by the change in the price of the underlying. Delta: The amount by which the price of an option changes for each dollar movement in the underlying instrument.
Other The Greeks
The change in the price of an option relative to the change in the price of the underlying. Delta The change in the price of an option relative to the change in the price of the underlying. Answer: C—The current price of the underlying minus the strike price of the call option.
Discussion: A call option is ITM when the price of the underlying asset is above the strike price. However, movements in the underlying asset will have a dramatic impact on the price of the option. Answer: A – The strike price of the put option minus the current price of the underlying asset.
Straddles, Strangles,
Discussion: This is the optimal type of risk chart that delta neutral traders like to see. Discussion: Like a long synthetic straddle, a straddle has unlimited profit potential and limited risk. Maximum reward = Unlimited at the top and limited at the bottom (since the underlying asset can only fall to zero) beyond breakevens.
Maximum Risk = Unlimited on the upside and limited on the downside (as the basis can only fall to zero) beyond rates of return. Discussion: A long synthetic straddle is a neutral delta trade that consists of long options versus stocks. The maximum profit is unlimited on the upside and limited on the downside (since the basis can only fall to zero) beyond rates of return.
Advanced Delta Neutral
Strategies
In addition, the strategist buys one or more put options and sells a larger number of puts with a lower strike price. Discussion: The put backspread ratio is determined by buying one or more puts and selling a larger number of puts with a lower strike price and the same expiration date. Call ratio backpread: A spread where one call is sold and a larger number of calls are purchased with a higher strike price and the same expiration month.
Put ratio backspread: A strategy that involves selling a put option and buying a larger number of put options with a lower strike price. Ratio call spread: A spread strategy that involves buying a call and selling a larger number of calls with a lower strike price and the same expiration date. Ratio put spread: A strategy to buy put options and sell a larger number of put options with the same expiration date but a lower strike price.
Trading
Techniques for Range-Bound
Markets
Go long the two inner option strikes of the body and go long the wings. Go long the two inner option strikes of the body and go short the wings. Go short the two inner option attacks of the body and go long the wings.
Go short the two inner option attacks of the body and short the wings. Answer:C—Go short the two inner option attacks of the body and go long the wings. In most cases, both the call and the put will be out of the money.
Increasing Your Profits with
The share of an option contract can change as the price of the underlying asset moves higher or lower. An option with a high delta will move much like the price of the underlying asset. Discussion: As the price of the underlying asset moves higher, the call will increase in value.
Discussion: As the price of the underlying asset rises, the put option will lose value. Readers should note that as the stock price increases, the delta of the call increases. Variable Delta: A delta that changes as the price of the underlying asset moves up or down.
Choosing the Right
Broker
Brokerage firms claim to work for their clients and buy at the best available prices. In addition, many online brokerage firms offer a wide range of research, investment tools and information to compete with each other. Brokerage firms that engage in this practice often face a conflict of interest, because because they get paid to route an order to a particular exchange, they may not send the order to the exchange showing the best prices.
Answer:A—Requires brokerage firms to work for their clients and shop for the best prices available. Duty of best execution: Brokerage firms have an obligation to seek the best prices for their clients. Brokerage firms use the form to determine whether options trading is appropriate for the investor.
Processing TradeYour
The two largest, the Chicago Board Options Exchange (CBOE) and the International Securities Exchange (ISE), handle the lion's share of volume. On the first stop at the Chicago Board Options Exchange website, pay particular attention to the "About CBOE" area of the website. Looking through the 30-year history of the first organized options exchange provides great insight into the development and evolution of options trading in the United States.
For example, the "On AMEX" section of the American Stock Exchange website includes information about the structure of the exchange as well as the trade execution process. Taken together, readers can find a wealth of information about how the options market works on the six US websites. Generally, all of these components will need to be part of the order when placed on the phone.
Margin Riskand
Current and historical margin debt levels can be found in the Margin Stats section of the site. Answer: The size of the transaction (number of shares, futures or options) and the risk charged on the transaction. Discussion: In a cash transaction, the investor must pay 100 percent of the transaction costs.
Discussion: In a margin account, traders can buy stocks for less than the 100 percent required to cover the cost of the trade. Therefore, the decision to use margin is ultimately left to the whim of the individual trader. Margin is the amount a company will lend you against the security of the investment you buy.
A Short Course in Economic
Analyses
To better understand economic events, let's start tuning in to events in the bond market. Discussion: In general, bond prices will move in the same direction as stock prices because falling interest rates often bode well for bonds. Traders in bond markets are constantly trying to gauge whether interest rates will move higher or lower, and then buy and sell based on those expectations.
Although trading in bond pits can get wild, the long-term relationship between stock and bond prices is pretty clear. Bond traders work through computers or in the trading pits of the Chicago Stock Exchange. Chicago Board of Trade (CBOT): The oldest commodity exchange in the US, founded in 1886.
Mastering Marketthe
