Nov

10

Advanced Options Trading – The Iron Butterfly

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The Iron Butterfly
 
 
We know that the butterfly is in reality made up of two vertical spreads. According to Ron Ianieri, co-founder of the Options University and ex Dell Market maker, “when we talk about the iron butterfly, we are really talking about “strangling the straddle”, because what we’re going to do is build the iron butterfly by having a straddle position that has a strangle around it”. With the Iron Butterfly, we might be short the straddle and long the strangle around it or we might be long the straddle and short the strangle around it.
 
Let’s look at the construction of the long Iron Butterfly. For example, we’re going to be short the May $50 put, long a May $55 call, long a May $55 put and short a May $60 call.
 
Short put (OTM); Long Call (ATM) and Long Put (ATM); short call (OTM)
 
When you examine it a little closer, you see long the May $55 call and long the May $55 put. What is that? It’s a long straddle.
 
That long straddle is surrounded by what? A short strangle.
 
The long iron butterfly is premium outlay because we’re long the at-the-money strikes. With the long butterfly, we’re short the interior because we want to collect premium. But with the iron butterfly, we’re looking for a stock to move away from that middle strike in either direction heading toward either the $50 strike or the $60 strike, we don’t care. You see, the $55 straddle is costing us a pretty penny, so how do we offset that price? We sell the strangle around it. By selling that strangle we’re going to take in the little bit of money from the $50 put and we’re going to take in a little money from the sale of the $60 call. Moreover, the extrinsic value that we’re taking in from those two shorts helps to somewhat offset the extrinsic value that we’re putting out for that long $55 strike straddle.
 
However, by selling that strangle around the straddle to help to make the straddle more affordable, we’ve taken away the unlimited upside potential return of the long straddle. So, as Ron puts it, “with both the long iron butterfly and either the short call butterfly or the short put butterfly, we want the stock to move away from the at-the-money strike. We want the stock to move toward either of the other two outside strikes.
 
We know that the short call butterfly and the short put butterfly are synthetically equivalent. Now, we also know that the short call butterfly equals the short put butterfly which equals the long iron butterfly. So many butterflies, so little time.
 
The short iron butterfly acts and behaves not only a lot like your long regular call butterfly or your long regular put butterfly, it acts identically in the same way. They are synthetic equivalents. On the other side, short call butterfly, short put butterfly and long iron butterfly are all synthetic equivalents.
 
So why all these butterflies fluttering around? Knowing that these facts can provide us with an advantage when we’re trying to see which one we’re going to use. We may opt for the call form. We may opt for the put form. We may opt for the iron one because it all depends on which side of the trade we’re doing and what the total effective cost is.
To find out all about stock options, contact the Options University at www.optionsuniverstiy.com

Nov

9

Advanced Options Trading – Greeks and Butterflies

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Greeks and Butterflies
 
Because the long butterfly is set up for premium collection, it’s probably going to have a pretty neutral Delta. If the short butterfly is set up to be able to move away from the strike in either direction, it is going to be a movement play and its not going to have Delta. It’s going to be like your straddles and strangles where we have a Delta neutral position. 
 
From a Gamma standpoint, a long butterfly is going to be short Gamma because in our long butterfly we’re short those two at-the-money strikes. Our long butterfly is a premium collection strategy which means it has to be short two options at the at-the-money strike.
 
In the case of the short butterfly, which is a premium outlay strategy, we’re long those at-the-moneys and they will be long Gamma because we’re going to want movement when we’re short the butterfly. What about our Vega’s? 
 
For the long butterfly, we’re going to be short the at-the-moneys, so if we’re short the at-the-moneys the odds are highly in favor that in our long butterfly we’re going to be short Vega. Why? Because Vega is highest at-the-money and we’re short the two at-the-money options with the long butterfly. With our short butterfly, which makes us long two at-the-money options, we’re going to be long Vega. Ok, what about Theta?
 
In the long butterfly, because we’re short two the at-the-money options, we’re going to be what? Long Vega. Remember, in a premium collection strategy, we’re collecting premium and that means Theta is positive every day and as time goes by the position is decaying and we’re making money off the decaying Theta. We’re going to be long Theta in a long butterfly because a long butterfly is a premium collection strategy and in order to collect premium you’ve got to be long Theta. 
 
But in the short butterfly, as we’re long the two at-the-money options, they have the biggest rate of decay and as we’re long that means we’re going to be losing money every day; Theta, in our short butterfly, is negative. Every day that goes by, those two long at-the-money options are going to decay more than the other two options combined and we lose money.
 
To sum it up, when we’re talking the long butterfly, stock movement hurts our long butterfly because we want a lack of movement. On the other hand, with the short butterfly, movement helps our short butterfly because our short butterfly- being long those two at-the-money options- needs movement.
 
If you find yourself confused about Butterflys and Greeks, take a look at the Options Mastery Course put out by the Options University.

Nov

8

Advanced Options Trading – More about the Butterfly

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More about the Butterfly
 
What is the purpose of the butterfly position? With the long butterfly, we’re talking about a hedged time decay play; we’re looking for premium collection. Moreover, it’s also a hedged volatility trade and it gives us the ability to play volatility but in a fully hedged manner. In short, the butterfly lets us play volatility either long or short in a fully hedged fashion. 
 
In the Stock Options Mastery Course offered by the Options University, they point out that when you break the butterfly down, you are really long a synthetic put. The short put and short call butterfly are the same things, but when you really look at a butterfly and you break down the strikes, what you’re going to find is you’ve got two vertical call spreads in the case of a call butterfly or you’re going to have two vertical put spreads in the case of a put butterfly.
 
For example, if we have a long call butterfly spread, we would be long the $50, short two $55, and long one $60. In reality, we’ve got two vertical spreads, we’re long the $50, $55 call spread and we’re short the $55, $60 call spread. If these were puts, we’d be long the $60, $55 put spread and we’d be short the $50, $55 put spread. So, what we have in a long butterfly are two separate vertical spreads each sharing a common strike.
 
If we’re long the $50, $55 call spread, we want the stock to move right to $55 or better. However, when we look at our $55, $60 call spread that we sold we want to see the stock heading down to $55 or worse. You see, the butterfly is actually two vertical spreads in the same position.
 
The same thing happens with the short butterfly; you’re either going to be short the $50, $55 call spread and long the $55, $60 call spread or you’re going to be long the $50, $55 put spread and short the $55, $60 put spread. Two spreads.
 
But if we look at it further, we’ll see that we have two converging vertical spreads or two diverging vertical spreads. With the long butterfly, we have two call spreads, the first we’ve got the $50, $55 call spread. We want the stock to trade to $55 or better. Meanwhile we’re short the $55, $60 call spread so we want that stock to trade down to $55 or worse. 
 
What we have here are two conflicting call spreads, both converging on a single spot and that’s the shared middle strike, $55. Both hit their maximum profit potential at that point right at $55. So the long butterfly is simply two converging vertical spreads. The long butterfly whether it’s a put or a call wants these two vertical spreads to converge in the middle at that one point, that point of maximum profit for both of them the short strike, the $55 strike.
 
With the short butterfly, we are short the $50, $55 call spread; we want the stock to trade away from $55 heading down toward $50. Meanwhile, we are long this $55, $60 spread and we want it to trade up towards $60 where we maximize our value. In fact, we have two diverging vertical spreads; both starting at the same point which is the point of highest potential loss and wanting to move away from that point in either direction, diverging away from that point. So when you’re looking at the butterflies look at converging and diverging vertical spreads.
 
If this sounds too confusing and you want to learn more, contact the Options University at www.optionsuniversity.com

Nov

7

All About The Butterfly Options Trading Strategy

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About the Butterfly
 
This article is not about Michael Phelps and his Olympian deeds; this is about one of the most popular stock option strategies used by knowledgeable option traders.
 
But there are some who feel that the four legged strategy, meaning its got four different options involved, generates a lot of commissions, which is nice for the brokerage firms and that is probably why it is so popular.
 
Some newcomers to the strategy get a bit flustered because it appears to be more confusing than it really is. According to Ron Ianieri, co-founder of the Options University, when you sit there and see the butterfly, don’t get confused and scared. It’s really just a combination of a couple very basic strategies, so don’t get all freaked out. 
 
Long Butterfly
 
First, when we’re constructing the long or short butterfly we must use either all calls or all puts to construct the conventional butterfly. A long butterfly always starts out with three equally spaced strikes. So, for instance $50, $55 and $60, and we’ve got $5 between each of the end strikes. We have to make sure that the strikes are the same distance between each one in the series.
 
For the long Butterfly, we start with one long in-the-money call or put option. We then sell two call or put options at the center strike price. To complete the position, we buy one long call or put option which is out-of-the-money. It is like a sandwich with the two short options between the two long options. We are trying to position the two center options as close to the money as possible. Remember, we use all calls or all puts. The ratio is 1:2:1. Indeed, the “meat” (credit) is in the center and that’s why we want them as close to at-the-money as possible. Why? Because that’s where extrinsic value is at its maximum. All strikes are equidistant and we only use whole number differences; no 50 cent increment. As you can see, the two middle options are fully hedged.
Long Butterfly construction:
 Long one call (ITM) or put (OTM) ; short two calls (ATM) or puts (ATM) ; long one call (OTM) or put (ITM).
 
Short Butterfly Here is an easy way to remember the construction of a Butterfly. With the long Butterfly, the first position is long. With a short Butterfly, the first option is short. The center options are the opposite of the first position with the exception of having two options instead of just one as do each end positions. So, in the case of a short butterfly, the two center options are long and the last option is short. 
Short Butterfly construction:
Short one Call(ITM) or put (OTM); long two calls (ATM) or puts (ATM); short one call (OTM) or put ( ITM).
 
If I’m going to go ahead and buy a butterfly, I’d probably want to buy the cheaper priced one. If I want to sell a butterfly, then I’d probably want to go ahead and sell the most expensively priced one. From an individual investor’s standpoint, 99% of the time you are going to be doing a long butterfly when we’re talking about the conventional butterfly.

Nov

6

Trading Options Straddles

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Trading Straddles
 
According to Ron Ianieri, co founder of the Options University, buying a straddle is not an every day thing. You are taking on so much premium that without some type of major news announcement to move the underlying stock big time, you could end up eating some or all of those big premiums. Needless to say, your timing has to be impeccable.
 
The Theta involved with a long straddle is so big to start with and it gets bigger every day. If you’re waiting on some major news announcement, by the time the announcement comes, if it does, that announcement may not have enough juice to boost you over the breakeven. It may indeed move, but not enough.
 
What happens if the anticipated news announcement gets postponed until the next month after the period you have set up the straddle in? If you try rolling it, you will probably take a big hit. So it is very important to get the timing right.
 
A short straddle is a different story; we want nothing to happen. As a matter of fact, If nothing is happening and we are short a straddle we might want to do it again. However, from a mechanical stand point, they are not an easy roll into the next month. According to Ron Ianieri, what you have to do is buy your front month back and sell the next month out just like you would roll any type of normal option position. There is no easy roll here except buying the whole thing back and selling it again in the next month.
 
Mr. Ianieri recommends that with a long straddle we’re not even going to think about rolling because there is usually too much money involved in premiums. For a short straddle, if you have it on and it is working and you did it one month and it worked and you want to do it the next month, just shut the front month down and open up the next month.
 
What about morphing the straddle? Unfortunately, the straddle doesn’t give us a lot to work with. At Options University, they recommend that If we’re in a long straddle and the stock starts moving in the right direction- whether it be up or down- leave the other option alone. Chances are there was a gap opening and the put or the call on the other side of the movement went down in price big time. So, its probably best to just leave it on.
 
With the option that is in play, it should be treated as if it were a stock replacement option. As long as that stock keeps running up, roll the counter movement option up with it. Likewise, if that stock keeps running down, roll that put down with it.
 
If you’re in a long straddle and the stock doesn’t move, shut it down. Get out. However, one possible solution is to reverse. For example, you may have bought five straddles. For example, say you sold 10.  That would take you from long five straddles to short five straddles. There is really nothing wrong with that because short straddle wants stagnation.
 
News is the key with the long straddle. You need news to get the stock to move enough to offset the price of the straddle. On the other side, your short straddle, you don’t want news. You don’t want movement. It’s an extremely powerful premium collector given the fat premiums.

Nov

5

Synthetic Straddle Options Trading Strategy

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Synthetic Straddle
 
According to the Options Mastery Course put out by the Options University, there is more than one way to set up a straddle. As a matter of fact, there are three different ways to set up a straddle. The first way is obviously the conventional way: buy a put and buy the corresponding call.
 
We can also create a straddle synthetically. We don’t have to buy a put and a call as we do in the conventional way, we could just buy puts. The reason is the ratio we use. In the conventional straddle, we’re going one to one; buy one call and buy one put. But with the synthetic straddle, things get a little more complicated.
 
Perhaps the best way to go about it is to use an example. If we buy two puts and we buy half the amount of shares (100 shares) and we team one of the puts with the 100 shares of stock, we’ll be long 100 shares and long one put. What is this? Answer: a synthetic call. We’re now long one synthetic call and long its corresponding put which makes us long the straddle. Bingo!
 
Let’s look at an example. Say we buy two May $40 puts and we buy 100 shares of the underlying stock. We’ll take one of these puts and match it up with the long stock. Now we are long stock and long a put which is the same as a synthetic long call. We’re synthetically long one May $40 call. Since we’ve left one put isolated, we’re long one May $30 put. Indeed, we are now in a synthetic long straddle.
 
A third way to construct a straddle is to construct one using calls and stock. We will buy two May $40 calls and sell 100 shares of the underlying stock. We’re going to take one of the calls and pair it with the shares which leaves one May $40 call. We’re now short 100 shares and long one call and that makes us now long one May $40 synthetic put. The big picture is that we are now long one May $40 synthetic put and long one May
$ 40 call; a synthetic straddle.
 
So why would you want to do a synthetic straddle?
 
If we bought a straddle conventionally using one long call at 31 volatility and one long put at 33 volatility, at what volatility are we purchasing the straddle? Under these conditions, we’re going to do it at a 32 volatility. If we went with the put and stock combination, called the put alternative, we will be buying two puts at 33 volatility. Our straddle is going to be a 33 volatility. If we are looking to buy a straddle and we see the calls are trading at 31 volatility and the puts are trading at 33 we know conventionally that the straddle is 32 volatility. With the calls trading cheaper than the puts, if we bought two calls we could get in at a 31 volatility. That’s cheaper and buying lower is almost always a good thing.
 
To learn everything about stock options, go to www.optionsuniversity.com.

Nov

4

Advanced Options Trading – Selling Gamma

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Selling Gamma
 
When a trader takes on a short straddle position, he/she is actually loading up with Gamma and selling it to someone else who thinks there is going to be some big movement in the underlying stock.
 
As straddles are made at the money, it accomplishes two important things. First, it creates a balanced Delta situation and second, it provides for the maximum Gamma. For the long straddle position, the idea is to not be biased so that the straddle can take equal advantage of up or down movement. Heavy Gamma provides for the maximum amount of option price increase with the movement in Delta. This is what the long straddle player wants.
 
On the other side of the trade is a person who doesn’t believe that there will be enough movement to overcome the high protective breakevens created by the costly premiums collected. For example, if some news on a company is going to come out, there will be differing opinions of how it will affect the stock. No doubt, if the news comes out and is no big deal, the wave of volatility will pass and the price will have a much higher probability of expiring out of the money, which is the objective of the seller.
 
As mentioned, selling Gamma is best done at the money and this is the primary interest of the seller. Also, for the seller, is the importance of Theta. As a straddle seller is long Theta, every day that goes by the seller is collecting big premiums. He’s not just a short at-the-money option, the trader is short two options. There is a lot of decay being reaped every day. Every day that stock doesn’t move the trader is bringing in more and more through Theta decay and as this stock isn’t moving and volatility starts creeping down so he’s making money on the Vega side too.
 
This is what makes selling straddles so intriguing. The markets can become very emotional and over react to even the slightest innuendos. If the trader sees that there is a high component of emotion by noticing the high premiums at the money, and there are reasons to believe that the news is over reacting, selling a straddle can be an excellent strategy. Remember, the high premiums collected translate into wide breakevens on both high and low sides of the strike.
 
It is well known that premium collection has a high probability of turning out as expected. That’s why people who are sellers of an option are right 80% of the time. However, we have to be careful because we know short straddles have an unlimited risk potential. Even though we know there is a very low probability of something bad happening, that 20% probability can come to fruition and a short straddle could really hurt.
 
For more information about a complete line of online instruction, mentoring, and shadow trading, contact the options University at www.optionsuniversity.com.

Nov

3

Using A Short Straddle Profit and Loss Profile

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Short Straddle Profit and Loss Profile
 
The breakeven for the long straddle is the same for the short straddle. Why?
According to Ron Ianieri, co founder of the Options University, its because the straddle is going to trade at the price and at the same price no matter what the position. If the $55 straddle trades for $5.80, one person is buying it at $5.80 and the other is selling it at $5.80 and both have to have the same break evens.
 
As you may recall, the upside breakeven is going to be the strike price plus the straddle price. The downside breakeven is going to be the strike price minus the cost of the straddle. The reason the breakevens are the same is that we’re looking at two sides of the same trade.
 
If the stock trades up to the upside breakeven, the put that we sold is going to be worthless but the call with the stock at $60.80 is now at breakeven and any father up move will place the option in the money. If the stock trades down to the bottom breakeven, the call will become worthless and the put will be ready to move into the money.
 
The point to emphasize is that there is a fixed, limited potential gain and an unlimited potential loss. For a seller, the maximum profit is at the price where the straddle was sold. If the straddle was sold at $55 straddle, that very same price is where we want the stock to be at expiration. That’s our point of maximum profit. That is because both the call and the put will be worthless and the premium is kept. As sellers, we’re looking for the stock to stay inside the breakevens.
 
Because straddle premiums are usually very juicy, this strategy usually provides the highest ROI for premium collection strategies. Not only that, the strategy has a very high probability in that the stock has to make a hefty move in either direction to get past breakeven. However, we have to be aware of the fact that once the price gets outside of the breakevens, either to the up side or the down side, we’re going to start losing dollar for dollar with the stock going up or down.
 
In the Options University Mastery Options Course, its mentioned that if the stock was trading at $52 and we picked the $55 straddle the $55 call in this case would be out-of-the-money. The $55 call might only be 30 Deltas. The put in that case would have to be 70 Deltas. The absolute value of the call and the absolute value of the corresponding put added together must equal 100.
 
To minimize a directional bias, it is best to be at the money in the front month where both put and call are near 50 Deltas. This keeps the position much more neutral and unbiased to any movement, up or down. Remember, we use the straddle position when we think there is going to be a big move but are not sure in which direction.
 
To take the best advantage, it is best to be Delta balanced and be where Gamma is largest. Gamma, as you may recall, is the Greek variable that measures how much the price of the option will move with respect to a change in Delta. When we are at the money, Gamma is at its largest so we can maximize profit with any move once past breakeven. In other words, at the money is where we get Delta neutral and find the largest Gamma.
 
For a complete course of study of stock options, contact the Options University at www.optionsuniversity.com for a listing of all of their course offerings and services.

Nov

2

Assessing the Long Straddle Profit & Loss

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Long Straddle Profit & Loss
 
Ron Ianieri, co-founder of the Options University and author of their renown Mastery Options course, provided an excellent example of how a Straddle functions. For example, we buy the May $55 straddle and let’s say the call is trading at $3 and put is trading at $2.80. The straddle is actually going to equal a total of $5.80. What does that mean?
 
The point of maximum loss is the $55 strike itself. The worst place for the stock to wind up when you’re long a straddle is directly at the strike at expiration. When it’s directly at the strike, our call is going to go out worthless so we’ll lose the $3 there, and we will also lose the whole $2.80 we paid for the put. So, the worst place for the stock to close when you’re long the straddle is directly at the strike.
 
To find the up-side break even, we simply take the strike price of $55 and add it to the total straddle price. In the example, that’s going to give us $60.80. That is going to be our up-side break even.  
 
To calculate our-down side break even, we take the strike price and subtract the total straddle price. In out example, $55 minus the total straddle price of $5.80 gives us a down-side break even of $49.20. That means by expiration the stock needs to be either below $49.20 or above $60.80 for you to profit because come expiration the long straddle holder or buyer only profits in the area above the up side break even or below the down side break even.
 
In the case of our $55 straddle, the stock has to go up $5.80 just to break even because that’s how much we paid for the straddle. That means that the stock has to go all the way up to $60.80 just to breakeven. At $60.80 the put will be worthless but at $60.80 the $55 call will be worth $5.80. The value of the spread will be $5.80, $5.80 in the call, zero in the put; and the position is at breakeven.
 
If the stock traded down to $49.20 the call will be worthless so we lose the whole $3 premium for the call but with the stock trading at $49.20 the $5 put will be worth $5.80. As we paid $5.80 to get in the position, it’s now worth $5.80 because there’s $5.80 in the put and zero in the call, we have broken even.
 
In summary, a straddle needs large movements to be able to move past the wide breakevens caused by the high premiums. Not only are at-the-money premiums at their highest, but usually the market is aware of the potential price move and has priced it into the premiums. As a result, straddles are usually applied in very special situations where large price swings are possible.
 
For all things stock option, contact Options University at www.optionsuniversity.com

Nov

1

Advanced Options Trading – Straddles

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Straddles
 
A long straddle is a strategy which is set up to give you a non specific directional trade. What does that mean? If we don’t have a clear idea of which direction the stock may be moving, we would want to be in a position to make money if the stock moves in either direction. One important characteristic of the scenario is that this strategy is used when the stock is highly volatile and has a potential large price movement-in either direction. It will either go up big or down big but you aren’t sure which way it’s going to go. But you know that its going to move.
 
Most typically, straddles are most often used when some significant news related event could have a large impact on the stock. We have some sort of idea when the news release is coming out but we’re not sure what the news is but it’s the type of news that can move the stock.
 
For example, we know roughly when earnings are going to come out. We’ve have an idea that if earnings are better than expected the news will move the stock up. If the reports are worse than expected, the news will probably push the stock down. Along the same lines, Information about a new drug, passing FDA clinical trials, court hearings or a major court situation can also move the stock and usually the least expected announcement will have the greatest impact. We might hear that some news is coming out on a stock but not know exactly what it is. Because we don’t know which way the news is going to affect the stock, we can hedge out bets by putting on a straddle.
 
If we are not sure which way the stock will move, we just buy a call and a put in the same month and strike price. This is called a long straddle. In theory, it’s a thing of beauty. If the stock goes up, then our call kicks in and eventually our put dies out and the call gains money with the rise of the stock. If the stock moves to the down side, our put kicks in and the call eventually goes to worthless as the put is gaining unlimitedly as the stock moves down. However, if the stock doesn’t move either way, we languish and suffer the maximum risk of cost of the call and put premiums at expiration.
 
However, the market may very well be aware of the same information you have and the volatility will push up the price of the premiums. If the market has already priced in the anticipated news, the stock may not move enough to cover the high premiums.
 
The short straddle is a premium collection strategy. The one thing we’ve got to realize about a short straddle is it’s not fully hedged. At Options University, they preach against holding an unhedged short option but there’s a little bit of a difference with a straddle.
 
With the short straddle, we’re selling a call and selling a put. Only one of them can hurt us and that is the one that moves into the money and can be exercised. However, because we collect substantial premiums for selling these options, the premium collection will give us a nice wide break-even.
 
The short straddle is the most powerful of premium collection strategies but it’s also the riskiest because we are short two options and if the stocks moves in either direction we are going to be short a naked option with a good sized loss.

Oct

31

When To use a Jellyroll Options Trading Strategy

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When To use a Jellyroll
Options Universtiy goes into detail about complex spreads in its comprehensive Options Mastery course. One of the strategies covered is the complex strategy called the “Jellyroll”. And indeed, it is sweet. This strategy employs the use of calendar spreads-also known as time spreads. When postioned properly, Jellyrolls are going to help option traders choose between whether it is best to use the call spread on or to use the put spread.
 
The best way to digest a jellyroll is to eat one. So, let’s look at an example used in the Options University Mastery course. Let’s say we want to buy the June-July $65 time spread. The stock is trading at $65. So, we buy the July $65 call and we’re selling the June $65 call. The reason we did that was when we looked at the interest and dividend, we said the call spread must be trading higher than the put spread by the amount of interest minus a dividend but there is none in this case so there is no dividend.
 
When we saw there was a difference of interest of 10 cents, we knew the call spread should be trading at the same amount as the put spread except for that 10 cents. It should be trading higher by 10 cents so that means the put spread should be 10 cents lower but the put spread was trading at the same price.
 
As we let time on the front month erode the extrinsic value and widen the spread, we will have accumulated some gains. Volatility for the stock is increasing and we know that if the stock moves in either direction away from the strike we are going to lose money. There is no sense in staying in this thing. We have our profit and we want to get out. We look at the put spread and see that it is still priced the same as our call spread and we know that it should be 10 cents lower because of the interest in the call spread. Because selling the call spread is the same thing as selling the put spread and the put spread is trading effectively higher than the call spread, its best to get out of our long call spread by selling the put spread. What?  Now the jellyroll is getting messy
 
You see, we actually would have two contra synthetic positions: short call, long put, that equals what? Short stock. Also, w are long call, short put which equals what? Long stock. So, in affect, we are short and long stock. Now here’s the value of a jellyroll: it is an arbitrage play on the difference between the interest rates of the two months. If the stock closes below the strike, our short call will be worthless, we’ll be long a put that’s now in-the-money, If this happens, we
exercise our put creating a short stock postion. Come expiration, we will be short real stock, long a call and short a put; we are in a reversal!
 
While we’re in this arbitrage, we’re going to be collecting short interest in our position. Come July expiration, our synthetic long stock position in our reversal will become real long stock and cancel out with the short stock. At July expiration, we’ll have nothing more. In other words, when we come out of that position in June we will be collecting interest for the month of July.
 
In summary, If you’re a buyer, you want to get in the cheaper spread. Likewise, if you’re a seller, you want to sell the more expensive spread and the jelly roll helps us compare the cost of both of those spreads together..
 
For more on all things stock options, go to www.optionsuniversity.com

Oct

30

The Jellyroll Options Trading Strategy

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The Jellyroll
When we want to buy a calendar (time) call spread or to buy a calendar put spread, we look for which once is the least expensive. If we are buying the June-May $25 call spread, it is the same thing as buying the June-May $25 put spread adjusted for interest and dividend. To figure out what the call spread value is, we need to consider the effects of interest and dividend. To do that, we need to subtract the interest less the dividends.
 
For example, if the May-June $25 call spread is trading for $1.30 and the put spread is trading for $1.25 we would need to find out the interest and the dividends if applicable. If the interest between May and June is 10 cents and there are no dividends to be paid out, the call should be trading at $1.35. Why? Because the call spread should be trading higher than the put spread by the amount of interest minus dividend. In this case, the call spread is selling for 5 cents less than it should. This, the call is under valued.
 
As a general rule, we want to buy the cheapest spread and sell the more expensive one. What if we’re already in the long time spread; we bought the call spread because it was a better value than the put spread. Now, we’re looking to get out and we’re noticing that the put spread is effectively priced higher. Now that it’s time to sell, it’s the put spread that’s more expensive. We want to sell the more expensive one. It makes perfect sense. When you do that- buying the call spread and then getting out by selling the put spread or buying the put spread and getting out selling the call spread- you’ve set up an arbitrage called a “jelly roll”.
 
According to Ron Ianieri, co-founder of the Options University, the jelly roll is to the time spread in the same way “the box” is to the vertical spread. Remember, the box helps us to mathematically relate two corresponding vertical spreads to each other. The jelly roll does the exact same thing for time spreads.
 
The jelly roll is two corresponding time spreads in combination; one long, one short the call time spread, short the put time spread. We can do this because the call time spread and its corresponding put time spread are the same thing. Because they are the same thing, we can buy one and sell the other. To understand how the jelly roll works, we need to polish our understanding of its synthetics.
 
Let’s say we bought the July $50 call and we short the May $50 call and we can say that’s the same thing as buying the July $50 put and selling the May $50 put. When it was time to get out, we noticed that the put spread was still priced higher. So, we sold the put spread against our long call time spread. What is left is long the call time spread and short the put time spread. The long call time spread is the same thing as the long put time spread. Buying the long call is the same as buying the long put so selling the put is the same as selling the call. Or, buying the call and selling the put works the same way.
 
Herein lies the secret:
Instead of looking at it horizontally, let’s look at it vertically. Going back to our synthetics, what is short May $50 call, long May $50 put? Indeed, that’s a short stock position. That is synthetic short stock. We’re synthetically short stock in May. What is Long July $50 call, short July $50 put? That’s synthetic long stock. What do we have here? We have a synthetically long stock. Do you see it?
 
What is a same strike short stock and a long stock? Nothing. No position. Zero. It becomes a straight arbitrage; we bought stock and we sold stock at the same time and captured the difference between months.
 
For more on all things about stock options including basic through advanced online courses, mentoring and trade shadowing, go to the Options University website at: www.optionsuniversity.com

Oct

29

Pricing Time Spreads Options Trading Strategy

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Pricing Time Spreads
 
Remember, when trading time spreads (aka:calendar spreads) we’re not really trading strikes, we’re trading time and the time value between one option month to another option month. Both options must be equally reflected in the difference between one month to the other-regardless if we’re using calls or puts. The difference in time between a May $25 call and a June $25 call is the exact same difference in value as the difference in time between the May $25 put and the June $25 put. They are the same; buying the call time spread is the same thing as buying the put time spread.
 
If this is so, that means when we look at a call spread we can look at the corresponding put spread and know that the two are supposed to be equal. But according to the Options University, before we buy the call time spread we might want to look at the put time spread. If we’re going to buy a spread, we want to buy the cheaper one if they are both going to do the same thing.
 
A call spread will normally trade higher than its corresponding put spread by the amount of interest minus dividend. If there is no dividend, the call spread should trade higher than it’s corresponding put spread by the amount of interest.
 
The following is an example taken from the Options Mastery Course put out by the Options University. Suppose we’re looking at the May $25-June $25 (could be a call or put) and we’re saying that if the May-June $25 call spread is trading for $1.30 and the put spread is trading for $1.25. In this example, there is no dividend. To see it the rule holds true, we need to know what the interest between May and June is. Let’s say the interest between May and June is 10 cents. The rule is telling us that this call spread should be trading 10 cents higher than the put spread- but it’s not. 
 
The call spread is only trading 5 cents higher. It should be trading 10 cents higher. That means the call spread is slightly under valued versus its corresponding put spread. Remember this is for corresponding options. In this scenario, we would rather buy the June $25-May $25 call spread at $1.30 than we would want to buy the May $25-June $25 put spread at $1.25 even though it has a higher price. However, in reality the call is 5 cents under priced.
                       
Now, things get interesting. In this example, we would buy the call spread and when it was time to get out or if we are a seller of the spread instead of a buyer of the spread, we would sell the put spread. Why? Because the call spread should trade higher than the put spread by the amount of interest minus dividend. With no dividend then the call spread should trade higher than the put spread by 10 cents. Right now it’s not. That means the call spread is under valued.
 
If the call spread were trading for $1.40 instead of $1.30 things are different.
If the interest is the same at 10 cents and there is no dividend, the call spread is trading higher than the 10 cents and is thus over valued.  If we are going to buy a time spread, we want to buy the corresponding put spread at $1.25 because in theory it’s like buying the call spread for $1.35 because the call spread is always supposed to be 10 cents higher.
 
Four times a year, on dividend paying stocks, we might have the put spread actually trading higher than the call spread. For example, what if there’s a 25 cent dividend? Then the call spread should be trading higher than the put spread by 10 cents minus 25 cents.
 
In Summary, if one spread is more expensive than the other, and we’re a buyer, we want to get in the cheaper one. As a seller, we want to obviously sell the more expensive one
 
For information on all things stock option, go to www.optionsuniversity.com

Oct

28

Advanced Options Trading – Time Spread Volatility

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Time Spread Volatility
Often, when people do spreads, they want to know what the volatility of the spread is. They want to know what the implied volatility of each option in the spread is. Traders will say something like “I sold 34 volatility, I bought 32 volatility, so it’s like I have a combined volatility of 33. That statement is incorrect.
 
At the Options University, they point out that you can’t just take the two options and average them. When you average something you normally are making a simple assumption that both values are weighted equally. But in the case of spreads, it’s a bit different. When you’re doing a spread and trying to figure out the volatility of the spread, you need to understand that implied volatility in the front month and implied volatility of the out month are not weighted equally. Why? Because of Vega- the amount that the price of an option changes compared to a 1% change in volatility- is what weights volatility sensitivity and we know that the front month is not going to have the same Vega as this out month.
 
Before we can determine the actual volatility of the spread, we must first equalize the volatility of both options. Perhaps the best way to explain it is do an actual example. Suppose I bought the 34 volatility for $3 and I sold the 32 for $2. The option that’s at 34 volatility is trading at a volatility level that’s two ticks higher than the 32 volatility option and we know this option’s Vega is 8 cents. We know that the 32 volatility option is trading for $2, we know that we can bring this option up to the 34 volatility option’s level very easily. At 32 volatility it’s worth $2 and we know that Vega is 8 cents. So, if we move up from 32 volatility to 34 volatility we would move up 2 ticks times 8 cents. At volatility 34, the Vega would have the value at $3.16.
 
Now that we have brought the theoretical value of this option up to a volatility level that matches both options, we can figure out that at 34 volatility this spread should be worth $3.16 minus $2, or $1.16. This spread is worth $1.16 at 34 volatility.
 
The underlying idea is that we take 32 volatility up to 34 volatility. If you aren’t confused yet, try this one on: We found out that the spread is worth $1.16, but now we traded it at $1.20. How do we figure out what volatility we traded the option at? Now that we’ve got it equalized we can use the spread’s Vega to compute the difference between the two values. We did a spread at $1.16 and as we said it’s a 34 volatility and now we need to figure out what $1.20 volatility is. Both have their own Vega and we are long one and short the other. If I know that the Vega difference between the two options is 3 cents, this gives us a spread Vega of 3 cents. If I take volatility up one tick to 35 volatility it’s going to take this value up 3 cents making it $1.19 which is right around $1.20. The implied volatility of this spread is 35.
 
Whenever you’re doing two options with different strikes, different Vega values you can’t just sit there and average them out. Where this becomes important, especially is when a trader is trying to hedge their volatility exposure. But that story is for another time.
 
For information on all things stock option, go to www.optionsuniversity.com

Oct

27

Morphing Time Spreads Options Trading Strategy

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Morphing Time Spreads
 
As you recall, a time spread-also known as a calendar spread-involves a front and an out month. One of the considerations that must be taken into account is what happens when the front month expires? If we were in a long time spread, our front month short call expires and we are left with a naked long call in the out month. If we were long a put time spread, we will also be long a put. What should we do?
 
We have a few things that we can do. We can leave it as it is. Maybe we think the stock is going to trade down and you might be long the naked put. The reverse might be in play for a long call time spread where the price may be moving up. Either way, you’re naked long this option from the previous month. We must either morph it, hold it or close it out.  
 
If we’re short the time spread, we’re going to have a naked short option remaining and we know that’s unacceptable. According to Ron Ianieri, co-founder of Options University, when we’re short a naked option in our short spread, either short a put or short a call, that position must be addressed on expiration day of that front option.
 
In the Options Mastery training course offered by the Options University, they use the following example. Let’s say we’ve got a long the May and short the June, a short time spread. On the day that this option expires you must do something to this position and we cannot let this position become naked into the next month. If we’re short a time spread, we must take care of that out month short option on expiration day of the front month.
 
If you were in a short time spread and are stuck in a naked short put position at the end of the front month expiration, and the stock suddenly plummets, you could be in real trouble. When stocks breakdown, they usually do it in a hurry and can shed points like a dog shaking off water. Before you know it, the stock can lose 50% of its value. If this happens and you have sold a put, you will be assigned and obligated to buy the stock at the strike price, which could be way above the current price. On the other hand, if you are long a time spread, you will be naked long and the worst that can happen is the loss of premium.
 
To find out all about stock options, contact the Options University at www.optionsuniverstiy.com

Oct

26

Advanced Options Trading – More on Time Spreads

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More on Time Spreads
The Short Time Spread
According to Ron Ianieri, co-founder of the Options University, in situations of high volatility where the straddle might be very expensive, we can look to selling the time spread. We know that with a short time spread we’re short the out month option. That also means we’re short Vega and we’re short volatility sensitivity. If volatility increases and we’re short volatility, we’re going to lose money. Likewise, if volatility decreases and we are short Vega, we’re going to make money. It all depends on where volatility goes.
 
We also know that we don’t want to be short a time spread and have time go by and nothing going on. Why? Well, we’re long the front month option and Theta is decaying extrinsic value like crazy; indeed, we are going to lose money when nothing happens and time passes when we’re short the time spread. We need movement away from the strike for the short time spread to work.
 
To reiterate, if you think a stock is going to move but you aren’t sure of which direction and volatility is so high that you’re straddles and strangles aren’t a good alternative because of price, then you might substitute with a short time spread.
 
Time Spread P & L
The most we can lose in a long time spread is the amount of money we spent to put on the position. At the outset, we have established what the maximum potential loss would be. Because of this fact, we are said to be fully hedged in this position. We know exactly how much we can lose at the absolute very worst scenario.
 
As far as profits are concerned, because of the two different months, things can get complicated. As both options end at different points in time, it means they are more susceptible to a greater amount of different potential variables. For example, for a long time spread at expiration of that front month, whatever your profit or loss is at that point you are now going to be long a naked call and you will be subject to the risks and rewards of that naked long call for as long as you have it on. That adds into the mix of the risk and rewards; in other words, you know your max losses only when both options are still in play. Once the front month expires, the whole situation changes.
 
For the short time spread, the situation is different. The most you can make is what you sold the option for. On the risk side of the equation, if that front month expires then we end up with an out month option; a short naked out month option, and we know we don’t like that. Indeed, there is not enough to gain compared to what could be lost.
 
Because there are two different months involved, when the front month expires we need to take action; the position we’re left with has to be adjusted, closed or moved.
 
For more on all things stock options, go to www.optionsuniversity.com

Oct

25

The Dynamics of a Calendar Spread Options Trading Strategy

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The Dynamics of a Calendar Spread
 
Time is at the heart of a calendar spread. You see, due to the nature of Theta, as an option approaches expiration date, its extrinsic value goes non linear and starts to plunge as it approaches about 15 days out from expiration.
 
If we buy a long calendar spread, we will sell the front month and buy the out month.
As the front month approaches its expiration, its extrinsic value burns off much more rapidly than does the out month. As a result, the spread between both options widens.
As the out month extrinsic value is higher, it creates a debit spread and as the front
month decreases faster than the out month, the gap between the prices of both widens. Basically, We’re trying to find a stock that is stagnant, that is trading sideways around the strike and we’re just allowing the natural effects of time decay, of Theta, to make our money for us and to expand the spread between the two options.
 
Let’s use an example taken from the online Options Mastery Course put on by the Options University. Let’s use this time spread. We’re going to be short the 30 day option and long the 60 day option. In 30 days however, that spread is going to increase and the reason is because of the time decay slope. Our 60 day option for the next 30 days is not going to decrease  as much as  in the front month. The Theta of that 60 day option is going to be much smaller than the Theta of our 30 day option.
 
If the front month had a value of $2.00 and the out month had a value of $2.70 (remember, both options are one-to-one and at the same strike price) and the front month expires, it will have a worth of zero whereas the out month might have a value of $2.00. The spread has widened from .70 cents to $2.00. In effect, all we are doing here is trading time.
 
The reason we use the at-the-money option for this type of trade is because that’s where all the highest time premium and extrinsic value is. Intrinsic value does not decay.
 
Sound good so far? Well, let’s talk about some of the risks of calendar spreads. The most obvious is if the stock moves away from the strike. If that happens, instead of a widening gap over time, it is going to start to shrink. We know that being long the time spread the last thing we wanted to do was shrink. We are looking for opportunities where the stock is going to stay in a general area.
 
Spreads are not a standardized contracts as are exchanged traded put and calls and there is NO spread market. As a result, the "market" cannot be "held" to a price. Additionally, spreads are executed at the discretion of a market maker and may require more time to fill. There are other technical ramifications of trading spreads and it is suggested that all spread investors be familiar with the differences between a spread and a legged spread position.
 
For information on all levels of stock options, courses in options, mentoring and trade shadowing, contact the options university at www.optionsuniversity.com

Oct

24

Calendar Spreads Options Trading Strategy

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Calendar Spreads
 
Floor traders used to call calendar spreads, “Time spreads”. The reason calendar spreads are also called time spreads is that they try to take advantage of the non linear decay of Theta- also known as time decay. What we are trying to take advantage of is the passage of time with two options decaying at different rates.
 
Construction
 
Long
The most popular way people set up time spreads is a long time spread where we will be long an outer month option and short a nearer term option of the same strike in a one to one ratio. This is a premium collection strategy. For example we might be long the May $25 call and short the April $25 call, or long the June $70 put and short the May $70 put. We’re always trying to be long the out month option and short the nearer term option.
 
This trade is done most of the time at-the-money. The reason for that is because that is where the biggest amount of premium is; that’s where all that big fat extrinsic value is. It’s obvious when you think about it; one more little step and it moves from at to in-the-money where parity and intrinsic value starts to kick in.
 
It doesn’t matter if we want to do a call spread or a put spread, we are looking at selling the front month option, buying the out month option and as close to at-the-money as possible. Our strategy is to take advantage of the front month’s more rapid rate of decay.
 
Short
Where the long function described above is really a premium collection strategy trying to take advantage of a stock that’s either consolidating or stagnating and trading sideways, the short time spread is a little different. Obviously it is the opposite of the long time spread.
 
With a short time spread, we’re going to be short the out month option and long the nearer term option. Of course, we use the same strike and in a one to one ratio. So, why would somebody do that type of trade?
 
As a matter of fact, the short time spread trades very much like a straddle. According to Ron Ianieri, co-founder of the Options University, if we sold a time spread and the stock started moving away from the strike, in either direction away from the strike, we would profit, much like a long straddle. The difference here is that with the long straddle we have an unlimited potential reward. With the short calendar spread, that is not true. We have a limited potential reward but we have that limited potential reward as the stock moves in either direction away from the strike and you’ll find it to be a much cheaper way to play a non-specific directional trade.
 
For all things stock option, go to www.optionsuniversity.com

Oct

23

Advanced Options Trading – Some Vertical Spread Morphs

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Some Vertical Spread Morphs
 
Let’s say you are  long a call spread. The stock suddenly starts trading down and the next thing you know it’s now breaking down and you’re  definitely in the wrong position. Here is a simple morph for this situations.
 
All you need to do is buy the put of the strike that’s corresponding to your short call. If you’re short the June $65 call, you buy the June $65 put. That creates a synthetic short stock position at $65. You haven’t sold anything.
 
If you are bearish and things start moving up and you are long the put spread; the stock starts to trade up. If you bought the call, you’d be long call and short put at the $60 strike. That makes you long synthetic stock; you are long synthetic stock and long the actual put. Long stock and long put equals long call with the stock now breaking out to the up side.
 
Let’s go over that one more time. You are long a put spread and expect the stock to go down. But, it turns on you and now you are in the wrong position and want to morph into a long position.
 
I think the sock is going down
 
Long Put Spread
Put
Long
$ 65
 Short
$ 60
 
 
Oops. Its going the other way. Wait for me!
 
Morph to Synthetic Long
Put
Call
Long
$65
$60
Short
$60
Synthetic long stock
 
 
Long stock and long put equals long call
 
Genrally, for debit call and put vertical spreads, if things go against you, look at the short option, go to its counterpart and buy it. That works for either a debit call spread or a debit put spread.
 
To recap:
  1. If we’re in the right direction but we want to get more in the right direction, buy back the short option.
  2. If we’re in the wrong direction and we need to spin the position around, we go to where the short option is and buy the corresponding option.
 
For all things stock options, go to www.optionsuniversity.com

Oct

22

The Box and Trading the Vertical Spread Options Trading Strategy

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The Box and Trading the Vertical Spread
The first thing we need to do is find the charting patterns. Are we looking at an up trading or a down trading stock? What is our anticipation of the stock movement? If we think it’s going to go up, we’re going to enter into a bull spread. We ‘re either going to buy the call spread or sell the put spread.
 
To help us decide which strategy is the best, we are going to base that decision on “the box”.
 
To do that, we are going to add the call spread and its corresponding put spread together and come up with the difference between the two strikes. If we find that we are below that difference, then we want to be a buyer of the call spread. If we are above, then we want to be the seller of the put spread.
 
For example, if the chart displays that the stock is heading down, we would normally want to get into a bear spread; we would either want to buy the put spread or sell the call spread. At this point, we look to the box to decide which one we would want to do. We want to add the two corresponding spreads together and subtract the result from the spread between strikes-in this case $5. If the result of the difference is below $5, we would want to be a buyer of a put spread or seller of a call spread.
 
Remember, we know that the value of the two of them has to equal the difference between the two strikes. If we have a call spread trading for $3, its corresponding put spread must be trading for $2 and we’re assuming a $5 box, a $5 difference between the two strikes. Whenever these boxes add up to below the strike spread, we want to do the debit side, no matter if it’s a call spread or a put spread, bull spread or bear spread, it doesn’t matter. If it adds up below, we do the debit side.
 
The nice thing about a vertical spread is it has a limited loss and a limited gain and it makes or loses money in a pretty tight range. There is not a lot of adjusting to be made. However, according to Ron Ianieri, co-founder of the Options University,” there are a couple of real easy morphs that we can do to take advantage of a changing environment while we’re in a vertical spread”.
 
Morphing is actually the changing of strategy and not shutting down one trade and reopening another. Let’s look at a couple of easy morphs we can do out of the debit spread.
 
Let’s assume a long vertical call spread. We buy the June $60s and sell the June $65s; we’re expecting the stock to trade up. Suddenly the stock breaks out of its range. It’s now a break out; the stock is no longer going to trade up a little bit, it’s going to fly and here we are in our vertical spread and we’ve got a limited up side because we sold the $65s. To remove our cap, we simply buy the short option back, which makes us totally long and clears the way on the upside. It also works the same way with a put spread if we have a debit put spread on and the stock is trading down.
 
For more on all things stock option, go to www.optionsuniversity.com

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