Options Basics Part II Class 9

Size: px

Start display at page:

Download "Options Basics Part II Class 9"

Lindsey Williams
5 years ago
Views:

1 Options Basics Part II Class 9 UD Osher OLLI Spring 2019 Rajeev A. Vaidya Guy Werner Disclaimer in plain language: Opinions are like noses, everyone has one! You are going to see mine today!! I am simply sharing my perspective. This is not investment advice or recommendation. Form your own opinion, make your own decisions. 4/22/2019 Rajeev Vaidya - OLLI 1

2 Class # 9 Swing trading with Naked Calls What is the trade? What is the setup? The Process Work before the trade Trade Trade Management 4/22/2019 Rajeev Vaidya - OLLI 2

3 What is a swing trade? Trending stock Trend takes a breather Stock goes counter trend for a 2-3 days Stock resumes the trend direction movement after that Swing in the trend The counter trend breather enables a buy The resumption of the trend creates profit vs. the buy. Profit is made by selling into the trend after the buy In an Uptrend, the trade can be Going long the stock at the end of the down leg. Selling at a higher price later. Gong long the call on the stock more capital efficient. 4/22/2019 Rajeev Vaidya - OLLI 3

4 4/22/2019 Rajeev Vaidya - OLLI 4

5 Bull Flag / Pennant One of the most reliable continuation patterns John Murphy Technical Analysis of Financial Markets Target Price Flag pole projected from flag bottom Flag pole Strong up leg with high volume Pause in the up-move Declining volume Breakout and resumption of up-move Rising volume 4/22/2019 Rajeev Vaidya - OLLI 5

6 Example position Long Call Bullish on ABC.. $100 Expect ABC to rise to $125 in 3 months. ABC is a liquid stock with options trading as follows 50 days out $100 call is trading at $2 20 days out $98 put is trading at $1.5 Long Stock Profit Unlimited Profit Long Call Profit Unlimited Profit Stock Price Unlimited Loss Loss Stock Price Buy Price = $100 Buy Price = $2 Max Loss = $2 Loss Underlying Price at start = $100 Break Even Price = $102 April 19 Rajeev Vaidya

7 How does a long call trade work? More capital efficient than the Long Stock Can lose the entire amount of money invested. Trade makes money if the value of the call rises and the call is sold Buy low sell high Must get timing and direction right. Trade loses the most money If the option expires worthless Stock moves down instead of up. Time erodes value of the call. Time is your enemy Call option loses value 4/22/2019 Rajeev Vaidya - OLLI 7

8 Buying vs. selling options Buying Options Right to buy or sell Limited risk loss of premium paid to buy the option Unlimited gain only limited by movement of the undelying Time erodes value for the buyer Must get the direction and the rate of movement of the underlying to make money > Many options traded expire worthless Selling Options Obligation to buy or sell Limited gain premium received to sell the option Unlimited risk determined by the movement of the underlying Time creates value for the seller Multiple scenarios to make profits. Make money on options expiring worthless April 19 Rajeev A. Vaidya

9 Choices the buyer and seller have on a call option Call Buyer Buys to Open position at a net debit Position opened Call Seller Sells to Open position at a net credit Stock price goes up Volatility stays the same Opt. Int Value goes up Opt. Ext Value decays with time Buyer can Sell to Close profit Seller can Buy to Close position to limit loss before expiration Stock price goes down Volatility stays the same Opt. Int Value goes down Opt. Ext Value decays with time Buyer can Sell to Close position to limit loss Seller can Buy to Close profit Stock price < Strike price Option expires Out of The Money Option premium decays to zero. Buyer loses all of the premium paid for the Option. Seller keeps all of the premium received on the Option Stock price below breakeven Buyer has loss on the trade Stock price is above breakeven Buyer has unrealized profit on the trade Stock price > or = Strike price Option expires In The Money Buyer puts up capital to buy the underlying at strike expiration Seller puts up capital to buy the underlying at market price and deliver it to the buyer at strike price. Seller s loss is reduced by premium received. time April 19 Rajeev Vaidya 9

10 What is the setup? Bullish on the market Bullish on the long stock Uptrending Stock Good Fundamentals Chart technical show a swing Bull Flag Sustained uptrend Short down-leg. Reversal on down-leg. Close of the up day above the high of the low day. Liquid options Low bid / ask spreads 4/22/2019 Rajeev Vaidya - OLLI 10

11 What is the trade? Buy a near out of the money call on the underlying Exit quickly, if the trend reversal does not hold and the stock resumes the down move. Exit at profit by selling the call when the uptrend continues and the stock and the call rise in price Target based on bull flag projection. Exit in due time if no significant movement. Limit losses from theta decay. 4/22/2019 Rajeev Vaidya - OLLI 11

12 Extrinsic Value Decay A option is a perishing asset To limit Theta decay, you want your trade to happen in the flat part of this curve Zero at expiration April 19 Rajeev Vaidya

13 What is the trade? Buy a near out of the money call on the underlying 30 delta strike about 50 days out Exit quickly, if the trend reversal does not hold and the stock resumes the down move. Exit at profit by selling the call when the uptrend continues and the stock and the call rise in price Target based on bull flag projection. Exit early at partial profit as needed. Exit in due time if no significant movement. Limit losses from theta decay. Exit in 10 days if no action 4/22/2019 Rajeev Vaidya - OLLI 13

14 Finding Candidates Find uptrending liquid Stocks. We covered how to do this in the CC/BW plans. Look at charts and find bull flags. Confirm that the fundamentals are right for a continued uptrend. Confirm that the options are liquid 4/22/2019 Rajeev Vaidya - OLLI 14

15 StockCharts Scan Uptrending liquid stocks in a bull flag Criteria for scan NYSE or NASDAQ listed 30 day average daily volume is > 500,000 shares Underlying price is > $10 Closing price > SMA(20 days) SMA (20 days) > SMA(50 days) SMA(50 days) > SMA(200 days) 6 days ago close < 3 days ago close 2 days ago close < 2 days ago open] and 2 days ago high < 3 days ago high yesterdays close < yesterdays open and yesterdays high < 2 days ago high Today s close > yesterdays high Output comes as a Excel CSV file Import into ThinkorSwim 4/22/2019 Rajeev Vaidya - OLLI 15

16 Evaluating Candidates Watchlist Processes produce Candidates For all candidates gather the following information Analyst ratings and target prices CFRA, Ford, Credit Suisse, Street.com, MorningStar Metrics Short interest, Put/call ratio Technicals.. Confirm uptrend & bull flag on chart. Support levels and exit price based on the low of the low day in the bull flag Resistance levels and targets based on the estimated target from the bull flag Events Upcoming Dividends ex-divd, record and payment dates Earnings announcements etc. Potential call options Todays date and underlying price Potential call options strike prices, expiration dates and bid/ask prices. 4/22/2019 Rajeev Vaidya - OLLI 16

17 Evaluation Calculations Entry price on the call = Cp e Target price on the underlying = t Calculated option price 10 days out at target price = Cp t Exit Price based on the low of the low day = l Calculated option price 3 days out at the exit price = CP l Estimated Loss per contract = (CP l Cp e ) = L Eestimated Profit per contract = ((CP t Cp e ) = P Upside downside ratio = P / L Days to expiration = D Return per dollar invested per day = P/(Cp e *D) 4/22/2019 Rajeev Vaidya - OLLI 17

18 Record keeping For every trade Setup for the trade At entry Date of Entry, Number of contracts, Total investment Exit scenario Profit or Loss on exit, $ amounts and % gain or loss Number of days in the trade, return per day per $ invested Key learnings from the trade For the system Number of trades with a profit Average size of the profit Number of trades with a loss Average size of the loss Average size of the investment Average number of days in the trade. 4/22/2019 Rajeev Vaidya - OLLI 18

19 Live Action We will go live and look at some bull flag setup s 4/22/2019 Rajeev Vaidya - OLLI 19

20 Class Schedule 4/22/2019 Rajeev Vaidya - OLLI 20

21 Thanks!! Happy Investing!! My Class website 4/22/2019 Rajeev Vaidya - OLLI 21

Options Basics Part II Class 8

Options Basics Part II Class 8 UD Osher OLLI Spring 2019 Rajeev A. Vaidya Guy Werner Disclaimer in plain language: Opinions are like noses, everyone has one! You are going to see mine today!! I am simply