The Option Trader Handbook Strategies and Trade Adjustments Second Edition GEORGE VI. JABBOIiR, PhD PHILIP H. BUDWICK, MsF WILEY John Wiley & Sons, Inc.
Contents Preface to the First Edition Preface to the Second Edition xlli xvli CHAPTER 1 Trade and Risk Management 1 Introduction 1 The Philosophy of Risk 2 Truth About Reward 5 Risk Management 6 Risk 6 Reward 9 Breakeven Points, 11 Trade Management 11 Trading Theme 11 The Theme of Your Portfolio 14 Diversification and Flexibility 15 Trading as a Business 16 Start-Up Phase 16 Growth Phase 19 Mature Phase 20 Just Business, Nothing Personal 21 SCORE The Formula for Trading Success 21 Select the Investment 22 Choose the Best Strategy 23 Open the Trade with a Plan v, 24 Remember Your Plan and Stick to It 26 Exit Your Trade 26
Vl CONTENTS CHAPTER 2 Tools of the Trader 29 Introduction 29 Option Value 30 Option Pricing 31 Stock Price 31 Strike Price 32 Time to Expiration 32 Volatility 33 Dividends 33 Interest Rates 33 Option Greeks and Risk Management 34 Time Decay 34 Trading Lessons Learned from Time Decay (Theta). 41 Delta/Gamma 43 Deep-in-the-Money Options 46 Implied Volatility 49 Early Assignment 63 Synthetic Positions 65 Synthetic Stock 66 Long Stock 66 Short Stock 67 Synthetic Call 68 Synthetic Put 70 Basic Strategies 71 Long Call, 71 Short Call. - 72 Long Put.' 73 Short Put 74 Basic Spreads and Combinations 75 Bull Call Spread 75 Bull Put Spread 76 Bear Call Spread 77 Bear Put Spread 78 Long Straddle 78 Long Strangle 79 Short Straddle 80 Short Strangle 81 Advanced Spreads 82 Call Ratio Spread 82 Put Ratio Spread 83
Contents vli Call Ratio Backspread 84 Put Ratio Backspread 85 Long Butterflies 86 Short Butterflies 87 Long Calendar Spreads 88 Short Calendar Spreads 89 The Greeks and Spread Trades 90 Delta/Gamma 91 Vega 92 Other Greeks and Spreads 93 Valuable Derivative Traders Program 93 Step 1: VEGA and Implied Volatility (IV) 94 Step 2: Delta and Strike Selection 96 Step 3: Theta and How Much Time to Expiration 97 Putting the Program to Work 99 Introduction to Trade Adjustments 100 CHAPTER 3 Long Stock 105 Introduction 105 Protective Put 106 Stock Moves Higher 109 Stock Moves Lower 111 Bear Put Spread ^ 114 Rolling from a Protective Put into a Bear Put Spread 116 Rolling from a Bear Put Spread into a Protective Put 118 Call Replacement 120 Stock Moves Higher 121 Stock Moves Lower 122 Call Replacement versus Protective Put 123 Sell Covered Calls 123 Stock Moves Higher 125 Strike Selection 127 In the Money Calls 128 Time to Expiration, 131 Scaling-Out Strategy 1 32 Collars 134 Opening Position Regular Collar 1 34 Stock Moves Higher Profit Collar 1 37
CONTENTS Ratio Write 139 Opening Position 140 Stock Moves Higher Regular Ratio Write 143 Stock Moves Higher Variable Strike Ratio Write 149 Stock Moves Lower Ratio Write/Variable Strike Ratio Write 1 53 Short Straddle/Short Strangle 156 Opening Position Short Straddle 1 56 Opening Position Short Strangle 160 Stock Moves Higher Short Straddle 163 Stock Moves Higher Short Strangle 168 Stock Moves Lower Short Straddle/Stock Repair 1 72 Stock Moves Lower Short Strangle 1 76 Call Ratio Spread 179 Opening Position 182 Stock Moves Higher 186 Stock Moves Lower Stock Repair Strategy 191 Call Calendar Spread 193 Opening Position 195 Stock Moves Higher ' " 196 CHAPTER 4 Short Stock 201 Introduction 201 Protective Call Insurance 203 Opening Position Protective Call 203 Opening Position Protective Call Spread 208 Short Stock + Protective Call = Long Put 210 Stock Moves Lower Protective Call 212 Stock Moves Lower Protective Call Spread 21 5 Rolling between Protective Calls and Protective Call Spreads 219 Stock Moves Higher 221 Put Replacement 223 Stock Moves Lower 224 Stock Moves Higher 226 Put Replacement versus Protective Call 227 Covered Puts 228 Stock Moves Lower 229 Short Collars 234 Opening Position Regular Collar 235 Stock Moves Lower Profit Collar 237
Contents ix Put Ratio Write 239 Opening Position 240 Stock Moves Lower Regular Ratio Write 243 Stock Moves Lower Variable Strike Ratio Write 248 Put Ratio Spread 250 Opening Position 250 Stock Moves Lower 253 Stock Moves Higher Short Repair Strategy 256 CHAPTER 5 Calls and Puts 259 Introduction 259 Long Call 260 Protective Put Stock Moves Higher 260 Protective Put Stock Moves Lower 262 Call Replacement 264" Rolling into a Bull Call Spread Stock Moves Higher 267 Rolling into a Bull Call Spread Stock Moves Lower/Call Repair Strategy 269 Rolling into a Bear Call Spread 271 Short Stock 272 Rolling into a Synthetic Straddle 274 Rolling into a Calendar Spread 276 Rolling into a Ratio Spread 278 Stock Moves Lower Call Repair Strategy 281 Short Call 285 Long Put 288 Protective Call 288 -Underlying Stock Moves Lower 288 Underlying Stock Moves Higher 290 Put Replacement Therapy. 292 Rolling into a Bear Put Spread 294 Underlying Stock Moves Lower 294 Underlying Stock Moves Higher Put Repair Strategy 295 Rolling into a Bull Put Spread 297 Long Stock/Synthetic Straddle 298 Put Calendar Spread 302 Put Ratio Spread 305 Underlying Stock Moves Lower < 305 Underlying Stock Moves Higher Put Repair Strategy 308 Short Put 311
X CONTENTS CHAPTER 6 Spreads 317 Introduction 317 Bull Call Spreads/Bear Put Spreads 317 Protective Puts/Protective Calls 318 Bull Call Spread Protective Put 318 Bull Call Spread Protective Put Spread 320 Bear Put Spread Protective Call 321 Bear Put Spread Protective Call Spread 322 Convert to Ratio Spreads 323 Bull Call Spread Stock Moves Higher 323 Bull Call Spread Stock Moves Lower/Repair Strategy 326 Bear Put Spread Stock Moves Lower 330 Bear Put Spread Stock Moves Higher/Repair Strategy 332 Convert to Butterflies 336 Bull Call Spread 337 Bear Put Spread 338 Bear Call Spreads/Bull Put Spreads 340 Calendar Spreads 340 Call Calendar Spread 341 v Stock Moves Higher Rolling into a Bull Call Spread 341 Stock Moves Higher Rolling into a Diagonal Ratio Spread 342 Stock Moves Lower Rolling into a Lower Strike Bull Call Spread 343 Stock Moves Lower Convert to a Calendar Strangle 344 Put Calendar Spread 345 Stock Moves Lower Rolling into a Bear Put Spread 345 Stock Moves' Lower Rolling into a Diagonal Ratio Spread 345 Stock Moves Higher Rolling into a Higher Strike Bear Put Spread 347 Stock Moves Higher Rolling into a Calendar Strangle 348 Butterfly Spreads 348 Long Butterfly to Long Condor 348 CHAPTER 7 Combinations 353 Introduction 353 Long Straddle 353 Straps/Strips 354 Modified Straps/Strips 357 Calendar Straddle 359 Rolling a Long Straddle into an Iron Butterfly 361 Diagonal Iron Butterfly 363
Contents xl. Partial Iron Butterfly 363 Long Call/Long Put Adjustments 365 Long Strangle 365 Diagonal Iron Butterfly 365 Calendar Strangle 367 Long Call/Long Put Adjustments 367 Short Straddle/Short Strangle 368 Short Straddle 368 Rolling Short Straddle into Iron Butterfly 371. Short Strangle 373 Index 37S