How to Choose Your Strategy Part 4: Options Strategy Cheat Sheet Disclaimer Options involve risks and are not suitable for all investors. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options, sent to you in previous communication. Additional copies may be obtained by calling TRADEKING at 877-495-KING visiting www.tradeking.com/odd or by downloading the file in the pop-up window on your screen. Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax advisor. Any strategies discussed and examples using actual securities and price data are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results. Consider the following when making an investment decision: your financial situation, your risk profile and transaction costs. System response and access times may vary due to market conditions, system performance, and other factors. 2 1
Disclaimer The projections or other information generated by TradeKing's tools regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility, there is no guarantee that this forecast will be correct. Market timing is a complex investment strategy which involves risk and may incur additional commission costs. Webinars are provided for educational and informational purposes only. All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. You alone are responsible for evaluating the merits and risks associated with the use of TradeKing's systems, services or products. 3 Disclaimer Delta represents the consensus of the marketplace as to the theoretical price movement of the option relative to the underlying security. Gamma represents the consensus of the marketplace as to the theoretical rate of change of Delta relative to the underlying security. Theta represents the consensus of the marketplace as to the amount a theoretical option's price will change for a corresponding one-unit (day) change in the days to expiration of the option contract. Vega represents the consensus of the marketplace as to the amount a theoretical ti option's price will change for a corresponding one-unit (point) change the implied volatility of the option contract. Rho represents the consensus of the marketplace as to the amount a theoretical option's price will change for a corresponding one-unit (percent) change in the interest rate used to price the option contract. There is no guarantee that these forecasts will be correct. TradeKing selects and defines as All-Stars certain independent market commentators who are recognized industry personalities and experienced traders. TradeKing All-Stars provide timely market commentary via the TradeKing All-Star Webinars. Each All-Star commentator's bio, related qualifications and disclosure as to their relationship with TradeKing can be found on the All-Star roster, available at http://community.tradeking.com/members/tk-all-star/details. The selection of All-Stars commentators is solely based on the quality and style of the content provided. d TradeKing does not measure, endorse, or monitor the performance or correctness of any statement or recommendation made by independent All-Stars commentators. Supporting documentation for any claims made by Nicole Wachs will be supplied upon request by the author of the webinar, who is solely responsible for the views expressed here. Send a private message to All-Stars using the link below the profile image. 4 2
How to Choose Your Strategy June 23, 2011 How do you get from here to there? 3
Planning a trade: Your Outlook 1. What is the price of the security today? Quotes and charts 2. What is your price target for the future? How long do you estimate the price movement will take? Technical analysis (part 1) Fundamental analysis (part 1) Upcoming news (part 1) 3. How much capital do you plan to use? How much risk is acceptable? Risk management (future series) 4. What problems might you encounter? How can you prepare for these problems? Monitor news (part 1) Risk management (future series) Implied volatility analysis (part 2) Estimate changes with the Greeks (part 3) 7 Planning a trade: Your Outlook 5. What are the conditions today for the overall market and your security? What do you estimate the conditions to be in the future? Technical analysis (part 1) Fundamental analysis (part 1) Upcoming news (part 1) Implied volatility analysis (part 2) Estimate changes with the Greeks (part 3) 6. Are there known events during the expected holding period? News (part 1) Dividends (part 1) 7. How do you plan to deal with both known and unexpected events? How do you plan to deal with possible problems along the way? Risk management (future series) Implied volatility analysis (part 2) Estimate changes with the Greeks (part 3) 8 4
Planning a trade: Your Outlook 8. What type of security and what kind of strategy is appropriate? Estimate changes with the Greeks (part 3) Strategy cheat sheet (part 4) 9. What will you do if you reach your target? How will you know you are successful? What will you do if you do not reach your target? How will you know you are unsuccessful? Risk management (future series) 9 How to Choose Your Strategy Part 1: Your Outlook on Direction, News and Time June 23, 2011 5
Outlook on the underlying Things to consider: 1. Top-down analysis 2. Technical analysis 3. Fundamental analysis 4. News 5. Calendar 6. Perspective and time horizon Speaker: Nicole Wachs Audio Help: 11 866-569-3239 How to Choose Your Strategy Part 2: Your Outlook on Implied Volatility 6
Evaluating potential trades How can we compare High Flyer to Wash N Wear? Is one stock better than the other? Is one implied volatility better than the other? Is one straddle better than the other? Which straddle would you buy? Which straddle would you sell? Key: Relative implied volatility analysis 13 Relative Implied Volatility Analysis Simple method* 1. Pull up Volatility Chart (Under Quotes + Research) 2. Determine the High IV and Low IV over the past 12 months 3. Calculate the range of IV over the past 12 months IV Range = High IV - Low IV 4. Divide the IV Range into 3 parts (thirds) One-third = IV Range 3 5. Determine boundaries of lower third Lower boundary = Low IV + one-third IV Range 6. Determine boundaries of upper third Upper boundary = High IV one-third IV Range 7. Determine which third (lower, middle or upper) IV is now 8. Estimate future direction of IV *Other methods divide the range into quartiles (4), quintiles (5), or deciles (10) and determine boundaries of the regions accordingly 14 7
15 Is one stock better than the other? High Flyer, Inc. with ATM IV = 30% Wash N Wear, Ltd. with ATM IV = 25% No IT DEPENDS ON YOUR STRATEGY! 16 8
How to Choose Your Strategy Part 3: Aligning Your Outlook with the Greeks DELTA as a guideline DIRECTION Delta: represents your outlook as to how Bullish or Bearish you are (on the underlying, not the option itself) Positive Delta: for Bullish plays Higher delta (absolute value) = more bullish Lower delta (absolute value) = less bullish Delta close to zero = neutral (between 0 and +10) Negative Delta: for Bearish plays Higher delta (absolute value) = more bearish Lower delta (absolute value) = less bearish Delta close to zero = neutral (between -10 and 0) Use your outlook on direction from part 1 of this series 18 9
VEGA as a guideline IMPLIED VOLATILITY Vega: represents your outlook on Implied Volatility over the life of the trade The more time Premium, the higher the Vega is for an option. Positive Vega: you expect IV to increase If IV increases, options become more valuable; may profit If IV decreases, options become less valuable; may cause loss Negative Vega: you expect IV to decrease If IV decreases, options become less valuable; may profit If IV increases, options become more valuable; may cause loss Use your outlook on IV from part 2 of this series 19 GAMMA as a guideline NEWS Gamma: represents your outlook for the amount of movement in the underlying (not the option itself) over the life of the trade Positive Gamma you expect a lot of movement in underlying (lively party / news) If you get the movement, your delta will change in your favor Gamma will increase as we near expiration (higher positive) Negative Gamma you expect minimal or range bound movement in the underlying price ( library / quiet period ) If you get the movement, your delta will change against you Gamma will increase as we near expiration (higher negative) Use your outlook on news from part 1 of this series 20 10
THETA as a guideline TIME (and NEWS) Theta: represents your outlook on time over the life of the trade Negative Theta: time is working against you; a lot of movement in underlying price is needed for success (lively party / exciting news); Reduces value of your long option position Over time will result in a loss Positive Theta: time is working in your favor; minimal or range bound movement in the underlying price is needed for success ( library / quiet period ) Reduces value of your short option position Over time may result in gain Use your outlook on news from part 1 of this series 21 RHO as a guideline INTEREST RATES Rho: represents your outlook on interest rates over the life of the trade Positive Rho: you expect interest rates to increase Negative Rho: you expect interest rates to decrease Rho: mostly a factor for trading leaps Delta and Vega are usually more of a concern 22 11
How to Choose Your Strategy Part 4: Options Strategy Cheat Sheet Using the knowledge from Parts 1, 2 and 3 Outlook on direction Outlook on news Relative Implied Volatility Analysis and IV Outlook Greeks and how they might affect your options strategies Lays important foundation Necessary groundwork for use with the Play Box 24 12
Play Box - Assumptions and Guidelines Relative Implied Volatility Analysis Divided into deciles High Low = Range / 10 = width of each decile Mean reverting If IV is relatively high, it is estimated to decrease and move towards the middle of the range If IV is relatively low, it is estimated to increase and move towards the middle of the range No expectations as to time 25 Play Box - Assumptions and Guidelines Strategies are based on The Options Playbook Play Box is a tool, not a crystal ball These are guidelines, not commandments Subject to traders interpretation and application Plays can be customized as to strike and month, changing relative location within the Play Box Outlook on News and Personal Risk Assessment will affect choices and not included in the Play Box Preferred probability of success will also impact Play Box and choices NOTE: Not recommended to short naked options due to unlimited risk!!! 26 13
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