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ONE STRATEGY FOR ALL MARKETS
TABLE OF CONTENTS
Option Fundamentals 9
Calls 10
Puts 11
Call and Put Variables 12
Strike Price 13
Expiration 13
Interest Rates (Rho) 15
Volatility (Vega) 15
Decay (Theta) 16
Intrinsic Value 17
Settlement 18
Put Option Analogy 19
Call Option Analogy 20
What makes up the Value of an Option 22
Intrinsic Value 22
Time Value 22
Function of Probability 23
Option Chain Time Values 25
Pricing Increments 26
Bid-Ask Spread 27
Broken Wing Butterfly Spreads (BWB) 29
Introduction 30
Definition 31
Practical definition of BWB 31
Ratio Spread portion 32
Breakeven and maximum profit at expiration 32
“Tail” purchase portion of trade 33
Risk and margin without the “tail” 36
Exact margin guidelines 36
Maximum loss 37
Formula for calculation of margin 38
How to reduce the risk and margin 39
Risk Graphs 39
Ratio spreads and the Greeks 40
Refresher of option's Greek definitions 41
Copyright Material © 1 All Rights Reserved
Option's Greeks calculation charts 42
Charts explained 45
Cost analysis 45
Delta analysis 47
Gamma analysis 48
Theta & Vega analysis 49
Why the Greeks work so well 49
The practical use and mechanics of Ratio Spreads 50
OEX option chain 51
How Ratio Spreads react in reality to Price 52
Market stays flat – no time passes 53
Market runs up – no time passes 54
Study of 535 put as Index advances 55
Formula for pricing options after a move 56
OEX example 57
OEX example using calls 61
How Ratio Spreads react in reality to Time 65
Market stays flat – time passes 65
Practical example 66
Illustration of reaction to time and price movement 69
Setting up an example 70
How to line up the option chains 70
What was the profit/loss 73
Broken Wing Butterfly Spreads (BWB) Entry Criteria 75
Introduction, circumstances and considerations 76
Step 1 – Select an underlying 77
Indexes 77
Stock 79
Step 2 – Decide bullish, bearish or neutral 79
OEX option chain 80
Call vs. put spread for even comparison 81
Step 3 – Select the month(s) 82
Front month 82
Back month 83
Step 4 – Determine with which strikes to begin 83
OEX option chain 84
Step 5 – Calculate the cost of small ATM spread 85
What is the ATM option trading for? 85
What do the next 2 OTM options trade for? 85
What is the net debit/credit? 85
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Step 6 – Calculate the cost of a medium width ATM spread 87
Pricing charts 88
Step 7 - Calculate the cost of a large width ATM spread 89
What can you expect to see? 90
Expected range of Ratio and BWB trades 91
Put skew 93
Call skew 93
Step 8 – Find the spread in the next month out 94
April OEX option chain 94
Same trade one month further out results 95
Step 9 – Determine range if underlying moved 5-6% 95
Step 10 – Calculate spread value after underlying moves 95
OEX put option chain 96
Approximating probability 97
Step 11 – Compare/contrast price possibilities 99
Step 12 – Determine if front or back month is better 100
Same month, same strike 100
Two months, two different strikes 101
Which month and strike is better? 102
Step 13 – Compare other indexes 107
Step 14 – Ratio Spread or Broken Wing Butterfly? 108
Ratio spread vs. BWB margin 109
Margin comparison 110
Step 15 – Converting a Ratio Spread to a BWB 110
Margin reduction 110
Risk reduction 111
Conclusion 114
Important note 115
Broken Wing Butterfly Spreads (BWB) Exit Criteria 117
Introduction and benefits 118
Step 1 – Calculate profit/loss on spread 119
Step 2 – Establish P/L goal and rolling down area 119
Step 3 – Front and Back month maintenance/closing 120
Front month 121
Back month 121
Step 4 – Watch the markets 121
Step 5 – How often to recalculate P/L points 122
Greater than 3 weeks to expiration 122
Less than 3 weeks to expiration 122
Step 6 – Re-evaluate P/L of the spread 123
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Adjusting for time and price movement 123
Worksheets 124
Step 7 – After re-evaluation, note where spread loses 125
Step 8 – Some action may be necessary 125
Exit for breakeven 126
Roll the trade further OTM 126
Be patient 127
Consider the “tail” 127
Step 9 – When to close 128
Market running in wrong direction 128
Profit less than 50% of maximum 129
Step 10 – Time to take the trade off 131
Risk Ratio Spreads (Aggressive) 133
Index Options 135
Why use index options? 136
OEX as an example 139
Bonus Chapter: The New Margin Rules 141
Margin: A Definition 142
Old Rules: Basic Option Strategies 143
Major Difference Between Old and New 144
So What Other Positions May be Affected? 145
Married Puts 145
Collars 150
Synthetic Puts 154
Reverse Collars 159
Gamma Scalping 164
Basic Synthetics 170
Call Time Spreads and Short Call Vertical Spreads 170
Put Time Spreads and Short Put Vertical Spreads 172
A Brief Word on Short Time Spreads 174
Things to Avoid 175
The Conversion 175
Going out Too Far in Time 176
A Few Last Thoughts 177
Appendix
Terminology 181
Types of Orders 197
|
ONE STRATEGY FOR ALL MARKETS
TABLE OF CONTENTS
Option Fundamentals 9
Calls 10
Puts 11
Call and Put Variables 12
Strike Price 13
Expiration 13
Interest Rates (Rho) 15
Volatility (Vega) 15
Decay (Theta) 16
Intrinsic Value 17
Settlement 18
Put Option Analogy 19
Call Option Analogy 20
What makes up the Value of an Option 22
Intrinsic Value 22
Time Value 22
Function of Probability 23
Option Chain Time Values 25
Pricing Increments 26
Bid-Ask Spread 27
Broken Wing Butterfly Spreads (BWB) 29
Introduction 30
Definition 31
Practical definition of BWB 31
Ratio Spread portion 32
Breakeven and maximum profit at expiration 32
“Tail” purchase portion of trade 33
Risk and margin without the “tail” 36
Exact margin guidelines 36
Maximum loss 37
Formula for calculation of margin 38
How to reduce the risk and margin 39
Risk Graphs 39
Ratio spreads and the Greeks 40
Refresher of option's Greek definitions 41
Copyright Material © 1 All Rights Reserved
Option's Greeks calculation charts 42
Charts explained 45
Cost analysis 45
Delta analysis 47
Gamma analysis 48
Theta & Vega analysis 49
Why the Greeks work so well 49
The practical use and mechanics of Ratio Spreads 50
OEX option chain 51
How Ratio Spreads react in reality to Price 52
Market stays flat – no time passes 53
Market runs up – no time passes 54
Study of 535 put as Index advances 55
Formula for pricing options after a move 56
OEX example 57
OEX example using calls 61
How Ratio Spreads react in reality to Time 65
Market stays flat – time passes 65
Practical example 66
Illustration of reaction to time and price movement 69
Setting up an example 70
How to line up the option chains 70
What was the profit/loss 73
Broken Wing Butterfly Spreads (BWB) Entry Criteria 75
Introduction, circumstances and considerations 76
Step 1 – Select an underlying 77
Indexes 77
Stock 79
Step 2 – Decide bullish, bearish or neutral 79
OEX option chain 80
Call vs. put spread for even comparison 81
Step 3 – Select the month(s) 82
Front month 82
Back month 83
Step 4 – Determine with which strikes to begin 83
OEX option chain 84
Step 5 – Calculate the cost of small ATM spread 85
What is the ATM option trading for? 85
What do the next 2 OTM options trade for? 85
What is the net debit/credit? 85
Copyright Material © 2 All Rights Reserved
Step 6 – Calculate the cost of a medium width ATM spread 87
Pricing charts 88
Step 7 - Calculate the cost of a large width ATM spread 89
What can you expect to see? 90
Expected range of Ratio and BWB trades 91
Put skew 93
Call skew 93
Step 8 – Find the spread in the next month out 94
April OEX option chain 94
Same trade one month further out results 95
Step 9 – Determine range if underlying moved 5-6% 95
Step 10 – Calculate spread value after underlying moves 95
OEX put option chain 96
Approximating probability 97
Step 11 – Compare/contrast price possibilities 99
Step 12 – Determine if front or back month is better 100
Same month, same strike 100
Two months, two different strikes 101
Which month and strike is better? 102
Step 13 – Compare other indexes 107
Step 14 – Ratio Spread or Broken Wing Butterfly? 108
Ratio spread vs. BWB margin 109
Margin comparison 110
Step 15 – Converting a Ratio Spread to a BWB 110
Margin reduction 110
Risk reduction 111
Conclusion 114
Important note 115
Broken Wing Butterfly Spreads (BWB) Exit Criteria 117
Introduction and benefits 118
Step 1 – Calculate profit/loss on spread 119
Step 2 – Establish P/L goal and rolling down area 119
Step 3 – Front and Back month maintenance/closing 120
Front month 121
Back month 121
Step 4 – Watch the markets 121
Step 5 – How often to recalculate P/L points 122
Greater than 3 weeks to expiration 122
Less than 3 weeks to expiration 122
Step 6 – Re-evaluate P/L of the spread 123
Copyright Material © 3 All Rights Reserved
Adjusting for time and price movement 123
Worksheets 124
Step 7 – After re-evaluation, note where spread loses 125
Step 8 – Some action may be necessary 125
Exit for breakeven 126
Roll the trade further OTM 126
Be patient 127
Consider the “tail” 127
Step 9 – When to close 128
Market running in wrong direction 128
Profit less than 50% of maximum 129
Step 10 – Time to take the trade off 131
Risk Ratio Spreads (Aggressive) 133
Index Options 135
Why use index options? 136
OEX as an example 139
Bonus Chapter: The New Margin Rules 141
Margin: A Definition 142
Old Rules: Basic Option Strategies 143
Major Difference Between Old and New 144
So What Other Positions May be Affected? 145
Married Puts 145
Collars 150
Synthetic Puts 154
Reverse Collars 159
Gamma Scalping 164
Basic Synthetics 170
Call Time Spreads and Short Call Vertical Spreads 170
Put Time Spreads and Short Put Vertical Spreads 172
A Brief Word on Short Time Spreads 174
Things to Avoid 175
The Conversion 175
Going out Too Far in Time 176
A Few Last Thoughts 177
Appendix
Terminology 181
Types of Orders 197