It is not technical, and not dry, allows me to get interested in options, before I took on more technical books that explains more on options, the greeks involved.
I have read a lot of books, and summarised them in my notepad.. will slowly blog them out to share with anyone who are interested in option trading as an income generating strategy.
Hope this Summary helps anyone who is interested!
Get Rich with Options - Lee Lowell
Calls - the right to buy at a strike price, before expiry date
Puts - the right to sell at a strike price, before expiry date
Option calculator of delta, option pricing
Delta-
the percentage relationship of security price with your option price
Example 0.60- When the underlying security moves up $1, your option price moves up 0.60
Volatility
HV - Historical Volatility (based on historical) and IV Implied Volatility (forward looking)
The higher the volatility, the higher option price is
The lower the volatiltiy, the lower option price is
Buy and sell at opportunate time
option price of different stocks may varies a lot due to volatility.
Reverse Skew (usually stocks)
For certain stocks, as strike prices goes down, the implied volatility goes up, due to fear factor of downside moves, this is known as reverse skew. People start paying higher price for downside protection, which inflates option prices, which in turn heats up IV numbers.
Forward skew
As strike prices goes up, IV goes up. Typical for soybean market, especially during summer growing months.
Soybeans trae wtih IV levels getting higher as you move up in strike prices. As dry summers can produce potential droughts and a reduced supply of soybeans, investors tend to favour buying upside protection, which causes more interest in upside strikes.
Smiling Skew
Incorporates a reverse skew and a forward skew
A forward skew develops when the higher-strike options have an increasing large IV. ATM is usually at bottom of the IV curve
Spread - buying 1 option and selling 1 to hedge
1) hedging keep initial cost down and allow more trades
2) spreads can offset an option purchase a lower IV with a sale of option at higher IV. - getting the "volatility edge"
Strategy 1- Buying DITM options on stocks / indexes
Idea- to spend only 50% or less of the stock costs, to control the same amount of stock, using options, and enjoy close to the same price movement (hence to seek delta > 0.9), and with limited losses.
To close this position once profitable, to not hold till the expiry.
1) Choose the deepest DITM option, that has a delta of at least 0.9 and above
2) Choose the lowest strike price possible.
3) If you have choices, try to choose the one with the nearest breakeven price (strike price + premium)
End-results
1) Expire worthless
2) Sell options at any time
3) Roll your options (sell and then buy a new DITM option
4) Exercise the call options and own the assets
Benefits-
1) Lower up-front cost
2) Less Capital at risk
3) Maximum movement- high delta
4) Higher ROI
5) With less capital and lower cost, you can divert funds to other low risks assets
Drawbacks
1) No dividends nor voting rights
2) Expiry dates
Strategy 2- Get paid to buy stocks "naked put selling"
Idea- To own a stock at a lower price than current market price, but instead of waiting for prices to drop and buy, sell naked put options for an income. If prices drop below your targeted price, you would be forced to execute but that is alright as you want to own the stock anyway.
Do not sell naked put options on stocks that you don't want to potentially own.
Good to go in when valued stocks get hammered down, the IV will make put options even more expensive.
1) Choose a stock that you like to own, potentially for long term.
2) Choose a lower price than its current price, that you would think is a bargain
3) Sell a put option
4) Collect income most of the time, and be prepared to execute it if needed
Margin requirements = [(20% of underlying price) + (credit received) - (amt strike price is OTM)] x 100
End-results
1) Expire worthless
2) Own stocks that you want to own, but carries risks that stocks plunge, which would affect you anyway if you outright own the stock
Strategy 3- (Most Favourite of Lowell) Credit Spread (also taught in Daniel Loh)
Sell 1 option and buy the less expensive options for credit
Bull Put Spread
Bear Call Spread
Idea- instead of choosing the price direction where you predict it will go, choose the direction you predict it will not go. This will give you extra allowance. As long as as price does not go too wrong, you benefit due to Time Decay.
1) Sell and buy nearest pair of OTM put options when you think the security is bullish.
2) Sell and buy nearest pair of OTM call options when you think the security is bearish.
3) Sell the more expensive, and buy the cheaper options, for positive credits into your account. (hence credit spread)
4) Debit spread is when you sell the cheaper option, do it only when you are very confident of the directional bias, meant for punting, not a credit spread earning.
5) Wait for time decay or close for profits
Best trades- majority of your trades.
Daniel Loh focusing on this strategy
Strategy #4- Selling covered calls
Idea- If you own a stock, sell covered calls on your own stocks at a higher price
1) Option premiums allow you to earn some income. higher probability
2) If you had to exercise the options, take it as an opportunity to realise your gains.
3) Same golden rule, whenever an option moves swiftly in your favour, usually good idea to buy back the position and take profits.
Strategy Bonus- Ratio Option Spreads- More risky, more rewards, need more experience
Idea- buy 1 expensive OTM options and selling multiple less expensive OTM options to hedge
Allows you to take advantage of a directional bias without incurring an initial debit or having to speculate on low probability OTM option.
Even if all expires, you keep money. As it involves selling naked options, there is a low chance but high risks of losing a lot.
1) buying an OTM option, and selling multiple, less-expensive, farther OTM options against it in 1 single spread trade
2) the multiple sales would provide extra credit on your 1 expensive option purchase
3) You will get credits if all options expire worthless
4) Best case scenario- Price moves towards the middle of the range you bought, giving your bought options profits, and making your sold options worthless
5) Selling put ratio spread is better than call ratio spread, as security can only go to zero, but can rise to infinity. However, some call ratio spreads are worth it
Smiling Skew - optimal as higher IV as you move away from ATM makes option pricing more expensive and worthwhile to sell.
Example- Call ratio spread on soyabeans
Soyabean options great to trade at summer months, just in spring- Soybean forward skew
Nov price 604 3/4
Buy 680 calls for 90cents
Sell 5 Nov 820 calls for 21 cents each
Total credit $1.40
if soyabeans move up to 680 - 820, you gain in bought calls of 680, but your sold options of 820 can expire worthless. Good returns
Be mindful of StopLoss, as what you do not like may still happen. SL and stay Sharp
Stock / Indexes Call Ratio Spreads
Indexes are reverse skew- sales of far OTM put options offset by purchase of not-so-far OTM put options -> big winner.
Example:- Put ratio spread on 2006 DJ 11,000
Sell 56 7000 put options for $560, and buy 3 10,400 put options for $30
If all expire worthless, earn $530 credit
If it moves to between range of 7000 and 10,400, then you earn big profits.
if it moves below 7000, huge losses.
Unlimited Risk exposure, stay sharp with SL
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