How to Trade Options: Non-Directional Strategies

Transcription

1 How to Trade Options: Non-Directional Strategies MICHAEL BURKE

2 Important Information and Disclosures This course is provided by TradeStation, a U.S.-based multi-asset brokerage company that seeks to serve institutional and active traders. Please be advised that active trading is generally not appropriate for someone of limited resources, limited investment or trading experience, or low risk tolerance, or who is not willing to risk at least $50,000 of capital. Neither TradeStation nor its affiliates provide or suggest any specific analysis, options strategy, or other trading strategies. TradeStation offers brokerage services along with unique tools to help you analyze and test your own trading ideas and strategies. While we believe this is very valuable information, we caution you that simulated past performance of a trading strategy is no guarantee of its future performance or success. We also do not recommend or solicit the purchase or sale of any particular securities or securities derivative products. Any securities symbols referenced in this book are used only as an example not as a recommendation. All proprietary technology in TradeStation is owned by our affiliate TradeStation Technologies, Inc. Equities, equities options, and commodity futures products and services are offered by TradeStation Securities, Inc., a member of NYSE, FINRA, NFA and SIPC. TradeStation and EasyLanguage are registered trademarks of TradeStation Technologies, Inc. TradeStation, as used in this document, should be understood in the foregoing context. Options Risk Disclosure Options trading carries a high degree of risk. Purchasers and sellers of options should familiarize themselves with options trading theory and pricing, and all associated risk factors. Please read Characteristics and Risks of Standardized Options, available from the Options Clearing Corporation website ( or by writing TradeStation, 8050 SW 10 Street, Suite 2000, Plantation, FL Trading options can be much more complex and challenging than trading stocks, and is not suitable for all traders. Traders should always consult a tax advisor about any potential tax consequences of their trading. Copyright , TradeStation, ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of TradeStation, Inc. WHILE EVERY PRECAUTION HAS BEEN TAKEN IN THE PREPARATION OF THIS COURSE, TRADESTATION ASSUMES NO RESPONSIBILITY FOR ERRORS OR OMISSIONS, OR FOR ANY DAMAGES RESULTING FROM THE USE OF THE INFORMATION CONTAINED HEREIN.

3 Contents Important Information and Disclosures... 2 Options Risk Disclosure... 2 Options Strategies... 4 Market Outlook... 4 Reading a Position Graph... 5 General Options Multi-leg Strategy Theory... 6 Maximum Loss... 6 Maximum Gain... 6 Long (Buy) Straddle... 7 Long (Buy) Strangle... 8 Long (Buy) Butterfly... 9 Long (Buy) Condor Long Calendar Spread Additional Educational Resources... 12

4 Options Strategies Options trading offers the ability to take advantage of non-directional market opportunities in both quiet low volatility conditions and potentially active high volatility situations. With dozens of possible option strategies to employ, choosing the right strategy for the right situation comes down to knowledge and experience. Options trading requires effort and a greater understanding of the mechanics and pricing of options strategies in order to make informed options trading decisions. In this course we will look at both quiet and active market strategies. Option Strategies Long Straddle Long Strangle Butterfly Long Iron Condor Calendar Spread Market Outlook Market neutral, volatility increasing (Limited Risk) Market neutral, volatility increasing (Limited Risk) Quiet market (Limited Risk) Quiet market (Limited Risk) Quiet market (Limited Risk) Note: There are additional multi-leg option strategies that you can learn about and employ in your options trading. Each leg of a multi-leg spread incurs a commission and bid/ask cost that can be significant to your profit or loss. 4

5 Reading a Position Graph We will look at some of the most popular strategies traders are using today. Each position graph provided shows the option position profit/loss profile at expiration. You can also derive the maximum gain, maximum loss, and breakeven points from these graphs. Each plot on the graph represents a date in time; often, the expiration date is a default plot. Long Call Position Graph at Expiration Each option position graph shows the position profit and loss (P&L) on the left y-axis. The underlying asset price is along the bottom on the x-axis. Strike prices of the position are generally at the angle points of the P&L line, which are also generally the points of maximum gain or maximum loss of the position. The dotted line at 0 is the breakeven line. When the P&L line crosses the breakeven line, you can read the position breakeven price of the underlying asset on the x-axis. The profit or loss above does not factor in commissions, interest, bid-ask spread, or tax considerations. With TradeStation s OptionStation Pro, you can create position graphs for any options position or strategy, even custom positions that include LEAPS or the underlying asset. 5

6 General Options Multi-leg Strategy Theory Now that we have looked at the four basic options strategies, we can use these strategies as building blocks to create more complex multi-leg options strategies. Multi-leg strategies are options positions that can create trading opportunities for virtually any market mode or situation. The behavior and characteristics of multi-leg options positions have several things in common across most strategies. By understanding these characteristics, you can quickly determine important profit/loss and risk information that can help you better analyze your positions. The most common types of multi-leg options strategies are options spread positions: an options position that has two or more different options contracts (legs) traded in combination, usually comprised of buying and writing both puts and/or calls of the same of different strike prices and/or expiration dates. Spreads allow the trader to take advantage of a wide array of market conditions and often help to increase the leverage of capital of the trade. When writing options in combination with buying options, the options you are buying can often offset the margin requirements for the options you are writing, reducing or sometimes eliminating a margin requirement. You can generally determine the underlying asset s maximum gain and maximum loss price points for any spread position by looking at the strike prices of the options that make up your strategy. The maximum gain price point of the underlying asset is generally at the strike price of the options you are selling, and the maximum loss price point is generally at the strike price of the options you are buying. Maximum Loss Any time you create and open an options spread position with a debit (a debit is incurred whenever the options you are buying are more expensive than the options you are selling), the debit is usually the maximum amount you can lose on the position. However, there is the risk of early exercise for options you are writing, and this can cause a generally safe strategy to lose considerably more money than expected. Maximum Gain When you create and open a spread position with a credit (a credit is incurred whenever the options you are buying are less expensive than the options you are selling), the credit is usually the maximum gain of the position. There will be a margin requirement equal to the maximum loss of the position. Note: The profit or loss for the following examples below do not factor in commissions, interest, bid/ask spread, or tax considerations. Multi-leg spreads incur multiple commissions and must also overcome multiple bid/ask spreads, which can affect the profit and loss of an options position. 6

7 Long (Buy) Straddle A long straddle is a neutral position taken when a large move is expected either up or down but the direction is uncertain. A long straddle is made up of two options positions; a buy put and a buy call at the same strike price in the same expiration month, typically using strike at or near the current asset price. Normally, you need to give this type of position plenty of time to produce profits as the asset needs to make a significant move in one direction. Since we are buying options, the position can also benefit from an increase in volatility. There is no margin requirement other than the cost of the options, and the maximum loss is the premium paid to purchase the straddle. The position benefits from a large directional price move, and is not profitable if the underlying asset price movement becomes stagnant and does not move enough in either direction to cover the cost of the position. Long Straddle Options Strategy: Long 1 XYZ SEPT , $245 premium paid (debit account). Long 1 XYZ SEPT , $221 premium paid (debit account). Results: Maximum gain is unlimited in either direction. Maximum loss is the debit: ($2.45+$2.21) X 100 = $466. Maximum loss is realized at expiration at the strike price of the options bought (48). Breakeven prices occur at the strike price + and - the premium paid: ( = 43.34) and ( = 52.66). Risk Factor Effect: Price sensitivity (Delta) position generally increases in value by the Delta value as the underlying asset price rises or falls. Time decay (Theta) position profit decreases in value by the Theta value with the passage of time. Volatility sensitivity (Vega) position profit increases in value by the Vega value with rising volatility. 7

8 Long (Buy) Strangle A long strangle is a neutral position taken when a large move is expected either up or down but the direction is uncertain. A long strangle is made up of two options positions; a buy put and a buy call at different strike prices in the same expiration month, typically using strikes just out-of-the money. Normally, you need to give this type of position plenty of time to produce profits, as the asset needs to make a significant move in one direction. Since we are buying options, the position can also benefit from an increase in volatility. There is no margin requirement other than the cost of the options, and the maximum loss is the premium paid to purchase the strangle. The position benefits from a large directional price move, and is not profitable if the underlying asset price movement becomes stagnant and does not move enough in either direction to cover the cost of the position. Strangles cost less to put on than straddles, but the area of maximum loss is increased for a strangle. Long Strangle Options Strategy: Long 1 XYZ SEPT , $195 premium paid (debit account). Long 1 XYZ SEPT , $179 premium paid (debit account). Results: Maximum gain is unlimited in either direction. Maximum loss is the debit: ($1.95+$1.79) X 100 = $374. Maximum loss is realized at expiration between the strike prices bought (47-49). Breakeven prices occur at the strike prices + and - the premium paid: ( = 43.26) and ( = 52.74). Risk Factor Effect: Price sensitivity (Delta) position generally increases in value by the Delta value as the underlying asset price rises or falls. Time decay (Theta) position profit decreases in value by the Theta value with the passage of time. Volatility sensitivity (Vega) position profit increases in value by the Vega value with rising volatility. Multi-leg spreads incur a commission and bid/ask cost that can be significant to your profit or loss. 8

9 Long (Buy) Butterfly A long butterfly spread is a neutral position taken when the market is expected to have little directional movement, sometimes called a quiet market outlook. A long butterfly is made up of three options positions using either all calls or all puts: sell 2 options at-the-money, buy 1 option in-the-money, and buy 1 option out-of-the-money, all in the same expiration month. Although this is called a long Butterfly, the trading position is actually net short and benefits from time decay and decreasing volatility. The riskreward for a butterfly typically often looks very advantageous, but there is only a small window of underlying price range for profitability. In addition, the odds of hitting the exact price for the maximum gain are very low. The margin requirement for this position is the maximum loss of the positon, usually a relatively small amount. Long Butterfly Options Strategy: Long 1 XYZ SEPT , $370 premium paid (debit account). Short 2 XYZ SEPT , $480 premium received (credit account). Long 1 XYZ SEPT , $153 premium paid (debit account). Results: Maximum loss is the net debit: Net Debit = (2.40 x 2) - ( ) =.43. Maximum gain is based on the strike price proximities minus the net debit: (48-46) - net debit = =1.57 or $ Breakeven Prices occur at the center strike price + and - the maximum gain ( = 46.43) and ( = 49.57). Risk Factor Effect: Price sensitivity (Delta) position generally decreases in value by the Delta value as the underlying asset price rises or falls. Time decay (Theta) position profit increases in value by the Theta value with the passage of time. Volatility sensitivity (Vega) position profit decreases in value by the Vega value with rising volatility. Multi-leg spreads incur a commission and bid/ask cost that can be significant to your profit or loss. 9

10 Long (Buy) Condor A long condor spread is a neutral position taken when the market is expected to have little directional movement. A long condor is made up of four options positions using either all calls or all puts: sell 1 option slightly in-the-money, sell 1 option slightly out-of-the-money, buy 1 option slightly more in-themoney, and buy 1 option slightly more out-of-the-money, all in the same expiration month. Although this is called a long condor, the trading position is actually net short and benefits from time decay and decreasing volatility. The margin requirement for this strategy is the maximum loss of the position. Since this strategy benefits from time decay, it may be advantageous to only trade this strategy with days left to expiration. Long Condor Options Strategy: Long 1 XYZ SEPT 44 $87 premium paid (debit account). Short 1 XYZ SEPT , $173 premium received (credit account). Short 1 XYZ SEPT , $325 premium received (credit account). Long 1 XYZ SEPT , $510 premium paid (debit account). Results: Maximum loss is the net debit: Net Debit = ( ) - ( ) = Maximum gain is based on the strike price proximities minus the net debit: (47-44) - net debit = =1.51 or $ Breakeven prices occur at the strike prices of the options sold + and - the maximum gain ( = 45.49) and ( = 51.51). Risk Factor Effect: Price sensitivity (Delta) position generally decreases in value by the Delta value as the underlying asset price rises or falls. Time decay (Theta) position profit increases in value by the Theta value with the passage of time. Volatility sensitivity (Vega) position profit decreases in value by the Vega value with rising volatility. Multi-leg spreads incur a commission and bid/ask cost that can be significant to your profit or loss. 10

11 Long Calendar Spread A calendar spread is a neutral market position, sometimes referred to as a time spread. It is used when the underlying asset price is stable and is not expected to make any major move over the life of the position. A calendar spread is made up of writing a near-term call or put and buying a longer-term call or put that covers the option sold. Both options must be of the same type and the same strike. The idea with a calendar spread is that the value of the near-term options will decay faster than the far-term options, allowing the trader to capture time decay. Maximum gain occurs at the strike price of the near-term option at expiration, at which time you can elect to close the entire position or continue with the long options trade. The margin requirement is the maximum loss of the trade, which is the debit you incur to put on the position. Long Calendar Spread: Long 1 XYZ SEPT , $370 premium paid (debit account). Short 1 XYZ AUG , $480 premium received (credit account). Results: Maximum loss is the net debit: Net Debit = (1.95) - (1.69) =.26 or $ Maximum gain is difficult to calculate, but is limited to the premium received, minus the net debit, minus the cost to buy back the SEPT long call Approx: ( ) -.75 to buy back the call (rough guess) =.68 in profit or $ Breakeven prices require a pricing model to estimate. OptionStation Pro position graphs make this calculation. (see graph above) Risk Factor Effect: Price sensitivity (Delta) position generally decreases in value by the Delta value as the underlying asset price rises or falls. Time decay (Theta) position profit increases in value by the Theta value with the passage of time. Volatility sensitivity (Vega) position profit decreases or increases in value by the Vega value with rising or falling volatility depending on the underlying asset s price proximity to the strike price of the option sold. 11

12 Additional Educational Resources How to Trade Options - Primer Series: Session 2 - Volatility and the Greeks Session 3 - Option Strategy Building Blocks Getting Started With OptionStation Pro (Lesson 9) OptionStation Pro Video Tutorials Session 1 - How Options Are Priced Advanced How to Trade Options Seminars FREE VideoStation Trading App (makes it easier to access/find/view videos) Strategy Concepts Club - Premium Content Monthly magazine with strategy trading ideas, strategy development concepts, and sample EasyLanguage code. - Free Sample Issue Here 12