ACE Class Report # 77: Stock Options.
Begin: 7/18/2024
Finish: 10/3/2024
Title: Stock Options
Instructor: Paul Mata, Abbas Saeddi
Why I choose to take this class:
To learn more about Options trading in the financial market. Option trading could be my new investment vehicle while I am retired.
What I learned from this class:
Option Contracts:
The exchange begin trading in Options in the 1970’s. In 1973 the Chicago Board Option Exchange opened a market for trading call options on major stocks. Buyers of these options acquire the right, but not the obligation to buy a fixed number of shares of a stock at a certain price at any time over a fixed period. Options contracts provide a way to minimize losses due to price changes. Assume, that an investor owns bonds and plan to sell them in 6 months, buy a put option, the investor guarantees a minimum selling price. The investor also leaves open the possibility that if the bonds price rise, he or she can ignore the put option and sell the bond at a higher price.
Investments: Understanding Stock Options:
An option is a contract that gives the buyer a right, but not an obligation to buy a stock at a certain price (strike price) at any time by expiration date by paying a premium.
If a trader buys a contract (opening), he is long (Call).
If a trader sells a contract (opening), he is short (Put).
Premium and change due to strike price; time remaining before option expire (time value); volatility; current interest rates; supply and demand. Interest rates, higher rates effect borrowing. So if shorting an option (selling) when interest rates are high would increase the overall cost. Still, Th interest rate is one of the least factors affecting the option price.
Volatility – magnitude of movements in an option. Th overall market is measured by VIX (Volatility Index aka ‘The fear Index.’ Each option has its own volatility measure. When volatility is low-Look for option buying strategies. When Volatility is high – Option premium is high – Take advantage of over- valued premiums – selling option strategies. We want double confirmations – it reduces the risk.
If the trend is up and IV low – Buy Options.
If the trend is down and IV low – do nothing.
If the trend is down and IV low – Sell options.
Buy Call – expect market to go up – Long – Call Option.
Buy Put – expect market to fall – Short – Put Option.
Sell Call – expect market to fall – Short – Call Option.
Sell Put – Expect market to go up – Long – Put Option.
Why stock options? – 60-70% of the time market is sideways.
1) Leverage – magnifying gains when you are correct on the market.
2) Strategies – strategies can be profitable over a wide range of prices.
3) Strategies – can make money when predictions are wrong.
4) Limited Risk – Limited to the amount of premium paid for the option.
5) Hedging – hedging underlying asset with a small premium.
There are two types of options:
1) Call (Make someone sell)- purchaser of a call has the right to buy an underlying asset at a specific price within a certain time frame (Make them sell). Seller of the call has the obligation to sell underlying assets at a strike price prior to expiration.
2) Put (Make someone Buy) – Put option gives the option buyer the right to sell underlying asset at a certain price prior to expiration (Make them buy) and conversely obligates the seller to take delivery at this price on or before expiration date (Make you buy), if option is exercised.
There are four choices of Options:
1) Buy a Call option – and you pay a premium. You make the seller of option sell to you (You call the stock away from them) – you want the stock to advance.
2) Buy a Put Option – and you pay a premium. You make the seller of the option buy the stock at the strike price (You put the stock to them) – You want the stock to decline.
3) Sell a Call Option – You get the premium. The buyer of the option can make you sell the stock to them at the strike price (They call the stock away from you) – You want the stock to decline.
4) Sell a Put Option – You get the premium. The buyer of the option can make you buy the stock from them at the strike price (They put the stock to you) – You want the stock to advance.
Technical Indicators:
Technical Indications as moving average and Bollinger Bands are technical analysis tools that traders and investors use to analyze the past and to predict future price trends and patterns. There are hundreds of technical indicators but goal is to narrow to 3-5 indicators that work for your style of trading.
Different Categories of Indicators:
– Trend Indicators.
– Momentum Indicators.
– Volatility Indicators.
Bollinger Bands – Volatility Indicator: Three lines compose Bollinger Bands: a simple moving average (Middle band); an upper band: and a lower band. The bands are two Standard Deviations (+/-) from the 20 day Simple Moving Average. Bollinger Bands adapt to Volatility in stocks. A large gap will lead to less Volatility, when the price is stable people are ready to buy, they know something will happen. A squeeze – will lead to high Volatility (Because of the buildup of price pressure – price will fluctuate more and Volatility will go up substantially).
Moving Average Crossover – Momentum Indicator:
The moving average of an instrument price is the average price over last n period of days. Moving Average crossover – Mac(f,s)= MA(f) – MA(s) when price changes, a faster moving average (small n) will react to change quicker than a slower moving average (large n). Hence , in an uptrend a faster moving average will move higher than the slower in a downtrend their positions is reversed. MA(f)> MA(s); MAC>0 go long, MA(f)<MA(s) MAC<0 Go Short. MAC is positive (+) indicate uptrend, MAC is negative indicate a downtrend.
RSI – Relative Strength Indicators:
RSI is a momentum indicator that compares the number of days a security closes up vs closing down over a period of time. These values are then plotted in a range from 0 to 100. Securities are typically overbought (too much demand during the price up so people start selling so the price will go down) When RSI returns to value over 70, and oversold (too much supply driving the price down, so the price will then go down) when the value is less than 30.
RSI >70 Pressure to push the price down.
RSI<30 Pressure to push the price up.
Cross check RSI with Bollinger Bands to continue the trend. Indicators may give false signals so it is very important to cross check and confirm.
Spreads:
A spread is a strategy that involves taking opposing positions in different but related instruments. It always consists of two sides or legs (A buy and a sell) it can be Calls or Puts and is usually executed as one transaction.
Free trade: (Also known as Bull or Bear Spread) combines the best principles of money management and taking advantage of undervalued or overvalued options. It can help build a large position in a trending market without adding to initial risk.
Steps: 1) Purchase (ATM) – best priced option (cheaper) a) If trend is in your direction – up (Call) or down (Put) then you can initiate a free trade spread otherwise close the trade by letting the option expire or by selling a call.
2)If and when price and volatility rise – sell OTM Options (such as a call) at the same price as ATM purchase earlier (so ATM purchased with OTM sold cancels out premium- get your 80-100% of your money back), 2-6 strike prices above stock market price.
3) If market moves in your favor, you can continue to add position on the next pull back. If the trend remains intact an the market pull back, then you are in position to purchase another option to begin building a large position (repeat step 1 and 2). Keep you buys (3 or 4) which are paid for free.
When to make free trade and what strike price to use:
– look for the initial stages of a trend (RSI, Bollinger Bands, MAC agree).
– Look for location of heavy resistance on a chart and then sell option outside of the range.
– Selling Options at 2-6 prices OTM at the same price paid for purchase.
– Align with the market – Free your mind – Cost you nothing – not winning the lottery but consistently makes money. The risk/Reward ratio is high.
There are other option trading strategies:
Credit Spread and Neutral Options position.
Credit Spread – transact at the same time.
– Buy 330 Put (Strike price $330)
– Sell 340 Put (Strike price $340)
– Net Credit of $297 (Premium)
– Potential gain $300 (Net Credit)
– Margin required $700
Neutral Option Position:
– Sell OTM Call and Puts
– Sell Option 30-60 days of Option expiration
– trade like a bookie ( you take both sides of a bet)
– margin is tied up when you sell an option.
How will this class contribute to my success upon release:
Options trading is a way for me to make extra income while I am retired. It is a way to keep my mind agile and alert and understanding of the financial market.
