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Archive for the ‘Greeks’ Category

Andy’s Market Report 6/17/12

Sunday, June 17th, 2012

June options expiration is behind us and it ended in the bulls favor. The S&P 500 just came off the best week of 2012, only to have another rally this past week of 1.3%. But, that does not mean we can rest on our laurels because now we have what could be the biggest event of the summer upon us – the Greek elections.

European leaders have basically pleaded with Greece to reject the leftist SYRIZA party as the party promises to reject what would certainly be punishing terms from the 130 billion euro bailout offered by the EU.

The bailout will not be renegotiated, warned German Chancellor Angela Merkel, whose country’s wealth is vital to shoring up its weaker partners in the bloc.

But many in Greece and beyond state that Greece’s lenders are bluffing when they threaten to turn off the funds if Athens reneges on the terms of the bailout – tax hikes, job losses and pay cuts that have helped condemn the country to five years of record-breaking recession.

So, the question is how will the outcome on Sunday affect the U.S. markets? The answer is easy….no one knows.

The only certainty is the gap from 6/6 in the SPDR S&P 500 ETF (SPY) has yet to close. A move back to $129.36 would close the gap.

Moreover, the DOW just pushed above its 50-day moving average. A continuation of that trend has proven positive over the next 6 months, but a failure as seen by an almost immediate push back below the 50-day has been rather volatile for the market.

According to Jason Goepfert of Sentimentrader.com, “when the Dow was lower after it rose above its 50- day moving average, then the next six months were positive 55% of the time”. But the swings ranged from up 22.7% to lower -15.8%. I think we could see much of the same as we enter the summer doldrums. Low- volume allows for widely vacillating markets and that is exactly what we tend to see during the months of July, August and part of September.

As for the short-term direction of the market, most of the major indices are nearing a short-term overbought state. This means that a pullback (1-3 days) is anticipated. Furthermore, the day following options expiration, particularly a triple witching event is historically bearish. However, with the Greece election Sunday I think all of the historical precedents should be tossed aside.

If we do see a push higher at the open Monday I would not be surprised to see an immediate sell-off. Remember, things aren’t so great in the U.S. economy right now. I am amazed how the poor jobs report reported only a few weeks ago has been forgotten.

The best thing you can do right now, stay nimble. Expect volatility and don’t be surprised by a nice “summer doldrums” sell-off.

How to Make a Portfolio of Calendar Spreads Either Bearish or Bullish

Monday, June 11th, 2012

I am pleased to offer the 2012 ebook version of Making 36% for only $2.99. This is your chance to learn everything you need to know about options (ok, maybe almost everything) for a lower price than ever before.  Order here and use the code [this code is no longer valid].  The order form will say that you will receive the 2011 paperback edition but if you use the [this code is no longer valid] code, you will receive the 2012 ebook instead. (The revised 2012 paperback edition will be available in about two weeks if you would prefer to wait and get the hard copy at the regular price).

Even if you have purchased an earlier edition of my book, you might want to see the new version.  Two new important strategies are spelled out for the first time – the 10K STUDD (Short Term Ultra Double Diagonal) and the Calendar Twist (a new approach to placing calendar spreads).  Either strategy might change everything you ever thought about trading options.

How to Make a Portfolio of Calendar Spreads Either Bearish or Bullish:

At Terry’s Tips, we use an options strategy that consists of owning calendar (or diagonal) spreads at many different strike prices, both above and below the stock price.  Six of the eight actual portfolios we carry out use SPY as the underlying so we are betting on the market as a whole rather than any individual stock.

We typically start out each week or month with a slightly bullish posture since the market has historically moved higher more times than it has fallen.  In option terms, this is called being positive net delta.  Starting in May and extending through August, we usually start out with a slightly bearish posture (negative net delta) in deference to the “sell in May” adage.

Any calendar spread makes its maximum gain if the stock ends up on expiration day exactly at the strike price of the calendar spread.  As the market moves either up or down, adding new spreads at different strikes is essentially placing a new bet at the new strike price.  In other words, you hope the market will move toward that strike.

If the market moves higher, we add new calendar spreads at a strike which is higher than the stock price (and vice versa if the market moves lower).  New spreads at strikes higher than the stock price are bullish bets and new spreads at strikes below the stock price are bearish bets.

If the market moves higher when we are positive net delta, we should make gains because of our positive delta condition (in addition to decay gains that should take place regardless of what the market does).  If the market moves lower when we are positive net delta, we would lose portfolio value because of the bullish delta condition, but some or all of these losses would be offset by the daily gains we enjoy from theta (the net daily decay of all the options).

Another variable affects calendar spread portfolio values.  Option prices (VIX) may rise or fall in general.  VIX typically falls with a rising market and moves higher when the market tanks.  While not as important as the net delta value, lower VIX levels tend to depress calendar spread portfolio values (and rising VIX levels tend to improve calendar spread portfolio values).

Once again, trading options is more complicated than trading stock, but can be considerably more interesting, challenging, and ultimately profitable than the simple purchase of stock or mutual funds.

Discussion of Delta, Continued:

Monday, April 30th, 2012

Last week we discussed an interesting way to think about Delta (i.e., it is the percentage number that the market believes the option is likely to expire in the money).  Today we will talk about how delta varies depending on how many weeks or months of remaining life it has.

Discussion of Delta, Continued:

Just in case you missed last week’s newsletter, Delta tells us how much the price of the option will change if the underlying stock or ETF changes by $1.00. 

If you own a call option that carries a delta of 70, that means that if the stock goes up by $1.00, your option will increase in value by $.70 (if the stock falls by $1.00, your option will fall by a little less than $.70).  Since each option is good for 100 shares, a price change of $.70 in the option means that the total value of your option has gained $70.

If a call option is deep in the money (i.e., at a strike price which is much lower than the stock price) and there are only a few days until it expires, the option is highly likely to finish in the money (i.e., at a higher price than the strike price).  If SPY is trading at $140 with a week to go until expiration, a 130 call option would naturally have a very high delta (approaching 100).  The stock would have to fall by $10 before it was no longer in the money, and that size move is unlikely in just a few days.

Owning a deep in-the-money call with only a few days until expiration is almost like owning the stock.  If the stock goes up by a dollar tomorrow, the option is likely to go up by that amount ($1.00, or $100 since the option is for 100 shares of stock).

On the other hand, if the 130 option had six months of remaining life, a lot can happen over those six months.  The delta value of the 130 call might be closer to 70 than it is to 100 since the stock is far more likely to fall by $10 if it has such a long time over which to change.  If the stock goes up tomorrow and you own a call with six months of remaining life, you can only expect your option to gain about $70 in value.

The opposite occurs when the option is out of the money.  At today’s option prices (which are a little lower than the historical mean average), with SPY at $140, the 143 call with one month of remaining life is 30.  Owning that call is the equivalent of owning 30 shares of stock.

If the 143 option had six months of remaining life, the delta would be 45 at today’s option prices.  The market is saying that there is a higher likelihood of that option finishing in the money since it has so many more months to fluctuate.  Owning a 143 call with six months of remaining life is like owning 45 shares of stock.

Delta is one of the most important Greeks to understand about options.  Just like most everything about options, it is not simple, especially since it changes depending on how close to the stock price the strike price is, and how much time is remaining in the option’s life.

 

A Useful Way to Think About Delta

Monday, April 23rd, 2012

This week we will start a discussion about the “Greeks” – the measures designed to predict how option prices will change when underlying stock prices change or time elapses. It is important to have a basic understanding of some of these measures before embarking on trading options.

I hope you enjoy this short discussion.

A Useful Way to Think About Delta

The first “Greek” that most people learn about when they get involved in options is Delta.  This important measure tells us how much the price of the option will change if the underlying stock or ETF changes by $1.00. 

If you own a call option that carries a delta of 50, that means that if the stock goes up by $1.00, your option will increase in value by $.50 (if the stock falls by $1.00, your option will fall by a little less than $.50).

The useful way to think about delta is to consider it the probability of that option finishing up (on expiration day) in the money.  If you own a call option at a strike price of 60 and the underlying stock is selling at $60, you have an at-the-money option, and the delta will likely be about 50.  In other words, the market is saying that your option has a 50-50 chance of expiring in the money (i.e., the stock is above $60 so your option would have some intrinsic value).

If your option were at the 55 strike, it would have a much higher delta value because the likelihood of its finishing up in the money (i.e., higher than $55) would be much higher.  The stock could fall by $4.90 or go up by any amount and it would end up being in the money, so the delta value would be quite high, maybe 70 or 75.  The market would be saying that there is a 70% or 75% chance of the stock ending up above $55 at expiration.

On the other hand, if your call option were at the 65 strike while the stock was selling at $60, it would carry a much lower delta because there would be a much lower likelihood of the stock going up $5 so that your option would expire in the money.

Of course, the amount of remaining life also has an effect on the delta value of an option.  We will talk about that phenomenon next week.

A Useful Way to Think About Delta

Monday, December 5th, 2011

This week we will ignore the looming European debt crisis for a minute and talk a little about one of the “Greeks” – a measure designed to predict how option prices will change when underlying stock prices change or time elapses. It is important to have a basic understanding of some of these measures before embarking on trading options.

I hope you enjoy this short discussion.

A Useful Way to Think About Delta

The first “Greek” that most people learn about when they get involved in options is Delta.  This important measure tells us how much the price of the option will change if the underlying stock or ETF changes by $1.00. 

If you own a call option that carries a delta of 50, that means that if the stock goes up by $1.00, your option will increase in value by $.50 (if the stock falls by $1.00, your option will fall by a little less than $.50). 
The useful way to think about delta is to consider its value to be the probability of that option finishing up (on expiration day) in the money.  If you own a call option at a strike price of 60 and the underlying stock is selling at $60, you have an at-the-money option, and the delta will likely be about 50.  In other words, the market is saying that your option has a 50-50 chance of expiring in the money (i.e., the stock is above $60 so your option would have some intrinsic value).

If your option were at the 55 strike, it would have a much higher delta value because the likelihood of its finishing up in the money (i.e., higher than $55) would be much higher.  The 55 call might have a delta of 80 or 90 (or if the option is about to expire, it will approach 100).  With the stock at $60 and the strike at 55, the stock could fall by $4.99 or go up by any amount and it would end up being in the money, so the delta value would be quite high.

On the other hand, if your call option were at the 65 strike while the stock was selling at $60, it would carry a much lower delta (maybe 10 if expiration is near, or 30 if there are a few months to go until expiration) because there would be a much lower likelihood of the stock going up $5 so that your option would expire in the money.

Of course, the amount of remaining life also has an effect on the delta value of an option.  For in-the-money call options, the closer to expiration you are, the higher the delta value.  For out-of-the-money options, delta values are higher for further-out expirations.  As in many things concerning options, even the most simple measure, delta, is a little confusing.  Fortunately, most brokers (especially thinkorswim) show you the net delta value of your long and short options at all times (or the deltas of any options you are thinking of buying or selling).
In one Terry’s Tips portfolio, we have sold December call options for AAPL which expire on December 16th.  With the stock currently trading about $395, the Dec-11 395 call carries a delta of 50 (meaning the market is betting that there is a 50-50 chance of AAPL trading above $395 in two weeks, at expiration).  We are also short a Dec-11 405 call which carries a delta of 30.  The market figures that there is about a 30% chance that AAPL will be above $405 in two weeks.  And the Dec-11 415 call has a delta of only 14, so the expectation is that 14% of the time, the stock might rally by $20 over those two weeks.

A Useful Way to Think About Delta

Monday, October 24th, 2011

This week we will talk a little about one of the “Greeks” – the variables designed to predict how option prices will change when underlying stock prices change or time elapses. It is important to have a basic understanding of some of these measures before embarking on trading options.

I hope you enjoy this short discussion.

A Useful Way to Think About Delta 


The first “Greek” that most people learn about when they get involved in options is Delta.  This important measure tells us how much the price of the option will change if the underlying stock or ETF changes by $1.00. 

If you own a call option that carries a delta of 50, that means that if the stock goes up by $1.00, your option will increase in value by $.50 (if the stock falls by $1.00, your option will fall by a little less than $.50).
The useful way to think about delta is to consider it the probability of that option finishing up (on expiration day) in the money.  If you own a call option at a strike price of 60 and the underlying stock is selling at $60, you have an at-the-money option, and the delta will likely be about 50.  In other words, the market is saying that your option has a 50-50 chance of expiring in the money (i.e., the stock is above $60 so your option would have some intrinsic value).

If your option were at the 55 strike, it would have a much higher delta value because the likelihood of its finishing up in the money (i.e., higher than $55) would be much higher.  The stock could fall by $4.90 or go up by any amount and it would end up being in the money, so the delta value would be quite high, maybe 70 or 75.  The market would be saying that there is a 70% or 75% chance of the stock ending up above $55 at expiration.

On the other hand, if your call option were at the 65 strike while the stock was selling at $60, it would carry a much lower delta because there would be a much lower likelihood of the stock going up $5 so that your option would expire in the money.

Of course, the amount of remaining life also has an effect on the delta value of an option.  We will talk about that phenomenon next week.

Using Options to Prosper in Down Markets

Monday, September 26th, 2011

Last week was the worst week for the market for almost three years.  The S&P 500 fell by a whopping 6.6%.  Investors seem to be dumping everything.  Usually, when stock markets crash, gold moves higher, but last week, gold fell $100 in a single day, the worst one-day drop in its history.  Silver and other commodities were crushed as well.  Billions of dollars are going into treasuries even though over half the S&P 500 companies have higher yields. 

What do you in times like these?  Would you be surprised if I said that a well-designed options portfolio might be the perfect solution?

Using Options to Prosper in Down Markets

At Terry’s Tips, we conduct an actual portfolio which we call the 10K Bear.  We believe that this portfolio offers a better alternative than any other as a downside hedge vehicle.  Even better, the market does not have to go down for you to make a gain.  A flat or slightly higher market also makes weekly gains most of the time

Here is the current risk profile graph for our 10K Bear portfolio.  It shows the loss or gain that should result from a $5200 investment in SPY put options on September 30 when the Weeklys expire in a few days.  Last Friday, SPY closed at $113.54  (This graph assumes that today’s option prices – VIX – will remain unchanged – if VIX falls significantly over the next 4 days, the gains would be less than the graph indicates.)

The graph shows that about an 18% gain would be made if the stock stays flat, and a higher gain would result if SPY fell up to $3 (if it fell that far, we would make an adjustment to extend the downside potential).  Commissions would reduce results somewhat as well. The stock could go up as high as $116.50 before a loss would occur on the upside.  Clearly, this is an excellent hedge against a market drop, and it has the added advantage of also making gains if the market is flat or slightly higher.

How do we create an options portfolio like this?  It is the strategy we use when we want to bet on the direction of the market.  Most of the portfolios at Terry’s Tips make the assumption that we have no idea of which direction the market will take in the short run.

The 10K Bear portfolio involves buying put options with several months of remaining life and selling short-term (Weekly) puts to someone else.  The puts we sell are mostly at lower strikes than those we own.  Rather than trying to sell short-term puts which maximize the amount of short-term decay we could collect, we aim to sell just enough short-term decay to cover the decay of the longer-term puts we own.

In Greek terms (pardon me for using Greeks if you are not familiar with them), we seek to maximize the negative net delta of the portfolio while maintaining a positive theta.  As the stock fluctuates during the month, adjustments are often required to maintain these two goals.  (Adjustments we made in the August expiration month enabled the 10K Bear  portfolio to gain 55% while the original positions at the beginning of the month projected a gain of less than half that amount).

While this may seem to be a little complicated right now, if you become a Terry’s Tips subscriber, it should all become quite clear.  You can follow how the 10K Bear operates over time (as well as several other bullish-leaning portfolios) so that you can do it on your own if you wish.  (Most of our subscribers don’t do it on their own, but sign up for the Auto-Trade program at thinkorswim and have them execute the trades automatically for them).

Making 36%

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Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

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I have been trading the equity markets with many different strategies for over 40 years. Terry Allen's strategies have been the most consistent money makers for me. I used them during the 2008 melt-down, to earn over 50% annualized return, while all my neighbors were crying about their losses.

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