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Posts Tagged ‘Out-Of-The-Money Calls’

Using Puts vs. Calls for Calendar Spreads

Monday, April 7th, 2014

I like to trade calendar spreads.  Right now my favorite underlying to use is SVXY, a volatility-related ETP which is essentially the inverse of VXX, another ETP which moves step-in-step with volatility (VIX).  Many people buy VXX as a hedge against a market crash when they are fearful (volatility, and VXX. skyrockets when a crash occurs), but when the market is stable or moves higher, VXX inevitably moves lower.  In fact, since it was created in 2009, VXX has been just about the biggest dog in the entire stock market world.  On three occasions they have had to make 1 – 4 reverse splits just to keep the stock price high enough to matter.

Since VXX is such a dog, I like SVXY which is its inverse.  I expect it will move higher most of the time (it enjoys substantial tailwinds because of something called contango, but that is a topic for another time).  I concentrate in buying calendar spreads on SVXY (buying Jun-14 options and selling weekly options) at strikes which are higher than the current stock price.  Most of these calendar spreads are in puts, and that seems a little weird because I expect that the stock will usually move higher, and puts are what you buy when you expect the stock will fall.  That is the topic of today’s idea of the week.

Terry

Using Puts vs. Calls for Calendar Spreads

It is important to understand that the risk profile of a calendar spread is identical regardless of whether puts or calls are used.  The strike price (rather than the choice of puts or calls) determines whether a spread is bearish or bullish.  A calendar spread at a strike price below the stock price is a bearish because the maximum gain is made if the stock falls exactly to the strike price, and a calendar spread at a strike price above the stock price is bullish.

When people are generally optimistic about the market, call calendar spreads tend to cost more than put calendar spreads.  For most of 2013-14, in spite of a consistently rising market, option buyers have been particularly pessimistic.  They have traded many more puts than calls, and put calendar prices have been more expensive.

Right now, at-the-money put calendar spreads cost more than at-the-money call calendar spreads for most underlyings, including SVXY.  As long as the underlying pessimism continues, they extra cost of the put spreads might be worth the money because when the about-to-expire short options are bought back and rolled over to the next short-term time period, a larger premium can be collected on that sale.  This assumes, of course, that the current pessimism will continue into the future.

If you have a portfolio of exclusively calendar spreads (you don’t anticipate moving to diagonal spreads), it is best to use puts at strikes below the stock price and calls for spreads at strikes which are higher than the stock price.  If you do the reverse, you will own a bunch of well in-the-money short options, and rolling them over to the next week or month is expensive (in-the-money bid-asked spreads are greater than out-of-the-money bid asked spreads so you can collect more cash when rolling over out-of-the-money short options).

Using Puts vs. Calls for Calendar Spreads

Tuesday, March 12th, 2013

A lot of our discussion lately has focused on pre-earnings-announcement strategies (we call them PEA Plays).  This has been brought about by lower option prices (VIX) than we have seen since 2007, a full six years ago.  With option prices this low it has been difficult to depend on collecting premium as our primary source of income with our basic option strategies. 

But the earnings season has now quieted down and will not start up again for several weeks, so we will return to discussing more conventional option issues. 

Terry 

Using Puts vs. Calls for Calendar Spreads 

 It is important to understand that the risk profile of a calendar spread is identical regardless of whether puts or calls are used.  The strike price (rather than the choice of puts or calls) determines whether a spread is bearish or bullish.  A calendar spread at a strike price below the stock price is a bearish because the maximum gain is made if the stock falls exactly to the strike price, and a calendar spread at a strike price above the stock price is bullish. 

When people are generally optimistic about the market, call calendar spreads tend to cost more than put calendar spreads.  For most of 2012 and into 2013, in spite of a consistently rising market, option buyers have been particularly pessimistic.  They have traded many more puts than calls, and put calendar prices have been more expensive. 

Right now, at-the-money put calendar spreads cost more than at-the-money call calendar spreads.  As long as the underlying pessimism continues, they extra cost of the put spreads might be worth the money because when the about-to-expire short options are bought back and rolled over to the next short-term time period, a larger premium can be collected on that sale.  This assumes, of course, that the current pessimism will continue into the future.

If you have a portfolio of exclusively calendar spreads (you don’t anticipate moving to diagonal spreads), it is best to use puts at strikes below the stock price and calls for spreads at strikes which are higher than the stock price.  If you do the reverse, you will own a bunch of well in-the-money short options, and rolling them over to the next week or month is expensive (in-the-money bid-asked spreads are greater than out-of-the-money bid asked spreads so you can collect more cash when rolling over out-of-the-money short options). 

The choice of using puts or calls for a calendar spread is most relevant when considering at-the-money spreads.  When buying at-the-money calendar spreads, the least expensive choice (puts or calls) should usually be made. An exception to this rule comes when one of the quarterly SPY dividends is about to come due.  On the day the dividend is payable (always on expiration Friday), the stock is expected to fall by the amount of the dividend (usually about $.60).  Since the market anticipates this drop in the stock (and knowing the specific day that the stock will fall), put prices are generally bid higher in the weeks before that dividend date. 

The bottom line is that put calendar spreads are preferable to call calendar spreads for at-the-money strikes (or even at strikes slightly higher than the stock price) coming into a SPY dividend date.   Even though the put spreads cost more, the Weekly options that can be sold for enough extra to cover the higher cost.  You do not want to own SPY call calendar spreads which might become in the money on the third Friday of March, June, September, or December because you will have to buy them back on Thursday to avoid paying the dividend, and you may not want to make that purchase to keep your entire portfolio balanced.

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.

 

Trading Rules for New 5%-a-Week Strategy

Tuesday, December 27th, 2011

Today I will list the trading rules for the new strategy that has made an average 6.4% gain every week since we set it up in early December.  

More importantly, we are repeating of our offer of becoming an Insider for the lowest price we have ever offered.

Trading Rules for New 5%-a-Week Strategy

Our goal is to make 5% a week.  Admittedly, that sounds a little extreme.  But we did it for the first 3 weeks we tried it in a real account.  In fact, we gained an average of 6.4% after commissions.  

We call it the STUDD StrategySTUDD stands for Short Term Under-Intrinsic Double Diagonal.  How’s that for a weird acronym?

Here are the Trading Rules:

1)    Purchase an equal number of deep in-the-money (5 – 8 strikes from the stock price) puts and calls for an expiration month which has 3 to 7 weeks of remaining life.

2)    At the same time, sell the same number of at-the-money or just out-of-the-money Weekly puts and calls.

3)    Make the above purchases and sales at a net price which is less than the intrinsic value of the long options. (Intrinsic value is the difference between the strike prices.  For example, we purchased IWM January-12 70 calls and 80 puts, and the intrinsic value of these two options will be at least $10 no matter where the stock ends up.  We paid a net $9.46 for the initial spreads, and as long as the short options are out of the money, the long options will eventually be worth at least their intrinsic value of $10).  Any out-of-the-money premium collected in subsequent weeks would be pure profit.

4)    During the week, if either of the short Weekly options become over $1 in the money, buy them back and replace them with another short option which is 2 strikes higher or lower (depending on which way the stock has moved).  Move both short Weekly options by 2 strikes in the same direction, one at a debit (buying a vertical spread) and one at a credit (selling a vertical spread).  The net amount that the two trades cost will reduce the potential maximum gain for the week.

5)    On the Friday when the Weeklys expire, buy back the short Weeklys and sell next-week Weeklys at the just out-of-the-money strike price for both puts and calls.

6)    On the Friday when the original monthly options are due to expire, close out all the positions and start the process over with new positions.
There will invariably be some variations to these trading rules.  For example, instead of selling just out-of-the-money Weekly options, we might sell some which are a dollar more than the just out-of-the-money strike.  We also might close out the original monthly options a week before the final Friday if they can be sold for appreciably more than the intrinsic price (the more the stock has moved during the month, the higher above the intrinsic value the options will be able to be sold for).

This all may seem a little confusing right now, but if you decide to make a serious investment in your financial future, it will all become clear as you can watch how an actual portfolio (or two) unfolds using these trading rules for the next two months as a Terry’s Tips Insider.

As our New Year’s gift to you, we are offering our service at the lowest price in the history of our company.  We have never before offered a discount of this magnitude.  If you ever considered becoming a Terry’s Tips Insider, this would be the absolutely best time to do it.  

So what’s the investment?  I’m suggesting that you spend a small amount to get a copy of my 70-page (electronic) White Paper, and devote some serious early-2012 hours studying the material.  

And now for the Special Offer – If you make this investment in yourself by midnight, December 31, 2011, this is what happens:

For a one-time fee of only $39.95, you receive the White Paper (which normally costs $79.95 by itself), which explains my two favorite option strategies in detail, 20 “Lazy Way” companies with a minimum 100% gain in 2 years, mathematically guaranteed, if the stock stays flat or goes up, plus the following services :

1) Two free months of the Terry’s Tips Stock Options Tutorial Program, (a $49.90 value).  This consists of 14 individual electronic tutorials delivered one each day for two weeks, and weekly Saturday Reports which provide timely Market Reports, discussion of option strategies, updates and commentaries on 8 different actual option portfolios, and much more. 

2) Emailed Trade Alerts. I will email you with any trades I make at the end of each trading day, so you can mirror them if you wish (or with our Premium Service, you will receive real-time Trade Alerts as they are made for even faster order placement or Auto-Trading with a broker).  These Trade Alerts cover all 8 portfolios we conduct.

3) If you choose to continue after two free months of the Options Tutorial Program, do nothing, and you’ll be billed at our discounted rate of $19.95 per month (rather than the regular $24.95 rate).

4) Access to the Insider’s Section of Terry’s Tips, where you will find many valuable articles about option trading, and several months of recent Saturday Reports and Trade Alerts.

5) A FREE special report  “How We Made 100% on Apple in 2010-11 While AAPL Rose Only 25%“.

With this one-time offer, you will receive all of these benefits for only $39.95, less than the price of the White Paper alone. I have never made an offer anything like this in the eleven years I have published Terry’s Tips.  But you must order by midnight on December 31, 2011. Click here and enter Special Code 2012 (or 2012P for Premium Service – $79.95) in the box to the right.

Investing in yourself is the most responsible New Year’s Resolution you could make for 2012.  I feel confident that this offer could be the best investment you ever make in yourself.

Happy New Year!  I hope 2012 is your most prosperous ever.  I look forward to helping you get 2012 started right by sharing this valuable investment information with you. 

Terry

P.S.  If you would have any questions about this offer or Terry’s Tips, please call Seth Allen, our Senior Vice President at 800-803-4595.  Or make this investment in yourself at the lowest price ever offered in our 8 years of publication – only $39.95 for our entire package – http://www.terrystips.com/track.php?tag=2012&dest=programs-and-pricing using Special Code 2012 (or 2012P for Premium Service – $79.95).

Update on 5% a Week “Conservative” Portfolio

Monday, December 19th, 2011

Last week was a bad one for the market.  The S&P 500 fell 3.5%.  Six of the 8 portfolios carried out at Terry’s Tips made gains last week. Once again, our subscribers where happy that they owned options rather than stock.

One of the two portoflios that lost money is not carried out with our basic strategy, but is a proxy for owning stock in AAPL (which fell over $12 last week, obviously causing a loss).

Our 10K Bear portfolio gained almost 10% for the week, and now has gone up over 70% since we started it 5 months ago (SPY has fallen 7.5% over that time period).  This portfolio continues to be a good hedge against other investments which do best when markets move higher.

Today I would like to update the report I sent out last week on a $1479 investment which we believe should make 5% a week.

Update on 5% a Week “Conservative” Portfolio:

Three weeks ago, we made the following trades in one of our portfolios as a demonstration of an option play that we believe will make at least 5% a week after paying all commissions.  At the time, SPY was trading just about $125:

Buy To Open 1 SPY Jan-12 132 put (SPY120121P132)
Sell To Open 1 SPY Dec2-11 125 put (SPY111209P125) for a debit of $6.98  (buying a diagonal)
 
Buy To Open 1 SPY Jan-12 118 call (SPY120121C118)
Sell To Open 1 SPY Dec2-11 125 call (SPY111209P125) for a debit of $7.05  (buying a diagonal)

These two spreads cost us a total of $1403 plus commissions of $5 (the commission rate for Terry’s Tips subscribers at thinkorswim).  It is an interesting option play because the deep in-the-money Jan-12 put and call together will be worth at least $1400 (their intrinsic value) when they expire on the third Friday in January (7 weeks after we made these trades).  Since we only paid $1408 for these options, as long as we don’t have to buy back any short options we might sell against them, we are guaranteed to collect at least $1400 when they expire in January.

An interesting additional feature of this portfolio is that if the stock manages to make a big move during the 7 or so weeks of the long options’ existence, the original long put and call might be able to be sold at the beginning of the final week for well more than their intrinsic value.  The closer to one of the original strike prices the stock becomes, the greater the additional time premium will be.  Of course, if the stock moves outside the original range (118 – 132), the total value would exceed the original intrinsic value of $14 (again, as long as the short options continue to be out of the money).

We will have 6 opportunities to sell Weekly puts and calls using the Jan-12 options as collateral for those sales.  Any money we collect from selling those options is pure profit (unless they end up in the money and we have to buy them back on the Friday that they expire).

Since the options we sold were both at the 125 strike price, one of them would have to be bought back on Friday, December 9th (unless SPY closed exactly at $125.00, an unlikely event). 

As we reported a week ago, the portfolio gained 6.2% after commissions in its first week, and we started out last week being short a Dec-11 SPY 127 call (which we had sold for $1.28 and a Dec-11 SPY 126 put (which we had sold for $1.99).  If we would be lucky enough for the stock to remain in the $126 – $127 range all week, the $324 we collected (after commissions) by selling these two options would be pure profit (a whopping 22% on our original investment in a single week).

The secret of success to this little strategy is in the adjustments that invariably need to be made because the stock usually doesn’t stay perfectly flat all week.  Last week was no exception.  SPY fell $4.46.  Ouch!

When SPY fell over $2, we bought back our short 126 put and sold a 123 put which also expired on Friday, December 16.  Buying this vertical spread cost us $181 after commissions, but our net cost was reduced by what we gained by selling a vertical spread on the short 127 call, replacing it with a short 124 call (this sale gained us $104 after commissions).  So we had now lost $77 of the potential maximum $324 gain for the week.

On Friday, we had to buy back the in-the-money 123 put, paying out $133, and we bought back the out-of-the-money 124 call for $1 (no commission charged at thinkorswim for this trade).  These trades reduced the potential maximum gain by $134. For the week, then, we gained $113, or 7.6% on the original investment of $1479 ($1408 plus an adjustment cost) three weeks earlier.

At the outset, we said that we expected this little investment would gain us an average of 5% a week, and we have exceeded that goal in each of the first two weeks.  Going into the third week, we have collected $127 from selling a 121 put which expires on December 23 and $142 from selling a 122 call which expires on that same day. 

If SPY ends up between $121 and $122 this Friday (and no adjustments become necessary), we could earn $269, or 18% on our original investment.  (At the end of the day last Friday, these two options were worth a total of $253, so we had already picked up a paper gain of $16).

Here is the risk profile graph for our positions, indicating the loss or gain next Friday at the various possible prices for SPY. Of course, if SPY fluctuates by $2, we would make an adjustment as we did this week, and hopefully turn a possible loss into a gain (as we did last week).

If you can follow the above trades, you have a good understanding how we carry out our portfolios at Terry’s Tips.  If this strategy can indeed make 5% a week (and there is the possibility of much more), we wonder why anyone would be buying stock or mutual funds rather than investing in an option strategy similar to this. 

Many of our subscribers are mirroring our trades in this portfolio (or having thinkorswim make the trades for them through their Auto-Trade service).  Last week they were all happy campers. 
___

Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.

You can see every trade made in 8 actual option portfolios conducted at Terry’s Tips and learn all about the wonderful world of options by subscribing here.   Why wait any longer to make this important investment in yourself?

I look forward to having you on board, and to prospering with you.

Terry

An Interesting “Conservative” Option Purchase That Could Make 5% a Week

Thursday, December 15th, 2011

This week I would like to describe an actual option play we made two weeks ago which you should be able to duplicate with no more than a $1600 investment.  We believe it will make at least 5% a week for the six remaining weeks of its existence.

We are pleased that every one of our portfolios made nice gains last week.  The average portfolio gained 7% after commissions in spite of fairly high mid-week volatility.  We were especially happy with our bearish 10K Bear portfolio – it gained 13% even though SPY ended up going up by 1% last week.  Our William Tell portfolio (using AAPL as the underlying) gained 8.7% while AAPL rose 1%.

An Interesting “Conservative” Option Purchase That Could Make 5% a Week:

Two weeks ago, we made the following trades in one of our portfolios as a demonstration of an option play that we believe will make at least 5% a week after paying all commissions.  At the time, SPY was trading just about $125:

Buy To Open 1 SPY Jan-12 132 put (SPY120121P132)
Sell To Open 1 SPY Dec2-11 125 put (SPY111209P125) for a debit of $6.98  (buying a diagonal)
 
Buy To Open 1 SPY Jan-12 118 call (SPY120121C118)
Sell To Open 1 SPY Dec2-11 125 call (SPY111209P125) for a debit of $7.05  (buying a diagonal)

These two spreads cost us a total of $1403 plus commissions of $5 (the commission rate for Terry’s Tips subscribers at thinkorswim).  It is an interesting option play because the deep in-the-money Jan-12 put and call together will be worth at least $1400 (their intrinsic value) when they expire on the third Friday in January (7 weeks after we made these trades).  Since we only paid $1408 for these options, as long as we don’t have to buy back any short options we might sell against them, we are guaranteed to collect at least $1400 when they expire in January.

We will have 6 opportunities to sell Weekly puts and calls using the Jan-12 options as collateral for those sales.  Any money we collect from selling those options is pure profit (unless they end up in the money and we have to buy them back on the Friday that they expire).

Since the options we sold were both at the 125 strike price, one of them would have to be bought back on Friday, December 9th (unless SPY closed exactly at $125.00, an unlikely event). 

Two days after we bought the two spreads, SPY shot up to $127 (when the stock moves $2 with this strategy, we make an adjustment because we do not want any of our short options to become more than $2 in the money).  These are the trades we placed:

Buy To Close 1 SPY Dec2-11 125 call (SPY111209C125)
Sell To Open 1 SPY Dec2-11 127 call (SPY111209C127) for a debit of $1.33  (buying a vertical)

Buy To Close 1 SPY Dec2-11 125 put (SPY111209P125)
Sell To Open 1 SPY Dec2-11 127 put (SPY111209P127) for a credit of $.67  (selling a vertical)

We paid out $133 to roll up the short call from the 125 strike to the 127 strike, and collected $67 when we rolled up the short put from the 125 to 127 strike.  After commissions, these two trades cost us a net $71.

The stock then fell back to $125 and we reversed the last put trade (but did not bother rolling down the short call to the 125 strike, electing to let it expire worthless):

Buy To Close 1 SPY Dec2-11 127 put (SPY111209P127)
Sell To Open 1 SPY Dec2-11 125 put (SPY111209P125) for a debit of $1.11  (buying a vertical)

This trade cost us $113.50 including commissions.  When we bought back the soon-to-expire short options on Friday (paying no commissions since thinkorswim does not change a commission to buy back a short option for $5 or less), we paid out another $8, making the total outlay $1600.50  ($1408 + $71 + $113.50 + $8). 

At last Friday’s prices, our long Jan-12 options were trading at a total of $1705.50, indicating that we had gained $105 for the week, or 6.2% after commissions.

At the outset, we said that we expected this little investment would gain us an average of 5% a week, so for the first week, we are right on target.

These are the orders we placed on Friday, December 9th:

Buy To Close 1 SPY Dec2-11 127 call (SPY111209C127) for $.05 (no commission)

Sell To Open 1 SPY Dec-11 127 call (SPY111217C127) for $1.28

Buy To Close 1 SPY Dec2-11 125 put (SPY111209P125) for $.03 (no commission)

Sell To Open 1 SPY Dec-11 126 put (SPY111217P126) for $1.99

For the second week, we collected a total of $324.50 by selling a Dec-11 126 put and a Dec-11 127 call which will expire next Friday, December 16th.  By the end of the day, their value had fallen to $252.25, so we had already made some of the gain we expect for the second week. If the stock ends up between these strikes (126 and 127) and we don’t have to adjust mid-week, the entire amount (about 20%) could be profit.

Here is the risk profile graph for our current positions.  It shows the expected loss or gain at the various possible prices where SPY might be on Friday (remember, if the stock moves by $2 in either direction, we will make an adjustment similar to those we made in the first week), and the curve will move in the direction that the stock moved.  Some of the potential gain will be erased when adjustments are made.

If you can follow the above trades, you have a good understanding how we carry out our portfolios at Terry’s Tips.  If this strategy can indeed make 5% a week (and there is the possibility of much more), we wonder why anyone would be buying stock or mutual funds rather than investing in an option strategy similar to this. 

Many of our subscribers are mirroring our trades in this portfolio (or having thinkorswim make the trades for them through their Auto-Trade service).  Last week they were all happy campers.

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.

How to Trade Rumors of Takeovers

Thursday, July 7th, 2011

Sometimes someone else says it as well as I think I can.  Today I would like to pass on what Steve Sears at Barrons.com wrote about trading on rumors of a takeover.  I agree with him completely.  Bottom line, I believe the answer is to do nothing about them.

“Everyone loves the idea of owning a stock, especially call options, on a company that might be taken over at a hefty premium. But the options market inflates with at least 10 false takeover rumors for every real deal. Individual investors need to be careful to avoid getting fleeced for reasons that have far more to do with market realities than risk-aversion.

The best bet for most investors is ignoring takeover rumors. If you own options on a takeover stock, sell them, and book the profits. How much better can it get? When rumors become facts, or fail to become facts, implied volatility declines.

If you must trade takeover rumors, buy inexpensive out-of-the-money calls that expire in three months or less. If the deal emerges, you’ll make money, and not lose much if nothing happens.

To be sure, institutional investors who own dud stocks, or who want to create profits where none exist, spread rumors to drive options and stock prices higher to attract unsophisticated investors.

The game works like this: traders buy enough out-of-the-money call options to be spotted by unusual-trading volume screens that monitor the options markets. Inevitably, a reporter, or one of the market-trading subscription Websites notes the unusual trading, and deal speculation sweeps the market. Takeover talk attracts greedy investors who pay top prices for call options, which creates selling opportunities for those who started the rumor.

No one has statistics on how many takeover rumors fail to materialize, but when you feel eager to get a piece of the action, think of the rows of grizzled gamblers hunched over Las Vegas slot machines. They have no special knowledge. They have no special skills. They just hope to get lucky. The same rubric applies to most takeover traders.

“Losers,” as seasoned traders like to say, “always come back to Vegas.”

Making 36%

Making 36% — A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

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.

~ John Collins