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Stock Option Glossary

Hedge:

No, this is not that green growing fence in front of your house that needs trimming every year.  Instead, a hedge is a method of reducing risk by putting on one option position and simultaneously selling another that contradicts what you hoped would happen with the first option.  Sounds like something a schizophrenic might do.  But it does make sense even to a rational investor. 

With a hedged bet, you give up some possible gain in exchange for a reduced loss if the market does not behave as you expected it to do.  A good example of a hedge is any option spread you might buy.  Common examples are the calendar spread, a butterfly spread, or a vertical spread.

Intrinsic Value:

In the option's world, intrinsic value is the difference between the current selling price of the underlying stock and the strike price of the option.  If an underlying stock is trading at $45 and a call option with a strike price of 40 is trading at $6, the intrinsic value of the option is $5.  The other $1 is called the time premium of the option.  It is the extra amount you have to spend to enjoy the benefit of having the right to buy the stock at $40 without having to come up with all the cash.

Maintenance Requirement:

This is something your broker will charge when you sell a credit spread with options.  There is no interest charged on a maintenance requirement but cash in your account is set aside by the broker.  You can't use this cash to buy other options or stock.

The requirement is calculated by the maximum amount that you could theoretically lose on the spread you place.   For some silly reason, the broker wants to make sure that you end up with enough cash to cover that potential loss so that he doesn't have to cough up the money himself.  It doesn't really sound fair, does it?  With all the commissions the broker is collecting on your trades, you would think he would be willing to take a little risk once in a while.  But that's not the way it works.  They insist that you take the entire risk.

One neat thing about selling a credit spread is that the cash you collect from selling a credit spread is used by the broker to offset any margin loan you might have on stock that you have purchased.  So if you break even on the credit spread, you might save a little in interest on your stock margin loan.  It probably won't change your way of living, but it beats a stick in the eye (as my mother used to tell me whenever I complained about something that was a positive, but only slightly so).

Terry's Tips Stock Options Trading Blog

November 22, 2021

On Target Trade


Target
(TGT) reported earnings before the bell on Wednesday that beat estimates on
both revenue and profits. The company also expects its fiscal Q4 comparable
sales growth to be higher than previous forecasts. Moreover, TGT claimed the
supply chain mess has not been an issue - store shelves are full and ready for
the holiday buying onslaught.





Analysts
were mostly bullish on the report, giving TGT several target price increases
(there was one lower price). One went as high as $350, a 38% premium to
Friday’s closing price. The stock price was not rewarded, however. The shares
dropped 4.7% on Wednesday and slid further the rest of the week. However, this
was a common theme among several retailers, including Walmart (WMT). In fact,
the overall retail sector was lower for the week.





The pullback dropped the shares to just above their 50-day moving average (blue line in chart). This trade is thus a bet that TGT will regain its footing and stay above the 50-day as holiday sales numbers – that are predicted to be robust – start rolling in. The short 245 strike (red line) of our put credit spread is below the 50-day, relying on trendline support to hold through expiration.









If
you agree that TGT will stay atop its 50-day moving average line in chart),
consider the following trade that relies on the stock remaining above 245  (through expiration in six weeks.





Buy
to Open TGT 31Dec 240 put (TGT211231P240)

Sell to Open TGT
31Dec 245 put (TGT211231P245) for a credit of $1.60 (selling a vertical)





This
credit is $0.02 less than the mid-point
of the option spread when TGT was trading around $251. Unless the stock rises
quickly from here, you should be able to get close to this amount.





Your
commission on this trade will be only $1.30 per spread.  Each spread would then yield $158.70. This
trade reduces your buying power by $500 and makes your net investment $341.30
($500 – $158.70) for one spread.  If TGT
closes above $245 on December 31, both options will expire worthless and your return on the spread would
be 46% ($158.70/$341.30).


November 15, 2021

An AFRMation Trade


Affirm
Holdings (AFRM) provides a platform for point-of-sale payments for consumers
and merchants. In August, AFRM announced a partnership with Amazon.com (AMZN)
to offer flexible payment solutions to customers with AMZN purchases above $50.
AFRM reported earnings on Wednesday after the bell that missed on profits but
beat on revenue. The company also raised sales guidance.





Wall
Street apparently forgave the earnings miss, largely because it was not clear
if the discrepancy used comparable numbers. Moreover, AFRM said its AMZN
relationship as a buy-now-pay-later service was exclusive. Clearly, analysts
were looking at AFRM’s growth prospects, as the company was greeted with
several target price upgrades that reached as high as $185 (the stock closed at
$149 on Friday).





After a nasty, four-day 21% plunge heading into earnings that pulled the stock to its 50-day moving average, the stock rebounded 13.7% the day after the earnings news. Given the earnings rebound, analyst target upgrades and deal with AMZN, we are going with a bullish trade on AFRM that keys on the stock maintaining its three-month rally and staying atop its 50-day moving average (blue line in chart). The short put strike of our credit spread sits at $133 (red line in chart), just below the 50-day.









If
you agree that AFRM will continue its uptrend and stay atop its 50-day moving
average line in chart), consider the following trade that relies on the stock
remaining above $133  (through expiration
in seven weeks.





Buy
to Open AFRM 31Dec 128 put (AFRM211231P128)

Sell to Open AFRM 31Dec
133 put (AFRM211231P133) for a credit of $1.85 (selling a vertical)





This
credit is $0.05 less than the mid-point
of the option spread when AFRM was trading at $149. Unless the stock rises
quickly from here, you should be able to get close to this amount.





Your
commission on this trade will be only $1.30 per spread.  Each spread would then yield $183.70. This
trade reduces your buying power by $500 and makes your net investment $316.30
($500 – $183.70) for one spread.  If AFRM
closes above $133 on December 31, both options will expire worthless and your return on the spread would
be 58% ($183.70/$316.30).


November 10, 2021

A Me(h)T Trade


MetLife
(MET) won’t get anyone’s juices flowing. It’s frankly a rather boring insurance
and financial services company that’s been around for 158 years. But who cares …
if we can make money on a trade, right?





MET
reported earnings last week that beat estimates on the top and bottom lines.
Hardly anyone noticed. Analysts were silent. There were no stories other than a
dry listing of its key performance numbers. And the stock fell 2% the next day.
Ho hum.





But MET is up 36% for the year, which is well ahead of the S&P 500’s 25%. After a swoon in June and July, the stock has been grinding steadily higher along the dual support of its 50-day and 200-day moving averages. The key is the 50-day (blue line in chart), which has allowed just three daily closes below it during the past three months. This trendline, which is rising slightly, sits at $61.10, which is above the short strike of our put spread trade. Thus, MET would have to pierce this support to hurt this trade. And the 200-day (red line in chart) sits at $61 to provide another layer of support. The last time MET closed below the 200-day was more than a year ago.









If
you agree that MET will continue its slow ascent and stay atop its 50-day
moving average line in chart), consider the following trade that relies on the
stock remaining above $62.50  (through
expiration in six weeks.





Buy
to Open MET 17Dec 60 put (MET211217P60)

Sell to Open MET 17Dec
62.5 put (MET211217P62.5) for a credit of $0.75 (selling a vertical)





This
credit is $0.04 less than the mid-point
of the option spread when MET was trading at $64. Unless the stock rises
quickly from here, you should be able to get close to this amount.





Your
commission on this trade will be only $1.30 per spread.  Each spread would then yield $73.70. This
trade reduces your buying power by $250 and makes your net investment $176.30
($250 – $73.70) for one spread.  If MET
closes above $62.50 on December 17, both options will expire worthless and your return on the spread would
be 42% ($73.70/$176.30).


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