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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

September 21, 2016

Calendar Spreads Tweak #4

Today I would like to discuss how you can use calendar spreads for a short-term strategy based around the date when a stock goes ex-dividend. I will tell you exactly how I used this strategy a week ago when SPY paid its quarterly dividend.

Terry

Calendar Spreads Tweak #4

Four times a year, SPY pays a dividend to owners of record on the third Friday of March, June, September, and December. The current dividend is about $1.09. Each of these events presents a unique opportunity to make some money by buying calendar spreads using puts to take advantage of the huge time premium in the puts in the days leading up to the dividend day.

Since the stock goes down by the amount of the dividend on the ex-dividend day, the option market prices the amount of the dividend into the option prices. Check out the situation for SPY on Wednesday, September 14, 2016, two days before an expected $1.09 dividend would be payable. At the time of these prices, SPY was trading just about $213.70.

September 7, 2016

Calendar Spreads Tweak #2

This week we will continue our discussion of a popular option spread – the calendar spread which is also called a time spread or horizontal spread. We will compare the expected costs and potential returns if you select different time periods for the long and short sides of the calendar spread.

Terry

Calendar Spreads Tweak #2

First, let’s look at a typical calendar spread on Facebook (FB). Today, the stock is trading just over $130, and you might buy an at-the-money calendar spread by placing this order:

Buy To Open 1 FB 16Dec16 130 call (FB161216C130)
Sell To Open 1 FB 14Oct16 130 call (FB161014C130) for a debit of $3.75 (buying a calendar)

This spread would cost about $3.75 ($375) to buy, plus $2.50 in commissions at the rate Terry’s Tips’ subscribers pay at thinkorswim, for

September 1, 2016

Calendar Spreads Tweak #1

This week we will continue our discussion of a popular option spread – the calendar spread which is also called a time spread or horizontal spread. We will check out the feasibility of buying spreads at different strike prices in an effort to reduce risk.

Terry

Calendar Spreads Tweak #1: First, let’s look at a typical calendar spread on Facebook (FB). Last Friday, when FB was trading about $124.20, we bought 5-month-out 20Jan17 calls and sold one-month-out 30Sep16 calls. The spread would cost $5.43 ($543), and this is what the risk profile graph looked like:

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