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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

June 27, 2015

5 Option Strategies if you Think the Market is Headed Lower

A subscriber wrote in and asked what he should do if he thought the market would be 6% lower by the end of September. I thought about his question a little bit, and decided to share my thoughts with you, just in case you have similar feelings at some time along the way.

Terry

5 Option Strategies if you Think the Market is Headed Lower

We will use the S&P 500 tracking stock, SPY, as a proxy for the market. As I write this, SPY is trading just below $210. If it were to fall by 6% by the end of September (3 months from now), it would be trading about $197 at that time. The prices for the possible investments listed below are slightly more costly than the mid-point between the bid and ask prices for the options or the option spreads, and include . . .

June 1, 2015

Why Option Prices are Often Different

This week I would like to discuss why stock option prices are low in some weeks and high in others, and how option spread prices also differ over time. If you ever decide to become an active option investor, you should understand those kinds of important details.

Terry

Why Option Prices are Often Different

The wild card in option prices is implied volatility (IV). When IV is high, option prices are higher than they are when IV is lower. IV is determined by the market’s assessment of how volatile the market will be at certain times. A few generalizations can be made:

May 28, 2015

How to Make 80% a Year With Long-Term Option Bets

One of my favorite options plays is a long-term bet that a particular stock will be equal to or higher than it is today at some future date. Right now might be a perfect time to make that kind of a bet with one of my favorite stocks, Apple (AAPL).

Each January, I pick several stocks I feel really positive about and buy a spread that will make an extraordinary gain if the stock is flat or any higher when the options expire one year out. Today I would like to tell you about one of these spreads we placed in one of the Terry’s Tips portfolios we carry out, and how you can place a similar spread right now. If AAPL is only slightly higher than it is today a year from now, you would make 100% on your investment.

Terry

How to Make 80% a Year With Long-Term Option Bets

I totally understand that it may seem preposterous to think that over the long run, 80% a year is a possible expectation to have for a stock market investment. But if the AAPL fluctuates in the future as it has in the past, it will absolutely come about. It can be done with a simple option spread that can be placed right now,

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