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Copyright © 2016 Market Technologies, LLC. 1
Introduction to Options
Course 3.1
Copyright © 2016 Market Technologies, LLC. 2
Option Basics – Part IAgenda
Option Basics and Lingo
Call and Put Attributes
Profit and Loss Diagrams
Call and Puts in Action
Copyright © 2016 Market Technologies, LLC. 3
Option Contract Basic Value
Options originally developed to hedge risk Call Options developed in 1973
Put Options developed in 1977
Option Purpose Hedge against commodity loss
Reduce income fluctuation
Options allows the trader to be extremely versatile Bullish
Bearish
Neutral
Direction Indifferent
Copyright © 2016 Market Technologies, LLC. 4
Option Lingo 1 Option Contract is worth:
Equity (Stocks) = 100 Shares
Futures = 1 Future Contract
LEAPS:(Long Term Anticipation Securities) Options that have an
expiration period greater than 1 year
Strike Price: The price at which an underlying stock can be
purchased or sold
Expiration Date (Expiry) The date of that Option Contract Expiration.
Most Options Expire on the Saturday following the 3rd Friday of each
month
In-the-Money (ITM) That portion of an option that has value if the
contract were to expire
At-the-Money (ATM) When an Option’s Strike price is the same as
the current price of the underlying security
Out-the-Money (OTM) If there is no value should an Option expire at
that time
Copyright © 2016 Market Technologies, LLC. 5
ITM – ATM – OTM
Option Examples
CALLS STRIKES PUTS
100
105
110
115
120
125
Sample Option Chain Layout
Copyright © 2016 Market Technologies, LLC. 6
Option Lingo Exercise: Option owner (Holder) who invokes their right to buy or
sell is said to Exercise their Option Contract [note that Call Option
Holders exercise their right to buy; Put Option Holders exercise their
right to sell]
Assignment: When the Option Holder Exercises their rights, the
Option Writer is then Assigned
American Style Options: These options can be exercised any time by
the option Holder [most options are American Style].
European Style Options: These are options that can only be
exercised upon contract expiration. [examples include options on
stock indexes like the S&P 500 [SPX] or the Russell 2000 [RUT]
Parity: An option is said to be trading at Parity with the underlying
security if it is trading for its intrinsic value
Open Interest: Unlike stocks where there are a fixed number of
shares traded, option trading involves the creation of option
contracts. Open Interest tells you the number of option contracts
currently open.
Copyright © 2016 Market Technologies, LLC. 7
Participants in the Option Markets
Buyers of Calls
Call Option Holder
Sellers of Calls
Call Option Writer
Buyers of Puts
Put Option Holder
Sellers of Puts
Put Option Writer
Copyright © 2016 Market Technologies, LLC. 8
Options Basics
Only 2 Option trade positions you can take
Opening Position (Buy to open, Sell to open)
Closing Position (Buy to close, Sell to close)
Expressed as BTO, BTC, STO, STC
ROI example using Stock vs. Options
Owning Stock Using an Option
Purchased 100 shares = $5,000 Purchased 1 Call Option at $4.00 = $400
Risk = $5,000 Risk = $400
Stock Increases in Value by $2.00 per share
Stock profit = $2 or 4% ROI Option Value = $4.50 = %12.50
XYZ Company @ $50.00 per share
Copyright © 2016 Market Technologies, LLC. 9
Option Review
Long Call Right to buy
Expectation is Bullish
Debit Trade (pay to play)
Buy to Open (BTO)
Long Put Right to sell
Expectation is Bearish
Debit Trade (pay to play)
Buy to Open (BTO)
Short Call Obligation to sell
Expectation is Bearish
Credit Trade (paid to play)
Sell to Open (STO)
Short Put Obligation to buy
Expectation is Bullish
Credit Trade (paid to play)
Sell to Open (STO)
Copyright © 2016 Market Technologies, LLC. 10
Option Pricing Theory
Option Pricing is based upon a mathematical
formula define in the Black-Scholes Model (and
others)
Option Price is composed to 2 components:1. Intrinsic Value
2. Extrinsic Value
Option Price Components
XYZ Stock = $50 per share
Call Option with a strike price of 45 due to expire in 3 months = $8.50 per contact
Intrinsic Value = $5.00
Extrinsic Value = $3.50
Extrisnic Value Components
Time Decay
Volatility
Interest Rates
Copyright © 2016 Market Technologies, LLC. 11
Option P&L Graph
Profit
Loss
$0
-$0
+$0
$20 $60$40 $80
Copyright © 2016 Market Technologies, LLC. 12
Option P&L GraphBullish Positions – Long Stock
Profit
Loss
$0
-$0
+$0
$20 $60$40 $80
Copyright © 2016 Market Technologies, LLC. 13
Option P&L GraphBearish Positions – Short Stock
Profit
Loss
$0
-$0
+$0
$20 $60$40 $80
Copyright © 2016 Market Technologies, LLC. 14
Option P&L GraphBullish Positions – Long Call
Profit
Loss
$0
-$0
+$0
$20 $60$40 $80
Long Call•Right to buy•Expectation is Bullish•Debit Trade (pay to play)
Copyright © 2016 Market Technologies, LLC. 15
Option P&L GraphBearish Positions – Short Call
Profit
Loss
$0
-$0
+$0
$20 $60$40 $80
Short Call•Obligation to sell•Expectation is Bearish•Credit Trade (paid to play)
Copyright © 2016 Market Technologies, LLC. 16
Option P&L GraphBearish Positions – Long Put
Profit
Loss
$0
-$0
+$0
$20 $60$40 $80
Long Put•Right to sell•Expectation is Bearish•Debit Trade (pay to play)
Copyright © 2016 Market Technologies, LLC. 17
Option P&L GraphBullish Positions – Short Put
Profit
Loss
$0
-$0
+$0
$20 $60$40 $80
Short Put•Obligation to buy•Expectation is Bullish•Credit Trade (paid to play)
Copyright © 2016 Market Technologies, LLC. 18
Option GreeksWhat are They?
Statistical references that are calculated by the Option
Pricing Model
Measurements of an individual option’s sensitivities to
the changes in the component variables that effect
option pricing1. Underlying price
2. (K) Strike price
3. Time to Expiration
4. Volatility
5. Dividends
6. Interest Rates
Used to determine risk in an individual option or the
entire portfolio
Copyright © 2016 Market Technologies, LLC. 19
Option Greeks – Delta (Δ)
Delta (Δ) can be defined 4 ways:
1. The rate of change of an option value relative to a change in
the underlying
2. The derivative of the graph of an option value in relation to
the stock price
3. The equivalent of the underlying shares represented by an
option position (Hedge Ratio)
4. The estimate of the likelihood of an option expiring ITM
Most watched and common Greek
In-the-Money (ITM) options have higher Delta
Out-of-the-Money (OTM) options have lower Delta
At-the-Money (ATM) options have medium Delta
Copyright © 2016 Market Technologies, LLC. 20
Option Greeks – Delta (Δ)
Definition 1 – Rate of Change
This is the most used definition of Delta
It defines the size of the option price move per $1 move in the
underlying price
Copyright © 2016 Market Technologies, LLC. 21
Option Greeks – Delta (Δ)
Underlying Price Movement
Long Calls
Stock Price $60.00 $61.00
Call Value 3.00 3.50
Delta 0.50 0.54
UNDERLYING STOCK PRICE MOVE
Stock Price $60.00 $59.00
Call Value 3.00 2.50
Delta 0.50 0.46
UNDERLYING STOCK PRICE MOVE
Copyright © 2016 Market Technologies, LLC. 22
Option Greeks – Delta (Δ)
Underlying Price Movement
Long Puts
Stock Price $60.00 $61.00
Put Value 2.25 1.85
Delta -0.40 -0.36
Stock Price $60.00 $59.00
Put Value 2.25 2.65
Delta -0.40 -0.44
UNDERLYING STOCK PRICE MOVE
UNDERLYING STOCK PRICE MOVE
Copyright © 2016 Market Technologies, LLC. 23
Option Greeks – Delta (Δ)
Definition 2 – Derivative of option price
Mathematically, for any given point on graph below the derivative will show the rate of
change of the option price
CALL
VALUE
STOCK PRICE
Call
Price
Stock Price
Copyright © 2016 Market Technologies, LLC. 24
Option Greeks – Delta (Δ)
Definition 3 – Underlying shares equivalent (Hedge Ratio)
In absolute terms the Delta of an option is between 0.00 – 1.00
A Call with a delta of .60 means that a dollar rise in the stock price causes the option price to go up $0.60
1 Contract = 100 shares to = $60.00 =60 shares
If you Buy to Open 5 contracts with a 0.43 Delta you have the equivalent of 215 Deltas (5 x .43 x 100)
The share equivalent is 215 shares
Copyright © 2016 Market Technologies, LLC. 25
Option Greeks – Delta (Δ)
Definition 4 – Likelihood of expiring ITM
It is not exactly/mathematically precise, but the option delta projects the probability
of the option finishing ITM
A option with a delta of .60 = 60% probability of ITM
An option with a delta of .34 – 34% probability of ITM
Copyright © 2016 Market Technologies, LLC. 26
Option Greeks – Delta (Δ)
Option deltas are not constant and are based upon the dynamic
inputs of the pricing model – stock price, time to expiration,
volatility
Call and Put pairs – the delta’s are closely correlated
As a general rule, the absolute value of a call delta + the absolute
value of the put delta add up close to 1.00
The reason is the mathematical relationship between Put-Call
Parity (we explain this in more detail in our Option Synthetics
video)
Options ITM have higher delta’s
Options ATM have delta’s approx .50
Options OTM have delta’s less than .50
Copyright © 2016 Market Technologies, LLC. 27
Option Greeks – Delta (Δ)
Effect of Time on Delta
The more time left until an option expires the less certain it is whether
the option will be ITM or OTM
Therefore, the Delta’s of both ITM & OTM options reflect that
uncertainty
ITM Option Delta’s increase as expiration approaches
OTM Option Delta’s decrease as expiration approaches
Effect of Volatility on Delta
As Volatility increases OTM Delta’s increase & ITM Delta’s decrease
As Volatility decreases OTM Delta’s decrease & ITM Delta’s increase
Copyright © 2016 Market Technologies, LLC. 28
Option Greeks – Gamma (Г)
Gamma (Г) can be defined:1. Gamma is the rate of change of an option’s delta given a change in the price of
the underlying security
2. Gamma is stated in terms of deltas per dollar move
Gamma is the second derivative of the graph of the option price relative to the stock price
Gamma (like Delta) is not constant
ITM & OTM options have lower gamma
ATM options have higher gamma
Copyright © 2016 Market Technologies, LLC. 29
Option Greeks – Gamma (Г) Underlying
Price Movement
Long Calls
Stock Price $60.00 $61.00 $62.00
Call Value 3.00 3.50 4.04
Delta 0.50 0.54 0.58
Gamma 0.04 0.04 0.04
Stock Price $60.00 $59.00 $58.00
Call Value 3.00 2.50 2.04
Delta 0.50 0.46 0.42
Gamma 0.04 0.04 0.04
UNDERLYING STOCK PRICE MOVE
UNDERLYING STOCK PRICE MOVE
Copyright © 2016 Market Technologies, LLC. 30
Option Greeks – Gamma (Г)
Underlying Price Movement
Long Puts
Stock Price $60.00 $61.00 $62.00
Put Value 2.25 1.85 1.49
Delta -0.40 -0.36 -0.32
Gamma 0.04 0.04 0.04
Stock Price $60.00 $59.00 $58.00
Put Value 2.25 2.65 3.09
Delta -0.40 -0.44 -0.48
Gamma 0.04 0.04 0.04
UNDERLYING STOCK PRICE MOVE
UNDERLYING STOCK PRICE MOVE
Copyright © 2016 Market Technologies, LLC. 31
Option Greeks – Gamma (Г)
When you buy (Long) options you acquire positive gamma Positive gamma helps you – causes options to gain value at a faster rate and lose
value at a slower rate
When you sell (Short) options you acquire negative gamma
Negative gamma works against you as a short seller – it will
accelerate your losses
Copyright © 2016 Market Technologies, LLC. 32
Option Greeks – Theta (θ)
Option Prices/value are broken into 2 components; Intrinsic & Extrinsic…Intrinsic is easily measurable [the ITM part of premium]
Extrinsic value is considered the time value [the premium paid over parity for the option]
The decay in option value because of time passage is called time decay or Theta in the Greeks
Long Options = Negative Theta
Short Options = Positive Theta
If interest rates are above zero then call theta is higher than put theta
ATM options have highest theta
Only the option’s extrinsic value is subject to Theta
Higher Volatility also increases an Options premiums thus also increasing Theta decay
Copyright © 2016 Market Technologies, LLC. 33
Option Greeks – Theta (θ)
Theta is not constant...it is non-linear
The higher the extrinsic value the higher the Theta
Copyright © 2016 Market Technologies, LLC. 34
Option Greeks - Vega Vega measures the rate of change of an options theoretical value relative
to a change in Implied Volatility (IV)
This is the value that, when entered into an option pricing model returns the option’s theoretical value
When IV rises or falls, option prices rise or fall in line with it (Vega is the rate of this change)
A Call (Put) with the same expiration month & the same strike on the same underlying will have the same Vega value as its corresponding Put (Call)
Long options have Positive Vega/Short options have Negative Vega
The higher the time premium, the higher the Vega
ATM options have the highest Vega since Vega only effects extrinsic value
If an option is valued at 1.68 and it’s Vega is .06 then the following price change can occur with a change in Volatility
Volatility increases from 22% to 25%; Option value increases by .18 to 1.86 (10.7% increase in value)
Volatility decreases from 45% to 28%; Option value decreases by 1.02 to .66 (60.7% decrease in value)
Copyright © 2016 Market Technologies, LLC. 35
Option Volatility
Historical Volatility (HV) [Also known as Statistical or Realized Volatility]
Is defined as the Annualized Standard Deviation of daily returns
HV is a simple measure of how volatile the price movement of a security has been during a certain period of time
Example: (Both Stock A and Stock B are trading around 100 per share)
Stock A moves up/down $5 to $7 per share
Stock B moves up/down $1 to $2 per share
Stock A has tended to move more than Stock B as a percentage of price without regard to direction
Therefore Stock A is more volatile than Stock B
Therefore Stock A has a higher HV than Stock B
So HV is a measure of how volatile the price movement of a security has been during a certain period of time
But exactly how much higher is Stock A’s HV than Stock B’s HV?
Well, first Volatility of any given stock is measured in terms of Standard Deviation
Copyright © 2016 Market Technologies, LLC. 36
Option Volatility – Standard Deviation
Standard Deviation [Std. Dev] (σ or sigma is the Greek symbol)
Is a mathematical calculation that measures the dispersion of data from a mean value
The mean is the average stock price over a certain period of time
And the further from the mean the dispersion of the occurrences (daily close) was during the period, the greater the Standard Deviation
The most common time frame is the past 20 days (weekends do not count) to calculate HV
And understanding the timeframe in question is important to understanding what the output represents…
Standard Deviation is stated as a percentage move in the price of an asset.
For example, Stock 1 is at $100 per share has a standard deviation of 15% (when you are given a standard deviation measure, it is always assumed to be a Std. Dev of 1) then on an annualized basis the stock can move up to $115 or down to $85 per share
So on any given stock that has a Std. Dev of 15% is considered more volatile than a stock that has a Std. Dev of 6%
The graph of the data that represents the closing price dispersion of any given stock which is reflected in its 1 Std. Dev of movement is called a distribution curve.
Copyright © 2016 Market Technologies, LLC. 37
Random Walk Theory
* ** * *
* * * ** * * * *
* * * * * ** * * * * * *
* * * * * * * *
68%95%
Std Dev tells us not only how fast the distribution spreads out; -it tells us about the probability of a
ball ending up in a specific trough...it measures the dispersion of data from a mean value
Copyright © 2016 Market Technologies, LLC. 38
Copyright © 2016 Market Technologies, LLC. 39
Option Greeks – Rho (ρ)
Rho is the rate of change in an option value relative to a change in the interest
rate
If interest rates go up = Call Value rises
If interest rates go down = Call Value decreases
Usually the least followed Greek since it takes a very large move in interest rates
to effect Rho to an extinct that moves the option value…mostly in Leaps is where
Rho can be a factor
For example, a Call with a Rho of 0.12 will increase $0.12 if interest rates rise a
full point (100 basis points)
Copyright © 2016 Market Technologies, LLC. 40
Dividends Effect on Options
Dividends paid decrease Call value & increase Put value
4 Key dates you must be aware of:
1) Declaration date: when company formally declares a dividend
2) Ex-Dividend date: 2 days before the record date [due to stock settlement]
3) Record date: date of record for who gets the dividend payment
4) Payable date: date of payment
ABC Corp announces on March 31st (declaration date) it will pay a $0.25 dividend to shareholders of record on April 3rd (the record date) payable on April 23rd (the payable date)...the market participates wishing to get the dividend must own the stock on April 1st (the ex-dividend date).
Option holders or writers do not receive or pay dividends
Copyright © 2016 Market Technologies, LLC. 41
Dividends Effect on OptionsCall Value with $0.10 Dividend
Price 61
Strike 60
Days to Expiry 528
Volatility
25.5%
Interest
5.00%
Call Value
9.65
Call Value with $0.50 Dividend Price 61
Strike 60
Days to Expiry 528
Volatility
25.5%
Interest
5.00%
Call Value
8.13
Put Value with $0.10 Dividend
Price
61
Strike
60
Days to Expiry 528
Volatility
25.5%
Interest
5.00%
Put Value
5.42
Put Value with $0.50 Dividend
Price
61
Strike
60
Days to Expiry 528
Volatility
25.5%
Interest
5.00%
Put Value
6.08
Copyright © 2016 Market Technologies, LLC. 42
If You AreYour Delta
Position is
Your Gamma
Position is
Your Theta
Position is
Your Vega
Position is
Long Stock Positive 0 0 0
Short Stock Negative 0 0 0
Long Calls Positive Positive Negative Positive
Short Calls Negative Negative Positive Negative
Long Puts Negative Positive Negative Positive
Short Puts Positive Negative Positive Negative
Greek Effects on the Underlying
Copyright © 2016 Market Technologies, LLC. 43
If Your Greek Postion is…. You Want Your Stock Postion to….
If your Delta Postion is positive
If your Delta Position is negative
Rise in Price
Fall in Price
If your Gamma position is positive
If your Gamma position is negative
Move very swiftly, regardless of the direction
Move very slowly, regardless of the direction
If your Theta position is positive
If your Theta position is negative
If your Vega position is positive
If your Vega position is negative
Greek Effects on the Underlying
If your Rho position is positive
If your Rhoa position is negative
You want interest rates to rise which will increase value
You want interest rates to fall which will increase value
The passage of time will generally increase your value
The passage of time will generally decrease your value
You want volatility to rise which raises your value
You want volatility to fall which raises your value
Copyright © 2016 Market Technologies, LLC. 44
Trade Selection Strategy Checklist1. Security Selection Process
2. What is your current bias
a. Neutral
b. Mildly Bullish
c. Strongly Bullish
d. Mildly Bearish
e. Strongly Bearish
f. Unknown (Breakouts; up or down) and Volatility Trades
3. What is the magnitude of the forecasted move
4. What is the timeframe of the forecasted move
5. Is there a Trigger price for the move
6. What is the support & resistant for the security
7. How will I know if my original bias is wrong during the trade
8. What is the current IV and HV of the security
9. What is your current Risk Appetitea. Position Size
b. Primary Exit Point (PE)
c. Secondary Exit Point (SE)
d. Trade Stops/taking profits & losses
10. Trade Objectives1. Income
2. Downsize Protection
3. Revenue Gain (+20%)
Copyright © 2016 Market Technologies, LLC. 45
Option Strategies
“Make everything as simple as possible, but not simpler”
Albert Einstein
Copyright © 2016 Market Technologies, LLC. 46
Option Strategies
Single Leg Strategies – Calls & Puts
Vertical Spreads
Copyright © 2016 Market Technologies, LLC. 47
Option Review
Long Call Right to buy
Expectation is Bullish
Debit Trade (pay to play)
Buy to Open (BTO)
Long Put Right to sell
Expectation is Bearish
Debit Trade (pay to play)
Buy to Open (BTO)
Short Call Obligation to sell
Expectation is Bearish
Credit Trade (paid to play)
Sell to Open (STO)
Short Put Obligation to buy
Expectation is Bullish
Credit Trade (paid to play)
Sell to Open (STO)
Copyright © 2016 Market Technologies, LLC. 48
Vertical Spreads
Strategy Overviews
Description
Vertical Spreads are 2 legged option strategies designed to play
either a bullish or bearish bias with either Calls or Puts in the
same contract month. Two major Vertical Spread Types: Debit
Spreads where you “pay to play” meaning your account is
debited for the cost of the trade since you are long the more
expensive option and short the less expense option in the same
month and Credit Spreads where you get “paid to play” meaning
you are shorting the higher priced option contract and going long
the lower priced contract.
ObjectiveYour goal is to have the price action move to and through the
short option strike price.
Trade OutlookTrade is executed when your bias is Bullish using Call options or
Bearish using Puts.
Trade
Rationale
Vertical Spreads are designed to capture a Bullish or Bearish
Play while reducing the effect of delta on your overall option
position and enhancing your odds of success. Typical returns
can be anywhere from 20% to well over 400% depending upon
strike selection.
CompositionAll Calls or all Puts in the same contract month at different
strikes
Copyright © 2016 Market Technologies, LLC. 49
Vertical Spreads
Four Types
1) Bull Call Spread Vertical Debit Spread or just Debit Spread
Vertical Bull Spread or just Bull Spread
2) Bear Call Spread Vertical Credit Spread or just Credit Spread
Vertical Bear Spread or just Bear Spread
3) Bear Put Spread Vertical Debit Spread or just Debit Spread
Vertical Bear Spread or just Bear Spread
4) Bull Put Spread Vertical Credit Spread or just Credit Spread
Vertical Bull Spread or just Bull Spread
Copyright © 2016 Market Technologies, LLC. 50
Vertical SpreadsStrategy Highlights
Bullish Bearish Sideways Limited Unlimited Limited Unlimited
1 XX XX XX
2 Bear Call Spread
3 Bull Call Spread
4 Bear Put Spread
Option Strategies
Bull Put Spread
Directional Bias Risk Reward
Copyright © 2016 Market Technologies, LLC. 51
Vertical SpreadsStrategy Highlights
Bullish Bearish Sideways Limited Unlimited Limited Unlimited
1 XX XX XX
2 Bear Call Spread XX XX XX
3 Bull Call Spread
4 Bear Put Spread
Option Strategies
Bull Put Spread
Directional Bias Risk Reward
Copyright © 2016 Market Technologies, LLC. 52
Vertical SpreadsStrategy Highlights
Bullish Bearish Sideways Limited Unlimited Limited Unlimited
1 XX XX XX
2 Bear Call Spread XX XX XX
3 Bull Call Spread XX XX XX
4 Bear Put Spread
Option Strategies
Bull Put Spread
Directional Bias Risk Reward
Copyright © 2016 Market Technologies, LLC. 53
Vertical SpreadsStrategy Highlights
Bullish Bearish Sideways Limited Unlimited Limited Unlimited
1 XX XX XX
2 Bear Call Spread XX XX XX
3 Bull Call Spread XX XX XX
4 Bear Put Spread XX XX XX
Option Strategies
Bull Put Spread
Directional Bias Risk Reward
Copyright © 2016 Market Technologies, LLC. 54
Vertical SpreadsStrategy Highlights
Spread Type Trade Rationale Construction BiasDebit
CreditMax Risk Max Reward Breakeven
Bull Call Spread
Reduces trade BE and costs of
a bullish option trade plus
reduces delta and theta effect
BTO lower strike Call
STO higher strike CallBullish Debit Debit
Diff between strikes
minus Debit
Lower Strike +
Debit
Bear Call Spread
Creates premium based strategy
whereby you are using theta
decay to your advantage
STO lower strike Call
BTO higher strike CallBearish Credit
Diff in Strikes
minus CreditCredit
Lower Strike +
Credit
Bear Put Spread
Raises trade BE and costs of a
bearish option trade plus
reduces delta and theta effect
BTO higher strike Put
STO lower strike PutBearish Debit Debit
Diff between strikes
minus Debit
Higher Strike -
Debit
Bull Put Spread
Creates premium based strategy
whereby you are using theta
decay to your advantage
STO higher strike Put
BTO lower strike PutBullish Credit
Diff in Strikes
minus CreditCredit
Higher Strike -
Credit
Copyright © 2016 Market Technologies, LLC. 55
Vertical Bull Spreads
Bullish Vertical Spreads can be constructed using either Calls or Puts
Bull Call Spread Construction [Debit Spread]
Bull Put Spread Construction [Credit Spread]
These are synthetically equivalent if same expiry/same strike
Bull Call Spread
CALLS STRIKES PUTS
100
+1 105
-1 110
Bull Put Spread
CALLS STRIKES PUTS
100
105 +1
110 -1
Copyright © 2016 Market Technologies, LLC. 56
Bullish Vertical Spreads
Risks & Rewards
• Bull Call Spread
– Max Loss = Debit Paid for the Spread
– Max Gain = Difference between K’s minus price paid
– Breakeven = Lower K + price paid for spread
• Bull Put Spread
– Max Loss = Difference between K’s less Credit
– Max Gain = Credit Received
– Breakeven = Higher K – Credit Received
Copyright © 2016 Market Technologies, LLC. 57
Vertical Bear Spreads
• Bearish Vertical Spreads can be constructed using either Calls or Puts• Bear Call Spread Construction [Credit Spread]
• Bear Put Spread Construction [Debit Spread]
• These are synthetically equivalent if same expiry/same strikes
Bear Call Spread
CALLS STRIKES PUTS
100
-1 105
+1 110
Bear Put Spread
CALLS STRIKES PUTS
100
105 -1
110 +1
Copyright © 2016 Market Technologies, LLC. 58
Vertical Bear Spreads
Risks & Rewards
• Bear Call Spread
– Max Loss = Difference between K’s less Credit
– Max Gain = Credit Received
– Breakeven = Lower K + Credit Received
• Bear Put Spread
– Max Loss = Debit Paid for the Spread
– Max Gain = Difference between K’s minus price paid
– Breakeven = Higher K - price paid for spread
Copyright © 2016 Market Technologies, LLC. 59
Vertical Option Spread Summary
• Designed to reduce risk while holding an option
position
• Delta in the position is reduced due to short call
position
• Can generate very good returns in excess of 25%
while also allowing for stock pullback (by using
ITM Spreads)
• The stock can make a smaller move in your
direction and you will make more money than by
holding a single leg option or put position
Copyright © 2016 Market Technologies, LLC. 60
Trade Selection Strategy Checklist1. Security Selection Process
2. What is your current bias
a. Neutral
b. Mildly Bullish
c. Strongly Bullish
d. Mildly Bearish
e. Strongly Bearish
f. Unknown (Breakouts; up or down) and Volatility Trades
3. What is the magnitude of the forecasted move
4. What is the timeframe of the forecasted move
5. Is there a Trigger price for the move
6. What is the support & resistant for the security
7. How will I know if my original bias is wrong during the trade
8. What is the current IV and HV of the security
9. What is your current Risk Appetitea. Position Size
b. Primary Exit Point (PE)
c. Secondary Exit Point (SE)
d. Trade Stops/taking profits & losses
10. Trade Objectives1. Income
2. Downsize Protection
3. Revenue Gain (+20%)