Ron Ianieri asked:


The selection and management of a vertical spread are only two-thirds of the game. Closing out, rolling or morphing the position has to be analyzed and executed with the same due diligence as was used in the selection and management processes.

Looking at the closing out of a vertical call spread, we find there are three possible outcomes that must be addressed. The spread can finish out-of-the-money and valueless. For a call spread, this scenario occurs when the stock closes at or below the lower strike of the spread. In this scenario, in order to close out the spread, one would just let it expire. Both options finish out of the money so no residual position will be left over.

If the spread finishes fully in the money, (at maximum value) that is with both options in-the-money, then both options will be exercised. You will exercise your long call and your short call will be assigned. They will cancel each other out and you will be left with no residual position. This scenario occurs when the stock price closes lower than the lower strike call involved in the spread.

The difficult scenario is when the stock closes in between the two strikes of the spread. This scenario, the closing of the stock between the two strikes creates a situation where one strike winds up being in-the-money while the other ends up out-of-the-money.

When both options expire in-the-money, they are both exercised-one creating a long stock option, the other creating a short position thus canceling each other out. This is not the case here. Here, one option, the one that is in-the-money will leave a residual stock position and since the other option is out-of-the-money, it will not be able to be used to offset the residual stock position created by the expiring in-the-money option.

There are two actions that could be taken. Choice number one involves trading out of the spread on expiration Friday just before the close. Because of the bid/ask spread of the two options, you will probably have to give away some of your profits in order to close out the position. Giving up a portion of the profits may be the best thing to do in order to avoid naked, unlimited risk.

If you only trade out of the in-the-money option, you run the risk (albeit short-lived because you are doing this late on expiration day of the expiring month) that the stock moves adversely and the out-of-the-money option suddenly becomes in-the-money. If that happens, you will now be naked the residual stock position. Of course, if there is still time, you could always trade out of the option then but that is very risky. However, if the stock is at a relatively safe distance from the out-of-the-money you may want to just close out the in-the-money option and let the out-of-the money option expire worthless.

The two factors that must be considered are: the combination of the distance of the strike from the stock price in relation to the short amount of time for the stock to get there, and the amount of money saved by not buying back the out-of-the-money option. Remember, this is being done at the very end of the day on expiration day. These options only have minutes of life left. So, knowing this, the risk is somewhat mitigated, but still there none the less.

The catch is the proximity of the stock to the out-of-the-money option. If the stock is close to the out-of-the-money option, you would be best advised to trade out of the spread entirely.

Again, as stated before, if the stock closes either with the spread fully in-the-money, or fully out-of-the-money, the position will adjust itself through the exercise process leaving no residual position. If the stock price finishes between the two strikes, there will be a residual position. We discussed above how to trade out of this position. Your second choice is not to trade out and allow yourself to go through the expiration process. You must remember that if you are going to accept a residual stock position, you must be able to afford it.

Then, if you have 10 July 50 calls and you exercise them you will be receiving 1000 shares of stock at $50.00 per share. Thus, you must have $50,000.00 of cash and/or margin in your account to receive the stock. If you do not have enough cash and/or margin to accept delivery of the stock, then you must trade out of the position before it expires.



Raymond

Andy Poon asked:


An option contract is an agreement between two parties to buy/sell an asset (In this case, the asset refers to stock) at a certain price and specific date.

It is called an option because the buyer is not obliged to carry out the transaction. If, over the life of the contract, the asset value decreases, the buyer can simply elect not to exercise his/her right to buy/sell the asset.

There are two types of option contracts - Call options and Put options. A Call option gives the buyer the right to buy the underlying asset, while a Put option gives the buyer the right to sell the underlying asset.

A simple example: Peter buys a Call option contract from Sarah. The contract states that Peter will buy 100 Microsoft shares from Sarah on the 5th May for $25. The current share price for Microsoft is $30.

Note: this is an example of a Call option as it gives Peter the right to buy the underlying asset.

If the share price of Microsoft is trading above $25 on the 5th May, then Peter will exercise the option and Sarah will have to sell him Microsoft shares for $25. With Microsoft trading anywhere above $25 Peter can make an instant profit by taking the shares from Sarah at the agreed price of $25 and then selling the shares on the open market for whatever the current share price is and making a profit.

The $25 value, which is stated in the agreement, is referred to as the Exercise (or Strike) Price. This is the price at which the asset will be exchanged.

The date (in this case 5th May) is known as the Expiry (or Maturity) Date. This date is the deadline for the option contract. At this date, the option buyer is to decide if a transaction of the underlying asset is to occur.

Outcomes: Let’s imagine that at the expiration date, Microsoft is trading at $30, then Peter will buy the shares from Sarah at the agreed $25 and then he can sell them back on the open market for $30 and make an instant $5.

Alternatively, if Microsoft is trading at $20, then buying the shares from Sarah at $25 is too expensive as he can buy them on the open market for $20 and save $5. In this situation, Peter would choose not to exercise his right to buy the shares and let the options contract expire worthless. His only loss would be the amount that he paid to Sarah when he bought the contract, which is called the Option Premium - more on that a little later. Sarah would, however, keep the option premium received from Peter as her profit.

All in all, there are more than 50 strategies you can deploy in options trading by combining many different strike prices and expiration. But do you need to know all?

The good news is you do not have to!In fact, most of them allow you to make money very slowly or limited.



Danny

Timothy Stevens asked:


To read a forex price quote consisting of two different currencies you have to note that the first currency is known as the base currency while the second currency is called the quote currency. Another point of note is that the first currency value is always 1 (one).

To further illustrate, the price quote or exchange rate tells us how much of the quote currency we must pay to obtain one unit of the base currency. Likewise. The price quote or exchange rate tells us how much we will receive in the quote currency by selling one unit of the base currency.

For example, if you wanted to buy the EUR/USD a price quote of EUR/USD of 1.3550 means that 1 EURO dollar (EUR) is equal to 1.3550 US dollars (USD). This means that to buy 1 EURO dollar (EUR), you would have to pay 1.3550 US dollars (USD).

In the above case, if the currency pair’s prices rises (i.e. the EUR/USD price goes up) it would mean that the EURO dollar (EUR) has appreciated against the US dollar (USD) which has weakened. If the EUR/USD has now risen to 1.3850 from 1.3550 it will mean that the EURO dollar is stronger now compared to the US dollar (USD) as 1 EURO dollar can buy more US dollars (USD) than before.

Likewise if the EUR/USD has now dropped to 1.3350 from 1.3550 it will mean that the EURO dollar has become weaker relative to the US dollars as 1 EURO dollar now can only purchase lesser US dollars

To be continue… on Forex Options Trading - How To Read FOREX Price Quotes (Part 3 of 3)



Phillip

Abhishek Agarwal asked:


Even in earlier days, most people looked upon the trading business as a lucrative one. The scene is no different today. As a matter of fact, the business is attracting more and more people all the time! Along with “people” growth, there has also been “technological” growth. The result is sophisticated softwares that provide help to the trader/investor in realizing his/her dream of generating huge revenues. The latest one to join the bandwagon is option trading software!

Below is a detailed commentary on the trading world, and how it has ultimately led to the development of option trading software–

(1) Looking at the history of the trading business, it has brought about so many changes. The business has expanded globally, giving rise to international trading markets and exchanges. For example, the New York Stock Exchange and the London Stock Exchange. The capital turnover is quite massive. And people are rushing to invest in stocks and bonds, hoping to get a share of the profits!

(2) All courses on economics focus on trade now-a-days; it has become so much a part of our lives! Actually, regional and international trade have become sources of wealth for developed countries like the United States. Looking at their progress, other developing countries (especially those from Asia) are also jumping into the fray.

(3) What Asian countries do is, export the products that they manufacture to other countries. The payment is made in dollars. These dollars are in turn used to import foreign products. Thus, the performance of the export trade decides the economies of the respective countries.

(4) More lucrative is the foreign currency exchange market, otherwise known as Forex! The capital in circulation daily is around $1.5 trillion, making it the cynosure of all eyes! Of course, there is commodities trading too, and some people are very interested in venturing into that arena also.

(5) What does one have to do in “trading”? Be like a sales agent. The investor/trader purchases what he/she wants, and then tries to sell it at a greater price. With more and more successful trades, the profits keep growing! Sometimes, the revenue generated in a single day itself is quite large!

(6) There is a certain term that the investor/trader needs to be familiar with, when venturing into the trading world–that is, options trading. There are particular “options” that are selected and that work better than others in the market. It is to this end that the option trading software was developed later on.

(7) What exactly are “options”?

They are actually contracts that afford “buyer rights”. The investor/trader is free to buy or sell any amount that he wants to, of a particular security, which could be stocks/commodities. The price for buying, and the price for selling are already determined beforehand (depending on market trends). The purchase/sale has to take place within specified time limits only. The investor/trader is not bound by any obligations.

(8) Contrast option trading with futures trading. The buyer who goes in for futures trading is under an obligation to pay the ordered security at the price asked for. Also, the pre-determined date has to be adhered to. In the same way, the seller is under an obligation to deliver the ordered security on the particular date specified and stick to the price asked for.

(9) In option trading, as mentioned before, the buyer is not obliged to do something that he/she does not want to do. If he/she feels that the security is not going to yield any profits, he/she can allow the option to lapse. What is lost in the process? Only the initial payment made.

(10) The person who chooses to take up options trading would be well advised to also go for option trading software so that risks are minimized. The software can be a guide to some amount of profit, if not 100% profits.

(11) The price may seem too high–$400. In fact, many may feel it is an unwanted luxury, well worth staying away from. But for a neophyte in the trading world, option trading software promises to be an extremely useful tool. It helps in making the right decisions.

(12) Finally, how is option trading software valuable to the trader/investor?

To illustrate with an example, there may be a “call” (for selling) option or a “put” (for buying) option that the investor/trader is dealing with. Despite knowing the market movements, if the buyer pays too much for a particular commodity, he/she stands to lose. The reverse is the case with an underpriced commodity. The risks are therefore lessened by the option trading software.



Gene

Jason Ng asked:


The recent stock market crisis (2008) not only rocked the financial system and the world economy but also the pockets of countless options traders all over the world. Options traders who used to profit in the years prior to this market crisis broke their bank as none of their options strategies seem to work in this market anymore. So what is it about extremely volatile markets and how should one profit through options trading under such conditions?

Extremely volatile market conditions not only produce unpredictable short term stock price swings but also open up the bid ask spread of individual stock options due to a lower liquidity and profiteering by market makers. This combined effect not only made it doubly hard for options traders to make a profit. Volatile options strategies, supposed to be meant for such conditions due to their ability to make a profit when the market moves up or down strongly and their ability to profit from an increase in volatility, also failed to produce any consistent profits due to the higher premium outlay and wide bid ask spreads, soaking up most of the profits. Unexpected rallies also crunch volatility to the extent of producing losses through decaying the premium of long legs at express speed. Short term (weekly, monthly) directional options strategies fared even worse as it not only became almost impossible to predict short term price swings but the high premium and bid ask spreads also took most, if not all, of the profits away even if the stock did move in the expected direction.

So what works in an extremely volatile market condition such as this one?

First of all, let’s look at all the different ways to trade options. There are 3 main options trading methodologies; Swing Trading, Position Trading and Day Trading.

Swing trading is a directional options trading methodology that aims to pick stocks that will move quickly and strongly within a short period of time in a predictable direction and then execute bullish or bearish options strategies in order to profit from these moves. As mentioned before, trying to profit from directional swing trading in an extremely volatile market is like swimming against the tide. Not only is directions hard to predict in the first place but the high options premium along with gapping bid ask spread all work against its favor.

Position trading is more complex than Swing Trading as it aims to profit mainly (although there are also position trading strategies that are directional in nature) from volatility or premium decay through putting together several different options and / or stocks in order to produce a hedged, market neutral position. Position trading has produced some pretty profitable results for me in this market crisis as volatility soared and options premiums are high. This puts the disadvantages of an extremely volatile market condition in the favor of the options trader. Such positions include dynamically hedged delta-neutral as well as delta-gamma-neutral positions. Both of these position trading strategies aim to neutralize market movement such that unexpected swings do not affect the position significantly while the position safely takes the high options premium on the short legs into your pockets.

Day trading is an extremely dynamic options trading method where options are bought and sold very quickly within one day in order to profit from the slightest intraday price swing or change in volatility. This strategy was a pretty hard one to profit from in low volatility market conditions as prices doesn’t change enough within a day to produce significant profits. However, day trading becomes extremely profitable in the hands of seasoned options trading veterans in extremely volatile market conditions such as this market crisis as the Dow itself has produced intraday trading ranges of up to 10%! Yes, this is the kind of trading range and price range that cannot be realized in normal market conditions. Day trading often takes the form of simply buying or shorting call or put options and then quickly covering them when profitable. Day trading also avoids the extreme overnight uncertainties that so often catch swing traders by surprise in this market crisis. Sudden overnight good news can often gap the Dow up by a significant amount and closing it over 10% higher. This can wipe out all your profits if you had been betting in the opposite direction overnight. Day trading, however, is extremely risky for beginners in options trading as the price movement is so fast and dynamic that when things happen, beginners may not know what to do and be able to do it quickly. This is therefore not recommended for beginners.

So, there you have, 2 ways to profit from this market crisis through options trading which I have used profitably. Options trading (http://www.optiontradingpedia.com) is definitely profitable under any market conditions as long as you use the right method for the prevailing conditions.



Den Burke