Options Trading Blog


Thursday, October 27, 2016

Bull Call Spreads and Long Calls

With the S&P 500 still not moving much lower as many had predicted up to this point, an option trader still needs to consider some bullish strategies until the market does drop. Sentiment may push stocks lower at some point, but certainly there is no guarantee it will. Even if a pullback does happen sooner than later, there will be another bullish opportunity at some point rest assured. Traders often ask me is there a way that you can take advantage of this bullish investing scenario while limiting risk? Certainly, there are a few option strategies that can accomplish this goal. One that may be a better option compared to the rest is a debit call spread which is sometimes referred to as a bull call spread.


When implementing a bull call spread, an option trader purchases a call option at one strike and sells the same number of calls on the same stock at a higher strike with the same expiration date. Here is a trade idea we looked at in Group Coaching earlier this year. UnitedHealth Group Inc. (UNH) moved up and closed at $122 and formed a bullish base. With implied volatility (IV) generally being low at the time (which is advantageous for purchasing options as with a bull call spread) and a directional bias, a bull call spread can be considered.

The Math

The trader's maximum profit on a bull call spread is limited; he can make as much as the difference between the strike prices less the net debit paid. For simplicity, let's assume that at the time one April 120 call (ITM) was purchased for 3.00 and one April 123 call (OTM) was sold for 1.00 resulting in a net debit of $2 (3 - 1). April expiration was about a month away. The difference in the strike prices is $3 (123 - 120). He would subtract $2 from $3 to end up with a maximum profit of $1 per contract. So if he traded 10 contracts, you could make $1,000 (10 X 100). He would need the stock to move a dollar or more higher ($123) by expiration to realize the maximum profit ($1).

Although he limited his upside profit potential, the trader also limited the downside to the net debit of $2 per contract. To simply breakeven, the stock would have to stay at its current price of $122 (the strike price of the purchased call (120) plus the net debit ($2)) at expiration. Effectively, the trader has created a theta (time decay) neutral position at the onset of the trade since he would break even if the stock never moved  penny off of its current price of $122. The same could not be said of a long call position. A long call always has some type of negative theta meaning that for every day that passes, the option premium will get smaller due to the passing of time.

Advantage Versus Purchasing a Call

When trading the long call, a trader's downside is limited to the net premium paid. If he simply purchased the in-the-money April 120 call, he would have paid $3. The potential loss is, therefore, greater when implementing a call-buying strategy. If he had moved to a call with a longer time frame to expiration, he would have even paid more for the option. This would also increase his potential loss per option as well.


By implementing a bull call spread, traders can hedge their bets; limiting the potential loss. In addition, buying an ITM debit spread like the bull call can offset time decay (theta). A long call or put position cannot be structured to offset theta completely. These are a couple of the advantages when comparing purchasing options outright to spreads. Remember that there are no sure-fire ways to make money by using options. However, knowing and understanding the different strategies is a good way to limit potential losses.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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Thursday, October 20, 2016

Multiply Delta

As an option trader, there are quite a few areas to learn and master before being able to extract money from the market on a regular basis. Learning what the option greeks mean and how they function alone and in relation to the other greeks is very important as an option trader. Here we will take a look at one of the greeks and consider what many option traders often fail to consider.

Option Delta

Delta is probably the first greek an option trader learns and is focused on. In fact it can be a critical starting point when learning to trade options. Simply said, delta measures how much the theoretical value of an option will change if the stock moves up or down by $1. A positive delta means the position will rise in value if the stock rises and drop in value of the stock declines. A negative delta means the opposite. The value of the position will rise if the stock declines and drop in value if the stock rises in price. Some traders use delta as an estimate of the likelihood of an option expiring in-the-money (ITM). Though this is common practice, it is not a mathematically accurate representation.

The delta of a single call can range anywhere from 0 to 1.00 and the delta of a single put can range from 0 to -1.00. Generally at-the-money (ATM) options have a delta close to 0.50 for a long call and -0.50 for a long put. If a long call has a delta of 0.50 and the underlying stock moves higher by a dollar, the option premium should increase by $0.50. As you might have derived, long calls have a positive delta and long puts have a negative delta. Just the opposite is true with short options—a short call has a negative delta and a short put has a positive delta. The closer the option’s delta is to 1.00 or -1.00 the more it responds closer to the movement of the stock. Stock has a delta of 1.00 for a long position and -1.00 for a short position.

Taking the above paragraph into context, one may be able to derive that the delta of an option depends a great deal on the price of the stock relative to the strike price of the option. All other factors being held constant, when the stock price changes, the delta changes too.

AAPL Example

What many traders fail to understand is that delta is cumulative. A trader can add, subtract and multiply deltas to calculate the delta of the overall position including stock. The overall position delta is a great way to determine the risk/reward of the position. Let’s take a look at a couple of examples.

Let’s say a trader has a bullish outlook on Apple (AAPL) when the stock was trading at $116 and purchases 3 October 115 call options. Each call contract has a delta of +0.55. The total delta of the position would then be +1.65 (3 X 0.55) and not just 0.55. For every dollar AAPL rises all factors being held constant again, the position should profit $165 (100 X 1 X 1.65). If AAPL falls $2, the position should lose around $330 (100 X -2 X 1.65) based on the delta alone.

Using AAPL once again as the example, lets say a trader decides to purchase a October 115/120 bull call spread instead of the long calls. The delta of the long $115 call is once again 0.55 and the delta of the short $120 call is -0.40. The overall delta of the position is 0.15 (0.55 - 0.40). If AAPL moves higher by $3, the position will now gain $45 (100 X 3 X 0.15) with all factors being held constant again. If AAPL falls a dollar, the position will suffer a $15 (100 X -1 X 0.15) loss based on the delta alone.

Last Thought

Calculating the position delta is critical for understanding the potential risk/reward of a trader’s position and also of his or her total portfolio as well. If a trader’s portfolio delta is large (positive or negative), then the overall market performance will have a strong impact on the traders profit or loss.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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Wednesday, October 12, 2016

Consider the Overall Market When Picking Option Strategies

With the market acting in a volatile manner as of late, and with many traders and investors expecting a decline sooner than later, it is extra important to consider your outlook for the market when choosing option strategies. Making stock option picks with profit potentials, whether the market is up or down, depends on diligent market research and a thorough understanding of stock option fundamentals. In my class, I always talk about how essential it is for traders to take into consideration the overall market sentiment when choosing strategies.

Finding profitable trading opportunities can be tough no matter what the market is doing. But you don't have to do all the work yourself. Some professional trader services, such as Market Taker’s Group Coaching, make stock option picks that they share with other like-minded traders, saving individual traders time and effort.

But whether you do your own research or rely on a seasoned professional for your option picks, its essential to understand some basic facts about options trading.

Making stock option picks based on individual stock assessment requires an understanding of specific fundamental parameters. Traders may learn how to read an annual report and 10K stockholders report for income statements, past earnings, sales, assets, new products, and overall industry trends.

Stock option picks based on technical analysis is essential for success and requires the investor to examine the historical price movement and sometimes volume in order to determine price patterns and forecast future price movements. The single most important technical analysis technique is the simplest: Support and resistance lines. I use them all the time and it is the most important component of my trading. Specifically, horizontal support and resistance lines at the same price level in two or more multiple time frames.

Option strategy picks based on broad market analysis examines overall activity based on performance indices. Is the overall market bullish (moving up), bearish (moving down) or neutral (moving sideways)? Ask yourself if you prefer to be on the side of the overall market? Without a doubt, the answer is probably a resounding yes! The broad market will affect individual equities and don't forget to take into account implied volatility and possible changes.

Stock option picks based on psychological market indicators attempts to interpret the facts and gauge whether a change from bullish to bearish (or vice versa) is on the horizon. Successful options traders are frequently contrarians who buy puts in a bullish market and purchase calls in a bearish market -- against convention.

The bottom line is that a lot goes into picking successful option strategies. Either doing it on your own or using the help of a professional with experience and “putting it all together” can make the process easier and can result in better trade ideas with greater profit potential.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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Wednesday, October 5, 2016

The Cubs Hope to Turn Many Double Plays

With the baseball post-season in full gear, the Chicago Cubs are hopeful that their long streak without a World Series title (108 years), might just come to an end. Their stellar defense may be an important factor to success which may include their ability to turn double plays when someone gets on for the opposition. This makes me think about a subject that is brought up often in MTM Group Coaching and Online Education; double calendars vs. double diagonals. And with a volatile market as of late, there are opportunities available for knowledgeable option traders that are talked about below.

Double Calendars vs. Double Diagonals Both double calendars and double diagonals have the same fundamental structure; each is short option contracts in nearby expirations and long option contracts in farther out expirations in equal numbers. As implied by the name, this complex spread is comprised of two different spreads. These time spreads (aka known as horizontal spreads and calendar spreads) occur at two different strike prices. Each of the two individual spreads, in both the double calendar and the double diagonal, is constructed entirely of puts or calls. Either position can be constructed of puts, calls, or both puts and calls.

The structure for each of both double calendars or double diagonals thus consists of four different, two long and two short, options. These spreads are commonly traded as "long double calendars" and "long double diagonals" in which the long-term options in the spread (those with greater value) are purchased, and the short-term ones are sold. The profit engine that drives both the long double calendar and the long double diagonal is the differential decay of extrinsic (time) premium between shorter dated and longer dated options.

The main difference between double calendars and double diagonals is the placement of the long strikes. In the case of double calendars, the strikes of the short and long contracts are identical. In a double diagonal, the strikes of the long contracts are placed farther out-of-the-money) OTM than the short strikes.

Why should an option trader complicate his or her life with these two similar spreads? The reason option traders implement double calendars and double diagonals is the position response to changes in IV; in other words, the vega of the position. Time spreads like calendars and diagonals can thrive and have wider break evens and max profits when there is an IV skew with the short options having a higher IV than the long options.In other words sell high and buy low.

Both trades are vega positive, theta positive, and delta neutral—presuming the price of the underlying lies between the two middle strike prices—over the range of profitability. However, the double calendar positions, because of the placement of the long strikes being closer to ATM, responds favorably more rapidly to increases in IV while the double diagonal responds more slowly. Conversely, decreases in IV of the long positions has a negative impact on double calendars more strongly than it does on double diagonals.

If you have not traded a single-legged calendar or diagonal, it might be just the time to give them a look with Alcoa kicking off another round of quarterly earnings. Maybe you have never even traded a calendar or a diagonal. This might be the perfect time to find out about these time spreads.  Once a single position spread makes sense, a double might make even more sense and be more profitable too.

Being that I live in Chicago I need to say, Go Cubs!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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Thursday, September 29, 2016

Credit Spreads Can Act Like an Insurance Policy

Selling a credit spread involves selling an option while purchasing a higher or lower strike option (depending on bullish or bearish) with the same expiration and with the short option being more expensive than the long option. For example, selling a put credit spread involves selling a put and buying a lower strike put with the same expiration. Maximum profit would occur if the underlying is trading at or above the sold put strike at expiration; the spread would expire worthless. Selling a call spread involves selling a call and buying a higher strike call with the same expiration. Maximum profit would be realized if the stock is trading at or below the sold call strike at expiration; the spread would expire worthless.

The long options are there to protect the position from the potential losses associated with selling options. With a spread, the most the position can lose is the difference between the strikes minus the initial credit received. This would occur if the stock is trading above at or above the long call or at or below the long put. Using a call credit spread as an example, if a trader sold a 50 call and bought a 55 call, creating a credit of $1, the most the trader can lose is $4 (5 – 1) if the underlying closed at or above $55.

The Objective

The objective of a credit spread is to profit from the short options' time decay while protecting gains with further out-of-the-money (OTM) long options. The goal is to buy back the spread for less than what it was sold for or not at all (meaning it expires worthless). Just like selling short stock, a trader wants to sell something that is expensive and buy it back for cheaper. The same holds true for credit spreads.

An Example

Here is a credit spread trade idea we recently looked at in Group Coaching. When the SPDR S&P 500 ETF (SPY) was trading around $215 towards the end of September, a Sep-30 211/212.5 put spread could have been sold for 0.25. This means the Sep-30 212.50 put strike was sold and the Sep-30 211 put strike was purchased for a credit of 0.25. The maximum profit in the spread was the credit received (0.25) and would be realized if SPY was trading at or above $212.50 at Sep-30 expiration which was less than a week away. Remember that a profit would be realized if the spread could be bought back (closed out) for less than the credit of 0.25. The most that can be lost on the spread is 1.25 (1.50 – 0.25) and that would be realized if the stock was to close at or below $211 at expiration.

What’s the Point?

The risk/reward ratio of this credit spread begs the question why would anyone want to risk maybe nine times or more on what they stand to make in the example above? The simple answer is probability. Given the ability to repeat the trade over and over again with different outcomes, the trader will make $25 many, many more times than he or she will take the $125 loss. This was a hypothetical situation, but let's say that the strategies winning percentage was close to 85% like in the example above. The trader needs to look at prior historical price action of the stock to determine probability of success.


How does this seem similar to insurance you ask? The credit spread strategy is similar to the insurance business because insurance companies get to keep premiums if people don't get sick or if people don't have accidents, etc. Traders turn themselves into something like an insurance company when they implement credit spreads and keep premium as long as something doesn't go drastically wrong.

Just like an insurance company has to decide if the risk is worth the potential reward, option traders that trade vertical credit spreads have to analyze how much can they collect, how much can they lose and the probability of having a profitable trade. In a future blog, we’ll discuss how a trader can use options implied volatility to help put probability on his or her side.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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Wednesday, September 21, 2016

Is There Such a Thing as Cheap Options?

It seems like every so often in my Group Coaching class or through an email, a student will ask me about buying a deep out-of-the money (OTM) options. Many option traders especially those that are new, initially buy deep out-of-the-money options because they are cheap and can offer a huge reward. Unfortunately many times, these “cheap” options are rarely a bargain. Don’t get me wrong, at first glance an OTM call that costs $0.25 may seem like a steal. And don't get me wrong again, a big move higher can certainly make it seem like a great trade. Since the baseball season is less than two weeks away, we can use a baseball analogy and say that if the trade works out, it could turn into a real home run; maybe even a grand slam. But if the call’s strike price is say $20 or $30 (depending on the stock price) above the market and the stock has never rallied that much before in the amount of time until expiration, the option will likely expire worthless or close to it at expiration.

Negative Factors

Many factors work against the success of a deep OTM call from profiting. The call’s delta (rate of change of an option relative to a change in the underlying) will typically be so small that even if the stock starts to rise, the call’s premium will not increase much. In addition, option traders will still have to overcome the bid-ask spread (the difference between the buy and sell price) which might be anywhere from $0.05 to $0.15 or even more for illiquid options.

Option traders that tend to buy the cheapest calls available are probably calls that have the shortest time left until expiration. If an OTM call option expires in less than thirty days, its time decay measured by theta (rate of change of an option given a unit change in time) will be often larger than the delta especially for higher priced and more volatile stocks. Any potential gains from the stock rising in price can be negated by the time decay. Plus each day the OTM call option premium will decrease if the stock drops, trades sideways or rallies just a tad.

Quick Example

With Alphabet Inc. (GOOGL) trading at around $800, a trader can purchase an October 900 call with about 30 days till go until expiration for about 0.45. Yes that is about $100 higher than the stock price. With GOOGL being a fairly expensive stock, in-the-money (ITM), at-the-money (ATM) and plenty of OTM options can be very expensive for many traders. Buying the October 900 call may look enticing. What many option traders fail to recognize is that the option has a delta of 0.02 and theta of 0.03. So even if the stock rose $5 over the course of two days, the call option would only increase by about $0.04 (0.10 - 0.06). This is computed by adding $0.10 from delta ($5 X 0.02) and subtracting $0.06 (2 days X 0.03) because of theta. So option traders need to ask themselves is it really a bargain?

Final Thoughts

A deep OTM call option can become profitable only if the stock unexpectedly jumps much higher. If the stock does rise sharply, an OTM call option can hit the proverbial home run and post impressive gains. The question option traders need to ask themselves is how much are they willing to lose waiting for the stock to rise knowing that the odds are unlikely for it to happen in the first place? Trades like these have very low odds and may be better suited for the casino then the trading floor.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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