What is a butterfly spread?
Posted on December 18, 2008
Filed Under Stock Option Info | Leave a Comment
A butterfly spread is an options strategy built on four trades at one expiration date and three different strike prices. For call options, one option each at the high and low strike price are bought, and two options at the middle strike price are sold. For put options, the trades are reversed. This is a limited risk, limited return strategy that pays off when the price of the underlier remains around the middle strike price. This strategy is essentially a combination of a bull and bear spread.
What is a covered call?
Posted on December 9, 2008
Filed Under Stock Option Info | Leave a Comment
A covered call is the selling of a call option while simultaneously holding an equivalent position in the underlier. This is an attempt to take advantage of a neutral or declining stock. If the option expires unexercised, the writer keeps the premium. If the holder exercises the option, the stock must be delivered, but, because the writer already owns the stock, risk is limited. This is the opposite of an uncovered call, when the writer sells a call for a stock that he/she does not already own, a dangerous strategy with unlimited risk.
Record Options Trading Slows After Hedge Funds Fold
Posted on November 21, 2008
Filed Under Stock Option Info | Leave a Comment
U.S. options trading slowed this month from a record pace after hedge funds collapsed and the biggest market swings since 1929 made equity derivatives too expensive to be used as insurance against stock losses.
About 12.5 million contracts linked to shares changed hands each day in November on average, according to data compiled by Bloomberg. That’s 23 percent less than in October, the worst month for the Standard & Poor’s 500 Index since 1987, and 13 percent below the 2008 average, according to Options Clearing Corp., which processes all exchange-listed U.S. options.
Trading decreased as hedge funds suffered their worst back- to-back monthly declines in September and October, according to Hedge Fund Research Inc. Costs skyrocketed as the Chicago Board Options Exchange Volatility Index, the key measure of contract prices in the U.S., jumped to the highest level in its 18-year history in October.
“It’s broader and deeper than anything that’s happened before,” said Bill Brodsky, chief executive officer of the Chicago Board Options Exchange, the largest U.S. options market. “Our situation is as sound as we could wish it to be under these circumstances, but we’re part of the equity markets of this country and the equity markets have been knocked for a loop.”
The slowdown follows a record for annual options trading spurred by the stock-market retreat, which erased more than $30 trillion in value since October 2007. Over 3.26 billion contracts have been traded on U.S. exchanges this year, already more than the full-year record of 2.86 billion set in 2007, according to Chicago-based Options Clearing Corp.
‘Protecting’ Returns
The recent slump dims the prospects for exchanges and brokerages as investors shy away from trading equity derivatives and transfer holdings to cash to avoid more losses.
“It’s a significant drop but it doesn’t surprise me,” said Gary Katz, chief executive officer of the International Securities Exchange, the New York-based options market acquired in December by Frankfurt’s Eurex AG. “Firms are coasting to the end of the year and being very conservative in protecting what they have returned so far in 2008.”
Options are derivatives that give the right though not the obligation to buy or sell a security at a set price and date. Hedge funds are largely unregistered pools of capital that cater to wealthy individuals and institutions and allow managers to participate substantially in profits from investments. They try to make money in rising as well as falling markets.
November 1929
The S&P 500 rose or fell at least 1 percent in 86 percent of October’s trading days, making it the second-most volatile month in its 80-year history, according to S&P analyst Howard Silverblatt. Only November 1929 produced bigger swings, he said.
The CBOE Volatility Index, which averaged 17.54 last year, jumped to 89.53, its highest intraday level, on Oct. 24. It increased 91 percent in September and 52 percent in October. The measure, known as the VIX, tracks the cost of options linked to the S&P 500, which fell 17 percent last month.
The S&P 500 fell 6.7 percent to 752.44 today, sinking to the lowest closing level since April 1997. The index has fallen 49 percent in 2008, which would be the steepest annual retreat in the measure’s 80-year history. The VIX increased to 80.86, a record close.
U.S. options volume was fewer than 10 million contracts on three days in November. That’s below the total trading during the holiday-shortened session of July 3, when exchanges closed early before Independence Day.
“We’re going to see a pullback to more normal volumes,” said Ed Boyle, senior vice president for U.S. options at NYSE Euronext, the world’s largest operator of stock exchanges. “It’s a big deal because it can hurt the revenue of exchanges and the ability of trading firms to profit.”
Shifting to Cash
One reason for the decline is that investors have sold assets to protect against losses by moving money into cash, which reduces the need to use options to protect against drops in the underlying assets, said Jeremy Wien, who trades VIX options at Societe Generale SA in New York.
“People have fewer underlying positions to hedge,” Wien said. “There are fewer and fewer people taking positions because they’re saying, ‘I just want to make it to next year.’”
An estimated 700 hedge funds may go out of business by the end of the year, an increase of 24 percent from 2007, according to Hedge Fund Research. The Chicago-based firm’s Fund Weighted Composite Index fell 6 percent in September and another 6 percent in October.
“Over the last 10 years, the amount of volume that was because of hedge funds really went up as they were getting bigger and bigger and trading more and more,” said George Ruhana, chief executive officer of Chicago-based OptionsHouse LLC, the online brokerage unit of PEAK6 Investments LP. “Now their capital base isn’t going to allow them to trade as much.”
What is option price?
Posted on October 23, 2008
Filed Under Stock Option Info | Leave a Comment
Option Price also called option premium is the amount per share that an option buyer pays to the seller. The option premium is primarily affected by the difference between the stock price and the strike price, the time remaining for the option to be exercised, and the volatility of the underlying stock. Affecting the premium to a lesser degree are factors such as interest rates, market conditions, and the dividend rate of the underlying stock. Because the value of an option decreases as its expiration date approaches and becomes worthless after that date, options are called wasting assets. The total value of an option consists of intrinsic value, which is simply how far in-the-money an option is, and time value, which is the difference between the price paid and the intrinsic value. Understandably, time value approaches zero as the expiration date nears.
What are LEAPS?
Posted on September 26, 2008
Filed Under Stock Option Info | Leave a Comment
Long-Term Equity Anticipation Securities (LEAPS) are Long-term stock options or index options, with expiration dates up to three years away. LEAPs are very similar to standard options except for the fact that they expire much further in the future. They can be safer than traditional options because it is somewhat easier to predict stock movement over longer periods. Like options, they allow an investor to lock in a fixed price for the underlying security. Therefore, like options, they can be effective for both leverage and insurance purposes. Expiration generally occurs 36 months after purchase, and LEAPs are American style, so they can be exercised at any time before expiration. Strike prices usually range around 25% above or below the price of the underlying stock when the LEAP is first offered.
What is a Bull Call Spread?
Posted on September 9, 2008
Filed Under Stock Option Info | Leave a Comment
Establishing a bull call spread involves the purchase of a call option on a particular underlying stock, while simultaneously writing a call option on the same underlying stock with the same expiration month, at a higher strike price. Both the buy and the sell sides of this spread are opening transactions, and are always the same number of contracts. This spread is sometimes more broadly categorized as a “vertical spread”: a family of spreads involving options of the same stock, same expiration month, but different strike prices. They can be created with either all calls or all puts, and be bullish or bearish. The bull call spread, as any spread, can be executed as a”unit” in one single transaction, not as separate buy and sell transactions. For this bullish vertical spread, a bid and offer for the whole package can be requested through your brokerage firm from an exchange where the options are listed and traded.
What is the break-even point of an option?
Posted on August 28, 2008
Filed Under Stock Option Info | Leave a Comment
The price at which an option’s cost is equal to the proceeds acquired by exercising the option. For a call option, it is the strike price plus the premium paid. For a put option, it is the strike price minus the premium paid.
What is an Option Contract?
Posted on August 1, 2008
Filed Under Stock Option Info | Leave a Comment
The right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike price) during a specified period of time. For stock options, the amount is usually 100 shares. Each option contract has a buyer, called the holder, and a seller, known as the writer. If the option contract is exercised, the writer is responsible for fulfilling the terms of the contract by delivering the shares to the appropriate party. In the case of a security that cannot be delivered such as an index, the contract is settled in cash. For the holder, the potential loss is limited to the price paid to acquire the option. When an option is not exercised, it expires. No shares change hands and the money spent to purchase the option is lost. For the buyer, the upside is unlimited. Option contracts, like stocks, are therefore said to have an asymmetrical payoff pattern. For the writer, the potential loss is unlimited unless the contract is covered, meaning that the writer already owns the security underlying the option. Option contracts are most frequently as either leverage or protection. As leverage, options allow the holder to control equity in a limited capacity for a fraction of what the shares would cost. The difference can be invested elsewhere until the option is exercised. As protection, options can guard against price fluctuations in the near term because they provide the right acquire the underlying stock at a fixed price for a limited time. risk is limited to the option premium (except when writing options for a security that is not already owned). However, the costs of trading options (including both commissions and the bid/ask spread) is higher on a percentage basis than trading the underlying stock. In addition, options are very complex and require a great deal of observation and maintenance. also called option.
Why Should I Trade Options?
Posted on July 2, 2008
Filed Under Stock Option Info | Leave a Comment
Countless traders and investors categorize options trading as too complex and too risky when, in reality, they can actually offer a greater risk/reward ratio when compared to simply purchasing the underlying equity. Options present a fine method for investors and/or traders to realize the gain on equity movements without actually purchasing the underlying securities. Unfortunately, there is only a small fraction of people who utilize options in their portfolios.
One of the main reasons people veer away from options are because their value decays over time. But, in certain situations, options can actually supply investors with a superior way of multiplying their profit while simultaneously reducing risk. On some occasions, utilizing options in lieu of equity in the long-term can also considerably increase risk vs. reward.
Since trading options is defined by a particular strategy and there is considerably less capital at stake, the additional benefit here is that you are able to make more rational decisions as there is less emotion involved.
For many investors and traders, options provide the ideal alternative for equity, enabling them not only the opportunity to increase their rewards but also to minimize their risk. Nonetheless, not all options are perfect for everyone in every situation – they should always be researched thoroughly.
Retail Investors Expand Into Options
Posted on June 27, 2008
Filed Under Stock Option Info | Leave a Comment
Trading of equity options has flourished in the past decade and it is not just the professionals leading the way. Retail equity investors have also started taking the initiative in the use of such derivatives.
Traditionally, retail investors are usually seeking stocks that are likely to stay range-bound over the short term, rather than deploying more aggressive strategies. The expansion into the buying of options can help investors to insulate their portfolio against a sharp decline in equity prices and also allow them to profit from a market rally. Selling options then generates income that can boost the bottom line, so long as equity prices do not change much over the life of an option contract.
By writing options, the investor receives an upfront premium. Should the price of a stock not deviate greatly, they can retain that income and do not have to compensate the buyer of the option.
In the event that the stock price rises significantly and triggers the option, the investor already owns the stock and thus faces a reduced profit as they compensate the option buyer. If the stock stays steady or falls, the investor keeps the premium. Such an approach lowers the risk of being burned through the use of more aggressive option trading, which can tempt some investors.
With online trading platforms and an expansion of education about options providing a fertile ground for retail investors, they are breaking away from relying on putting their money strictly into mutual stock funds. A recent Charles Schwab survey of 500 active retail investors showed that 40 percent of traders surveyed now regularly trade options.
Nearly half of the traders were over 55 years of age. Schwab said 95 percent of them expect to maintain or increase their options trading during the next six months. The survey also found that 75 percent of traders who incorporate options in their portfolio do so with the goal of generating income or hedging for risk management.
During 2000, the exchange reported 279 million equity contracts traded, representing options on 27.9 billion shares of underlying stock. For 2007, 501 million equity contracts were traded, representing options on 50.1 billion shares of underlying stock.