IntroductionOneoftheamazingthingsabouttheoptionsmarketisthatyoucancreateaprofilethatyoufeelcanbestcapitalizeoncurrentmarketconditions.Optionstrategiescanbebullishorbearish,theycanbehighlyspeculative,highprobabilityorcanreduceportfoliorisk.Witheverystrategythereisatendencytoemphasizeoneormoreoftheseattributes.Thethreeoptionstrategiesthatwe’regoingtocoverinthisreportareshortputs,shortverticalsandmarriedputs.Whentradingoptions,therearethreeforcesthataffecttheirvalue.Theseforcesareprice,timeandvolatility.Whenanalyzingwhichstrategywillbebesttotakeadvantageofasetuponastock,you’llwanttoaddresseachofthesefactors.Aseachstrategyisdiscussed,theseforceswillbeaddressedandthecorrespondinggaugethathelpsmeasuretheimpactofeachforceontheoptionprice.Thesegaugesarereferredtoasoption“Greeks.”Beforewediveintothestrategies,let’sreviewtheeffectsofprice,timeandvolatilityonoptionprices.PriceWhenweconsidertheeffectsonthevalueofanoption,priceis“king.”Thatmeansthatthemovementofthepricewillalwayshavethegreatestimpactonthepriceofanoptionbothpositivelyandnegatively.TheeffectofpriceonthevalueofanoptionismeasuredbytheoptionGreek“delta.”It’saGreekthatisdisplayedonyourbroker’splatforminpersharetermsandwillbeexpressedasanumberbetweenzeroandone.Avalueof0.50meansthatthepriceoftheoptionwillchangebythatamountgivena$1changeintheunderlyingstock.Calloptionshaveapositivedeltabecausetheoptionpriceincreasesinvalueasthepricerisesandaputhasanegativevaluebecauseitsvalueincreasesasthepricefalls.Therefore,thesignofthedeltaisanindicationofthedirectionthepriceneedstomovetomakemoney.Thestrikeorexercisepriceofanoptionisclassifiedaseitherin-the-money(ITM),at-the-money(ATM)orout-of-the-money(OTM).Theclassificationisdeterminedbywherethestrikepriceisinrelationtothestockprice.Iftheoptionhasintrinsicvalue,theoptionisconsideredtobeITM,ifitisclosesttothecurrentstockpriceitisconsideredtobeATMandifthereisnointrinsicvalueitisconsideredtobeOTM.Anoptionhasintrinsicvalueifthereissomevaluetobecapturediftheoptionisexercisedandthestockisboughtorsold.Foracalloption,theintrinsicvalueiscalculatedasfollows:

IntrinsicValue(Call)=StockPrice–StrikePrice

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Therefore,acalloptionhasintrinsicvalueifthestockcanbepurchasedataprice(thestrikeprice)thatisbelowthecurrentmarketprice.Forexample,ifthestockpriceisat$55andthestrikepriceisat$50,thestockcanbepurchasedfor$50andsoldfor$55,capturing$5ofintrinsicvalue.Foraputoption,theintrinsicvalueiscalculatedasfollows:

IntrinsicValue(Put)=StrikePrice–StockPriceTherefore,aputoptionhasintrinsicvalueifthestockcanbesoldataprice(thestrikeprice)thatisabovethecurrentmarketprice.Forexample,ifthestrikepriceisat$55andthestockpriceisat$50,thestockcanbepurchasedfor$50inthemarketandsoldfor$55,capturing$5ofintrinsicvalue.Gettingbacktodelta,ITMoptionshaveadeltathatisgreaterthan0.50,ATMoptionshaveadeltathatisapproximately0.50andOTMoptionshaveadeltathatislessthan0.50.ThereasonforthisrelationshipisthatdeltaisalsoameasureoftheprobabilityoftheoptionexpiringITM.ThefactthatanITMhasadeltagreaterthan0.50makesintuitivesensesinceitalreadyhasintrinsicvalue,andthereforewillhavegreaterthana50%chanceofkeepingitandremainingITM.AnATMoptionhasadeltacloseto0.50becauseit’ssittingnearthecurrentpriceofthestockandthepricehasa50%probabilityofmovingupordownfromitscurrentvalue.AnOTMoptionhasnointrinsicvalueandthestockwouldhavetomoveinthedirectionofthestrikepriceinordertomoveITM,andthereisalwayslessthana50%probabilityofthathappening.Theconceptofusingdeltaasameasureofprobabilityisveryimportantwhenyouconsiderstrategy.Theinclusionofdeltainthewayyouselectstrikepriceswillbeanimportantwaytoaddconsistencytoyourtrading.TimeWejustdiscussedtheconceptofintrinsicvalueandanoptioneitherhasitoritdoesn’t.Theremainingportionoftheoption’svalueisreferredtoasextrinsicvalue.Thisisthevaluethatyou’repayingfortheopportunityforthestocktomove.Partoftheextrinsicvalueisdirectlytiedtotheamountoftimetheoptionhastoexpiration.Themoretimethatyoupurchase,themoretimevaluethatyouwillbepaying.Thismakessensesincetherangeofpossiblepricesthatthestockcanreachincreaseswithmoretimetodoit.Forexample,thepricewilltypicallymovelessinaweekthanitwilloverthecourseofayear.Sincetimevalueisdirectlytiedtotheamountoftimebeforeexpiration,thevalueassociatedwithtimewillbeerasedaseachdaypasses.ThisdynamicisreferredtoastimedecayandismeasuredbytheoptionGreek“theta.”Thetaistheamountofvalueanoptionloseseachday.Therateofdecay,ortheta,increasesexponentiallyasyouapproachexpirationuntilalloftheextrinsicvalueisgoneastheoptionexpires.Thefactthattheoptionisdecayingovertime

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benefitstheoptionsellersincetheoptioncanberepurchasedatalowerpriceeachday,allthingsbeingequal.Thetaalsoworksagainsttheoptionbuyersincetheoptionpurchasedisworthlessandlesseachday.Thisdynamiccontributesdirectlytowhycertainoptionstrategieshaveahigherprobabilityofsuccessthanothers.Optionsellersnaturallyhaveahigherprobabilityofsuccessbutiscappedintheamountofmoneytheymake.Theoptionbuyerhasalowerprobabilityofsuccessbuthasvirtuallyunlimitedreturnpotential.Theconceptofthetahelpswhenselectinganoptionexpiration.Anoptionbuyerwilltypicallywanttobuyenoughtimetomorethanaccommodatetheirexpectedmoveandwilloftentimesavoidholdinganoptionasthethetaisincreasingrapidlythelasttwoweeks.Anoptionsellerwilltypicallysellshorteramountsoftimetoexpirationinordertocapitalizeonthetimedecayandmaylettheoptionexpireworthlesstoreachtheirmaximumgain.ImpliedVolatilityImpliedvolatilityisoftentimesoneofthemoredifficultthingsforoptiontraderstounderstand.Itistheportionofanoption’sextrinsicvaluethatisdeterminedbythesupplyanddemanddynamicsproducedasbuyersandsellerscometogethertodeterminetheoption’sprice.Asdemandforoptionsincrease,thevalueofanoptionincreasesandisreflectedbyanincreaseinimpliedvolatility.Thedemandforoptionsincreasebecauseofincreasedexpectationsformovementinthestockprice.Therefore,impliedvolatilityisthefutureexpectedmovementorvolatility“implied”intheoptionprice.Impliedvolatilityisconstantlychangingthroughoutthecourseofthedayasbuyersandseller’sexpectationsareconstantlyshiftingwiththeprice,news,etc.Asimpliedvolatilityincreases,theoptionvalueincreasesandtherebybenefittingcallandputoptionbuyers.Asimpliedvolatilitydecreases,theoptionvaluedecreasesandtherebybenefitingcallandputoptionsellers.Impliedvolatilityhasatendencytoremainrange-boundovertime.Therefore,analyzingvolatilityisimportantwhendeterminingwhichstrategytoemploy.InFigure1you’llseeagraphofimpliedvolatilityforMicronTechnologyInc.(MU)forthelast6months.Forthemostpart,Micron’simpliedvolatilityhasrangedbetween40%to50%withperiodicspikesabove50%.Theyellowlinerepresentstheaverageimpliedvolatilityforthelastyearat44%.Whenthecurrentimpliedvolatilityisgreaterthantheaverage,youmightassumethattheimpliedvolatilityhasagreatertendencytodeclineandwouldtendtobenefitoptionsellers,andviceversaforoptionbuyers.

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Figure1—ImpliedVolatilityforMicronTechnology—sourceiVestPlus.comTheeffectofimpliedvolatilityonthevalueofanoptionismeasuredbytheoptionGreek“vega.”Vegaisdefinedastheamounttheoptionpricewillchangewitha1%changeinimpliedvolatility.Callandputoptionbuyersbenefitbyariseinimpliedvolatilitysincetheoptionincreasesinvalue,andsotheyareconsideredpositivevegatrades.Callandputoptionsellersbenefitbyadropinimpliedvolatilityastheoptionlosesvalue,andsotheyareconsiderednegativevegatrades.Whenselectingastrategy,yourconsiderationforthedirectionofimpliedvolatilitywillbeveryimportantinyourselectionprocess.Asimpleruleofthumbisiftheimpliedvolatilityisaboveaverageyoumightleanmoretowardsellingoptions,andiftheimpliedvolatilityisbelowaverageyoumightleantowardbeinganoptionbuyer.ShortPutsWhenyouenteranoptiontrade,youcanenteroneitherthesideofthebuyerortheseller.Ashortputisinitiatedasasell-to-openorderthroughyourbroker.Ashortputisalsoreferredtoasan“uncovered”or“naked”putsinceyouaren’tpurchasinganyinsurancetoreducethetraderisk.Withashortputtradeyouarepaidapremiumfortheobligationtobuythestockatthestrikeprice.InFigure2you’llabletotakeacloserlookattheprofileofashortput.

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Figure2—ShortPutProfileFromtheprofile,you’llseethatthemostyoucanmakeasaputoptionselleristhepremium,andforthisstrategythatmaximumgainisachievedifthepriceclosesatorabovethestrikepriceatexpiration.Themaximumlossisthestrikepriceminusthepremiumreceivedwhentheputwassold.Thispricealsorepresentsthebreakevenstockpriceatexpirationforthistrade.Thisisabullishtradesinceitisdeltapositive,butdependingonthestrikeprice,thepriceofthestockdoesn’tnecessarilyneedtogouptomakemoneyatexpiration.Thisisbecausethetradeisthetapositiveandeachpassingdaythetradeismakingmoneythroughtimedecay.Lastly,thetradeisvegapositivesinceitwillbenefitfromdecliningimpliedvolatility.

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Sinceshortputscarrytheobligationtobuythestock,sometraderswillsellaputwiththeintenttobuythestockandsetasidethenecessarycapitaltodoso.Thisapproachcanbeaparticularlyapplicablestrategyonlargecapstocksthatpayarelativelyhighdividendyieldandaretradingatgoodvaluations.Ifthestockcontinuestodeclineandexpiresbelowthestrikeprice,thestockwillbepurchasedatthestrikeprice.IfanOTMoptionissoldandtheimpliedvolatilityishigh,thestrikepricemaybeatasignificantdiscountfromwherethestockwastradingatthetimeoftheputoptionsale.Thisapproachtosellingputsiswhat’sreferredtoasa“cashsecuredput.”Thisstrategyhasasimilardegreeofrisktoowningthestockbuthasahigherprobabilityofmakingmoney.WhensellingputsinanIRAthereisnoopportunitytotradeonmarginandsoeveryshortputiscashsecured.MarginWhenaputoptionissoldinamarginaccount,youhavethepotentialtosellmorecontractsthanyouactuallyhavecashtobuytheshares.Thisisbecauseyourbrokerwillonlyrequireyoutoputuptheinitialmarginrequiredtoplacethetrade.Thinkoftheinitialmarginasagoodfaithdeposit.Themarginrequirementcanincreaseordecreasedependingonwhatthepriceofthestockdoesandotherconsiderations.FINRAsetstheminimumrequiredmargin,butmanybrokersrequirehigheramountsofmarginthanthey’rerequiredtodoso.Thisiswherepeoplecanputthemselvesatgreaterrisk.ExpirationSelectionWhensellingputs,youneedtobalancesellinganamountoftimethatwillgenerateasignificantenoughreturnfortherisk,theabilitytomanagethetradeandmakemoney.Sellingtooshortoftimecarriestheriskofcollectingrelativelylittlepremiumandriskifthestockmovesquicklyagainstyou.Sellingtoomuchtime,willyieldalargerinitialpremium,butwilltakelongertorealizegainswithoutasignificantmoveinthestockprice.Sellingoptionswithone-monthtoexpirationtendstobalancealotoftheseconsiderations.StrikeSelectionTypically,shortputsaresoldOTMinordertoyieldgreaterthana50%probabilityofexpiringworthless.However,it’seasytotakethistoanextremeandsellreallyfarOTMoptionsthathaveanextremelyhighprobabilityofsuccess.Whiletheprobabilitymaybehigh,thesmallcreditreceivedwilltakeuntilexpirationtorealize.Typically,sellingOTMoptionswithabouta60-70%probabilityofsuccessisagoodbalancebetweenhavingaconnectiontothestockpriceandstillbeabletobenefitbyadropinimpliedvolatility.Thatmeanssellingputoptionswithabouta0.30to0.40delta.ReturnExpectationsWhensellingputsonlargecompaniesthathavelowervolatility,theamountofcreditreceivedwilltypicallybearoundonetotwopercentofthestrikepricesold.Formorevolatile,growth-

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orientedcompaniesthecreditwilltypicallybeovertwopercent.Becarefulifpremiumsaretoohigh,thiscouldbeasignalthereisapendingannouncementthatcouldcreateasignificantpricemove.ExitsWhensellingpremium,you’retypicallyengagedinahigherprobabilitystrategy.However,inorderforthehighprobabilitiestoberealized,thetrademustbecarriedtowardexpiration.Incircumstanceswhereashortputistradedwithouthavingthecashtocoverbuyingthestock,you’llneedtohaveapricepointtoexitearly.Thisistypicallybelowthestrikepricesoldandwouldbebasedonyourallowableriskpertrade.Inthecaseofaprofitableposition,it’simportanttohaveapointwheretheoptionwillbeboughtback,andthetradeclosed.Typically,thiswouldbeifyou’vemadeabout70%to80%ofthemaximumgain.TradeExampleInthisexample,we’regoingtouseMicronTechnologyIncorporated(MU).InFigure1wealreadysawthattheimpliedvolatilityisaboveaverage,whichmeansthatthiswillallowustosellfurtherawayfromthestockpricethanatotherpointswithlowervolatilityandcollectalargerpremium.Thisisthetypeofstockthatonewouldtypicallynotsellputsontobuythestockbutwouldbelookingforthepricetoremainstableandtheimpliedvolatilitytodrop.InFigure3belowisachartofMU.You’llseethatitiscurrentlytrendingaboveits30-daymovingaveragebuthasrecentlyfalteredasittestedtheMarch2018high.SellinganOTMputwillallowthepremiumtobemadeifthestockgoesup,sidewaysordownalittle.TheoptionthatfitsthesamplerulesgivenforstrikeandexpirationistheJuly55putthatissellingfor$2.07atthebid.TheJulyexpirationhas33daysuntilitexpires,andthe$2.07premiumprovidesa3.8%returnifitexpiresworthless.Thedeltaoftheputisat-0.33,whichindicatesthistradehasa67%probabilityofreachingmaximumgain.

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Figure3—ChartofMicronTechnologyIncorporated(MU)Inthisexample,themaximumgainisachievedifthestockclosesabove$55atexpiration.Thereisapartialgainifthestockfinishesbelow$55andabove$52.93,andthetradebeginstolosemoneyatexpirationifthestockfinishesbelow$52.93.Thatmeansthatthestockcandropover9%fromitscurrentpricebeforethetradebeginstolosemoneyatexpiration.ShortVerticalsOneofthemostpopularoptiontradingstrategiesandabuildingblockofmanyhighprobabilitytradesisshortverticals.Withthepropersetup,thesetradescanprovideawinningpercentageofgreaterthan50%,andalsoprovidelimiteddownsiderisk.Highprobabilityanddefinedrisk—whatabeautifulcombination!Let’stakeacloserlookatthisstrategy.Shortverticalsarecreatedthroughbuyingandsellingeithercallsorputsatdifferentstrikes,butwithinthesameexpiration.Thus,they’resetup“vertically”withintheoptionchain.Theideaistosellthemoreexpensiveoptionandbuyandlessexpensiveoptionfurtherout-of-the-moneyforprotection.Asaresult,acreditispaidthemomentthetradeisentered.Astheterm“short”

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implies,thisisasellingstrategyandthemaxgainisthecreditreceived.Onecouldlookatthisstrategyassimplysellingashortcallorashortputbutusingpartoftheproceedsfromthesaletobuyinsurancetodefinethetrade’srisk.Sincethisisasellingstrategy,sellingacallverticalwouldbeconsideredabearishtrade,andsellingaputverticalwouldbeconsideredabullishtrade.Thus,shortcallverticalsareoftenreferredtoas“bearcallspreads”,andshortputverticals,“bullputspreads.”ShortPutVerticalInFigure4you’llabletotakeacloserlookattheprofileofashortputvertical.Forthisstrategy,thehigherstrikepriceissoldforacreditandaportionofthepremiumisusedtobuydownsideprotectionincasethestockdropsdramatically.Thepremiumreceivedisreferredtoasthe“netcredit.”

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Figure4—ShortPutVerticalProfileYou’llseeintheprofilethatthemaximumgainfromashortputverticalisthenetcreditreceivedandthemaximumlossisthedifferencebetweenthestrikepricesminusthecreditreceived.Youmaynoticesomesimilaritytotheshortputstrategy,exceptthatthedownsideriskiscappedatthestrikepriceoftheoptionpurchased.Sincethisisacreditspread,themaximumgainisreachedwhenbothoptionsexpireworthless.Forthattotakeplace,thestockneedstobetradingatorabovetheshortstrikeprice.Therefore,thisstrategyisdeltapositive(bullish),thetapositiveandveganegativewhenthestrikesareOTM.ShortCallVertical

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InFigure5you’llabletotakeacloserlookattheprofileofashortcallvertical.Forthisstrategy,thelowerstrikepriceissoldforacreditandaportionofthepremiumisusedtobuyupsideprotectionincasethestockrisesdramatically.Thepremiumreceivedisreferredtoasthe“netcredit.”

Figure5—ShortCallVerticalProfileYou’llseeintheprofilethatthemaximumgainfromashortcallverticalisthenetcreditreceivedandthemaximumlossisthedifferencebetweenthestrikepricesminusthecreditreceived.Sincethisisacreditspread,themaximumgainisreachedwhenbothoptionsexpireworthless.Forthattotakeplace,thestockneedstobetradingatorbelowtheshortstrikeprice.Therefore,thisstrategyisdeltapositive(bullish),thetapositiveandveganegativewhenthestrikesareOTM.

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MarginYouwillneedtoputupmarginforshortverticals,butthemarginneededisequaltotheriskinthetrade.VerticalscanbetradedinmarginaccountsandIRA-typequalifiedaccounts,butitissubjecttoyourbroker’srulesandthetradingauthorizationyouhavefortheaccountyou’retrading.ExpirationSelectionSimilartoshortputs,therearethingsthatyouneedtobalancewhenselectingtheexpirationforshortverticals.Themaindifferenceisthatsellingmoreorlesstimedoesn’tchangetheamountofthenetcreditreceivediftheprobabilitiesarethesame.Withverticalsthereisatimeelementthatismoresignificantthanwithasingleshortoptionbecauseyou’rebuyinganoptionwithnegativethetaandsellinganoptionwithpositivetheta.Asaresult,thenetthetaissmallerthanforasingleoptionthatissold.Therefore,sellingalotoftimeresultsinasignificantdelayinrealizingyourreturnwithoutssignificantmoveintheprice,andsellingshortamountsoftimeresultsinachievingmaxgainormaxlossmorefrequently.Similartoshortputs,sellingoptionswithone-monthtoexpirationtendstobalancealotoftheseconsiderations.StrikeSelectionWhensellingshortverticals,you’retryingtobalancetheprobabilitieswithgainingenoughofacredittocompensateyoufortherisk.Becausetwoseparatestrikesaretraded,commissionsarehigherandhastobeaconsideration.Therefore,it’simportanttosellastrikethatgivesyouenoughcredittonotonlyenterthetradebutexit,whilekeepingalargeportionofyourcredit.Unlikesingleoptions,sellingwhenimpliedvolatilityishighdoesn’tincreaseyourcredit,butitdoesallowyoutosellfurtherOTMforthesamecredit.Whenimpliedvolatilityisaboveaverage,sellinga0.30to0.40deltahelpstobalancealotoftheseconsiderationsandwillallowthetradetobenefitfromadropinimpliedvolatility.Ifimpliedvolatilityisbelowaverage,sellingthefirstOTMstrikepricewillgenerateahigherreturnonrisk.Typically,theoptionpricepurchasedwillbeonetotwostrikesfurtherOTM.ReturnExpectationsWhensellingshortverticalwitha0.30toa0.40deltaandbuyingonetotwostrikesfurtherOTMshouldyieldareturngreaterthan30%ROR.TheRORiscalculatedbydividingthecreditbythemaximumloss.WhensellingATM,thecreditshouldtypicallybegreaterthan60%ROR.Exits

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Whensellingpremium,you’retypicallyengagedinahigherprobabilitystrategy.However,inorderforthehighprobabilitiestoberealized,thetrademustbecarriedtowardexpiration.Inthecaseofshortverticals,youhavepurchasedprotectionifthestockmovesagainstyou.Asaresult,thetradeistypicallyexitedbecauseyou’rewithinonetotwoweekstoexpirationoryouhaveaprofitableposition.Ifyou’vemadeabout70%to80%ofthemaximumgain,thatwouldbeanindicationtoexitthetradebeforetheonetotwoweeksbeforeexpiration.TradeExample(ShortPutVertical)Let’stakethepreviousexampleoftheshortputandusethesameshortstrikeat$55onMU(seeFigure6).Inthecaseoftheshortvertical,theJuly$55strikepricewillbesoldfor2.07andthe$52.50forJulywillbeboughtfor$1.27.Thisproducesanetcreditof$0.80,a47%RORandabreakevenpriceof$54.20.Whilethecreditismuchlessthantheshortput,becauseofthereducedriskfromthelongoptiontheleverageissignificantlygreater.

Figure6—ChartofMicronTechnologyIncorporated(MU)TradeExample(ShortCallVertical)

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Forthisexample(seeFigure7)ofashortcallverticalwe’regoingtousetheSPDRS&P500ETF(SPY).TheSPYrecentlyretestedanestablishedareaofresistancefromFebruaryandMarchandbeganbreakingdown.TheimpliedvolatilityisfairlylowfortheSPYandsotheATM$278strikepricewillbeusedforacreditof$2.99.The$279strikepricewillthenbeboughtforadebitof$2.43,generatinganetcreditof$0.56fora127%ROR.Themaximumgainisachievedifthepriceclosesbelow$278.Betweentheshortstrikeof$278andthebreakevenpriceof$278.56therewillbeapartialgain,andabovethebreakevenandtothelongstrikeat$279willyieldapartialloss.Anythingabovethelongstrikeof$279willamaximumlossscenarioof$0.44ashareor$44acontract.

Figure6—ChartofSPDRS&P500ETF(SPY)MarriedPutsI’msureyoufindyourselfmanytimeswonderingwhetheryoushouldbuyastockornotbecauseyou’reworriedaboutthedownsiderisksassociatedwithstockownership.Maybeit’sanupcomingearningsreportormaybethestockhasafairamountofvolatility.Whateverthe

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reason,optionsprovideyouwiththeopportunitytoremovemostofyourriskforapremium.Thestrategyofbuyingthestockandaputatthesametimeiswhat’scalleda“marriedput.”Duringcertaintypesofmarkets,thebestwaytogrowyourportfolioisbypreventinglossesinthefirstplace.Thinkofaprotectiveputasaninsurancepolicy.Whenyoubuyautoinsurance,forinstance,youpayapremiuminreturnforprotection,justincaseyougetinanaccidentoryourcargetsdamaged.Similarly,whenyoubuyaprotectiveput,youpayapremiuminreturnforprotection,justincaseyourstocklosesvalue.Whetheryou’relookingtobuycarinsuranceortodoamarriedputyouknowthatyou’lllosethepremiumifyouneverusethecoverage,you’llneedtopaymoreforincreasedcoverageandyourcoverageexpiresattheendoftheperiodwithwhichyoupaidyourpremiumfor.Asyouevaluatewhethertopurchaseaputagainstastockthatyou’reconsideringbuying,rememberthattheputreducesyourdownsiderisk,butyouhavetopayupfrontfortheprotection.Therefore,thestockhastoincreaseinvaluetocompensateyoufortheputoptionpremium.InFigure7you’llabletotakeacloserlookattheprofileofamarriedput.

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Forthisstrategythestockispurchasedandaputispurchasedatthesametime.Thepremiumfromtheputreducesthedownsideriskonthestocktothestrikepriceminusthepremiumpaid.Thisisbecausethestrikepriceisthepricethatyouhavetherighttosellthestockandtheadditionalcostoftheputwillbesubtractedfromthatsaleprice.Lookingattheriskprofilegraph,youmaynoticethatithasthesameriskprofileasalongcall.Thatisbecauseyouaresyntheticallycreatingalongcalltradewithamarriedput.Thebreakevenpriceforthistypeoftradeisthecostofthestockplusthecostoftheoption.Theprofitbeyondthatlevelisinfiniteasthestockpricecantheoreticallygotoanyprice.Margin

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Themarginrequirementforamarriedputisthesameasbuyingthestock.Typicallyabrokerwillrequireyoutoputofatleast50%ofthestockpriceplusthepremiumoftheputoption.ExpirationSelectionWhenchoosinganexpiration,it’simportanttorememberthatthemoretimethatyoubuy,thegreaterthecost.Typically,youwouldbuyenoughtimetocoveryourpositionduringwhateverphaseyoufeelthatyouneedprotection.Typically,buying50-120daysisprettytypical.Moretimecanalwaysbepurchasedatalaterdateifyoufeelthatyoustillneedthecoverageandarewillingtopayit.StrikeSelectionIfyouweretoeliminate100percentofyourrisk,youwouldprobablybebetterofftojustsellthestock.Therefore,youwouldtypicallybuyaputthatwouldreducelessthan100%ofyourstockrisk.PurchasinganOTMoptionwitha0.30to0.40deltawillreduceyourstockriskby30-40%andwilltrackthestocklikeyouboughtanITMcalloptionwitha0.60to0.70delta.Ifthestockfalls,thedeltawillincreaseuntiltheoptionbecomesITMandwhichitwilleventuallybegintoperfectlyoffsetyourstockriskdollar-for-dollarsinceyouhavetherighttosellthestockatthatstrikeprice.ReturnExpectationsForthistypeoftrade,therewardissimilartothatowningthestock.TheoptionwillcostaboutonetotwopercentofthestockpriceforETFsandlargecapcompanies.Formorevolatilestocksthepricewillincreasetoabout3percentorhigher.Theoverallreturnisreducedbytheamountofthecostoftheoption.ExitsForthestock,theexitwouldbebasedonyourtradingplanforthestock.Fortheoption,ifthestockpriceincreaseseventuallytheoptionwillbeworthless.Thisoutcomewouldbegoodbecauseitmeansthatthestockhadperformedwell.Ifthestockdoesn’tappreciatealot,it’spossiblethatyoumayneedtorolltheoptionifyoustillfeelthatyouneedprotection.Rollingentailssellingthestrikepricethatyou’reinandbuyinganotherstrikepricewith50to120daystoexpirationanda0.30to0.40delta.Rollingtoincreasethetimetoexpirationwouldtypicallyhappenwithin2weekstoexpiration.TradeExampleInFigure8you’llseeanexampleofthechartofProctor&GambleCompany(PG).Thestockhasbeenunderperformingthemarketsignificantlyoverthepastseveralmonthsbuthasrecentlyshowedsomesignsoflifeandthe30-daymovingaverageisrising.Inthistradeexample,thestockisboughtforaround$77.38andaputoptioncouldbeboughtfor$1.20atthe$75strike.

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Thatmeansthatthemaxlossis$3.58($77.38–$1.20—$75)andthebreakevenis$73.80($75-$1.20).

ConclusionOptionstrategiesaresomethingthatcanbetradedinanymarketconditionbecauseyoucanalwaysgetthetypeofprofileyouwant.Asyouweighwhichstrategytoconsider,thinkaboutyouranticipateddirectionforthestockprice,thetimethetradeneedstomakeitsmoveandwhattheoveralllevelofimpliedvolatilityis.Consideringthesethreeareasofimpactonoptionpriceswillhelpyoubemoreconsistentinyouroptiontrading.

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http://reports.tradingtips.com/optionscashcow/