In fact, for the last seven years in a row, the volume of options contracts traded has steadily increased with last year setting an all-time high.

More and more people are now including options in their investments as a smart way to get ahead of the market.

And it's easy to see why.

Advantages

Most people know that options afford the investor many advantages, not the least of which is a guaranteed limited risk when buying calls and puts.

And you can also get a great deal of leverage while using only a fraction of the money you would normally have to put up to get into the actual stocks themselves.

But those are just some of the advantages of options.

Flexibility

The real advantage with options is the opportunity to make money if a stock goes up, down and, depending on your strategy, even sideways.

In fact, with some strategies you can even be wrong on the underlying stock's direction and still profit. Simply identifying a range is all you need to win.

This flexibility gives the options investor the opportunity to profit in virtually any market condition – even when you're unsure what the market will do.

Easier Than You Think

Even though the popularity of options has soared, they are still not as well known or understood as stocks.

But it's all a lot easier than you might think.

1.) Are You Bullish?

If you believe the price of a stock will go up, you can buy a call option on it and make money as it goes higher.

The option buyer gets a guaranteed limited risk, which is limited to the purchase price (or premium) plus any applicable commissions and fees.

Essentially, at expiration, your profit is the difference between where the stock price is and your option's strike price.

Example:

Let's say a stock was trading at $50.

You buy a $45 call option with a premium of $6.50, i.e., $650.

At expiration, the stock has shot up to $65.

Your $45 call would now be $20 in-the-money, making it worth $2,000.

So the option is worth $2,000.
You paid $650.
That's a gain of $1,350.
All on just a $650 investment.

Worst case scenario: if the stock at expiration closed below your option's strike price of $45, you could lose the entire $650. But even if the price went down to $0, you could never lose any more than that. Whereas with a stock, you'd be on the hook for it all.

2.) Are You Bearish?

If you believe the price of a stock will go down, you can buy a put option on it and make money as the price goes lower.

Once again, the option buyer gets a guaranteed limited risk, which is limited to the purchase price (or premium) plus any applicable commissions and fees.

At expiration, your profit is the difference between where the stock price is and your option's strike price.

Example:

Let's say a stock was trading at $60.

You buy a $65 put option with a premium of $7.00, i.e., $700.

At expiration, the stock has dropped to $40.

Your $65 put would now be $25 in-the-money, making it worth $2,500.

So the option is worth $2,500.
You paid $700.
That's a gain of $1,800.
All on just a $700 investment.

Worst case scenario: if the stock at expiration closed above your strike price of $65, you could lose what you paid for the option. But even if the stock went against you even more, you could never lose any more than that.

3.) Expecting a Big Move, But Not Sure Which Way?

A straddle is a way to make money when you're not sure which way the market will go, but you believe something big will happen in either direction.

With a straddle, you're buying both a call and a put at the same time, with the same strike price, and the same expiration date.

For example, let's say it's earnings season and you expect a big move to occur, either up or down, based on whether the company reports a positive surprise or a negative surprise. Or maybe the charts are suggesting a big breakout could be getting ready to take place in one direction or another.

With this strategy you can make money in either direction without having to worry about whether you guessed correctly or not.

Example:

Let's say a stock was trading at $100 a few days before their earnings announcement.

You buy the front month $100 strike call for $150.
And you buy the front month $100 strike put also for $150.

That's a cost of $300 (not including transactions costs) to put on the trade.

Now let's say the stock shoots up $15 as a result of a positive earnings surprise.

The call option is now worth $1,500.
The put option is worth $0.
You paid $300.
That's a profit of $1,200.
All on just a $300 investment.

The best part with this strategy is if the stock had posted a negative surprise and it dropped -$15 instead, you would have been just as profitable. The only difference is that the put would have been the profitable side and the call would have been the loser. (But so what, because you didn't care which way it went, you just expected something big to happen in one direction or the other.)

Worst case scenario: at expiration, if nothing big ever happens, you would have lost the entire $300.

4.) Expecting a Stock to Fall (or at Least Not Go Much Higher)?

Writing calls can be profitable in mildly bullish markets, sideways markets and bearish markets.

Buying a call option gives you the right but not the obligation to purchase 100 shares of a stock at a certain price within a certain period of time. The price you pay for the option, let's say $500 for example, is called the premium.

If you write an option, you're collecting that premium. Someone else is buying the right to own 100 shares of a stock at a certain price within a certain period of time. And that premium is paid to you.

If that stock goes down and the option expires worthless, the buyer of the option loses -$500, but the writer of the option makes $500.

Example:

Let's say a stock was at $70.

For whatever reason, you determined the stock would go down or at least not go much higher.

Let's also say that you wrote an $80 call for a premium of $5.00, i.e., $500. That means your account would be credited $500.

If at expiration, the stock is at or below the strike price of $80, you'd keep the entire premium of $500.

Even though the stock didn't go down like you thought, but instead went even higher -- $10 higher in this example -- as long as it stayed below your strike price of $80 by expiration, you'd still profit by the full $500 you collected.

Thought the stock was going down.
Instead it went up.
Still made money: $500.
Pretty exciting.

In fact, at expiration, the stock could literally be above the strike price of $80, plus an amount commensurate with what the writer collected for the premium, and still not lose any money. (In this case, the stock could literally be at $85 at expiration and you still wouldn't have lost anything.)

Worst case scenario: if the stock went up past the strike price plus the amount collected in premium, then you'd start losing on the trade. And for every $1 above that level, you'd lose $100.

But if the stock looks like it's breaking out above your price level, you can simply buy that option back to limit your loss, or depending on where you are in the trade, lock in a partial gain.

5.) Think a Stock Will Go Up, But You'd Like To Buy It at a Lower Price, Yet Still Make Money Even If You Never Get In?

Writing put options is a great way to make money if the market goes up, sideways and even down (to a limited extent).

This is also a way to potentially get into a stock that you'd like to own at a much cheaper price, and get paid while you wait, even if you never get the stock.

As you know, if you buy a put option, you're buying the right to sell a stock at a certain price within a certain period of time. The buyer pays a premium for this right. He has a limited risk – which is limited to the price he paid for the option.

However, the writer is taking the other side. He has to buy the stock if it's put to him at a certain price within a certain period of time. And for this 'risk', the writer collects a premium.

Example:

Let's say a stock was at $50.

And you decided to write a $40 put option, collecting a premium of $4.00, i.e., $400. (Not to mention, looking forward to potentially getting a chance to own that stock a full $10 cheaper than where it's trading at.)

If at expiration, the stock is trading anywhere above your strike price of $40 or higher, you'd keep the entire premium of $400. You may not have gotten that stock, but you still got paid for your wait.

Thought the stock would go up, but didn't want to buy it at that price.
Wanted it to go down to buy at a lower price.
Never does.
You still made $400.

If at expiration, the stock price is at $40, the buyer of the option could exercise it and you'd now be obligated to buy that stock for $40 a share, which means you've now got that stock at the price you wanted – plus your $400 premium.

Didn't want the stock at $50.
Wished it would go down so you could get it at $40.
Finally does and you get your stock.
Plus $400.

But even if the stock fell to $36 (i.e., down to your strike price plus an amount commensurate with the premium collected -- this would be your breakeven point), you still wouldn't lose anything.

Worst case scenario: the stock would have to fall below $36 to even begin to lose on the trade. And for every $1 below that level, you'd lose $100 due to the stock you now own.

Of course, if you changed your mind, or if you thought the stock could fall below your strike price and even your breakeven point, you could buy the option back at any time, thus cutting your loss or locking in your gain and ending the trade right there, without having to even bother with the stock.

Options give the investor numerous ways to make money in the market. Up, down or sideways, decide to make success your only option.

You can learn more about different types of option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]> Thu, 06 Jun 2013 08:08:01 GMT For those believing the rally might have run its course, or at least hit the pause button, you should consider giving the Bear Call strategy a try.

A Bear Call Spread is used when you have a neutral to negative view on a stock.

While this strategy has a limited risk, it also has a limited reward.

So if you're expecting a big down move to occur, you'd be better off looking at a more aggressive bearish strategy that affords unlimited profit potential.

But for this strategy, a neutral (or choppy) to bearish outlook can make the Bear Call Spread a great strategy to use.

Definition

A Bear Call Spread is when you sell a closer-to-the-money strike (usually an at-the-money strike) and buy a further out-of-the-money strike.

This strategy is put on as a credit, which is why it's often referred to as a Credit Spread.

The reason it's called a Credit Spread is because if you write a nearby strike and buy a further out strike, you'd collect more on the nearby option you wrote and spend less on the call that you bought; thus resulting in a credit to your account.

This can also be done with puts as well. But today we'll focus on the calls.

Example

Let's say stock XYZ was trading at $50:

• You write the December $50 Call for 5.00 and collect $500
• You also buy the December $55 Call for 3.00 meaning you spend $300

-----------------------------------------------------------------------------

• Net 'cost' (credit) = $200

(i.e., collect $500 for the short $50 call, less the $300 spent for the long $55 call and that equals a credit of $200)

How Do I Win and How Do I Lose?

Your maximum potential profit will be the credit you collected when you put this trade on. And your maximum profit potential will come if the stock closes below the lowest strike price at expiration – in this case the $50 call.

Why?

Let's look at each component of the spread individually.

• If the price of the stock stays at $50 or lower at expiration, the $50 call option you wrote for $500 will expire worthless, meaning you'd keep the entire $500 premium you collected
• The $55 call you purchased for $300 will also expire worthless, meaning you'd lose the entire $300 you paid.

-----------------------------------------------------------------------------

• But remember, you collected $500 and lost -$300, meaning you ended up keeping the entire credit of $200 -- which is your profit.

Your maximum loss would be the difference between the two strike prices less your credit.

Why?

• If the stock closes at or above the highest strike price ($55) at expiration, the $50 call that you wrote for $500 (collected) would now present a loss in premium to you of -$500, thus giving you a scratch ($0) on this side of the trade.
• The $55 call that you bought for $300 would expire worthless, meaning you lost the entire premium paid, i.e., -$300.

-----------------------------------------------------------------------------

• If you scratched on one side ($0) and lost -$300 on the other, your total loss was -$300.

If the stock went even higher, your loss would still be limited to -$300.

Why?

Because for every extra $1 you'd lose on the short call, you would make an extra $1 on the long call, thus never widening the loss.

But again, the maximum loss (albeit still limited) would come only if you are absolutely dead wrong on your neutral to bearish assumptions on the stock.

If the stock expires somewhere in between your strike prices of the short $50 call and the long $55 call, your trade would either gain a small profit or take a small loss.

Your breakeven point would be at $52.

Why?

• Because at $52, you'd retain only $300 of the $500 premium you originally collected on the short call
• And you'd lose the full $300 you paid for the long call

-----------------------------------------------------------------------------

• $300 gain less -$300 loss = $0 or breakeven
• At $53, you'd lose -$100
• At $54, you'd lose -$200
• And as illustrated above; at $55 and higher you'd lose -$300 (but never ever any more than that).

The profit potential is limited, but you have more ways to profit than a straight call or put can provide.

The trick is to put on a credit spread at the maximum credit you can because your maximum loss will always be the difference between the two strikes less the credit you collected. And the larger the credit, the lower your maximum loss could be and the larger your potential profit zone can be.

If you're looking for a neutral to bearish option strategy to put on with limited risk but with more ways to profit than lose, consider the Bear Call Credit Spread.

You can learn more about different types of option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader service.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

1. Buy a Call.

2. Write a Put.

How bullish you are will help determine which strategy is right for you.

1) Buy a Call

Buying Calls is one of the easiest and probably most well know option strategies.

If you believe the price of a stock will go up, you can buy a call option on it and make money as it does.

But unlike a stock, it needs to move within a certain period of time.

And based on the strike price you've got, it'll need to move a certain minimum amount to overcome your purchase price.

Knowing this, there are a few things to consider when you're selecting your option.

The first thing you'll want to consider is time.

As a rule of thumb, unless I'm speculating on a date-specific event, I'll normally buy a little extra time than I might need.

This gives me a little extra leeway and time in case the move I was looking for takes a bit longer than expected.

For example, if I'm expecting a move within two months – there's no harm in picking up an extra month or two to be on the safe side – especially if that extra month could mean the difference between a profit and a loss.

The next decision to make is if you'll pick up an in-the-money option (ITM) or an out-of-the-money option (OTM).

Just remember: an in-the-money option will have a greater likelihood of making money than an out-of-the-money option.

Why?

Because at expiration, your profit is the difference between the stock price and the strike price less your premium.

For example: let's say a stock was trading at $50 and you had two options:

• 1, $45 call (ITM) for $6.50
  
• and 1, $55 call (OTM) for $3.75

At expiration, the $45 call would be worth $15 or $1,500. Remove your premium of $6.50 and that's an $850 gain.

The $55 call on the other hand would be worth only $5 or $500. Subtract your premium of $3.75, and instead you'd only have a gain of $125.

Same stock move, but vastly different profit outcomes. Sure you saved a few hundred dollars on the way in, but look what it cost you on the backend.

Of course, if you're wildly bullish, you could really get a lot of leverage on the cheaper out-of-the-money options. But usually, the out-of-the-money options are best only if you're expecting some pretty big things to happen.

For your regular moves – good moves – but not astronomical moves, consider staying closer to the money as it'll increase your chances for success.

2) Write a Put

This strategy, unlike buying calls, is probably one of the least known option strategies.

And also, probably one of my favorites.

It's a bullish strategy.

But you have more ways to profit with this one.

When Writing Puts, the stock can go up, sideways or even down (albeit only a certain amount) and you can still make all of the money you expected to make when you put the trade on in the first place.

Essentially, writing a put means you might be obligated to buy the underlying stock at a certain price if the stock goes down to your strike price. This is called 'having the stock put to you'. But you'll get paid for taking that risk.

But the benefits are great.

First, when writing a put option, I don't favor getting more time than needed. Instead, try and get only as much time as necessary to ensure a big enough premium to make the trade worth your while. This strategy will benefit from time decay.

Moreover, I recommend writing out-of-the-money options too. Not too far out, but close enough to maximize the premium you'll collect. But far enough away so your chances of keeping the entire premium remains high.

Continuing with the same example, let's say the stock was at $50 and you thought it was going to go higher or maybe even a little lower at first, but you liked the stock and were essentially bullish on it.

If you wrote a put option, let's say the $45 put for $400:

• At expiration, as long as the price of the stock was above your strike price of $45, you'd keep the entire premium you collected. (It doesn't even have to be above $50, just your strike price of $45.)

• If the stock is at or below $45, the stock will likely be put to you, meaning you'll have to buy that stock at $45. But not only did you now get to own that stock at a cheaper price ($45 rather than $50), but you also got paid $400 while you waited and got in at a lower price.

  The stock would have to go below $41 to even begin losing money on the trade.

But if you're super-duper bullish on a stock, this would be the wrong strategy because you'll always be limited with what you can make.

But your chances are good that you'll get what you expected if you correctly determined what you broadly thought the stock would do (or at least wouldn’t do).

But these two strategies, buying calls or writing puts, should be considered based on how bullish you are.

You can learn more about different option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]> Thu, 23 May 2013 08:11:01 GMT There are actually several different ways, but I have found the ones below to be the most useful. Plus, it's what I do in my own trading.

As you know, you can get started in options with only a fraction of the amount of money you would normally need to invest in the stock itself.

But if you put in too little, it will hardly make a difference in your account if you're right. Put in too much and it'll put a big dent in your account if you're wrong.

How Much Should You Invest in Each Option?

Determining the right position size is critical for successful investing. Here's how you can determine the right position size for you.

For example: Let's say you would normally invest $10,000 in a stock. If stock XYZ was trading at $50 per share, that means you could buy 200 shares. And let's also say you were willing to risk 10% on the trade or $1,000.

Here's how to figure out your option size. One option essentially equals 100 shares. Two options equal 200 shares. If you buy one option at $500, under the worst case scenario, your maximum risk would be what you paid for the option or $500. Two options would be $1,000. And that's the equivalent of risking 10% had you invested $10,000 in the stock.

Of course, that's assuming the worst case scenario. Nobody intends to lose their entire premium. But it's a good idea to keep the worst case scenario in mind when determining your position size as this is a foolproof way to manage your risk.

Sometimes you may need to buy a few different strikes to stay within that dollar amount. Instead of buying two $45 calls, maybe you buy one $45 and one $47.50 call.

Of course, there will be times when you find yourself 'needing' to spend a little more on quality options. That's OK, as long as you have plenty of time.

In other words, if the stock collapses for whatever reason, your option will take a drubbing. But, if there's lots of time on it, it will not go to zero overnight. So as long as you're disciplined enough to pull the plug at a specified dollar loss, then you can still keep your losses to your preferred worst case scenario amount.

For example, if you purchased two great options for $700 each, that means your total cost/investment is $1,400. If those options ever lose a combined total of $1,000 (loss of -$500 on each), you'd sell them. And by doing this you're account would never get into trouble.

It takes discipline. But discipline is probably the most important skill in options trading. And if you can manage your downside, the profits will take care of themselves.

Put this method into practice on your next option purchase for a stress-free trade.

You can learn more about different types of option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our new Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]> Thu, 16 May 2013 08:01:01 GMT The answer is to know which style your stock falls into and which strategy best suits that style.

So here are some practical guidelines for picking the right stocks to go with the right option strategies.

Bullish

If you're bullish on a stock, you can buy a call option and make money as it goes up.

Momentum stocks and Aggressive Growth stocks are probably the best kinds of stocks to use for this. These are stocks that are on the move with some of the most explosive upside potential.

When buying call options you need to be right on the direction of the trade as well as the time allotted for it to move.

Zacks #1 Rank ('strong buy') stocks are ideal for this as these are some of the likeliest candidates to move and profit with this strategy.

Bearish

If you're bearish, you can buy a put option and make money as the price goes lower.

Look for stocks trading at excessive valuations. Focus in on the ones with downward earnings estimate revisions. And if they are below their major moving averages like the 50-day and 200-day moving averages, even better.

With put options, direction and time are important as well.

Stocks with a Zacks #4 Rank ('sell') or Zacks #5 Rank ('strong sell') will typically underperform the market over the short-term, which is perfect for this strategy.

Big Move in Either Direction

If you believe a big move could occur in either direction, but you're not sure which way, you can make money with a straddle or a strangle. This entails buying both a call and a put at the same time.

One of the best times to use this strategy is before an earnings announcement. And some of the best stocks for this option strategy are high beta stocks. These are stocks that can move big, and that's exactly what you need to see happen with this kind of strategy.

Once again, in order for a stock to make a big move, there usually needs to be a catalyst. One of the most reliable catalysts out there for big moves (up or down) is earnings reports.

If you also take a look at the stock's 'earnings uncertainty', you have the potential for the kind of volatility to make a strategy like this work.

Slower, Moderate Move

If you're expecting a stock to go up or down, but you expect the move to be moderate or slower, then spreads are a great strategy for this.

For example, a bull call spread involves buying a nearby strike and selling a farther out one.

If the stock goes up, but slowly, the nearby call you bought should increase in value, in spite of some time decay loss. But the call option you wrote will benefit from time decay, thus making the spread more profitable than had you only purchased a call.

Value style stocks and even Growth and Income stocks can produce some good picks for a bull call spread strategy. Stocks expected to move higher, but maybe not with a big splash.

Zacks #2 Ranks ('buy') and Zacks #3 Ranks ('hold') are good stocks to consider for this strategy.

The Option is Yours

These are just some of the ways to profit with options. And there are many more. As you can see, options give the investor numerous ways to make money in the market -- and in any direction. And you don't always have to wait for the next bull market to make money.

Once you know what stock characteristics go best with what types of options strategies, you'll quickly find yourself having more success in your options trading.

You can learn more about different option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]> Thu, 09 May 2013 08:32:01 GMT It could mean the difference between making money and losing money.

Intrinsic Value

Everybody knows what intrinsic means in regular everyday life: real, innate, inherent, of within.

In options, the concept is the same.

The definition of intrinsic value as it pertains to options is: the difference between the underlying stock price and the option's strike price (that's in-the-money).

For example: if a stock was trading at $50, and a $45 call option with 30 days of time left on it was selling for $6.50, that option would have $5 of intrinsic value.

$50 stock price - $45 call option = $5. If the option premium is worth $6.50, that means $5 of that is intrinsic value.

The other $1.50 of that is extrinsic value, also known as time value.

Extrinsic Value (aka Time Value)

Extrinsic value is the amount of the premium that's not comprised of intrinsic value. This part of the premium is said to be your 'time value'. Out-of-the-money options are comprised of only time value.

Using the same example as above:

A $6.50 premium - $5 intrinsic value = $1.50 of extrinsic value.

So the key to remember is that options are comprised of two parts: intrinsic value and extrinsic value, i.e., time value.

So what's the difference for the investor?

In the beginning, for all practical purposes, nothing.

If I bought an option at $500 and then sold it for $800, whether half of that was comprised of intrinsic value or none of it was comprised of intrinsic value, it makes no difference from that standpoint.

But ultimately, at expiration, when there's no time left of the option, your option's sole value will be its intrinsic value.

So at that point it makes all the difference.

For example: if I had a $50 call option with 2 months of time on it, and the price of the underlying stock was at $45, that option might be worth $3.50 or $350. And at that point, the premium is comprised on only time value.

But now fast forward two months - if that stock is still at $45, that option is $5 out-of-the-money, meaning it has no intrinsic value. And since it's now expiration, the time has run out, which means there's no time value either, which also means that option is worthless.

On the other hand, if the stock was at $53 at expiration, the option is now $3 'in-the-money'. All of the time value has disappeared. But it's now got $3.00 of intrinsic value (because it's $3 'in-the-money'), which means your option is worth $300 if you were to sell it.

And that's why I like to buy my options with intrinsic value to begin with (i.e., in-the-money options). If your options are comprised on only time value, you'll need to see a move commensurate to twice what you paid for the option come expiration just to break even.

But if your option is comprised of both intrinsic value and time value, now you'll only need to see the stock go up as much as your time value cost to breakeven.

Better yet, if the stock does nothing at expiration, I'll get most of my money back if it's comprised mostly of intrinsic value.

But if it's comprised of only time value, I could lose it all, even it goes up to the out-of-the-money strike.

So understanding intrinsic value is important in order to determine your potential profit and loss scenarios with your options strategies.

You can learn more about different option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]> Thu, 02 May 2013 09:47:01 GMT But today, I want to focus on options volatility and what it means for the options investor.

So let's start off with a definition:

Volatility measures the rate at which a security moves up and down. If a security is moving up and down quickly, volatility will be high. Conversely, if a security is moving up or down slowly, volatility will be low.

Options volatility is largely pinned to the underlying stock.

Traditionally, option traders look to buy options when volatility is low since premiums are lower.

And traders look to write options when volatility is high as option premiums tend to be higher.

Of course, the trick, like anything, is knowing what's high and what's low. If you're buying options with low volatility, you then want to see the volatility increase. And vice versa, when writing them.

But I do want to say, volatility is only one item in determining an option trade. Putting on an option solely because of volatility would be a mistake. But understanding how volatility affects your premium is important.

Volatility can also tip you off that something big might be getting ready to happen.

When option volatility is low, there is a high probability that a big move could be getting ready to occur.

Interestingly, when volatility drops and things are kind of quiet in the market, that's often when things heat up all of a sudden. The smart options trader will look to buy options in that environment - whether he's bullish or bearish - by buying calls or puts.

Because in addition to the option increasing in value due to moving in the right direction, it'll also increase in value because of the increase in volatility.

This happens because as volatility increases, there's an increased likelihood of rapid advances and larger price swings. That also means the higher the likelihood of an option trading in-the-money by expiration, the more it's worth to the buyer of an option.

And the writer of the option demands a higher premium for taking the other side of the trade because he's now taking more risk that he won't profit.

Looking at the other end of the spectrum, when volatility is high, or excessively high, the market is full of traders, and people are looking and expecting big things to happen.

Often times, that's when nothing happens, and the market falls into a trading range for while or slows down.

In this environment, volatility starts to shrink as the probability of large swings in the market shrinks. For the option writer, the risk of having an option he wrote get in-the-money by expiration has diminished. And for the option buyer, the chance of it getting in-the-money has shrunk as well.

As such, the writer demands less premium to cover his risk. And the purchaser pays less as his probabilities shrink as well.

So the buyer wants to see volatility trend up. And the writer wants to see the volatility trend down.

So for the writer, after volatility has trended up for a while, he will look to cash in on this by writing options as he expects volatility to cool down and maybe trend lower, increasing his chances of success.

A great way to think of volatility is this: if a security was trading at $50, and it had a 20% volatility, that means there's a greater likelihood that the security could trade within a 20% range (20% above $50 or 20% below $50) over a period of time.

That's a great way to wrap your mind around volatility.

In future examples, we'll talk about volatility and how to use it to your advantage in a practical sense.

You can learn more about different option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]> Fri, 26 Apr 2013 10:16:01 GMT But they can be a great way to position yourself in a trade if you think something big could happen. And, if you're right, you can use them to maximize your potential returns while at the same time lowering your cost of entry. In fact, you can even put these on as a credit – meaning you'd get paid to place this trade.

But we're going to focus on the more traditional (yet still rarely talked about) way to place this trade.

And once again, the strategy works best if you expect a big move to occur.

Here’s an example of how it works:

Let's say a particular stock was selling at $135. Let's also assume we're going to put on an out-of-the-money, ratio back call spread with 4 months of time on it.

1. You'll be selling one out-of-the-money call option
   (Let's say the 140 call at 11.25)

2. You'll also buy two further out-of-the-money calls
   (Let's say the 150 calls for 7.50 each or 15 total)

• On the one you wrote, you'll collect a premium.

• On the two you bought, you'll pay a premium.

• Net investment on the trade = $375
  (Paid $1,500 for the two calls I bought and collected $1,125 for the one I wrote = net cost of $375.)

Next, let's say the one I wrote had a delta of .50.

And the two I bought each had a delta of .39 for a total of .78.

What's my position's net delta?

If my purchased calls are gaining .78 of the underlying stock move, but my written call is losing .50 of the stock's move, my net delta is a positive .28.

Which means, at the beginning, for every dollar rise, my position will gain in value 28% of that.

Why would I do this?

For one, my cost is now only $375 for the trade. If I were to do a regular call buy for that price, I'd have to go all the way out to the 165 call, for instance, and likely get an even smaller delta - meaning it would profit more slowly.

But the real reason is this: It's a cheaper way to get into a position, and you're hoping to capitalize on the increase in delta (which means ultimately an accelerated increase in the value of this position) if a big move occurs.

The 150 calls I bought in this example are $15 out-of-the-money and have a delta of .39 each.

The 165 call by comparison is $30 out-of-the-money and has a delta of .24.

However, as the stock moves up, the closer strikes will see their delta increase more than the further out strike.

So, for example, if the stock now went up to $150, the 140 call would likely have a delta of around .70.

And the two 150 calls I bought would have a delta of around .58 each or 1.16 total.

That means my position's net delta is around .46. And my back call spread likely more than doubled in value by this time.

The 165 call by comparison would likely only see its delta increase to around 38.

As the stock continues to climb, the calls I bought that are now in-the-money will continue to increase in value more so than the further outs, thus giving me a bigger profit potential.

What's the downside?

The downside is that at expiration, if the option I wrote is in-the-money (don't forget, that's the part of the trade that's working against me in a sense) I'm losing on that end.

And if the ones I bought are out-of-the money, or even at-the-money, I've lost the full value of those.

So if I collected $1,125 on the 140 call -- that's now worth $1,000 at expiration, which means I've actually 'made' $125. But another way of looking at this is that I 'gave up' in a sense, $1,000 in premium.

On the two 150 calls I bought, I've lost the entire value of those, which was $1,500 total.

$1,500 - $125 = -$1,375 loss.

Alternatively, if the entire back call spread was in the money at expiration, then I'm for the most part 'OK'. In general, if the spread is $10 wide, you'll need to see the options you bought be at least $10 in the money to not lose at expiration.

But the way to really make this trade work, in my opinion, is to sell while there's plenty of time left. You're looking for options with increased volatility and you’re expecting a big move. This strategy will help you get into a stronger delta position, which means making more while spending less.

Now, since it's a ratio, you can do 3 buys for each 1 call you sell. Your profits will be bigger. But of course, so would your risk. But if you have a strong conviction on the market, this is an excellent way to approach it.

Next time, we'll talk about how to place this trade as a credit, meaning you'll collect a net premium instead of paying a premium.

You can learn more about different option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]> Thu, 11 Apr 2013 08:54:01 GMT

A straddle involves buying both a call and a put at the same strike price (at-the-money) at the same time.

With options, you buy a call if you expect the market to go up. And you buy a put if you expect the market to go down. A straddle, however, is a strategy to use when you're not sure which way the market will go, but you believe something big will happen in either direction.

For example, let's say you expect a big move to occur, either up or down, based on whether the company reports a positive surprise or a negative surprise. With these strategies, you can make money in either direction without having to worry about whether you guessed correctly or not.

For example: let's say a stock was trading at $100 a few days before their earnings announcement. So you decide to put on a straddle by buying:

• the $100 strike call
  
• and the $100 strike put

Because you only plan on being in the trade for a few days (to maybe a few weeks), you decide to get into the soon-to-expire options.

Note: usually, I'll advocate buying more time and getting in-the-money options. And I still do -- when playing one side of the market.

But when playing both sides of the market simultaneously for an event you expect to take place in the near immediacy, the opposite is best. Why? Because at expiration your profit is the difference between how much your options are in-the-money minus what you paid for them. So if you don't need a lot of time, this keeps the cost down and your profit potential up.

If you paid $150 for an at-the-money call option that will expire shortly and another $150 for an at-the-money put option that will expire shortly, your cost to put on the trade was $300 (not including transactions costs). If that stock shot up $10 as a result of a positive earnings surprise, that call option that you paid $150 for would now be worth $1,000. And that put option would be worth zero ($0).

So let's do the math: if the call, which is now $10 in-the-money, is worth $1,000; then subtract the $150 you paid, and that gives you an $850 profit on the call.

The put, on the other hand, is out-of-the-money, and is worth nothing, which means you lost $150 on the put.

Add it all together, and on a $300 investment, you just made a profit of $700. Pretty good—especially for not even knowing which way the stock would even go.

However, if you paid more for each side of the trade, those would be extra costs to overcome. But by keeping each side's cost as small as reasonably possible, that leaves more profit potential on the winning side and a smaller loss on the losing side.

Moreover, if the stock stays flat (in other words, the big move you expect doesn't materialize, thus resulting in both sides of the trade expiring worthless), your cost of the trade was kept to a minimum.

So buying a straddle by its very nature should be looked at as a short-term trade. If the outcome of the event that prompted you to get into the straddle in the first place now has you strongly believing that a continuation of the upmove or downmove is in order, you could then exit the straddle and move into the one-sided call or put and apply the in-the-money and more-time rules for those.

You can learn more about different option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]> Fri, 05 Apr 2013 05:43:01 GMT You can use a stop loss order, write call options, buy put options, and more.

Today, we're going to talk about buying puts, and compare that to using stops.

Buying puts is probably the closest alternative to using a stop loss. But it does have additional benefits and drawbacks.

First, it's important to remember that when you buy a put option, you stand to profit as the market goes down.

So in general, if someone buys a put, he or she has a bearish outlook.

But again, puts can also be used to protect profits and to hedge risk.

So how does it compare to stop loss orders?

With a stop loss order, you're essentially putting in an order to sell a stock if it goes down to a certain price. If your stock is profitable, and you want to try and lock in a certain portion of your gains in case the market goes down, a stop loss order is a common way to do this.

Let's say you bought $100 shares of a stock at $100 for an investment of $10,000. And it's now at $120. That's a $20 move, or a 20% gain.

You want to stay in, just in case it goes even higher, but you're worried about the downside as it gets ready to report earnings, for example. So you put in a stop loss order at $110.

If it goes down to $110, you're now out and you've locked in a $10 move or a 10% gain, which is $1,000.

The downside is that if it gaps down big, you could lose even more than you intended as that stop loss becomes a market order. In this case, you'll get filled wherever the market allows, even below that $110 level.

Buying a put can offer you protection as well. (And it can give you even better protection in the above gap down scenario.)

Using the same example of buying a stock at $100 that's now at $120, you can instead buy a put for protection.

Let's say you bought a $120 put with a little less than two months of time on it for $600. (Let's say this gave you enough time to go thru earnings.)

If, at expiration, it drops to $110, your put would now be $10 in-the-money, which means it would be worth $1,000. Therefore, you made $400 on the put.

So you're still up $1,000 of your stock buy, but you made an additional $400 on your put for a total of $1,400 on the trade. Essentially, you lost less on the pullback, which means you made more on the trade.

In theory, even if it dropped all the way to $100, which is your purchase price, you're protected in that you'll make the difference between your strike price and the price of the stock.

In that scenario, your stock trade would be back to $0 profit, but you'd be up $1,400 on the put option.

The drawback with the put though is that if the stock stayed at $120 (or in this case, above $114), you would have been better off by just using a stop as the money you spent on the put would be lost or breakeven at best.

So depending on the circumstance, a put might be the better choice for protection. But a stop might be better in other situations.

No strategy is perfect at all times.

But if you're looking for downside protection, especially in a volatile stock, buying a put, in my opinion, is always better than not putting in a stop. And often times, you'll find it more opportune than a stop as well.

The key is in determining where a put makes more sense than a stop and where you'll maximize your efforts in doing so.

Next time, we'll revisit how writing calls can offer you protection as well. But buying puts can offer you full downside protection from your strike price whereas writing calls gives you only limited protection.

You can learn more about different types of option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

And be sure to check out our new Zacks Options Trader.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

 
To read this article on Zacks.com click here.
 
Zacks Investment Research ]]>