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Swing Trading Options FAQ

For additional information on Options, check out www.investopedia.com, www.cboe.com and our own Options and Swing Trading course.

Terminology:

Monthly Options – Expire the the third Friday of each month. (Not all stocks trade options). Most of our options alert use monthly expiration options, unless otherwise stated in the alert.

Weekly Options – Expire every Friday at the close. (Not all stocks that trade options, trade weekly options). Most of our earnings alerts and iron condors use weekly expirations, unless otherwise stated in the alert.

The Greeks (Delta, Theta, Vega, Gamma, Rho) – Greeks are dimensions of risk involved in taking a position in an option (or other derivative). Each risk variable is a result of an imperfect assumption or relationship of the option with another underlying variable. Various sophisticated hedging strategies are used to neutralize or decrease the effects of each variable of risk.

IV – implied volatility – Implied volatility is the estimated volatility of a security’s price. In general, implied volatility increases when the market is bearish, when investors believe that the asset’s price will decline over time, and decreases when the market is bullish, when investors believe that the price will rise over time. This is due to the common belief that bearish markets are more risky than bullish markets. Implied volatility is a way of estimating the future fluctuations of a security’s worth based on certain predictive factors.

 

HV – historical volatility – Historical volatility (HV) is the realized volatility of a financial instrument over a given time period. Generally, this measure is calculated by determining the average deviation from theaverage price of a financial instrument in the given time period. Standard deviation is the most common but not the only way to calculate historical volatility. 

 

When do we want to use options?

When markets are trending up or down, when markets are flat, when volatility is high or low and when we want to manage risk and gain leverage! As you can see, there are MANY reasons to learn options trading and MANY scenarios in which you might trade them.

Credit Spread – An options strategy where a high premium option is sold and a low premium option is bought on the same underlying security.

Debit Spread – Two options with different market prices that an investor trades on the same underlying security. The higher priced option is purchased and the lower premium option is sold – both at the same time. The higher the debit spread, the greater the initial cash outflow the investor will incur on the transaction.

 

What kinds of options do I trade?

Call Options (Bullish) –  call option is an agreement that gives an investor the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specific time period. It may help you to remember that a call option gives you the right to call in, or buy, an asset. You profit on a call when the underlying asset increases in price.

Puts (Bearish) – A put option is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to buy shares.

Spreads:

Bull Call (Bullish, Debit) – Use when IV is low. Seeking an increase in low IV when compared to HV. An example of what a bull call spread we alert might look like if the SPY was trading at $200.00: “BOUGHT SPY APR16 201.5/205.5 bull call spread for a debit of 3.00” You can see in the example below, we buy the closest to the money call strike (201.5) and sell the back call strike (205.5) for protection.

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Bear Call (Bearish, credit) – Use when IV is high. Seeking a decrease in high IV when compared to HV. An example of what a bear put spread we alert might look like if SPY was trading at $200.00: “SOLD SPY APR16 201.5/205.5 bear call spread for a credit of 2.94” You can see in the example below, we sell the closest to the money call strike (201.5) and we buy the back call strike (205.5) for protection.

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Bull Put (Bullish, credit) – Use when IV is high. Seeking the decrease of high IV when compared to HV. An example of what a bull put spread we alert might look like if the SPY was trading at $206.00 “SOLD SPY APR16 201.5/205.5 bull put spread for a credit of 1.11” You can see in the example below, we sell the closest to the money put strike (205.5) and buy the back put strike (201.5) for protection.

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Bear put (Bearish, debit) – Use when IV is low. Seeking the increase of low IV when compared to HV. An example of what a bear put spread we alert might look like if the SPY was trading at $206.00: “BOUGHT SPY APR16 201.5/205.5 bear put spread for a debit of 3.00” You can see in the example below, we buy the closest to the money put strike (205.5) and sell the back put strike (201.5) for protection.

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Iron Condors (neutral, credit) – Use when IV is high and before a large event like earnings. Seeking the decrease of high IV when compared to HV. When receiving an alert for an iron condor, it will look like “Earnings Iron Condor – ABC Feb20 (weekly) 45/50/60/65 for a credit of $0.50” Breaking that alert down, we see that the Iron Condor is for an earnings play on ABC stock. We know we are using the February 20 WEEKLY expiration. The strike prices are read from left to right (lowest to highest). The first two represent the put spread and the second two represent the call spread. Since these are both credit spreads (Iron Condor = 1 credit/bull put spread and 1 credit/bear call spread), we know that the order of operations for this alert is long/short/short/long. So, buy to open 45p, sell to open 50p, sell to open 60c, buy to open 65c, for a net credit of $0.50.

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What do options chains look like?

Options chains will show you everything from current bid/ask spreads, to the Greeks, to volume and open interest. It is critical that you familiarize yourself with options chains in your broker, if you plan to trade options.

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Options Approval Level

To trade options, you will need to seek approval from your broker. The following are options levels that require separate approval:

Level 1: Covered calls, protective puts (Secured with stock you own)

Level 2: Long calls/puts

Level 3: Spreads (bull call, bear put, bull put, bear call, diagonal, vertical, condors)

Level 4: Uncovered or Naked options (risky business and potential for unlimited risk)