A friend was taking an exam to get Customer Portfolio Margin for his option trading account recently. He showed me the exam and I noticed that 20% of the exam were questions about option synthetics! If it’s that important to an option broker, it should be important to us.
My two youngest children attend the German school system. There are no multiple-choice exams: they are all essay questions. You have to show your work. Let’s do the same thing.
Write down your answers for each question.
Explain WHY the answer is what you say it is. Don’t just say, ___ . Show your work…you’ll learn a lot more. This is an open book exam since I can’t watch you, but try to answer the questions without looking anything up. You’ll get more out of it.
Here we go
1. How would you create a synthetic SHORT CALL?
2. How would you create synthetic LONG STOCK?
3. How would you create a synthetic LONG PUT?
4. How would you hedge an out-of-the-money SHORT CALL with a synthetic position?
5. If your underlying is near your upside expiration on a butterfly trade, how would you reduce your delta risk with a synthetic position?
6. How can you completely neutralize a 100/110 call credit spread with puts?
7. You are long a futures contract at $100. The contract is now at $125. How can you lock in the $25 profit without selling the futures contract over the weekend with a synthetic option position?
Good luck with the quiz! I’ll post the answers next week.
The American past time used to be baseball. But the last couple years that has changed. The new American past time has become get long AAPL any way you can and wait for the profits to accumulate. Over the last 2 years, AAPL has gone from around 190 to 500, you figure the yields, staggering! Since June 20, AAPL has risen from 315 to the current level of 502, 60% in 8 months! Let me say that one more time, 60% in 8 months! So why shouldn’t it continue and why is it becoming dangerous? I’m glad you asked. Over the last 2 weeks, AAPL has shown a changed personality that you should be aware of. This personality is much different than the fun loving, get on my back , and I’ll take you up, up, to always higher stock prices. From a psychological perspective, this personality change started about 2 weeks ago around February 3. AAPL was trading at 460, and the March at-the-money implied volatility was around 19. What does that mean in English, Spanish, and Portuguese? It means everything was OK, and no real fear of the downside was propping up. But was it? The speed to the upside was really picking up. From November 25 to February 3, AAPL went from 363 to 459, 26% in a little over 2 months. Everybody wanted in! On February 10th, AAPL hit 493 and March at-the-money implied volatility in the calls spiked to 27. What’s the big deal? Option volatility usually decreases on the upside as prices go up and fear of the downside isn’t usually there. And remember, this is AAPL, this is America! But the last week, the personality disorder got much worse. As AAPL climbed a bit higher to 500, the March at-the-money option volatility climbed higher to 32 in the calls. That is an increase in 2 weeks from 19 implied volatility to 32 , an increase of 68% with the stock rising. Why are the option volatilities going up and what does it mean? First of all why are the option volatilities going up? SPEED!! Look at a pivotal day, Wednesday Feb 15, AAPL traded intra-day to 526 and closed at 497. That’s a decrease of 5% from the daily high to the close. The stocks rate of speed up and down intraday is really picking up in both directions. Sellers are coming in a bit! The last time I really saw this kind of speed to the upside was the internet debacle many years ago when stocks were screaming to the upside, do you remember what happened after they went up very fast? What does increasing option volatility mean to the retail trader? It means the green light on the stock may possibly be turning to yellow and you should exercise a bit of caution. Does this volatility news mean I can’t stay bullish on my beloved AAPL? No, it just means HOW you get long may need to change. This leads me to the strategy for today if I want to be long AAPL but be cautious!
Strategy idea: With this disturbingly changed personality in AAPL the last 2 weeks, I would approach any bullish trade very cautiously and make sure the risk/reward looks acceptable to me. In other words, if AAPL nosedives, I’m very comfortable with my total downside risk. I would initiate the below strategy after 1-2 down days.
Strategy example: Stock at 502.5 Buy 1 March 500 call and sell 1 March 505 call for a debit of around $2.40 ( $240). This strategy called a vertical debit spread, allows you to play a high priced stock for a very reasonable cost. We are actually selling an option with more time premium than we are paying for with our long. This is good considering option volatilities called implied volatility have skyrocketed the last few weeks. The risk/ reward is about 1 :1 meaning we can make $250 profit potential with maximum risk of $250. If the stock is 505 or higher at expiration ( 2 ½ dollars higher than the current 502 level), I can make 100%. This again is a cheap way with limited downside risk ( $250) to play a very expensive and volatile stock.
Be careful and have a greatweek! Dan Sheridan firstname.lastname@example.org
One way to make money with options is through something called a calendar spread (also called a “time spread”). This is similar to doing a covered call strategy, only in this case you would buy a call with an expiration date that’s somewhere in the future to hold long (just like a stock). In the shorter term, then, you would sell a call with a nearer expiration date. (Or, if you’d bought a long put, you would sell a shorter-dated put against it.)
This is what’s known as doing a “long calendar spread.” We’ll touch upon the “short calendar” a little bit later. Today’s trade idea shows you how to establish a long calendar in the SPDR S&P 500(NYSE:SPY) – and not only will you get an options trade today, but also the logic behind setting it up this way.
There are a couple of keys to note here:
* Both option types must be the same (i.e., buying a put and selling a put in the same strategy, or buying and selling calls).
* You may have traded what are called “vertical” spreads in the past – options with the same expiration dates but with different strike prices. With the calendar spread, you have the “option” of trading the same strike price because you’re using different months. This can be helpful in making money with options without needing the stock to make a big movement.
Let’s take a closer look at an example, and then at a trade idea in the SPY, through this Q-and-A.
How can we play the SPY with an options calendar spread?
With SPY trading at $134, an example would be to “buy to open” 1 SPY April 134 Call at $4 and “sell to open” 1 SPY March 134 Call for $3. The cost of the spread would be $100 per contract ($4 – $3 = $1 x 100).
How do you make money?
On time decay, as we approach expiration and the SPY stays near $134, the March options will decay quicker than the April options.
Can we only make profits at the strike price?
No. In this example, your break-even points at expiration are around $130 and $138, so you can still make money even if the stock moves a bit away from that $134 strike.
How about if the stock moves too far?
One idea is to reposition the calendar. For example, if we move from $134 in this example to $130, we can take off the $134 calendar completely (i.e., sell the long April call and buy back the short March call) and put on a long call calendar at the $130 strike.
Would you put on a long call calendar at the $134 strike in SPY today?
No, but I would probably put on a long calendar at the $132 strike in the puts. An example would be to buy 1 April 132 Put and sell 1 March 132 Put.
Why would you put on the calendar at the $132 put strike?
With calendars, I want the stock to go to the strike price of the calendar. And right now, I’m slightly bearish.
What price would you pay for the April-March 132 put calendar?
It closed Friday at $1.40, so I would wait for an up day in the market and try to get it for $1.25.
Why would you wait for an up day to enter a bearish calendar?
Because the option volatilities would be lower and I like to enter these bearish calendars after a few up days, to get a better price.
How can you buy a calendar at $1.25 when it is trading at $1.40?
I have to be patient and wait for the stock to trade back up to around $135.40.
Once you buy the calendar at $1.25, what will you do if you’re wrong?
After I buy the calendar at $1.25 (if I do), then if SPY goes to $138 – although the SPY hasn’t hit $138 in years — then I might re-position the spread to $138.
Can you explain what you mean by “re-positioning the spread”?
Sure, if I’m wrong and SPY rallies up to $138, I will take off the $132 calendar completely and then enter a calendar spread at the $138 strike in the calls. An example would be to buy 1 April 138 Call and sell 1 March 138 Call after I close out the $132 spread.
This wraps up a frank discussion between Dan and himself on the calendar strategy in SPY Dan has his eyes on.
Today we talked about the long calendar strategy. There is also a short calendar strategy, where you’d instead buy a longer-dated option and sell a shorter-dated option. But that is considered to be unhedged and, therefore, your broker would be looking for you to put up a significant amount of margin.
So, the long calendar is lower-risk and may be a more-familiar strategy if you’re used to doing traditional vertical spreads and/or covered calls. Plus, you’re “hedged” here, which means the full amount you have at risk is what you pay for the spread. And your profit potential can be unlimited, particularly when the short option expires and not only is the credit yours to keep but you can also benefit from any additional movement that benefits the long (longer-dated) option.
Have a great day!