Short StraddleStrategy: Sell an ATM call and an ATM putwith the same strike price and the same expiration date.Market Opportunity: Look for a wildlyvolatile market where you anticipate a periodof low volatility.Maximum Risk: Unlimited to the upside andlimited, but high, to the downside (as the underlying can only fall to zero).
FIGURE C.14 ShortStraddle
Maximum Proﬁt: Limited to the net credit: (call premium + put premium)× 100. Proﬁt is possible when the underlying stays between thebreakevens.Upside Breakeven: ATM strike price + net credit.Downside Breakeven: ATM strike price – net credit.
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Long StrangleStrategy: Buy an OTM call and an OTM putwith the same expiration date.Market Opportunity: Look for a stable market where you anticipate a large volatilityspike.Maximum Risk: Limited to the net debit paid:(call premium + put premium) × 100.Maximum Proﬁt: Unlimited to the upside andlimited to the downside (as the underlying canonly fall to zero.
FIGURE C.13 LongStrangle
Upside Breakeven: Call strike + net debit.Downside Breakeven: Put strike – net debit.
Short StrangleStrategy: Sell an OTM call and an OTM putwith the same expiration date.Market Opportunity: Look for a wildlyvolatile market where you anticipate a drop-offinto a very stable market with low volatility.Maximum Risk: Unlimited to the upside andlimited, but high, to the downside (as the underlying can only fall to zero).Maximum Proﬁt: Limited to the net credit:(call premium + put premium) × 100.Upside Breakeven: Call strike + net credit.Downside Breakeven: Put strike – net credit.
FIGURE C.14 ShortStrangle
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Covered CallStrategy: Buy the underlying security and sellan OTM call option.Market Opportunity: Look for a bullish toneutral market where a slow rise in the priceof the underlying is anticipated with little riskof decline.Maximum Risk: Limited, but risky, to thedownside (as the underlying can only fall tozero).
FIGURE C.15 CoveredCall
Maximum Proﬁt: Limited to [short call premium + (short call strike –price of long underlying asset)] × 100.Breakeven: Price of the underlying asset at initiation – short call premium.
Covered PutStrategy: Sell the underlying security and sellan OTM put option.Market Opportunity: Look for a bearish orstable market where a decline in the price ofthe underlying is anticipated with little risk ofthe market rising.Maximum Risk: Unlimited to the upside beyond the breakeven.
FIGURE C.16 CoveredPut
Maximum Proﬁt: Limited to [short put premium + (price of underlying asset at initiation – put option strike)] × 100.Breakeven: Price of the underlying asset at initiation + short put premium.
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Option Strategy Reviews
Call Ratio BackspreadStrategy: Sell lower-strike calls and buy agreater number of higher-strike calls (the ratiomust be less than 0.67).Market Opportunity: Look for a marketwhere you anticipate a sharp rise with increasing volatility; place as a credit or at even.Maximum Risk: Limited to [(number of shortcalls × difference in strikes) × 100] – net credit(or + net debit).
FIGURE C.17 CallRatio Backspread
Maximum Proﬁt: Unlimited to the upside above the breakeven.Upside Breakeven: Higher strike + [(difference in strikes × number ofshort calls) ÷ (number of long calls – number of short calls)] – net credit(or + net debit).Downside Breakeven: Lower strike + (net credit ÷ number of shortcalls). No downside breakeven exists if the trade is entered at a net debit.
Put Ratio BackspreadStrategy: Sell higher-strike puts and buy agreater number of lower-strike puts (the ratiomust be less than 0.67).Market Opportunity: Look for a marketwhere you anticipate a sharp decline with increased volatility; place as a credit or at even.Maximum Risk: Limited to (number of shortputs × difference in strikes × 100) – net credit(or + net debit).
FIGURE C.18 PutRatio Backspread
Maximum Proﬁt: Limited to the downside below the breakeven (as theunderlying can only fall to zero).Upside Breakeven: Higher strike – (net credit ÷ number of short calls).No upside breakeven exists if the trade is entered at a net debit.Downside Breakeven: Lower strike – [(number of short puts × differencein strikes) ÷ (number of long puts – number of short puts)] + net credit (or– net debit).
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Long ButterﬂyStrategy: Buy lower-strike option, sell twohigher-strike options, and buy a higher-strikeoption (all calls or all puts).Market Opportunity: Look for a range-boundmarket that is expected to stay between thebreakeven points.Maximum Risk: Limited to the net debit paid:(long premium – short premium) × 100.
FIGURE C.19 LongButterﬂy Spread
Maximum Proﬁt: Limited to (difference between strikes – net debit) × 100. Proﬁt exists between breakevens.Upside Breakeven: Highest strike – net debit.Downside Breakeven: Lowest strike + net debit.
Long CondorStrategy: Buy lower-strike option, sell higherstrike option, sell an even higher-strike option,and buy an even higher-strike option (all callsor all puts).Market Opportunity: Look for a rangebound market that is expected to stay between the breakeven points.Maximum Risk: Limited to the net debit:(long premium – short premium) × 100.
FIGURE C.20 LongCondor Spread
Maximum Proﬁt: Limited to (difference between strikes – net debit) ×100. Proﬁt exists between breakevens.Upside Breakeven: Highest strike – net debit.Downside Breakeven: Lowest strike + net debit.
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Long Iron ButterﬂyStrategy: Buy a higher-strike call, sell a lowerstrike call, sell a higher-strike put, and buy alower-strike put.Market Opportunity: Look for a range-boundmarket that you anticipate will stay betweenthe breakeven points.Maximum Risk: Limited to (difference between long and short strikes – net credit) ×100.
FIGURE C.21 LongIron Butterﬂy Spread
Maximum Proﬁt: Limited to the net credit: (Short premium – long premium) × 100.Upside Breakeven: Strike price of upper short call + net credit.Downside Breakeven: Strike price of lower short put – net credit.
Calendar SpreadStrategy: Sell a short-term option and buy along-term option using at-the-money optionswith as small a net debit as possible (use allcalls or all puts). Calls can be used for a morebullish bias and puts can be used for a morebearish bias.Market Opportunity: Look for a rangebound market that is expected to stay between the breakeven points for an extendedperiod of time.
FIGURE C.22Calendar Spread
Maximum Risk: Limited to the net debit paid for a put calendar spread.For a call calendar spread, the risk can be greater for a dividend-payingstock. Normally, one would want to consider the risk equal to the debitpaid plus one quarterly dividend. If the stock pays no dividend, or if it isan index, the risk on a call calendar is equal to the debit.Maximum Proﬁt: Limited. Use software for accurate calculation.Upside Breakeven: Use software for accurate calculation.Downside Breakeven: Use software for accurate calculation.
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Diagonal SpreadStrategy: Sell a short-term option and buy along-term option with different strikes and assmall a net debit as possible (use all calls orall puts).• A bullish diagonal spread employs a longcall with a distant expiration and a lowerstrike price, along with a short call with acloser expiration date and higher strikeprice.
FIGURE C.23 DiagonalSpread
• A bearish diagonal spread combines a long put with a distant expiration date and a higher strike price along with a short put with a closerexpiration date and lower strike price.Market Opportunity: Look for a range-bound market that is expected tostay between the breakeven points for an extended period of time.Maximum Risk: Limited to the net debit paid.Maximum Proﬁt: Limited. Use software for accurate calculation.Upside Breakeven: Use software for accurate calculation.Downside Breakeven: Use software for accurate calculation.
Collar SpreadStrategy: Buy (or already own) 100 shares ofstock, buy an ATM put, and sell an OTM call.Try to offset the cost of the put with the premium from the short call.Market Opportunity: Protect a stock holding from a sharp drop for a speciﬁc period oftime and still participate in a modest increasein the stock price.
FIGURE C.24 CollarSpread
Maximum Risk: Initial shares price – (putstrike + net debit) (or – net credit).Maximum Proﬁt: (Call strike – initial shares price) – net debit (or + netcredit).Breakeven: Initial share price + [(put premium – call premium) ÷ numberof shares].
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Long Synthetic StraddleMarket Opportunity: Look for a market withlow volatility where you anticipate a volatilityincrease resulting in stock price movement ineither direction beyond the breakevens.Long Stock and Long PutsStrategy: Buy 100 shares of underlying andbuy two long ATM puts.Maximum Risk: Net debit of options + [(priceof underlying stock at initiation – option strikeprice) × number of shares].
FIGURE C.25 LongSynthetic Straddle
Maximum Proﬁt: Unlimited above upside breakeven and limited belowthe downside breakeven (as the underlying can only fall to zero).Upside Breakeven: Price of underlying at initiation + net debit of options.Downside Breakeven: [(2 × option strike) – price of underlying at initiation] – net debit of options.Short Stock and Long CallsStrategy: Sell 100 shares of underlying stock and buy two long ATM calls.Maximum Risk: [net debit of options + (option strike – price of underlying at initiation)] × number of shares.Maximum Proﬁt: Unlimited above upside breakeven and limited belowthe downside breakeven (as the underlying can only fall to zero).Upside Breakeven: [(2 × option strike) – price of underlying stock at initiation] + net debit of options.Downside Breakeven: Price of underlying stock at initiation – net debitof options.
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Index
Account, see Trading accountAccumulation phase, 248Active investing/trading, 47, 136–138Actively managed funds, 136Actively traded options/products, 49,340, 352Active shares, 26–28Actual volatility, 262–263, 266–267, 270,272, 281Adjustments:contract specifics, 287–288delta butterfly, 305–307directional long, 301–305limited risk strategies, 289–294position types, 289–290to straddles, 295–301to trade, 288–289Adobe Systems, Inc. (ADBE), 349Advance/decline line (A/D line),189–190Advanced strategies:characteristics of, 111, 131–132collar spreads, 111, 127–129,132defined, 111delta, 115–117diagonal spreads, 111, 129–132iron butterfly spreads, 111, 119–121,132long butterfly spreads, 111, 121–123,132ratio backspreads, 111, 123–127straddles, 111–113, 117–118, 132strangles, 111, 114–115, 117–118, 132AEQFI, 349
AEQRI, 349Aggressive buying/selling/trades, 42,155Airline sector, 79Alcoholic beverage industry, 17Allocation, 311, 316Altria (MO), 161Amazon.com (AMZN), 23American Association of IndividualInvestors (AAII), 208American International Group(AIG), 4American Stock Exchange (AMEX):Airline Index ($XAL), 2, 15, 32–33,79–81, 247, 266–268, 332Biotechnology Index ($BTK), 15Broker/Dealer Index ($XBD), 249characteristics of, 18, 59Eurotop 100 ($EUR), 17, 140Gold Bug Index ($HUI), 15holding company depositary receipts(HOLDRs), 22–24Hong Kong Index ($HKO), 17international funds, 24–26iShares Biotechnology Fund (IBB)Japan Index ($JPN), 17, 140MS Cyclical Index ($CYC), 249Natural Gas Index ($XNG), 224–225,235Oil Index ($XOI), 233–234Pharmaceutical Index ($DRG), 227QQV Index, 271S&P Depositary Receipts (SPY), seeS&P Depositary Receipts (SPY)sector indexes, 14–15
403
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404American Stock Exchange (Continued)stock options, 48web sites, 21, 198American-style options, 58, 64–65, 260,288AMG Data, 210Amgen (AMGN), 173–174, 329Analysis paralysis, xAnnouncements, market impact of,355Arbitrage, 152Arm, Dick, 191Arm’s Index, 191–193Art of Contrary Thinking, The (Neill),199Asia 25 Index ($EYR), 17Asian markets, 1Ask, defined, 68Ask price, 96, 351Asset allocation, 210–211, 311–312,320–321, 325Asset classes, 32, 315Assignment:implications of, 50, 57–59, 78, 84, 87,90put calendar spread, 110put options, 101, 103–104, 107ratio backspreads, 125unexpected, 81AT&T (T), 4, 161At-the money (ATM) options, 52–53, 76,112, 114, 117, 119, 121–122, 130,135, 273, 290–291, 293–294, 296,304, 306, 336, 346At-the-opening order, 350–351Auto-exercise, 58Auto industry/sector, 161–162,222Average directional index (ADI), 171,323–324Average directional index indicator(ADX), 171–172, 386–387Average losing trade, 170–172Average true range (ATR), 162–165,263–264, 266–267, 284,384–385Average true testing, 162–165
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INDEX
Average win-to-loss ratio, significanceof, 168Average winning trade, 170Backspread(s):call ratio, 397characteristics of, xii, 127put ratio, 397Back-testing, x–xi, 158, 172, 174, 181,320Bank of America (BAC), 3Banks/banking industry, 222, 233, 238,241–242Banz, Rolf, 196Bar charts, 7, 38, 45Basic Materials sector, 271–272, 283,334–335Bear call spreads, 79–81, 92, 110, 119,121, 289, 393Bear cycle, 6Bearish calendar spread, 84, 247Bearish market, 74, 92, 106, 108,241–242Bearish sentiment, 201, 203, 205, 207,219, 304Bearish signs, 43Bearish strategies, 208, 274Bearish strategists/traders, 48, 106Bearish trades, 23, 28, 45, 77Bearish trends, 46, 154Bear markets:bull markets distinguished from,30–31implications of, 29, 134, 153, 199,224, 227, 230qualifiers, 39trends in, 32Bear put spread, 106–108, 122, 241, 275,393Beating the Dow (O’Higgins),159Behavioral finance, 138. See alsoCrowd psychology; SentimentindicatorsBell curve, 265Benchmarks, 7, 18, 24, 34, 246, 316,318, 334, 337
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Index
Beverage companies, 223Bid, defined, 68Bid-ask quote, 350Bid-ask spread, 96Bid and offer, 68Bid price, 96, 351Biotech indexes, 16Biotechnology HOLDRs (BBH), 22, 27,294Biotechnology sector, 233Biotechnology stocks, 47Bjerksund-Stensland American optionmodel, 260Black, Fischer, 48, 197, 261Black-Scholes option pricing model,48, 260, 270, 276Blow-off, 185Blue-chip stocks, 3–4Bollinger, John, 205, 264Bollinger bands, 205, 382–384Bollinger’s Put Volume Indicator (PVI),200, 205–207Bond(s):categories of, 245–246funds, 26investment characteristics, 30, 315trading tools, 246–247trends in, 32Book-to-bill ratio, 231Book value, 142Boom and bust cycles, 230Boston Options Exchange (“the BOX”),49Boston Stock Exchange, 49Bottoms, see Double bottomsBreakeven:bear put spread, 108bull put spread, 103call options, 69, 74, 81, 83, 88covered puts, 114iron butterfly spread, 119–121put options, 95, 97ratio backspreads, 124–125straddles, 112–113, 118, 298strangles, 114–115Breakouts, 236, 238, 266Broadband HOLDRs, 22
Page 405
405Broker(s):functions of, 35, 57, 68, 74, 118relationship with, 353selection factors, 343–344types of, 66Brokerage firms:commissions, 137, 173functions of, 23, 68, 241online, 66program trading, 152trade management example,324trading levels, 90–92Buffett, Warren, 134Bull call spreads, 57, 87–91, 121, 142,275, 289, 392Bull cycle, 6Bull markets:bear markets distinguished from,30–31characteristics of, 1, 6, 29–30, 134,153, 200qualifiers, 39trading volume, 45Bull put spread, 101–104, 110, 119, 122,237, 275, 392Bullish butterfly, 306–307Bullish calendar spreads, 84Bullish markets, 39, 74, 101, 247, 302Bullish percents, 229Bullish sentiment, 201, 204–205, 207,219Bullish signals, 183, 192Bullish signs, 43Bullish spreads, 161Bullish strategies, 28, 274–275Bullish traders, 48, 159Bullish trades, 23, 190Bullish trends, 154Burke, Michael J., 168Business-to-business (B2B) InternetHOLDRs, 22Butterflies, xii, 132, 275Butterfly spreads:iron, 111, 119–121long, 111, 121–123Buttonwood Agreement, 1
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406Buy-and-hold strategy, 162Buying decisions, 136Buying pressure, 153Buying strategy, 136Buy low and sell high, 34Buy on close order, 351Buy on opening order, 351Buy signals, xiii, 44, 229Buy stop order, 351Buy write indexes, 335–337Buy write strategy, 82Calendar call spreads, 91Calendar skew, 272Calendar spreads, 84–88, 108–110, 247,399Call backspread, 125Call calendar spreads, 84–88, 92Call calendars, 142Call options:bear call spreads, 79–81breakeven, 64bull call spreads, 88–90call calendar spreads, 84–88cash settlement, 64–65characteristics of, 46, 50, 56, 71, 92,130, 161, 217–218, 274, 289,337–338collar spread, 127covered calls, 82–84defined, 51delta, 116dividends and, 55fair market value of, 48high-risk trades, 91historical perspectives, 48–49LEAPS, 49leverage, 52long call, 73–77option chains, 66–68premiums, 55price determinants, 52short call, 77–79short positions, 74skew, 274strike price, 58, 76trading levels, 92
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INDEX
Call ratio backspreads, 123, 275,397Call writer, 57Cancel former order, 351Cancellation fees, 23Candlesticks, 346Capital appreciation, 82Capital gains tax, 137Capitulation, 30Cash, generally:allocation, 320assets, 210–211indexes, 27, 38management, 311settlement, see Cash settlementCash-secured puts, 99Cash settlement:characteristics of, 59, 63–65, 161,288exercise settlement amount, 63exercise settlement value, 63–65,109Catalysts:active investing, 136–138earnings, 134, 140–143, 155economic conditions, 144–149,155efficient market theory, 133–136energy prices, 149–151, 155fear, 138–140, 155, 157Federal Reserve, 147–148,155greed, 138–140, 155, 157interest rates, 143, 155overview of, 354–355passive investing, 135–136program trading, 151–153Tick Index, 153–155CBOE PowerPacks Indexes, 16. Seealso Chicago Board OptionsExchange (CBOE)Central banks, 238Chartcraft, 229Charting:characteristics of, 37–39, 46, 353patterns, 370–371risk graphs, 68–70
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Index
Chicago Board Options Exchange(CBOE):Asia 25 Index ($EYR), 17Buy Write Index ($BXM), 335–336characteristics of, 13, 15, 18China Index ($CYX), 17Euro 25 Index ($EOR), 17Five Year Note Index ($FVX), 247historical perspectives, 200index options, 47–48Mexico Index ($MEX), 17mini-NASDAQ 100 (MNX), 276Oil Index ($OXI), 233–234PowerPacks Banks Index ($PVK),16PowerPacks Indexes, 15–16PowerPacks Oil Index ($POY),143PowerPacks Oil Services ($PVO),234put-to-call ratios, 200–204Sector Index Options, 16Semiconductor Index ($PVU), 227Ten-Year Rate Index ($TNX), 143,246–247Thirty Year Bond Index ($TYX),247utilities, 244Volatility Index ($VIX), 48, 259–261,276–281, 304$VXN, 271, 276–277, 279–280$VXO, 276web site, 15n, 200, 261, 336China Index ($CYX), 17China 25 Index, 24Chip industry, 230–233Chip sector, 253Chip stocks, 227, 232Cisco Systems (CSCO), 138–139,172Citigroup (C), 13, 161Clearing agents, functions of, 48“Closing TICK,” 154Closing price, 38, 164Closing trade/transactions, 76–77Cohen & Steers Realth Majors Index($RMB), 240
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407Collar spreads, 127–129, 400Collar strategy, 132, 241, 275Commercial banks, 241Commission, 173Commitments of Traders (COT),208Commodity Futures TradingCommission (CFTC), 208Commodity investments, 315Commodity Research Bureau (CRB),144Complete Guide to Option Pricing(Haug), 260Complex strategies, see AdvancedstrategiesConsensus, Inc., 208Consolidation periods, 163Construction