Option Strategies

OPTIONS

Options are used for a variety of reasons

Today, options are amongst the most widely used and flexible tool investors large and small have at their disposal.   We’ve reviewed the basics of being long or short options on the main page.

Proper option trade selection means selecting the right strike and expiration date to fit your goals and objectives.  The option strategy itself will be one of 16 basic strategies

Buying Options:

Outlook:  VERY Bullish (Calls)/Very Bearish (Puts)

Advantages:  Limited Risk, Unlimited Reward

Disadvantages:  Must overcome cost of option before trade is profitable

Risk Management:  Strike selection relative to current strike price will define risk profile of trade

Delta at outset:  .50 = option will go up/down .50 for each 1.00 move in the underlying asset

Gamma: If strike is at-the-money, the will have its maximum gamma.  Gamma will increase as expiration day approaches if option is at-the-money at that time.  Typically, gamma will increase at a great rate when options has less than 20 days to expiration.

Theta:  If option will be held to expiration, theta will rise coming into expiration day if option is at-the-money.  Typically, theta will increase at a great rate when option has less than 20 days to expiration.  When you are long the option, theta is your enemy.  Passage of time where the underlying asset does not move is dead money.

Vega:  If option held to expiration, vega will fall coming into expiration day if option is at-the-money.  Typically vega will decrease at a stable rate and slope through its life into expiration.

Gamma, Theta & Vega are all greatest when the option is at-the-money.  As options go depp in-the-money or way  out-of-the-money, all three greeks will decrease and the delta will be the primary driver of price changes.

Rho: Describes the expected price change for a change in interest rates & dividends.  FX options will have two Rho’s – same risk, but described in both currencies in the pair (i.e., EUR_USD).  For equity options, Rho will incresase as rates rise or dividends fall.  Rho will decrease as rates fall or dividends rise.

 

Selling Options:

Outlook:  MODERATELY Bearish (Calls)/Moderately Bullish (Puts

Advantages:  Premium Received

Disadvantages:  Unlimited risk if underlying asset rises (call) or falls (put) and the option is in-the-money at expiration

Risk Management:  Strike selection relative to current strike price will define risk profile of trade

Delta at outset:  .50 = option will go up/down .50 for each 1.00 move in the underlying asset

Gamma: If strike is at-the-money, the will have its maximum gamma.  Gamma will increase as expiration day approaches if option is at-the-money at that time.  Typically, gamma will increase at a great rate when options has less than 20 days to expiration.

Theta:  If option will be held to expiration, theta will rise coming into expiration day if option is at-the-money.  Typically, theta will increase at a great rate when option has less than 20 days to expiration.  When you are short the option, Theta is your friend.  The passage of time where the underlying asset does not move is a gift.

Vega:  If option held to expiration, vega will fall coming into expiration day if option is at-the-money.  Typically vega will decrease at a stable rate and slope through its life into expiration.

Gamma, Theta & Vega are all greatest when the option is at-the-money.  As options go depp in-the-money or way  out-of-the-money, all three greeks will decrease and the delta will be the primary driver of price changes.

Rho: Describes the expected price change for a change in interest rates & dividends.  FX options will have two Rho’s – same risk, but described in both currencies in the pair (i.e., EUR_USD).  For equity options, Rho will incresase as rates rise or dividends fall.  Rho will decrease as rates fall or dividends rise.

Option Risk Mangement: The Greeks

Option Volatility_defined

 

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