ESSENTIAL OPTIONS STRATEGIES FOR ANY MARKET · ESSENTIAL OPTIONS STRATEGIES FOR ANY MARKET Explore...
Transcript of ESSENTIAL OPTIONS STRATEGIES FOR ANY MARKET · ESSENTIAL OPTIONS STRATEGIES FOR ANY MARKET Explore...
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PRICE HEADLEY, CFA, CMT
ESSENTIAL OPTIONS
STRATEGIES
FOR ANY MARKET
ExplorePut your knowledge into action.
Practice and start using your new
trading tools to find and trade
opportunities
EducateUnderstand the tools you have for
trading. Learn what this indicator is
and how you can profit from it with
our unique tactics.
ExecuteNever trade alone. Join us in our
trading workshops to maximize your
new found expertise. We’ll trade
with you.
BIGTRENDS.COM
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BIGTRENDS.COM
Let’s Get Started!
PRICE HEADLEY, CFA, CMT
ExplorePut your knowledge into action.
Practice and start using your new
trading tools to find and trade
opportunities
EducateUnderstand the tools you have for
trading. Learn what this indicator is
and how you can profit from it with
our unique tactics.
ExecuteNever trade alone. Join us in our
trading workshops to maximize your
new found expertise. We’ll trade
with you.
COVERED CALLS
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What is a Covered Call
Covered Calls
Sometimes referred to as a buy-write
strategy
Considered one of the fundamental
options trading strategies
A directional strategy, seeking a
bullish or sideways trend
Involves buying a stock, then selling
a call of the same stock
Typically, the call that is sold will be
Out of the Money (OTM), in order for
it to expire more likely.
Critical Trading Strategy
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Covered Calls
Trading Strategy
Many stock investors will sell
covered calls to protect gains rather
than having to exit the position
Because selling covered calls limits
your maximum gain, traders often
sell OTM calls to have a higher
ceiling on their trade
Income focused traders often sell
covered calls with the goal of having
them expire worthless every month
Covered calls can also be used to
lower the cost basis for a stock trader
When to Use Them
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Covered Calls
To properly execute a covered call strategy,
you need to master each of the steps below.
Stick with an appropriate time frame
Weekly or Daily Charts
Don’t use intra-day charts
Have an indicator that can consistently point out strong trends
Have a systematic approach to choosing the strike price for your option
Understand Max Gain, Breakeven & Stop Loss Levels
Execute your exits appropriately
Key Strategy Points
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Time Frame
Trading Guidelines
When implementing an options
strategy, it must align with the type of
trader that you want to be
Day Trader
Swing Trader
Position Trader
For the Covered Call strategy, you
are placing a longer term trade
Position Trading is the best time
frame when trading Covered Calls
Covered Calls
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Long Stock Trade
Trading Tool
Buying a stock is a common strategy
that most traders have experienced
Using profit and loss charts to
visualize the potential outcomes for a
strategy is often very helpful
When buying a stock, the gain/loss is
in direct correlation to the gain/loss
on the stock itself
The line remains at a constant slope,
with a defined loss of the stock hitting
zero, and an infinite maximum gain
Profit/Loss Charts
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Profit/Loss Graph
Covered Call
The covered call graph is
similar to the long stock until
you reach the strike price
The maximum profit at
expiration is at the strike price
Once the stock reaches the
stock price, many traders will
roll the short call to a different
month and/or strike
When volatility is higher, the
premiums are higher, making
covered calls more attractive
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Options Execution
Trading Strategy
Once you understand the
fundamentals of an options strategy,
you need to learn how to apply it
This execution step is where most
traders fall short and make mistakes
Your technical indicators must
provide a signal before you consider
entering into an option trade
Once you have a confirmed signal,
you must analyze the available
options to find the correct play
Building a Strong Foundation
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Sample Trading Scenario
General Electria Company – (GE)
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Covered Call – Bullish Scenario
Trade
Stock – 100 Shares @ $16.78 each = $1678
Call – Sell 1 $17.5 Call (100 shares) @ $0.30 each = $30
$1,678
- $30
$1,648
If stock goes to $17.62 (5% gain) at expiration
Stock worth $1,762
Option worth $12
Net Profit $84 on stock
+$18 on option decay ($30-$12 = $18)
+$102 gain on trade or +6.1% gain on $1,648 cost
General Electric Company – (GE) @ $16.78
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Covered Call Bearish Scenario
Trade
Stock – 100 Shares @ $16.78 each = $1678
Call – Sell 1 $17.5 Call (100 shares) @ $0.30 each = $30
$1,678
- $30
$1,648
If stock goes to $15.94 (5% loss) at expiration
Stock worth $1,594
Option worth $0
Net Profit -$84 on stock
+$30 on option decay ($30-$0 = $30)
-$54 loss on trade or -3.2% loss on $1,648 cost
General Electric Company – (GE) @ $16.78
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Covered Call Neutral Scenario
Trade
Stock – 100 Shares @ $16.78 each = $1678
Call – Sell 1 $17.5 Call (100 shares) @ $0.30 each = $30
$1,678
- $30
$1,648
If stock stays at $16.78 (Zero Change) at expiration
Stock worth $1,678
Option worth $0
Net Profit -$0 on stock
+$30 on option decay ($30-$0 = $30)
+$30 gain on trade or +1.8% gain on $1,648 cost
General Electric Company – (GE) @ $16.78
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Covered Call Actual Results
Trade
Stock – 100 Shares @ $16.78 each = $1678
Call – Sell 1 $17.5 Call (100 shares) @ $0.30 each = $30
$1,678
- $30
$1,648
If stock goes to $20.37 (+21.3% Gain) at expiration
Stock worth $2,037
Option worth $287
Net Profit +$359 on stock
-$257 on option decay ($30-$287 = -$257)
+$102 gain on trade or +6.1% gain on $1,648 cost
Not managing the short call cuts your profits by $257
General Electric Company – (GE) @ $16.78
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Sample Trading Scenario
General Electria Company – (GE)
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Covered Call Bullish Scenario
Trade
Stock – 100 Shares @ $27.19 each = $2719
Call – Sell 1 $29 Call (100 shares) @ $0.55 each = $55
$2,719
- $55
$2,664
If stock goes to $28.55 (5% gain) at expiration
Stock worth $2,855
Option worth $0
Net Profit $136 on stock
+$55 on option decay ($55-$0 = $55)
+$191 gain on trade or +7.1% gain on $2,664 cost
Microsoft Corporation – (MSFT) @ $27.19
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Covered Call Bearish Scenario
Trade
Stock – 100 Shares @ $27.19 each = $2719
Call – Sell 1 $29 Call (100 shares) @ $0.55 each = $55
$2,719
- $55
$2,664
If stock goes to $25.83 (5% loss) at expiration
Stock worth $2,583
Option worth $0
Net Profit -$81 on stock
+$55 on option decay ($55-$0 = $55)
-$26 loss on trade or -0.9% loss on $2,664 cost
Microsoft Corporation – (MSFT) @ $27.19
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Covered Call Neutral Scenario
Trade
Stock – 100 Shares @ $27.19 each = $2719
Call – Sell 1 $29 Call (100 shares) @ $0.55 each = $55
$2,719
- $55
$2,664
If stock stays at $27.19 (Zero Change) at expiration
Stock worth $2,719
Option worth $0
Net Profit -$0 on stock
+$55 on option decay ($55-$0 = $55)
+$55 gain on trade or +2.0% gain on $2,664 cost
Microsoft Corporation – (MSFT) @ $27.19
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Covered Call Actual Results
Trade
Stock – 100 Shares @ $27.19 each = $2719
Call – Sell 1 $29 Call (100 shares) @ $0.55 each = $55
$2,719
- $55
$2,664
If stock goes to $28.02 (3% gain) at expiration
Stock worth $2,802
Option worth $0
Net Profit $83 on stock
+$55 on option decay ($55-$0 = $55)
+$138 gain on trade or +5.1% gain on $2,664 cost
The stock stayed below the short call, bringing in the full $55 premium
Microsoft Corporation – (MSFT) @ $27.19
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Sample Trading Scenario
General Electria Company – (GE)
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Covered Call Bullish Scenario
Trade
Stock – 100 Shares @ $94.68 each = $9468
Call – Sell 1 $105 LEAP Call (100 shares) @ $4.20 each = $420
$9,468
- $420
$9,048
If SPY goes to $104.14 (10% gain) at expiration
Stock worth $10,414
Option worth $0
Net Profit $946 on stock
+$420 on option decay ($420 - $0 = $420)
+$1366 gain on trade or +15.0% gain on $9,048 cost
S&P 500 ETF – (SPY) @ $94.68
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Covered Call Bearish Scenario
Trade
Stock – 100 Shares @ $94.68 each = $9468
Call – Sell 1 $105 LEAP Call (100 shares) @ $4.20 each = $420
$9,468
- $420
$9,048
If SPY goes to $85.21 (10% loss) at expiration
Stock worth $8,521
Option worth $0
Net Profit -$947 on stock
+$420 on option decay ($420 - $0 = $420)
-$527 loss on trade or -5.8% loss on $9,048 cost
S&P 500 ETF – (SPY) @ $94.68
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Covered Call Neutral Scenario
Trade
Stock – 100 Shares @ $94.68 each = $9468
Call – Sell 1 $105 LEAP Call (100 shares) @ $4.20 each = $420
$9,468
- $420
$9,048
If SPY stays at $94.68 (Zero Change) at expiration
Stock worth $9,468
Option worth $0
Net Profit -$0 on stock
+$420 on option decay ($420 - $0 = $420)
+$420 gain on trade or +4.6% gain on $9,048 cost
S&P 500 ETF – (SPY) @ $94.68
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Covered Call Actual Results
Trade
Stock – 100 Shares @ $94.68 each = $9468
Call – Sell 1 $105 LEAP Call (100 shares) @ $4.20 each = $420
$9,468
- $420
$9,048
If stock goes to $107.39 (13.4% gain) at expiration
Stock worth $10,739
Option worth $239
Net Profit $1271 on stock
-$239 on option decay ($420 - $0 = $420)
+$1032 gain on trade or +11.4% gain on $9,048 cost
Not managing the short call cuts your profits by $239
S&P 500 ETF – (SPY) @ $94.68
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Sample Trading Scenario
General Electria Company – (GE)
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Covered Call Bullish Scenario
Trade
Stock – 100 Shares @ $62.32 each = $6,232
Call – Sell 1 $75 LEAP Call (100 shares) @ $1.42 each = $142
$6,232
- $142
$6,090
If stock goes to $68.55 (10% gain) at expiration
Stock worth $6,855
Option worth $0
Net Profit $623 on stock
+$142 on option decay ($142 - $0 = $142)
+$765 gain on trade or +12.5% gain on $6,090 cost
Exxon Mobil Corporation – (XOM) @ $62.32
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Covered Call Bearish Scenario
Trade
Stock – 100 Shares @ $62.32 each = $6,232
Call – Sell 1 $75 LEAP Call (100 shares) @ $1.42 each = $142
$6,232
- $142
$6,090
If stock goes to $56.08 (10% loss) at expiration
Stock worth $5,608
Option worth $0
Net Profit -$624 on stock
+$142 on option decay ($142 - $0 = $142)
-$482 loss on trade or -7.9% loss on $6,090 cost
Exxon Mobil Corporation – (XOM) @ $62.32
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Covered Call Neutral Scenario
Trade
Stock – 100 Shares @ $62.32 each = $6,232
Call – Sell 1 $75 LEAP Call (100 shares) @ $1.42 each = $142
$6,232
- $142
$6,090
If stock stays at $62.32 (Zero Change) at expiration
Stock worth $6,232
Option worth $0
Net Profit -$0 on stock
+$142 on option decay ($142 - $0 = $142)
+$142 gain on trade or +2.3% gain on $6,090 cost
Exxon Mobil Corporation – (XOM) @ $62.32
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Covered Call Actual Results
Trade
Stock – 100 Shares @ $62.32 each = $6,232
Call – Sell 1 $75 LEAP Call (100 shares) @ $1.42 each = $142
$6,232
- $142
$6,090
If stock goes to $84.80 (36.0% gain) at expiration
Stock worth $8,480
Option worth $980
Net Profit $2248 on stock
-$838 on option decay ($142 - $0 = $142)
+$1410 gain on trade or +23.1% gain on $6,090 cost
On the BigTrends you must manage the short call to increase your profits
Exxon Mobil Corporation – (XOM) @ $62.32
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Covered Calls
Trading Strategy
A trader using covered calls must
always be aware of volatility levels
Covered calls work best when IV is
decreasing because it also
decreases the option’s value
When the IV of a stock is high, it is
likely for a reason
Be aware of earnings or major news
announcements that might cause IV
to be higher than normal
These can cause unnecessary risk
Implied Volatility (IV)
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Important Final Points
Covered Calls
When selling a covered call, you want the
stock to increase in value.
The call serves as protection.
You must buy both the underlying stock and
then sell the call option.
Pros
Lower Cost for the trade
Potential Losses lessened
Cons
Potential Gains lessened
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Let’s Get Started!
PRICE HEADLEY, CFA, CMT
ExplorePut your knowledge into action.
Practice and start using your new
trading tools to find and trade
opportunities
EducateUnderstand the tools you have for
trading. Learn what this indicator is
and how you can profit from it with
our unique tactics.
ExecuteNever trade alone. Join us in our
trading workshops to maximize your
new found expertise. We’ll trade
with you.
STOCK SUBSTITUTE
STRATEGY
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What is the Stock Substitute Strategy
Options
Standard Options represent 100
shares of stock, or a round lot
There are a few distinct
disadvantages to buying stocks as
your investment strategy.
Buying round lots of stock can get
expensive for stocks over $100
Making money on bearish trends with
stocks is complex and challenging,
having to find stock and short it
That is why BigTrends teaches using
options in place of stocks for trading
Critical Trading Vehicle
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Substitute
sub·sti·tute - [suhb-sti-toot] –noun,
1. a person or thing acting or serving in place of another.
2. (formerly) a person who, for payment, served in an army or navy in the place of
a conscript.
3. Grammar . a word that functions as a replacement for any member of a class
of words or constructions, as do in He doesn't know but I do.
4. to put (a person or thing) in the place of another.
5. to take the place of; replace.
Definition
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Buying Calls
Options
Many traders start by trading stocks, often
buying ones that appear to be in bullish trends
While this is a viable strategy, it requires a very
large amount of capital to succeed.
Fund managers pool capital together to
accomplish this goal, but the individual investor
simply can’t trade that way
Instead of buying large quantities of stock,
create a Stock Substitute by buying ITM calls
Because they have intrinsic value, ITM calls will
often perform better on the same bull trend
Critical Options Principle
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Stock Trade Option Trade
Buy 100 KO shares @ $66.50
Cost = $6,650
KO goes to $70.00 in 5 Days
Long Shares gain $350, or 5.2%
ROI
Buy 1 KO 65 CALL @ 1.90
Cost = $190
KO goes to $70.00 in 5 Days
ITMs reach $5.40
gain $350, or 184.2% ROI
Stocks vs. Options
Bull Trades
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Buying Puts
Options
Many traders are used to the “buy low and sell
high” method of investing
You can also make money in stocks by doing
the opposite, “selling high and buying low”
Strategy options for a bearish trend:
Borrow the shares from your broker and
sell the stock (short-selling)
Buy a put, anticipating that it will increase
in value as the stock declines
Opening up your trading to bearish trends
allows you to trade all market conditions
Critical Options Principle
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Stock Trade Option Trade
Sell 100 CAT shares @ $104.50
Cost = $10,450
CAT goes to $100.00 in 5 Days
Short Shares gain $450, or 4.3%
ROI
Buy 1 CAT 110 PUT @ 7.00
Cost = $700
CAT goes to $100.00 in 5 Days
ITMs reach $13.40
gain $640, or 91.4% ROI
Stocks vs. Options
Bear Trades
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Stock Substitute Rules
Options
Underlying Volume
500K+
Open Interest
100+
Volume Traded
50+
Bid/Ask Spread
Target 10%
No More than 25%
Liquidity
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Stock Substitute Rules
Trading Strategy
Buy options with 2/3 (66%) or more
intrinsic value.
For trades, less than 5 days, buy
front month options
Otherwise, bypass the front month
and buy contracts 2-6 months out.
Intrinsic / Current Price = % Intrinsic
Example: VZ Jan 30 Call is trading
at 5.00, while VZ is trading at $34.10
4.10/5.00 = 82% Intrinsic Value
18% Time Premium
Time Premium
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Buying Puts
Trading Strategy
The put buying strategy can be used
on many different types of securities:
Stocks
ETFs
Indexes
Futures
Currencies
Traders who were not prepared with
bearish strategy in 2001 & 2008 lost
a tremendous amount of money
You need to have a strategy that can
make money in bull & bear markets
A Broader Universe
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Option Terms Refresher
Out-Of-The-Money
No intrinsic value and low Delta.
Delta will increase rapidly when stock moves in your direction.
Options are cheap; Most bang for your buck; Most risk.
In-The-Money
Greater intrinsic value and higher Delta.
Options are more expensive.
Less bang for your buck; Lowest risk.
Little to no intrinsic value and medium Delta.
Options are moderately priced.
Decent bang for your buck; Medium risk.
At-The-Money
Characteristics…
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Case Study – KO Bullish
KO 37.5 call
5.40 bid by 5.70 ask
Delta - .87
Intrinsic – 5.34
Extrinsic – 0.21
$1500 buys 2 contracts
2 week profit/loss:
($1,065.00)
ITM
KO 42.5 call
1.60 bid by 1.70 ask
Delta - .52
Intrinsic – 0.34
Extrinsic – 1.31
$1500 buys 8 contracts
2 week profit/loss:
($1,372.50)
ATM
KO 45 call
0.50 bid by 0.60 ask
Delta – 0.26
Intrinsic – 0.00
Extrinsic – 0.55
$1500 buys 25 contracts
2 week profit/loss:
($1,470.00)
OTM
$1500 (5% of 30k) – Stock falls $3.74
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Case Study – KO Bearish
KO 50 put
7.40 bid by 7.70 ask
Delta – (.97)
Intrinsic – 7.16
Extrinsic – 0.39
$1500 buys 1 contract
2 week profit/loss:
$790.00
ITM
KO 45 put
3.00 bid by 3.10 ask
Delta – (.74)
Intrinsic – 2.16
Extrinsic – 0.89
$1500 buys 4 contracts
2 week profit/loss:
$1,600.00
ATM
KO 40 put
0.70 bid by 0.75 ask
Delta – (.26)
Intrinsic – 0.00
Extrinsic – 0.725
$1500 buys 20 contracts
2 week profit/loss:
$2,250.00
OTM
$1500 (5% of 30k) – Stock falls $3.74
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Definitions
If you have an option with a high
intrinsic value & a low time premium,
what does that mean?
How does implied volatility affect an in
the money option position?
When I find a trade right now, should I
trade front month contracts or buy
more time for my contracts?
How important is underlying volume for
an option?
What is the most important Greek for
the Stock Substitute strategy?
Common Stock Substitute Questions
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Knowing the Risks
Stock Substitute
The profit/loss chart for the Stock
Substitute strategy is similar to that
of the protective put.
Why?
Since you are only buying options,
your maximum loss is only what you
paid to purchase the option
Your maximum gain is limitless
Your break-even point is determined
by the difference between the strike
price and the cost of the option
Critical Options Principle
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Managing Risks
Trading Strategy
When buying options, time decay is
always working against you (Theta)
Increases in Implied Volatility (IV) are
positive for option buyers, because it
increases the value of the option
Since options are leveraged, you
need to properly size your positions
The BigTrends method for position
sizing is to trade according to the
amount of capital in your account
If you stick to this method, you will
risk the same amount each trade
Strategy
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Position Sizing
Invest a fixed percentage of your capital on each trade (eg. 10%)
In a $25,000 account, buy as many contracts that $2,500 will allow
This method works, regardless of account size, because it is based
upon percentages and not raw dollars
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Obstacles
Peak to Trough
Options buyers need to be
disciplined enough to manage their
Maximum Drawdown.
For the Stock Substitute Strategy,
this is usually a 30% - 50% loss
Preventing your losing trades from
damaging your account will keep you
ahead of most options traders
You must be able to handle TWICE
the Max Drawdown both:
Emotionally &
Financially
Big Draw-Downs
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Big Drawdowns
As Drawdowns increase in size, the gain
required to recoup the losses increases
Percentage Loss Gain Required to Breakeven
-10% 11%
-20% 25%
-33% 50%
-50% 100%
-75% 300%
-90% 900%
Hard to Recover
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Staying With Winning Trades
Trading Strategy
Give yourself a chance to stay with a
Big Trend by taking HALF of your
position profits at 100% or more
This allows you to release the fear of
giving up profits, as you recoup your
initial investment and guarantee at
least a breakeven
Ride the other half position until it
gives back half its gains, or exit half
again if it later doubles once more
Trade Management
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The Closing Stop
Stops
To prevent being stopped out by
intraday noise, Use the concept of a
stop only at the end of a given bar.
This “Closing Stop” concept can
prevent numerous whipsaws
Note: It requires a more effort to
implement correctly.
For a daily closing stop, use the price
15 minutes before the end of the day.
If the stop is violated, place a Market
Order to exit the position.
Critical Options Principle
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Exploring Stock Substitutes
Trading Strategy
Now that you know the ins and outs
of the Stock Substitutes, you need to
master proper options selection
We will use Percent R as our
indicator to identify strong trends
Once a trend is confirmed, you need
to choose the correct option to buy
You should be able to quickly
determine what option to buy
Focus on Execution
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Sample Trading Scenario
General Electria Company – (GE)
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Stock Trade Option Trade
Buy 100 BA shares @ $37.48
Cost = $3,748
Stock goes to $48.83
Long Shares gain $1135, or
30.2% ROI
Buy 1 BA 35 CALL @ 5.50
(BA has 1 point strikes)
Delta of 0.69
Cost = $550
Stock goes to $48.83
ITMs reach $14.50
gain $900, or 163.6% ROI
Stocks Substitute
Bull Trades
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Sample Trading Scenario
General Electria Company – (GE)
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LEAPS
Instead of buying 100 shares of a
stock for a year or longer, buy
LEAPS
While these options are more
expensive because you are
buying more time, they are still a
great stock substitute
100 Shares on MON @ $68.01
would cost $6,801
Compare that to buying an ITM
LEAP with the same rules
Option Trade
MON 60 LEAP CALL @ 17.50
-> Delta of 0.69
Cost = $1750
Stock goes to a high of $129.28
At the exit, stock is at $101.00
Option worth $42.00
gain $2,450, or 140% ROI
Stock gain $3,299, or 48.5% ROI
Stocks Substitute
Longer-Term Trades
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Sample Trading Scenario
General Electria Company – (GE)
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Stock Trade Option Trade
Short 100 PG shares @ $57.38
Cost = $5,738
Stock goes to $47.82
Short Shares gain $956, or
16.6% ROI
Buy 1 PG 60 PUT @ 8.60
(PG has 5 point strikes)
Delta of 0.76
Cost = $860
Stock goes to $47.82
ITMs reach $18.90
gain $1030, or 119.7% ROI
Stock Substitute
Bear Trades
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LEAPS
Instead of shorting 100 shares of
a stock for a long period of time,
you can buy LEAP puts
While these options are more
expensive because you are
buying more time, they are still a
great stock substitute
Buying LEAP puts also allows
you to make money on bearish
trends without needing to use a
margin account
Option Trade
COP 85 LEAP PUT @ 18.50
-> Delta of 0.68
Cost = $1850
Stock goes to a low of $34.12
At the exit, stock is at $45.94
Option worth $41.25
gain $2,275, or 122.9% ROI
Short gains $3,083, or 43.5% ROI
Stocks Substitute
Longer-Term Trades
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Important Final Points
Stock Substitutes
Instead of tying large amounts of capital up
on stock only trades, buy ITM options as a
substitute for the stock.
These ITM options are more expensive, but
they have Intrinsic Value that is important
Remember: With options, you often get
what you pay for
Buying enough Intrinsic Value (2/3 or more)
will allow the option to properly follow the
trend, and you can profit accordingly
LEAPS can be used for longer-term trends