High Probability Option Trading Covered Calls and Credit Spread
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High Probability Option Trading: Covered Calls and Credit Spreads Steve Lentz Director of Education and Research OptionVue Research, Inc.
Transcript of High Probability Option Trading Covered Calls and Credit Spread
High Probability Option Trading: Covered Calls and Credit Spreads
Steve LentzDirector of Education and Research
OptionVue Research, Inc.
Disclaimer
Option trading can involve highly volatile returns and unlimited risk. Option trading is not suitable for every
investor.
Overview
Introduction to Options and Graphical Analysis
Why Trade Option Spreads
The Role of Volatility
Advantages of Selling Premium
Covered Calls
Credit Spreads
Obtaining Candidate Stocks
Introduction to Options and Graphical Analysis
Call Option – Right but not obligation to buy stock at a certain price on a certain date
Put Option – Right but not obligation to sell stock at a certain price on a certain date
Bid Ask MIV Trade Bid Ask MIV Trade
Last Change Trade
IBM 2/18/03
Last Change Trade
Bid Ask MIV Trade Bid Ask MIV Trade
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IBM 2/18/03
IBM 2/18/03
Last Change Trade
Bid Ask MIV Trade Bid Ask MIV Trade
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Today’s Risk/Reward Line
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Risk/Reward Line for 16 Days Away
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1st Standard Deviation ofPossible Price OutcomesBased on Last Month of Trading
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Risk/Reward Line for Expiration in32 Days
Why Trade Option Spreads ?
To Obtain Favorable Risk/Reward Ratios
IBM 2/18/03
IBM 2/18/03
IBM 2/18/03
Long 100 Shares of Stock
Long 1 Call Option16 Days Out
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Long Stock1:1 Risk/Reward Ratio
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Long OptionNegative Risk/Reward Ratio
On Normal Sized Moves
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Long OptionPositive Risk/Reward Ratio
Only on Big Moves
Option Spreads
Help Create Positive Risk/Reward Ratios
On Normal Sized Moves
IBM
Option SpreadsPositive Risk/Reward Ratio
Only on Normal Moves
2/18/03
Advantages of Selling Premium:
Adopt the role of insurance company
Time is on your side
Through risk management, the long-term odds can be in your favor
The Role of Volatility
SV
IV
IMPLIED VOLATILITY (IV)
Measures the volatility of the underlying asset implied by current option prices
Higher IV Means More Time Premium to Sell
STATISTICAL VOLATILITY (SV)
Measures how much the price of the asset itself has bounced around recently
Higher SV Means a Wider Standard Deviation of Possible Price Outcomes
Percentile Rankings
Knowing a Good Premium Selling Situation
Expensive vs. Inexpensive
Overvalued vs. Undervalued
Expensive = High IV Percentile
Inexpensive = Low IV Percentile
IV Percentile Rankings
0
30%
70%
100%
INEXPENSIVE
EXPENSIVE
Overvalued = High IV/SV Ratio
Undervalued = Low IV/SV Ratio
Knowing a Good Premium Selling Situation
Sell Expensive and Overvalued Options
Purchase Inexpensive and Undervalued Options
Covered Calls for theStock Investor
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Last Change Trade
Bid Ask MIV Trade Bid Ask MIV Trade
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Covered Call
Last Change Trade
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Bid Ask T.Prem Trade Bid Ask T.Prem Trade
Covered Call
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Today’s Risk/Reward Line
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Risk/Reward Line for 16 Days Away
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Risk/Reward Line for Expiration in 32 Days
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73% Probability of Profit
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Bid Ask T.Prem Trade Bid Ask T.Prem Trade
Last Change TradeCovered Call
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Vertical Credit Spreads for theOption Trader
Bid Ask MIV Trade Bid Ask MIV Trade
Last Change Trade
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Vertical Credit Spread
Bid Ask MIV Trade Bid Ask MIV Trade
Last Change Trade
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Bid Ask MIV Trade Bid Ask MIV Trade
Last Change Trade
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Vertical Credit Spread
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IBM 2/18/03
Bid Ask MIV Trade Bid Ask MIV Trade
Last Change Trade
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Vertical Credit Spread
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81% Probability of Profit
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Bid Ask MIV Trade Bid Ask MIV Trade
Last Change Trade
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Vertical Credit Spread
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Position Requirements
Last Change Trade
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Bid Ask T.Prem Trade Bid Ask T.Prem Trade
Covered Call
Stock Position:100 shares
X $79.33 = $7,933
Margined Position:
$7,933 X 50% = $3,967
Minus $330 Credit for
The Sold Call
Total = $3,637
Bid Ask MIV Trade Bid Ask MIV Trade
Last Change Trade
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Vertical Credit Spread
Spread - Credit:Spread = $10 X 100 shrs
= $1000
Credit = $390 Collected
- 115 Paid Out
$275
$1000 - $275 = $725
IBM 2/18/03
Covered Call:$3,637
Vertical Credit Spread:$725
IBM 2/18/03
Covered Call:$3,637
Vertical Credit Spread:$725
Obtaining Candidate Stocks
High Probability Option Trading: Covered Calls and Credit Spreads
Steve LentzDirector of Education and Research
OptionVue Research, Inc.
