Sunday, February 1, 2009

Options Action

I got a chance to tune in to CNBC’s new options show, Options Action, this past Friday night - It airs every Friday at 11:30 PM EST. Below is a summary found on the CNBC website:

CNBC's "Options Action," hosted by CNBC's Melissa Lee, is a fast-paced, weekly half-hour roundtable discussion featuring four prominent options traders who will demonstrate how to profit from the news of the week using options. Fresh from the trading desks, the "Options Action" traders will not only offer the latest fundamental analysis of individual stocks, but also tell the viewer how to increase returns and limit losses by employing the right option strategies on those stocks. The playbook will include basic call and put buying, selling puts and covered calls, and some of the more advanced techniques, such as buying put and call spreads.

Being an avid options trader, I was rather interested in how useful the show would be for individual retail traders. Having now sat through two episodes I’m pleased to report they haven’t done too shabby. Below are a few of my observations.

1. I like the fact that they advocate using spreads vs. buying options outright. Hopefully this helps the majority of call & put buying retail traders see the benefit of using spreads as a way to drastically lower cost and risk. If the pros (with huge amounts of money at their disposal) are saying things like, “I’m cheap so I’m going to enter a spread…” or I’m going to sell a higher strike call to help finance the purchase of a lower strike call…”, it stands to reason that an individual trader (with much smaller accounts) would be interested in implementing spreads. All too often, I see new traders gaga eyed over the potential returns of call & put options, when in reality their overlooking the fact that most of the time these two strategies have low probabilities of success. One of the spread strategies they threw out was buying put spreads on the SPY (Jun 80-75 put spread) as a way to hedge a long portfolio vs. that of simply buying straight puts.

2. As the show continues, one change I’d like to see is spending a bit more time on education. Like explaining implied volatility and its effects on option prices. In addition, rather than simply stating that the market is pricing a 15% chance of stock XYZ going down to a certain price (as they sometimes do), it would be nice to teach individual investors how to use delta to calculate these probabilities themselves.

One of the trades they mentioned that I want to highlight was a bull call spread on GLD. Currently GLD is trading @ $91.31. The person that mentioned this (can’t remember the name) was bullish on GLD and wanted to use an April 100-105 call spread to take advantage of a further increase in its price.

Buy Apr 100 call for $4.10
Sell Apr 105 call for $3.10
Net Debit/Max Risk $1.00
Max Reward = $4.00 (if stock is above $105)
Breakeven (at expiration) = $101

Here's the risk graph:

It’s tough to deny the relative strength GLD has seen over the past 3 months. Although it is a bit overbought in the short term (see stochastic in chart).
Whether the uptrend continues or not though, time will tell. I do like the choice of using an out-of-the-money bull call spread. It’s a cheap low risk way to establish a bullish position- plus you’ve got until April for GLD to reach the $105 level.
As always, feel free to post your thoughts/questions in the comments board.



The Premium Collector said...

cool site...I've added it to my blog list.

Tyler said...

Thanks for stopping by - Feel free to pipe in with any pithy comments on my posts. I'll take a gander at your sight as well...


Excellent post on options.