5 Advanced Options Strategies

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5 Advanced Options Strategies

• Christopher Mercer
• Tradesight.com

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Introduction

• Experience and Tradesight
• Purpose of this seminar Options basic recap,
  backspreads, strangles, layered strangle
  backspreads, naked puts, and time spreads.

Dont be afraid.
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Options Definitions

• Calls The right to buy a certain stock at a
  certain price (the strike price) through a
  certain date (the expiration).
• Puts The right to sell a certain stock at a
  certain price (the strike price) through a
  certain date (the expiration)

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Options Definitions
Each contract represents 100 shares of stock.

• Options expire on the third Friday of each month.
• A leg is one part of a multi-option strategy,
  meaning different combinations of puts and calls
  or different strike prices or expirations.

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Option Montage Example

• Calls ABC Puts
• Bid Ask Nov Strikes Bid Ask
• 9.10 9.40 20 0.45 0.60
• 4.90 5.10 25 1.40 1.60
• 2.10 2.30 30 3.50 3.70
• 0.55 0.65 35 6.70 7.00
• Stock is at 29 currently.

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Backspread Purpose

• Backspreads are a way to guarantee a gain once
  the stock has moved in the right direction and
  leave you open to further gain potential without
  ANY downside risk.

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Backspread Timing

• Use a backspread strategy when you are in the
  money on a option play already. This is done in
  lieu of selling the option. There needs to be
  enough time left before option expiration for the
  stock to theoretically swing back past your
  strike price.

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Backspread Mechanics

• If you are long a call and the stock reaches your
  target, short the stock instead of selling the
  call. You are effectively short the stock with no
  risk and a guaranteed profit.
• If you are long a put and the stock reaches your
  downside target, buy the stock instead of selling
  the puts. You are effectively long the stock with
  no risk.

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CELG Long Trade
Initial Tradesight parameters on the stock
trigger is 16.25target is 18, stop is 15.15
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CELG Triggers
Stock triggers through 16.25 and hits 18 same day
for 1.75 gain.
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CELG Backspread

• Start the trade by buying the 15 call when the
  stock triggers. At 16.25, the 15 call would be
  1.25 plus some time premium. Lets say the call
  is 1.60.
• When the stock hits 18, that same option is
  worth at least 3. You could sell it and make
  1.40 per contract.
• Instead, short the stock at 18.

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CELG Backspread

• You now have a guaranteed gain. You can exercise
  the calls to own the stock at 15 plus the 1.60
  that you paid (16.60). You have already sold the
  stock at 18. There is a 1.40 gain that CANNOT
  disappear.
• At this point, the backspread is in place. Here
  are the possibilities.

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CELG Backspread

• Possibility 1 The stock remains above 15
  (strike price of the option). At expiration, the
  option is turned into stock to offset the short,
  and you end up with the 1.40 gain.
• Possibility 2 The stock drops under 15. At any
  point, you can buy the stock back to cover the
  short and lock in a gain of more than 3. You
  still own the option, which you bought for 1.60.

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Strangle Purpose

• The goal of a strangle is to make money on an
  anticipated move in either direction on stock or
  index. Strangles on indices can also be used as
  hedges for large funds.

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Strangle Timing

• You enter a strangle either at a key technical
  level that should either lead to a sharp drop or
  bounce, or ahead of a key news event. The
  downside of a strangle is no movement by the
  stock or index, so there needs to be a solid
  reason for expecting some sort of move.

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Strangle Mechanics

• Purchase equal numbers of calls and puts slightly
  out of the money from the current trading price
  of the stock. Your total cost basis is the cost
  of the call AND the put. The trade is a winning
  trade if you can sell either side of the trade
  for more than you purchased both sides together.

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Strangle Examples

• An index pulls back or rises up to a key
  technical support/resistance level.
• A stock is waiting for a major news announcement
  (i.e. Microsoft court ruling, biotech
  announcement, sometimes earnings on key stocks).

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Strangle Issues

• Make sure that you add up the cost of both sides
  of the strangle. It needs to be plausible that
  one side could get to a value higher than the
  cost of both sides. The QQQs are a great example
  of where a strangle can work consistently. Its
  also easier when the current price of the stock
  is dead in the middle of two strike prices.

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When Not to Strangle

• You see a key support line on RDN, which it would
  likely either breakdown under or bounce off of.

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RDN Strangle Conversation

• Calls RDN Puts
• Bid Ask Near Strikes Bid Ask
• 7.30 7.80 35 0.60 0.80
• 3.60 3.90 40 2.10 2.40
• 0.80 1.00 45 4.10 4.30
• 0.10 0.20 50 8.60 9.00
• Stock is at 41.52 currently.

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RDN Gaps Past Target

• RDN opens at 36.01 on bad news, past the target,
  for 5.50 gain.

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Exiting Strangle

• If you had run the strangle, you bought the 45
  calls for 1 and the 40 puts for 2.40, total of
  3.40. This means the stock needs to reach either
  36.60 or 48.40 to be guaranteed a winning
  trade.
• In this particular case, only because the stock
  moved so far, you made a little money. This would
  not have been an ideal strangle.

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QQQ Strangle

• Leading into possible war, the market is toying
  with breaking a key level. No war good, leading
  into war bad.

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QQQ Strangle

• Calls QQQ Puts
• Bid Ask Feb Strikes Bid Ask
• 1.70 1.80 23 0.45 0.50
• 1.35 1.45 24 0.70 0.80
• 0.70 0.80 25 1.20 1.30
• 0.20 0.25 26 1.60 1.70
• Stock is at 24.60 currently.

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QQQ Strangle

• The expectation is that a break of the
  December/January lows is technically bad, and
  leading into war, the market might drop back to
  the October lows and fill the gap near 21.50 on
  the QQQs.
• Any positive news avoiding the war should lead to
  a huge surge in the market.
• The cost of the QQQ strangle is only 1.60. At
  21.50, the puts would be worth at least 3.50, a
  nice gain.

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Strangle Backspreads Purpose

• The purpose of a strangle backspread is to double
  up your potential upside after you get in the
  money on a strangle. You do this by using the
  stock to close out one side of the trade instead
  of just closing the one leg.

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Strangle Backspreads Timing

• Once your strangle reaches a profitable target
  for one side of the trade, instead of selling
  that side of the trade, buy or short the stock
  instead.

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Strangle Backspread Mechanics

• You enter your strangle. Well use the QQQ
  strangle example that we were talking about
  earlier. The QQQs are 24.50, you buy the 24 puts
  and the 25 calls for a total of 1.60. The
  downside goal would be that the QQQs fill the gap
  to 21.50 with four weeks to expiration.
• Once the QQQs hit 21.50, the put is worth 3.50
  or so. Go long the QQQs.

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Strangle Backspread Mechanics

• Now, you have a guaranteed gain on the whole
  trade. You are long the QQQs at 21.50. You have
  the 24 puts, so you can sell the QQQs at 24 at
  any time through expiration. Thats 3.50. You
  spent 1.60. If the QQQ stay under 24, thats
  what you make. The calls expire, and the puts
  offset the long position.

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Strangle Backspread Mechanics

• However, if the market runs up sharper than that,
  you have the long on the QQQs AND the 25 calls on
  the QQQs. At 26.50, the calls are worth 1.50 at
  least, and the long position is 5 in the money.
  The puts are worthless (0.80 lost) and the calls
  cost 0.80. Basically, you can sell the stock and
  calls for 6.60, and you put 1.60 in, so 5 gain.

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Naked Put Purpose

• The goal of a naked put is to make money on an
  upward move in a stock without dealing with
  specific technical entries, stops, and targets on
  the stock itself. The downside of a naked put is
  that you could end up owning the stock if it
  declines.

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Naked Put Timing

• When a stock is at a point where you believe it
  will be higher by option expiration, execute the
  trade. One great way to time this is a stock
  holding over a clear base in an upward trending
  market.

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Naked Put Mechanics

• Sell the slightly out of the money puts. For
  this, you receive the premium. If the stock
  remains above the strike price, the puts expire
  on the third Friday of the month, and you get to
  keep the money that you took in. You can always
  close the trade by buying back the puts. If the
  stock drops under the strike by expiration, you
  will be put the stock at the strike, minus the
  premium received.

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SHFL Naked Puts
Very nice cup and handle base breaking out at 20.
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SHFL Naked Put Montage

• Calls SHFL Puts
• Bid Ask Nov Strikes Bid Ask
• 2.90 3.20 17.5 0.30 0.45
• 1.10 1.25 20 1.00 1.15
• 0.45 0.55 22.5 2.85 3.10
• 0.10 0.30 25 5.00 5.40
• Stock is 20.10 at long trigger.

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SCSC Naked Puts

• Long trigger 48.15, less perfect example, but
  higher price

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SCSC Naked Puts Montage

• Calls SCSC Puts
• Bid Ask Nov Strikes Bid Ask
• 8.80 9.10 40 0.50 0.65
• 4.40 4.70 45 1.30 1.50
• 0.85 1.05 50 2.70 3.10
• 0.10 0.30 55 7.00 7.40
• Stock is 48.15 at long trigger.

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Time Spread Purpose

• The purpose of a time spread is to get involved
  in one side of a trade over the course of more
  than one option cycle, but get money back out of
  the trade immediately at a closer timeframe,
  ultimately leaving you with a call or put that
  doesnt cost what it should.

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Time Spread Timing

• Time spread timing is tricky. The idea would be
  to buy a put or call beyond the current month,
  then sell the current month option of the same
  type (put or call) at the same strike price. You
  want the current month option to expire
  worthless, and then have the stock move in the
  right direction.

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Time Spread Mechanics

• Again, lets say that you like a stock on the
  long side that is at 28, and were currently
  sitting at February 1. You buy the March 30 call
  and sell the Feb 30 call at the same time. If the
  Mar 30 call costs 1.50 and you can sell the Feb
  30 call for 0.70, then you are really paying
  0.80.

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Time Spread Mechanics

• From here, you want the stock to stay UNDER 30
  until the option that you sold expires. At
  expiration, the call that you sold for 0.70 is
  worthless, and you get to keep that gain,
  essentially lowering your cost on the calls that
  you own for another month out.

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Offshoot Strategies

• 1) Vertical strategies. With the stock at 28,
  buy the 25 calls for March and sell the 30 Feb
  calls against that to get some money back. If the
  stock goes over 30, you get called away on the
  ones you wrote at 30 minus what you brought in,
  but you own the stock at 25 plus what you paid
  for the other ones.

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Offshoot Strategies

• 2) Take one side of the trade, get in the money,
  and then write the same direction with a
  different strike. You like a stock at 14. You
  buy the 12.50 calls for 1.80, and the stock
  moves up to 16. Now you write the calls for the
  same month at 15 strike for 1.60. If the stock
  drops back under 15, you get to keep the 1.60
  on the 15s, but still own the stock at 12.50
  plus 1.80.

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