|
|
Generate income with options
So, for all option trading ideas, where the objective is to profit from intrinsic value, you really have to pay great attention to the underlying stock’s volatility metrics (Implied, historical, Beta) as well as the actual option contract in terms of it being IMT, ATM or OTM. All these come down to being one variable, and they behave as such, since changing only one of these variables enough, can achieve the desired profit results, while keeping everything else fixed.
Calculating the breakeven point at a glance
Suppose we want to trade ABC stock which is currently valued at $70, we are bullish on the stock so we go and pick a 2 month term Call option on that ABC stock, with a strike price of $75, this 75Call costs $1.20.
The breakeven point for this option is = strike price + premium paid = 75+1.20=76.20
This means that ABC stock has to reach the $76.20 level for the trade to break even. The problem is that the price move required is a ratio = 76.20/70=1.088 and that is a 8.8% stock price move! This is an OTM option that has cost us $120 plus commission. So the question is, will this stock ever make such a big swing, a move larger than 8.8%, in a month?
Then we also find, that we can pick an ITM option, with the same expiry term of 2 months but with a strike price of 68, this option costs 2.5 ($250 plus commission) And it has a break even point of = 68 + 2.5=70.5, and the stock has to make a 70.5/70=1.007=0.7% move for the trade to break even!
We can see that the ITM option is more than twice more expensive than the OTM one, one costs $250 and the other costs only $120, but the probability of the trade becoming a profitable is much stronger on the $250 ITM 68Call option! It only requires a 0.07% stock movement to reach the break even point, whereas the OTM 75Call requires a massive 8.8%. Will that ABC stock really move 8.8% up within few days, and then make one more move, even higher before the first month of the option term has passed? It depends on the stock, but again, statistics shows that most of the time, these OTM trades are long shot bets, and usually lose. Of course statistics is about probabilities on price events and doesn’t take into account the technical status of the stock. If ABC is on the tip of a massive triangle on the charts, then it does have a good chance it could move 20% or more in that month, that’s why we need to look at the trade from both perspectives!
For long shot bets, that is stocks that just happen to be at crucial points on their technical charts, and have proven historical volatility and significantly high Beta, an OTM option with a high break even point may do just fine. But it’s still riskier though!
This is where Analyzetrade.com offers the answer, it offers the option trader the tools to look at a stock’s volatility past, so that the trader can see the probability of the trade right away. For example on the previous ABC stock example, Analyzetrade.com tools will show you the following data:
Stock ABC
Month Stock Price Monthly % Movement
January 63 0
February 67 9.4
March 69 2.9
April 74 7.2
May 76 2.7
June 71 -6.5
July 72 1.4
August 70 -2.7
September 67 -4.28
October 69 2.9
November 64 -7.2
December 67 4.6
By looking at such data the option trader can tell right away, what kind of break even point, (in % terms) is required in his option trades. As you can see on the above data, a break even percentage of 8.8, used in outright Call purchases in the 7 Up months for ABC stock, would only have been marginally profitable in the month of February. Whereas a 0.7% break even ITM option trade would make a significant profit in all 7 Up months!
This is how you can get the odds on your side, by making sure the trade’s % breakeven number can be beaten by the underlying stock.
Generally, all aggressive option traders do not look to place a massive option trade using cheap OTM options, on a stock that just has a good technical reason to move by an exceptionally big magnitude this month. They don’t take such long shot bets! Rather, they make a series of low risk trades, on stocks and options that can beat those trades % breakeven number.
Analyzetrade.com is a leading options website offering great tools for analyzing your trades, seeing the probabilities before you risk your hard earned money, on the real thing. They also offer a very valuable mentoring program that can seriously enhance anybody’s trading skills.
|
