Options

[daverobev]

Can someone give me a plain English description of Options? I think I get enough to think about doing what I want to do, but I'm not 100%

Example - I'm thinking biotech in the US will likely bounce post elections. So I'm thinking about buying Calls on, say, Gilead GILD for Jan 2017 for the option to buy (strike price?) at $85 or something. I'm guessing they will go up a good chunk by then. If not, so sad, so bad.

Now, the premium seems high (one version was about $485 for a single contract, and if the stock went to $100 I'd get ~$2000). Is this a bad deal?

If I bought inside a registered account and wanted to exercise the option, do I actually have to have enough cash to *buy* or can I somehow convert the option straight to cash - so say I bought a $90 option and it went to $100, do I need the $9k to realise the $10k, or is there a passthrough?

Suggestions for a good read on this stuff?

*Edit* Hmm, just had a read of the Questrade novice's guide. Seems full of jargon but otherwise straightforward. Selling covered calls on stock you're somewhat ambivalent on, or want to get income from in the case of decline even while holding as part of your overall asset allocation, seems to make some sense.

Need to think further about it, but say - for example - you're 20% invested in emerging markets, you could sell some covered calls on some fraction that you might have to rebalance if it goes up/generate income to purchase more when rebalancing if it goes down...

Hmmmm.

[Mother Fussbudget]

There are lots of free resources available.  Glance through them, and read the one that best "speaks to you".

A quick search found these resources: 
www.mdwoptions.com/TheBasics.pdf (presentation by the author of "The Rookie's Guide to Option Trading")
http://www.optionseducation.org/content/dam/oic/documents/book/igto-kindleversion.pdf
http://online.slidehtml5.com/azff/nyuw/nyuw.pdf (Options trading for dummies)
http://i.investopedia.com/inv/pdf/tutorials/options_basics.pdf
http://www.traderslibrary.com/ProductPages/Simple_Steps_to_Option_Trading_Success/634414213916036893.pdf
http://www.cboe.com/learncenter/pdf/understanding.pdf (from the CBOE)

When I traded options, I almost never let the option go to maturity - instead I traded option contracts like stocks.  I always bought more 'time value' than I thought I needed in case the predicted change-in-the-market didn't happen right away, but happened a week or two later.

[Roland of Gilead]

I am not so sure Gilead will go past $85 by Jan 2017 to make that worthwhile.

I have sold Jan 2017 $80 puts on Gilead for $6.10 which means I profit if Gilead stays above about $74.  It is $81 today.

[Financial.Velociraptor]

I'd recommend against using long options as your first trade.  You are much more likely to have a winning trade by selling options e.g. short 'covered' call or short 'cash secured' put.  Like RoG's trade above.

[daverobev]

I am not so sure Gilead will go past $85 by Jan 2017 to make that worthwhile.

I have sold Jan 2017 $80 puts on Gilead for $6.10 which means I profit if Gilead stays above about $74.  It is $81 today.

I'll do some reading shortly, but what's the difference between selling a put, and selling a covered call?

Seems like a covered call is what I'd actually want to actually pad some income.

*Edit* re Gilead, I remembered over lunch how long the US takes to put in the new Prez. In the UK it's like 2 weeks from General Election to new Government. Not however long it is - Feb or March the next year! So, no I guess, the uncertainty won't be much diminished by Jan.

*Double edit* Ok so the buy is the right, Call=buy Put=sell. If you buy, you get the right, you pay the premium. Got it. If you sell puts, you're giving someone the option of forcing you to buy stock at a certain price. I'm going to have to let that digest a little. Calls make more sense, even though Puts are just the reverse.

[Financial.Velociraptor]

You can buy or sell either puts or calls.

If you buy a call, you have the right but not the obligation to buy the underlying at the strike price up to the expiry day.

If you sell a call, you have the obligation to sell shares at the strike on the buyer's timetable.  You keep the premium as income.

If you buy a put, you have the right but not the obligation to sell the underlying at the strike price up to the expiry day.

If you sell a put, you have the obligation to buy the shares at the strike on the buyer's timetable.  You keep the premium as income.

[daverobev]

You can buy or sell either puts or calls.

If you buy a call, you have the right but not the obligation to buy the underlying at the strike price up to the expiry day.

If you sell a call, you have the obligation to sell shares at the strike on the buyer's timetable.  You keep the premium as income.

If you buy a put, you have the right but not the obligation to sell the underlying at the strike price up to the expiry day.

If you sell a put, you have the obligation to buy the shares at the strike on the buyer's timetable.  You keep the premium as income.

Ok, so, with selling Puts - presumably you're ok with GILD as an outfit, and you'd actually not be unhappy to buy some (more?) at $74 a share...?

Only if they *crashed* would you be sad (fraud or whatnot). The buyer of your Puts gets insurance that, if stuff goes really south for GILD (ie, new government is like, um, generics for everyone! We're reducing patents to 3 years!), they still get $74 a share (actually ~$68 as they paid you $6 for the privilige).

[waltworks]

If you are asking these questions, you are certainly not going to make any money at trading options except perhaps through dumb luck.

-W

[Roland of Gilead]

If you are asking these questions, you are certainly not going to make any money at trading options except perhaps through dumb luck.

-W

Be nice, everyone has to start somewhere.  Covered calls and cash secured puts are actually safer than buying the stock outright.

On the trade above, I sold the put at $80 strike for Jan 2017 expiration.  I have to come up with $80 per share, $8,000 per contract on that date if someone wants to exercise the put.  Note that it would only be exercised if the stock were trading below $80.  Because I received $6.10 for selling the put ($610 per contract), I actually make some money if Gilead is trading anywhere above $74.  The $68 you mentioned is not correct, you are subtracting twice.

Covered calls and cash secured puts are very similar.  They are treated a bit differently tax wise.  You don't get dividends though like you do with covered calls, but usually the premium you get for the put sale takes that into account.   The margin thing is something I have done in conjunction with the online saving bonus.  Here, I will explain:

I sell 10 Gilead put at $80 strike, Jan 2017 expiration for $6.10.  I thus instantly receive $6100 (10 contracts represents 1000 shares).  I need to have $80,000 in the account on Jan 2017 to buy the shares if they are put to me at $80 each.   My account lets me get by with only having $40,000 in the account.  I take the other $40,000 and find a online saving account with a bonus offer, like $300 for keeping your money in the account for 90 days.  I thus make $6400 and there is no margin interest charged since my account always has a positive cash balance in it.


Note that my return is $6400/$73,900 = 8.6% but happens in just 5 months so annualized the return is above 18%.  An 18% return that just requires the stock to not drop below the current price.  :-)

[Financial.Velociraptor]

You can buy or sell either puts or calls.

If you buy a call, you have the right but not the obligation to buy the underlying at the strike price up to the expiry day.

If you sell a call, you have the obligation to sell shares at the strike on the buyer's timetable.  You keep the premium as income.

If you buy a put, you have the right but not the obligation to sell the underlying at the strike price up to the expiry day.

If you sell a put, you have the obligation to buy the shares at the strike on the buyer's timetable.  You keep the premium as income.

Ok, so, with selling Puts - presumably you're ok with GILD as an outfit, and you'd actually not be unhappy to buy some (more?) at $74 a share...?

Only if they *crashed* would you be sad (fraud or whatnot). The buyer of your Puts gets insurance that, if stuff goes really south for GILD (ie, new government is like, um, generics for everyone! We're reducing patents to 3 years!), they still get $74 a share (actually ~$68 as they paid you $6 for the privilige).

Now you are on the right track.

Selling options in a low risk way (only working with 'negative' outcomes that are acceptable to you) is the right way to learn options.  When you buy an option, you not only have to be right about the timing and direction, you have to be right about the size of the move because you start in the hole the amount of your premium payment.  As an option seller, you keep the premium win, lose, or draw.  You can be wrong about timing or direction and still come out with a winning trade if the size of the move is less than the premium you collected.  More ways to win and fewer to lose...

Take your time learning.  It can be a little confusing at first.  And don't use options as a tool to increase your leverage (use it as a tool to REDUCE your exposure).  You can seriously nuke your own portfolio with options if you get greedy instead of cautious.

[daverobev]

If you are asking these questions, you are certainly not going to make any money at trading options except perhaps through dumb luck.

-W

Q: How do you drive?

A: If you don't know how to drive, you shouldn't drive!

[daverobev]

You can buy or sell either puts or calls.

If you buy a call, you have the right but not the obligation to buy the underlying at the strike price up to the expiry day.

If you sell a call, you have the obligation to sell shares at the strike on the buyer's timetable.  You keep the premium as income.

If you buy a put, you have the right but not the obligation to sell the underlying at the strike price up to the expiry day.

If you sell a put, you have the obligation to buy the shares at the strike on the buyer's timetable.  You keep the premium as income.

Ok, so, with selling Puts - presumably you're ok with GILD as an outfit, and you'd actually not be unhappy to buy some (more?) at $74 a share...?

Only if they *crashed* would you be sad (fraud or whatnot). The buyer of your Puts gets insurance that, if stuff goes really south for GILD (ie, new government is like, um, generics for everyone! We're reducing patents to 3 years!), they still get $74 a share (actually ~$68 as they paid you $6 for the privilige).

Now you are on the right track.

Selling options in a low risk way (only working with 'negative' outcomes that are acceptable to you) is the right way to learn options.  When you buy an option, you not only have to be right about the timing and direction, you have to be right about the size of the move because you start in the hole the amount of your premium payment.  As an option seller, you keep the premium win, lose, or draw.  You can be wrong about timing or direction and still come out with a winning trade if the size of the move is less than the premium you collected.  More ways to win and fewer to lose...

Take your time learning.  It can be a little confusing at first.  And don't use options as a tool to increase your leverage (use it as a tool to REDUCE your exposure).  You can seriously nuke your own portfolio with options if you get greedy instead of cautious.

Got it, thanks.

So for a mostly couch potatoish portfolio, I can mitigate some downside "risk" because I can, basically, sell covered calls on a whole bunch of stuff I might sell anyway to rebalance if it went up. There is no real "risk" because I'm in it for the long term anyway. And the same with Puts, because if stuff drops, I'd want to buy more anyway.

Very interesting. I'm going to have to review my portfolio to think which would be a sensible place to start. Probably whatever my largest holding (or what has risen most) is, and take a small amount of that and do a covered call. I'm not actually looking to buy more stock generally (so I keep telling myself).

I wonder if there is a way of doing any of this automatically. For any position where you have > 1000 shares, write CCs for 100.

[Roland of Gilead]

It gets more complicated with taxes and long term cap gains vs short term cap gains.   When you sell a put, you don't have to pay tax on the money you receive until the put expires.  (So if these $80 Gilead puts I sold expire worthless in Jan because Gilead is trading at $80+, I will owe tax in 2017, not 2016 when I actually got the money).   If the shares are assigned to you, the put price actually just lowers your basis and you don't owe tax at all until you sell the shares (so my basis would be $74 instead of $80).

I have used this tax deferral to my advantage when I needed income this year but knew I was going to be in a lower tax bracket next year.  I also plan to use it to manage my ACA MAGI such that I always receive the maximum subsidy by deferring income to another year when needed.   I am sure this is what our congress intended :-)

[daverobev]

It gets more complicated with taxes and long term cap gains vs short term cap gains.   When you sell a put, you don't have to pay tax on the money you receive until the put expires.  (So if these $80 Gilead puts I sold expire worthless in Jan because Gilead is trading at $80+, I will owe tax in 2017, not 2016 when I actually got the money).   If the shares are assigned to you, the put price actually just lowers your basis and you don't owe tax at all until you sell the shares (so my basis would be $74 instead of $80).

I have used this tax deferral to my advantage when I needed income this year but knew I was going to be in a lower tax bracket next year.  I also plan to use it to manage my ACA MAGI such that I always receive the maximum subsidy by deferring income to another year when needed.   I am sure this is what our congress intended :-)

Heh. That's a whole other ballgame - I'm not in the US, so there is no differentiation between short and long term capital gains. I'll have to do that research.

*Ed* Love this site http://www.taxtips.ca/personaltax/investing/taxtreatment/options.htm - so, "the income from options sold (written) is reported in the tax year in which the options expire, or are exercised or bought back."

[waltworks]

Ha, driving a car. Good one.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=965810

Odds are, you'll do even worse than you would trying to pick stocks! Awesome!

Good luck, you'll need a lot of it.

-W

[daverobev]

Ha, driving a car. Good one.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=965810

Odds are, you'll do even worse than you would trying to pick stocks! Awesome!

Good luck, you'll need a lot of it.

-W

You'll note I'm asking questions before taking any action, yes? You'll note I'm on the MMM forum, not some stock tips site, yes? You'll note you know literally nothing about me, my situation, my tolerances, my history, yes?

I appreciate your link, but your delivery sucks.

[Roland of Gilead]

Ha, driving a car. Good one.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=965810

Odds are, you'll do even worse than you would trying to pick stocks! Awesome!

Good luck, you'll need a lot of it.

-W

I have done *ok*.   Started with a rollover IRA from a 401K in 2001 with $1700 in it.  No more contributions and today the balance is $102,000.  It does have some volatility but here is the performance report from 2016 compared to the S&P500:

[marty998]

Ignore him. We're all here to learn something.

I first looked at options 12 years ago while studying Finance. Didn't dip my toe in and lost a lot of the knowledge since. Always good to refresh the understanding of these things, even if I probably won't throw some cash at it.

[waltworks]

You'll note I'm asking questions before taking any action, yes? You'll note I'm on the MMM forum, not some stock tips site, yes? You'll note you know literally nothing about me, my situation, my tolerances, my history, yes?

I appreciate your link, but your delivery sucks.

You're asking at a forum where you are *least* likely to get useful advice. Off to a great start on the project. Did you read the link? Stick your money in something passive and diversified and boring and forget it.

-W

[Roland of Gilead]

You'll note I'm asking questions before taking any action, yes? You'll note I'm on the MMM forum, not some stock tips site, yes? You'll note you know literally nothing about me, my situation, my tolerances, my history, yes?

I appreciate your link, but your delivery sucks.

You're asking at a forum where you are *least* likely to get useful advice. Off to a great start on the project. Did you read the link? Stick your money in something passive and diversified and boring and forget it.

-W

My wife did that with her IRA.  She put it in a Vanguard international index fund and it has grown from $39,000 to $39,500 in about five years.

[Financial.Velociraptor]

Haterz gonna Hate.   Take your time and learn about options the right way (the way that is focused on managing risk instead of increasing returns).   You will do well as a result.

[waltworks]

My wife did that with her IRA.  She put it in a Vanguard international index fund and it has grown from $39,000 to $39,500 in about five years.

Better than nothing, which is what the OP will likely end up with.

But if you're one of the few who makes money at it, I can see the logic in encouraging him/her.

-W

[Roland of Gilead]

My wife did that with her IRA.  She put it in a Vanguard international index fund and it has grown from $39,000 to $39,500 in about five years.

Better than nothing, which is what the OP will likely end up with.

But if you're one of the few who makes money at it, I can see the logic in encouraging him/her.

-W

Well, notice how we steered the OP toward covered calls and cash secured puts, which are much safer than what you make out.  This is no different IMO than the countless people on here who tout real estate landlording as a way to FIRE.  There are risks there but very few on here actually acknowledge them.

[frugledoc]

It's very different.

Surely at least 50% of people must lose on calls, puts, options otherwise there would be no market.

It is just gambling, where the house will win in the end, except for a few who win through nothing but luck, and then try and make others think it is due to skill.

Real estate at least is a long term investment with a yield.   Not that I like it that much as an investment but it is not comparable to gambling.

[Roland of Gilead]

So because at least 50% of people lose at the casino there is no gambling?

When you sell a covered call or cash secured put, you are acting as the house.

You are lowering your risk, not increasing it.  You are lowering your potential return as well, but reducing volatility.  You are generating income in a flat market situation, which is probably the best case scenario.

You can sell covered calls and sell cash secured puts on a broad index like SPY so the diversity risk argument is not even valid.

If you go out and buy 100 shares of SPY at $218 and it falls to $200, you have a paper loss of $1800.

If you buy 100 shares of SPY at $218 and sell a covered call at $220 for $10 and it falls to $200, you have a paper loss of $800.

If SPY stays at $218, you have a gain of $1000 while the other guy has nothing. 

If it goes to $240, you have a gain of $1200 while the other guy has a gain of $2200.

Reduced risk, reduced return.  Certainly not something I would do for all of my portfolio but I think one should at least consider covered calls and cash secured puts when the forecast is for the market to have less than average returns because of the relatively high valuation compared to historical averages.

Also there is a sucker born every minute, so why not sell them some calls?  :-)

[daverobev]

It's very different.

Surely at least 50% of people must lose on calls, puts, options otherwise there would be no market.

It is just gambling, where the house will win in the end, except for a few who win through nothing but luck, and then try and make others think it is due to skill.

Real estate at least is a long term investment with a yield.   Not that I like it that much as an investment but it is not comparable to gambling.

Hmm, I think you're missing what people are saying - that you should use options as insurance against losses.

That is, now, what I am thinking of doing - writing covered calls for things I'd rebalance if they went up, and taking the premium either way. Or things I'm overweight in. Conversely, write puts on things that I'd like to buy more of.

What does the buyer get? Insurance. Is insurance good? Mm, well, you never want to be overinsured. I mean, I completely spurn life insurance and all that, but I'm not a single wage earner with a large mortgage and family that depends on me.

[StreetCat]

I'll do some reading shortly, but what's the difference between selling a put, and selling a covered call?

In terms of risk/return profiles the two are equivalent.  There are however, a couple of practical ( and possibly minor depending on your trade situation) differences.

If you are getting into positions from scratch, a covered put will cost you one commission and you'll navigate through one bid-ask spread.  A covered call on the other hand, will cost you two commissions (one for buying the stock and one for selling the call) and you will have to navigate through 2 bid-ask spreads (again, one for the stock and one for the option).

The other potential difference is if your covered put works in your favor (in other words, the stock goes up) and you want to close your position before expiration, then the OTM put is likely to have a relatively narrower bid-ask spread and you'll lose a smaller amount navigating through it.  If your covered call worked in your favor (if stock went up) and you want to close the position, the now ITM call will likely have a wide bid-ask spread and you'll lose a bigger amount navigating through it.

If the above paragraph was difficult to understand, try this: Choose a liquid option series (such as SPY) and pick an expiry date 1-2 months into future (say, Sep 16, 2016).  SPY is currently trading at 218.56.  Look at the bid/ask for ITM calls (such as 200 call) and for OTM calls (such as 230 call).  Do the same for puts.  You'll notice that ITM options have wider bid-ask difference than OTM options have.  Every time you buy/sell, you will lose that spread.

And on the other side, if the position works against you and you get assigned stocks, your covered put will incur another commission for assignment (some brokers don't charge commission for this).  In this same case, your covered call will expire worthless (AFAIK no broker charges commission for this).

[StreetCat]

I have done *ok*.   Started with a rollover IRA from a 401K in 2001 with $1700 in it.  No more contributions and today the balance is $102,000.  It does have some volatility but here is the performance report from 2016 compared to the S&P500:

That comes to around 31% CAGR.  Very impressive to say the least.  What strategy do you use?  I've been trading options for 13 years now and I understand the basic concepts.  I make some money here and there using low risk covered puts/calls and OTM credit spreads, but nowhere near what you've accomplished.

Can you share any details on what/how you do it and any resources that I can look into?

[Roland of Gilead]

Can you share any details on what/how you do it and any resources that I can look into?

Back in 2001 when I first rolled over the $1700 from a tiny 401K of a previous employer I didn't really care that much about risking it, so I did a lot of individual stock option trading.  Believe it or not, Microsoft was one of my better plays back then.  It was during the dark times for Microsoft and I would play the fall earnings tanking and eventual Santa Claus rally.   Microsoft would drop to $22 a share around October and end up at $30 a share in Jan.  I would buy $25 Jan calls for about a dollar and got lucky a few times with 200% to 400% gains.   When I broke $10,000 I started playing it a bit safer and switched to trading Apple.  Having still not much money ($10k didn't buy you much Apple even when it was $300 a share pre split), I would do the poor man's covered call for leverage.  I would buy deep in the money Apple leaps (long dated call options) and sell closer out of the money calls against them.    It was great.  I would sometimes get to sell 4 or 5 calls before my leaps expired.  When I broke $70,000 I really started playing safe and diversified into oil stocks.   I then dropped down to $50k  :-)    I recovered, got totally out of oil, and am at an all time high because I bought some mining stocks when gold dropped to $1100 and they have rallied 100% and more in the past six months.   I am now out of mining stocks and have a major play in Gilead, having sold 10 Jan 2017 $80 puts for $6,100.

[StreetCat]

That's interesting Roland.  I mostly don't trade with individual stocks and their options.  I'm glad it is working well for you though.

[daverobev]

Well, I think I've talked myself out of doing this stuff for now. I'm trying to tidy up my portfolio somewhat (actually made a spreadsheet with what I have and in what sector, so I have a better picture of my asset allocation!). It's not perfect (perfect = 3 ETFs!). While I was checking a couple of things out, though, I came across:

http://www.bmo.com/gam/ca/advisor/products/etfs?locale=en-CA#fundUrl=%2FfundProfile%2FZWU
http://www.bmo.com/gam/ca/advisor/products/etfs?locale=en-CA#fundUrl=%2FfundProfile%2FZWB

and

http://www.bmo.com/gam/ca/advisor/products/etfs#fundUrl=%2FfundProfile%2FZPW

Anyone got any opinions on those? Particularly the last, I guess. I'm interested as to why it is "med to low" risk vs a total stock market one being "medium".

[shipskin]

It's very different.

Surely at least 50% of people must lose on calls, puts, options otherwise there would be no market.

It is just gambling, where the house will win in the end, except for a few who win through nothing but luck, and then try and make others think it is due to skill.

Real estate at least is a long term investment with a yield.   Not that I like it that much as an investment but it is not comparable to gambling.

If I write puts on a stock that I want to own anyways and write them with a short enough contract expiration (I try to stay between 30-60 days), I can actually calculate the probability of those shares being put to me. I regularly aim for <= 20% chance of shares being put, which means the house (me) wins 80% of the time and the other 20% of the time I lose, I actually don't end up losing because I wanted to own those shares in the first place.

[forummm]

It's very different.

Surely at least 50% of people must lose on calls, puts, options otherwise there would be no market.

It is just gambling, where the house will win in the end, except for a few who win through nothing but luck, and then try and make others think it is due to skill.

Real estate at least is a long term investment with a yield.   Not that I like it that much as an investment but it is not comparable to gambling.

If I write puts on a stock that I want to own anyways and write them with a short enough contract expiration (I try to stay between 30-60 days), I can actually calculate the probability of those shares being put to me. I regularly aim for <= 20% chance of shares being put, which means the house (me) wins 80% of the time and the other 20% of the time I lose, I actually don't end up losing because I wanted to own those shares in the first place.

What about when you wanted those shares but they go up in price and you never get them at the price you wanted? It's not free money. You are trading off risks and rewards.