The list for Chicken Straddle Stocks
These stocks have shown big momentum to the upside, based on future projected earnings. These stocks are subjected to sharp sell off to the support signal. The support signal is the last signal line it has crossed since being identified by the harmonic stock screen. The way to profit from these momentum stocks are two fold. The best way to profit from these moves is to use options. The simplest approach would be to buy long call options that are in the money. The ideal call option would allow the owner of the call option to earn a 1 to 1 profit on any move higher with the stock. Since the move upward on these stocks, the option premium will be higher that a 1 to 1 ratio move on the stock. This is called Delta on the options. Delta is measured from 1 to 100 percent. A option with a delta of 100, would give you a 1 to 1 dollar ratio move with the stock's price. For example, if you are long call option for $2.00 on a stock xyz, if the price of the stock move upward $1.25, your option value would move upward $1.25 just like owning the stock. The downside of this of course, if the stock's price falls by $1.25, the value of the option would fall by the same $1.25 in value. The downside Vs. the upside potential of owning options is why people say owning options risky. The other risk factor of owning options is "time". Options expire the 3rd Friday of every month, and depending on the option you are buying, you will have "time" against you, since the clock is ticking toward expiration day. Time is call "Theta" , it is a decaying factor on all options. The Level 1 option account trader can use options for use a defined risks, you cannot loose more money that what you pay for the options. So in the example above, if the stock was priced at $27 like Vodafone, the most you could loose would be $2.00 on the call option you own. Unlike the stock holder, who may have bought Vodafone, and watched the stock plunge down to $22.00 a share overnight, loosing $5.00 per share. I know what your are thinking, "I have stops on all my stocks, so it couldn't fall like that!" Wrong, your stops are ineffective because they are triggered only after the first trade in the morning. So if your stop was placed at $25 a share, when the first trade in the morning starts off at $22 a share, your stops become market orders an are filled immediately. The Chicken Straddle Strategy was designed to prevent your losses by such unforeseen moves as these. Using my "chicken straddle" stock strategy you can actually make a profit with unforeseen moves!
Since I have had to re-install all programs on my computers, these options have been left unmanaged. Once the position is on, I have not issued an "audible" on what to do next. When I call an option audible, it will be designed to lock in profits and possibly to move to another option position to maximize the momentum move in the stock.
Option Review
There are options which allow you to profit from falling prices just like rising prices. These are called "put" options. Continuing with the example above with Vodafone, if you would have been long a put option at a strike price of $25 dollars, you would have made a profit on the opening gap in the morning, by closing your position or writing a spread at the next strike price lower. I will be covering spreads later on.
Now I have to introduce you to the term "strike price". The strike price is where the option could be exercised. Strike prices are set at $5.00 increments for all stocks above $25.00 and at each level below $25.00 at $2.50 for stocks trading below $25.00. The exception to this is if a stock has had a 2-1 or 3-1 stock split. When the stocks split, the number of options and strike prices split also. I hope you would download the free option toolbox read the tutorial for more detailed explanations.
The major purpose of why you are here is to make money, right? I can answer most questions you will have about options, since I have been trading them since 1997, when no one knew what an option was. There are more strategies for options than there are flavors at Baskin Robbins, so the purpose is to keep it simple and to make money.
I modified the simple chicken straddle strategy, for ease and simplicity, because there are more things in life than figuring out all the different strategies of trading options. I use options as a cheap stock substitute and for insurance against earnings warning and shortfalls. If you have been using my Harmonic Stock Clock signal lines, every stock that has crossed multiple signal lines have had an earnings warning or short falls when their prices break their upside momentum. A few stocks have had earning surprises to the upside, which causes their stocks to move higher, but the losers far outweigh the winners. Best Buy stock was the most recent crash to the red signal line after earnings shortfall.
Using options as a cheap, short term, and defined risks stock substitute, instead of buying a stock is the preferred method to profiting from these stocks.
Since you will be learning about options, I will define some of the terms you will need to know before you get involved in reading further.
Call option: The right, but not the obligation to buy the stock at the strike price or above.
Put option: The right, but not the obligation to sell a stock at the strike price or below the strike price.
In the Money: A call option is "in the money" if the stock price is higher than the call's strike price. For example, if you buy Google Jan $390 call option, it will be in the money because Google's stock price is higher, at $417 per share vs. the call's strike price of $390.
A put option is "in the money" if the strike price is higher than the price of the stock. For example, a $430 put option on Google is in the money because the put option's strike price is higher than the current price of Google's stock, at $417 a share.
Out of the money: When a call option's strike price is above the current stock price. A $430 Call option would be "out of the money" on Google, since the stock is currently trading at $417. An "out of the money" put option would have the put's strike price of $390, the stock's price is higher than the strike price of the put option.
I know It may sound confusing at first, draw a line down the center of a piece of paper. On the left side in the middle of the page, write call options. On the right side of the paper, across from the call options, write put options. Below the call options, draw a arrow downward toward the bottom and label it "in the money" strike prices. Draw an arrow upward from call options toward the top of the page and label it "out of the money" calls.
On the right side of the page below put options, draw and arrow downward and label it
"out of the money" strike prices. Above the put options, draw an arrow upward and label it
"in the money" strike prices.
Draw a horizontal line going across the page connecting calls and puts options. This horizontal line represents the current price of your favorite stock. The next strike price below the current stock's price for the call options are at the money. The other option strike prices below the current price are also "in the money options. All strike prices above the current stock's price on the call options side of the page are out of the money.
On the put options side of the page, the options just above current stock's price are "at the money options". All the put options strike prices above the current stock's price are "in the money" options. All the put options strike prices below the current price are "out of the money" put options. You should be able to draw a diagonal line connecting "in the money" for both puts and calls. Also a diagonal line could be drawn to "out of the money" options for both puts and calls. I hope that clears the semantics up, you can learn more from the options tool box program at the CBOE web site.
Exercised price: The price at which the option writer has to deliver the specified number of shares of the stock at the exercised price. Most option buyers and sellers use a "cash settlement" to close out their positions. The owner of a stock may write a covered call, the buyer of those options may want the number of shares of the stock instead of cash. If an option writer owns 1000 shares of xyz company, and writes, i.e. sells his rights of future appreciation to a buyer for an premium, his broker may assign the stock of xyz to the buyer. The writer of the options will receive the cash equivalent of exercised option's strike price for his stock, so both writer and buyer win. The option writer wins because he gets cash for the stock and he has capture a premium for holding onto the stock for that period of time. The buyer of the options win, because he assumes the risk of stock ownership at a guaranteed price when the options expire. The covered call option writer is receiving income for holding onto the stock immediately when he writes a covered call, whereas the option buyer is spending money. The option buyer is hoping that the stock will go up beyond the option's strike price for a big pay off.. The option writer, after the 3rd Friday, usually on Monday afternoon, will have either the cash or his stock in his portfolio if the option he wrote was not exercised..
I will be covering more in detail about option writing strategy, because most of you are holding onto stocks which have not moved over the last year. Writing covered calls is an excellent way to get paid for holding onto range bound or channeling stocks.
There are two more terms you need to learn, these are "Delta and Theta".
Delta: Delta is the change in option price with one unit change in the stock price. A unit, in the case of stock options, is one dollar. The higher the stock price moves toward being "in the money", the higher the "Delta" number will move toward 100. Delta can also be express in a percentage, 1% being the lowest and 100% being the highest on a theoretically scale. The same is true with put options, the closer prices move toward being in the money, the Delta will move upward toward 100. The delta's on a put and a call option with the same expiration month and strike price will have a combined delta of 100. For example, let's say the call option's on Jan $25 strike has a delta of 60%, then the corresponding delta on the Jan $25 strike put options have a delta of 40%. Same strike price, same month will always equal 100% . So, if you see a put option with a delta of 10%, what would be the delta on the call options with the same strike and expiration date? Answer: 90%
Theta: Theta is the expected change in option value per unit change in time remaining to expiration. This time decay is an important calculation for option buyers and writers. Theta, for the option buyers works negatively because the clock never stops. Theta for the option writer, allows him to charge a higher premium because of time. You heard of the phase, "time is money", right? Since options are composed of expectations and time, the longer the time frame, the greater the percentage of time is charged for the premiums. Options which are "out of the money" are composed of nothing more than "time" when pricing to a buyer and a small expectation that the stock may move higher based on recent volatility of the stock. As the volatility of a stock increases, so does the exptation of higher or lower prices. The harmonic heartbeat calculates the volatility of a stock for the short term.
Opening an Option Account
There are different type of options accounts that you can set up with your broker. Level 1
is simply buying calls and puts. Level 2 accounts are used for buying calls and puts and writing covered spreads. Level 2 accounts, are for writing covered positions. If you own a stock xyz, you could write covered call options, using your stock xyz as collateral if the option is exercise. Covered Call writing is safe enough to be use in a personal IRA trading account. You also can buy options and write covered position on the options you own, without ever having to tie up large amounts of capital. Your broker may have you put $2,000 on margin if you using writing covered spread options. If you own the stock, your stock is the margin requirement. Level 2 accounts let you write covered options, using options, which are called covered spreads. I like writing covered spreads for call options and for put options on the same stock, which creates multiple chances to earn income by owning theses options.
There are two types of spreads, both which require a margin account. One type called a debit spread, which you use your money to start the spread. The debit spread draws money from your trading account
The second type of spread is called a "credit spread", which you write an option collecting more premium than you spend to start the spread. The credit spread puts money into your account. I will be explaining only debit spreads for now it will be the easiest concept to learn first without having to deal with the margin requirements.
Level 3 accounts are for those who have enough cash and experience to write calls and puts "naked". Every option player's goal should be to achieve a Level 3 trading account status. When you have level 3 account status, you can write options using cash as collateral, instead buying stocks, or other options. The ability to write options without a "covering" is where the term "naked" trading comes from. At Level 3, you are "masters of the universe" in options, giving you the ability to create money at will simply by using time and your cash as collateral. You can "be the bookie" by writing the option contracts which are listed in the options market. A smart Level 3 option writer never loses completely, but covers his bets with a combination of buying and writing spreads to capture option premiums. His bank roll is the only limiting factor of writing options for other people to buy.
How can a Level 3 account option writer do this?
Since most options expire worthless, the option writer never has to cover most of his of his bets, he just collects the premiums from the option buyers. I know this may sound simplistic to experience option players, but it is essentially what happens in the option market.
When I say most options expire worthless, just pull up an option sheet on yahoo finance on your favorite stocks, you will see listing of strike prices around the stock's current price. Using the Yahoo finance page, choose in option view the "straddle display", so you can see all the calls option on one side and the puts on the other side. Scroll up and down the list, looking at the various price ranges of option contracts listed. Under the column called "open interest" are the number of contracts available for that strike price. Now all those call options who's strike prices are higher than the current stock price at expiration will be worthless. Look at all the call options below the current stock's price, these are the options he has to cover. The options above the stock's current price at expiration are not covered, and he gets to keep the premium for those options he sold. Just like a bookie, who gets to keep all the money if your team can't make it's point spread. Ah… now you understand the power of a Level 3 account. Conversely, all the puts strike prices that are below the current stock price will expire worthless also. Since the options expire worthless, it is not necessary for the option writer to cover the expiring out of the money options. The option writer gets to keep all the premium he has collected from the buy and hopeful buyers. The Level 3 option account writer is neutral most of the time, he makes money from the "Greeks". The "Greeks" are the Delta, Gamma, and Theta in options lingo. There are many other strategies he can use to offset any loses. You can witness this balancing act every month on Wed. thru Fri. There are some months which all these contracts expire, stock option, futures, bonds, commodities, called triple or quadruple witching day.
Level 1, the beginning option player can only buy calls and puts options with cash, which is debited from his account the same day in this electronic trading world. This means the level 1 option account has to spend money for an opportunity to make money. Most beginning option players buy options gambling on higher prices. They don't know how the game is played, and their inexperience is fodder for the Level 3 option writer. The level 1 option buyer rushes into the market buying call options based on some "new story" without the proper knowledge of technical analysis or understanding how options work in the market place. I have been there, at the beginning, buying options only, placing my bets on higher prices and few times on lower prices. The Wins and losses using this strategy is only about 30%, mainly due to the option buyer's greed. The level 1 option account buyer expects every option he buys to double or triple in price and they are sadly mistaken. The other reason most level 1 option account lose money is Theta, time decay. When you buy a stock option, the clock is ticking toward expiration and the stock has to move quickly. If you are buying call options, the stock has to move higher, if it goes lower, you could lose your entire option value. The call options could expire worthless for a 100% loss of the cash you paid for the option. The good news is, you cannot lose more than the cost you paid for the options.
For example, you want to buy Google's stock, but at $400 a share you can't buy many shares with $10,000. You could only buy 25 shares, not even a round lot of 100 shares. Google's stock price is currently at $417 a share for this example, and you see the $430 strike price on the call options are at $17 per contract. An option contract leverages 100 shares of any stock, so your total cost is $17 X 100 shares or $1700. To buy the equivalent of 100 shares of Google at $417, you would need $41,700 of cash or half , $20,850 if using a margin account.
However, you have a strong feeling that Google is going higher to $450 a share, as some people claim, at $417 a share is a bargain. Using the power of leverage, you are buying the Jan $430 call options, expecting the stock price to go higher. If you use $10,000 to buy these options, you could afford 5 contracts, giving you control of 500 shares of Google's stock, much better than owning the just a 25 shares. So you have two choices. #1. Spend $10K to buy 25 shares of stock, or #2. spend $1700 and control 100 shares till Jan. 20.
If the stock of Google moves higher to $430 a share, your option's value that you own will move higher. You could sell your option back to those in the market for a nice profit. If you bought 1 contract for $1700 on Google, you could possibly sell your option for $2500! Doing the math, buy for $17, sell for $25, net profit of $8.00 per contract. Multiply $8 X 100 shares would equal $800 profit. That is a return of over 40% on your $1700 investment in less than 1 month. You have also limited your downside risk to only losing $1700 if Google's price fails to move higher or if the price falls to below $400. To loose the same amount of money on 25 shares ($10,000) of Google, the stock would have to drop $68 a share. Could that happen? Sure, with other negative news, Google's stock price could drop that much. What if the price of Google's stock mover higher by $68 a share? Using the "Delta" of the Jan $430 strike price, which is at 41%, so $68 X .41= $27 plus what you paid for the option. Now this is just a quick calculation, because Google's stock price would be above the $430 strike price. Also the "Delta" would be closer to 100% at some point in time. If Google's zooms to $500 dollars, because they will announce a stock split, (don't tell anyone) you have unlimited profit potential by owning the stock. The profit potential for owning the options are unlimited until expiration day in January. Your little $1700 option contract could be worth $30, $40, $50 or more per contract.
I remember my first call options I bought, I doubled my money in 24 hours. I bought my second option contracts on a company called Phillip Morris, spent $1400 to buy call options. Just 3 weeks later, the stock split 3-1, so did my 10 call options, now I had 30 contracts instead of 10. I sold 30 contracts for $3.25, net profit of $8350 on $1400 investment.
The key to finding these is have an experience mentor and when I started out, very few people knew much about options, including my broker on Wall Street. My goal is to help you avoid those painful lessons, but I didn't have someone to help me, I have learned my lessons the hard way, with my hard earned money. I learned there are more strategies than simply buying, which is like a placing a bet with your bookie. Hence the need for you to have Level 2 option trading account.
The effects of Delta
Here is where people's expectations come into play with the options. Using Google's $430 Jan. call option , the cost of $17 is composed of time and the price difference of the option's strike price at $430. The difference in stock price and the option's strike price is a mere $13 dollars. If the current Delta on Google's Jan. $430 stock option is at 40%, means that for ever dollar gain or loss in the stock price of Google, your option value would move up or down 40 cents. As the stock price increases toward $430 strike price, the Delta on that option will move higher also. The Delta on the $430 stock option will move closer to 100%, matching or exceeding a 1 to 1 ratio, which is like owning 100 shares of the stock. When the Delta is 100%, there will be a 1 to 1 move in option prices mirroring the stock price movement.
The Delta on an option is composed of peoples expectation of the stock going higher and within the time frame till expiration of the option in January. This combination of price expectation and time can be defined in the option's cost, which is reflected in the "premium" cost of the option.
When you buy or sell something, there is premium for ownership, just like buying a stock, people bid the stock higher based on expectation of future growth of dividends or earnings. Stocks have a premium built into the price of each stock, whereas options separate expectation and the "time" into the components of time and expectation This is how options are defined, by time and by price expectation of the future. As prices move higher for call options, Delta become more price expectations rather than time dependent expectations. We can quantify the difference in time and price expectation by separating the difference by analysis of the options. For example, the current price of Google is $417 and the Jan $430 call options has $13 price differential, right? $430-$417= $13. Since the option is not yet in the money, the whole premium is based on time and people's expectations. Let's look at a in the money option at $390 strike for Jan. The price is at $38 dollars for the Jan. $390 call strike price. Subtract $417-$390= $27 dollars. The remaining difference of the option price of $38-$27= $11 dollars, of Theta, time value. You can assume, that every option in the money has and $11 in time, (Theta) factored into the option premium. Last week, you could have sold that $11 of time and as January's expiration moves closer, the $11 of time, (theta) would melt away to nothing. Theta calculates the effect of time decay on the option. Let's look at the option spread on Google.
Analysis of the Google Spread
Looking over the last month, at the Google spread options we wrote on Nov 8, you can see the following. Jan $390 calls for $24.90, write $430 calls for 11.6, total cost for spread was $1300. Google current stock price at the time was $390 a share. The audible on Google's stock is to first buy the call options when the price is dropping below the green Harmonic Stock Clock signal line. The next step is to wait till the price move up higher, then write a covered call like the $430 strike in the same month of Jan. like in the illustration.
The other strategy is to open the spread and close out the spread every time you have profit of $600-$800 as these weeks have shown.
See what has happened over the last month
Last week on the 12-3, the stock price was at $417 per share, up $27 from where we did the spread on 11-8-2005. Last week on 12-3, Google's stock price had moved up $27 dollars, and the Jan. $390 call option moved up to $38. The previous price was $24.90, so $38 -24.90= $13.10. The Delta on Google's $390 call options are at 80%, so these options should have moved 80% of the $27 dollar stock move, right? The options only moved up 50% of the $27 stock price. So what happened to the rest of the move? Time decay, Theta, decreased the options value with the passage of time. Remember the $11 of time that was factored into the cost of the $390 options?
How much did Theta cost on the options. An 80% Delta move of $27 dollars should be reflected in the options price $27 X .80= $21.60. However, the actual move of the option was $21.60 -$13.10= $8.5 for Theta. There is a loss of $11-$8.5= $2.50 in a time premium. I know this may sound complicated, so review the chapters in the Option Toolbox concerning time decay. Please, review the section called "Principal Factors Affecting an Option's price"
Since this was an originally just a covered spread, you can see the advantage of doing spreads, first the costs are cheaper, than just buying 1 call options and holding to get a higher price. For the cost of one contract for the Jan. $390 call options, we could have done two contracts spreads for $2600.When given a choice of costs, more contracts are always better than fewer because of leverage.
11-8-2005 spread entry
Jan $390 call buy for $24.90
Jan $430 call sell for $11.60
Spread total cost was $1300
12-3-2005
Jan $390 strike buy for $38,
Jan $430 strike write for $17.
Total spread value was $2100.
Net profit if we close both positions out this week $800.
Now look at the options prices on 12-13-2005
Jan $390 strike price is at $35
Jan $430 strike write is at $12.9
Total buy back of the spread= $2200
Net profit if we close the positions is $900
Notice how the in the money calls at $390 oscillated between $38 and $24 over the last three weeks? Now, the out of the money calls have oscillated also, between $17 and $11 a share.
Now, let's look at the numbers again, this time we are just going to buy Jan $390 call options for $24.90
11-8-2005
Jan $390 call for $24.90.
Total cost $2490.00
12-3-2005
Jan $390 call price is $38
If we just sold the Jan $390 call option at $38- $24.90 = $13 profit.
However, we see the Jan $430 call options are sell for $17!
Now if we are going to sell something, wouldn't it make more sense to sell something for a higher price? So we write a Jan $430 call option for $17, or $17 X 100= $1700
12-13-200
Jan $390 call options is at $35
Jan $430 call option is at 12.9
Now, if we buy an offsetting option we could look in profit of $17-12.9= $400
This is reflected in the price differential of the spread anyway $35-12.9.= $22
Looking at the harmonic stock clock signal lines, Google's stock is on the green
and yellow signal lines. Depending on Google's stock opening, you could close out the whole position for $2200 profit or if you feel Google's stock will stay above $390 till January, you could wait and buy the $430 options you sold at a cheaper price. Decision, decisions, with options. You could also wait until the Jan $390 call option's value falls to $25 a contract, then close out the entire spread. Either way, you will have made a profit by writing the spread. Remember, a bird in the hand with options, by selling the cover spread, you have made another $400 along with the $1700. There are many more "options strategies" to use depending on your option account level.
Summary
When you write a spread, you want to sell high, at $17, then buy them back for $11- $12 a contract. Looking at Google's stock price, you can see this offers an opportunity to make $500-$600 for the $430 out of the money calls. Sell price $ 17-$12 = $5 per contract. You are always covered when buying the option back at a cheaper price, so you never have to worry about a sudden surge upward over night. Now if you are able to write a covered spread and buy them back at a cheaper price 2-3 times over the life of this spread, you will have earned 100% of your cost for the spread. The next time Google's stock moves up above $430 or higher, you could close the position with all the gains that have accumulated from the higher prices of Google as it moves higher. Last week, the $390 call option was going for $3500.
If we are doing a chicken straddle spread, then we would buy first the puts and calls for the straddle. Next, after price movement up or down, then you write a spread on the higher premium, either puts or calls. The concept here is to look at the oscillating prices over these last weeks, and if this would have been entered into as a straddle, we could have cover calls and covered puts on the price oscillations.
The important point to remember is that if you are a buyer of options time, Theta, is against you. Since Theta is decreasing, the value of your option is also decreasing a little bit each day. Theta's decay eventually goes to zero, hypothetically, and all you are left with is the value of your option based upon the stock's price. If the stock is above your call's strike price, hypothetically, there is a 1 to relationship and the Delta is at 100%. This hypothetically, happens on option expiration day, that is why there are wild fluctuation on "Triple or Quadruple expiration day" in the market. All these derivatives are expiring, and the price moves are fast and furious with Level 3 accounts covering their losses and locking in their profits. While the Level 1 players trying to balance their gains and losses.
Hope this help you understand there are many more choices with options than with simple stock ownership. Options are a powerful profit tool and you should use them to maximize your profits.
God Bless
Doc
@www.HarmonicStock Clock.com 2005
|
