Explore Your Options
| Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it on the STOCKS & COMMODITIES website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C. |
Tom Gentile of Optionetics |
S&P 500 INDEX OPTIONS SETTLEMENT
Are Standard & Poor's 500 ($SPX) options settled American-style or European-style? Can they be assigned or exercised before expiration?
S&P 500 options settle European-style, which means that they can only be exercised at expiration. In fact, most index options settle European-style. There are a few exceptions, however. For example, options on the S&P 100 ($OEX) settle American-style, and exercise or assignment can take place at any time prior to expiration.
Exchange-traded funds (ETFS) also settle American-style, as do stock options, which can be exercised at any time before expiration.
So traders who want to trade the S&P 500, but with options with American-style settlement, will trade options on the S&P 500 Spdrs (SPY) or "spiders," because the Spy is an exchange-traded fund. However, to avoid the risk of early assignment with strategies like credit spreads, it's sometimes better to use an index that settles European-style.
CAN I GET OUT?
I'm very new to options investing and am getting ready to make my first trade. If I buy an option to enter the trade and, after some time, want to exit the trade by selling (instead of exercising) the same option, would I always be able to do so?
For every options contract, there is a buyer and a seller. It is an agreement between two parties. However, there is not always a natural buyer or seller in the market when a trader wants to open or close a position. In those cases, the market maker will provide the market. They are liquidity providers of last resort. For that reason, yes, you will be able to close the position when you try to do so.
SELECTING CREDIT SPREADS
On a credit spread, how do you set up the short leg? Do you do it with high delta and high volatility? If so, why?
The credit spread generally involves the sale of a near-the-money or an at-the-money option [ATM] and the purchase of an out-of-the-money [OTM] option. It can be established with puts or calls. One of the reason the trade works is due to time decay. That is, the trade is established for a credit, which the trader will keep if both options expire worthless, but this will only happen if the stock moves in the desired direction.
For example, XYZ is trading for $50. I sell one July 50 call for $4 and buy one July 55 call for $1. I earn a credit of $3 a contract, or $300. If the stock stays at or below $50 by July expiration, both calls will expire worthless and I keep the credit. However, if the stock rallies above $50, the July 50 call will be in-the-money [ITM] and will probably be assigned at expiration. If the stock moves up to $55 at expiration, the long call expires worthless, but short call will probably be assigned. From that point forward, however, the long call becomes protection against a rally in the stock. That is, the July 55 call, which I purchased, will also move ITM if the stock rises above $55 a share. Without this option, the position would simply be a short or "naked" call option and subject to unlimited risk as the stock price moves higher.
In any event, the goal is for the calls to expire worthless and to keep the credit. If the stock moves higher, I will exit the spread or face the risk of assignment at expiration.
When looking for interesting credit spread trades, I focus on low delta and high implied volatility [IV]. High implied volatility tells you that the options are expensive and worth selling. The long option is there as protection and will also have high IV, but it will also have a much lower premium due to the fact that it is OTM. As a general rule, the higher the IV, the better the credit.
Delta tells you how much the value of the option changes for each change in the value of the stock. For example, a delta of 0.75 says that the value of a call will increase by 75 cents for each $1 change in the stock price. In-the-money options have higher deltas than OTM options. So in the credit spread, the short option has a higher delta than the long option.
However, if you do high delta credits with high volatility it defeats the purpose of taking advantage of the high IV. That is, there will not be enough of a difference between the IV of the short option and the long option because the delta is high, which also means both options are in-the-money. Instead, I use the ATM or slightly OTM on the short, and farther OTM on the protection, with 30 days to expiration.
WIRELESS TRADING
Can options only be traded via Internet/telephone, or do people trade using mobile phone Internet?
Most option traders today either use online trading or call their brokers to place option orders. However, several brokerage firms do provide a wireless trading capability. In short, in order to trade options with wireless Internet, you must first find a broker that supports this type of trading.
Originally published in the August 2005 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2005, Technical Analysis, Inc.
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