Trading Foreign Options: Rules of the Game

[scandal 951]

This will likely interest only a very small number of people on this forum (mawilson, maybe one or two others?) . It is a long article, and quite old (2004). It is, however, the best summary I've yet found of the specific regulations that prevent trading in certain foreign options but not others by US residents. We hit this restriction all the time at our firm and I've never been entirely clear on why we can trade Euribor and short sterling options, and we can trade FTSE and CAC futures, but we can't trade FTSE or CAC options. Now I know. Read this, and you will too.

Trading Foreign Options: Rules of the Game

by Anthony Leitner and Edward Rosen

The hypothetical scenario described in this article is intended to illustrate some of the differences between the two regimes in the United States that regulate trading in foreign listed options. For reasons of space, the discussion only touches the high points of these differences.

Mary Jane is an investment adviser registered with the Securities and Exchange Commission and a commodity trading advisor registered with the Commodity Futures Trading Commission. She manages money for a large pension fund and for several very wealthy investors.

To diversify her clients’ investments she acquired a portfolio of European stocks and bonds. She now believes that European interest rates will rise over the short term, causing the value of the bond portfolio to fall. She decides to use options to hedge the interest rate risk in the bond portfolio. She also feels that since stocks in the portfolio generally are likely to trade in a narrow range, it would be a good time to sell out-of-the-money call options to enhance the income of the stock portfolio. She is also considering buying call options on certain of her foreign stocks that she believes will outperform the portfolio.

She sees that the Euronext.liffe exchange in London offers options on the Euribor futures contract and on the London-traded stocks in her clients’ portfolios. She also sees that the Eurex exchange in Frankfurt offers equity options. She calls Ted, a broker at the broker-dealer that helped her acquire her portfolio, to discuss her order. Ted tells her that, as a futures commission merchant, his firm would be happy to open futures accounts for her clients, and in these accounts she can trade Euribor options. But he will have to preclear with his legal or compliance departments whether his firm can execute the equity option trades for her clients on Euronext.liffe and Eurex.

The equity options, he informs her, will have to be booked in securities accounts. Any margin required for the derivatives will be computed and collected separately in each account, without any netting between the accounts.

She is not happy, and asks why it is so complicated to trade these options. Knowing he is out of his depth, Ted conferences in Bob, his in-house lawyer. Bob immediately thinks "Oh no, not again!" but agrees to try and answer Mary Jane’s questions.

"Mary Jane, the simple answer is that the Euribor options are products regulated by the Commodity Futures Trading Commission and equity options are securities regulated by the Securities and Exchange Commission," Bob explains. "The governing laws and regulatory schemes have taken very different approaches to these two types of options products and the foreign exchanges on which they trade. These differences affect whether and how U. S. investors and their brokers can access these foreign products.

"We can offer you direct trading in foreign listed options on interest rate futures because they are exclusively regulated under the Commodity Exchange Act and neither the CEA nor CFTC rules restrict a U.S. FCM from offering these products to U.S. clients. On the other hand, the CFTC has no jurisdiction over options on securities or equity indices. The SEC has jurisdiction over these products, so the federal and state securities laws apply."

Mary Jane is curious. "Bob, I just don’t understand why this is so. Options are exchange products. Aren’t all foreign exchanges treated the same?"

"Unfortunately no," Bob replies. "The CFTC has taken a number of steps that make it easier for U.S. investors to trade foreign futures and options, and has allowed a number of foreign exchanges to promote certain of their products to U.S. investors. The CFTC also has granted permission to several foreign exchanges to make their trading systems available in the U.S. Eurex, then known as DTB, was granted this right in 1996, and Euronext.liffe, then Liffe, in 1999. That makes it easy for our firm to execute your Euribor options order because we have Liffe’s trading terminals right here in Chicago and you can even place your orders electronically from your own office.

"It’s a very different situation for equity options. The federal securities laws regulate not only the exchanges that promote the trading of these products to U.S. investors but also the offer and sale in the U.S. of any product that is a security—and options on securities and equity index options are securities. So if foreign exchanges want to promote their equity options products to U.S. investors, they face having to register as exchanges with the SEC. No foreign exchange—as far as I know—has registered with the SEC. In addition, they have to either register the offer of options or find an exemption from that requirement."

"Wait a minute, Bob," says Mary Jane, "I’ve heard that some foreign exchanges have gotten permission from the SEC to sell equity options in the U.S."

"You’re right, Mary Jane," Bob replies. "The SEC’s Division of Market Regulation granted no-action letters to several foreign options exchanges relieving them from the exchange registration requirement. Euronext.liffe obtained a no-action letter but Eurex has not. These letters establish a number of conditions. For example, the division allowed the exchanges and their members to make available information about themselves, their clearinghouses and their products to eligible investors, which the SEC defines as QIBs, but only if they have prior experience in trading options. The exchanges also may allow their members to accept orders from QIBs, but they are required to send their own options disclosure statement to the QIBs before their members can take an order."

"What is a QIB?" asks Mary Jane.

"A QIB is a ‘qualified institutional buyer’ defined in SEC Rule 144A and includes a range of institutional investors, such as mutual funds, insurance companies, pension funds and trusts, that own and invest at least $100 million in securities. As a registered investment adviser you qualify if you manage at least $100 million in securities, but each account for which you trade options must also be a QIB. Unfortunately, individual investors don’t qualify as a QIB no matter how rich or experienced they are," Bob explains.

"Well, I guess I personally qualify, and the pension fund I manage has more than $100 million in securities, but the rest of my clients are wealthy individuals," replies Mary Jane. "Does that mean I can’t even use options for conservative strategies like writing covered calls or hedging with put options for my individual clients?"

"Unfortunately, you’re right, that won’t work under the no-action letters," Bob answers.

Mary Jane is stunned. "Let me get this straight. If I happened to be a professional options trader with a net worth of $10 million, I can’t trade the foreign equity options for my own account? Even Warren Buffet can’t trade foreign equity options? Not even as a hedge?"

"That’s right, at least not under the no-action letters," Bob replies. "But keep in mind that the SEC doesn’t actually forbid U.S. investors from trading. The SEC simply insists that the foreign exchanges must make sure that when their members take orders from U.S. investors, those orders are coming only from QIBs. But the result is the same if everyone is abiding by the terms of the letters.

"You could consider trading options for your high net worth clients in the over-the-counter market as an alternative. Of course, OTC options raise a number of additional considerations. We would have to set up additional documentation and you would have to consider a number of issues such as credit and liquidity risk."

Mary Jane is exasperated. "Why has the SEC made it so difficult for me to trade foreign equity options for my high-net worth clients?"

"That’s a tough question," Bob responds. "I guess that one of the reasons the SEC used the institutional QIB approach was to avoid undercutting the policies underlying the federal securities laws. As I said before, unlike the CFTC, the SEC regulates the offer and sale of options and of the equity security underlying the option. Specifically, the offer and sale of any security to a U.S. person is regulated by the Securities Act of 1933, as amended. This law basically requires that the offer and sale to the public of any security must be done pursuant to a registration statement that the SEC declares effective, and a prospectus must be delivered to purchasers before the trade unless there is an exemption available.

"Yes, but you were able to execute my trades in foreign stocks and bonds. How is that different from foreign options?" Mary Jane asks.

"We were able to sell the foreign stocks and bonds in your portfolio because none of these were involved in a distribution at the time and exemptions from registration were available. But options are unusual animals. The SEC considers that options are ‘continuously offered.’ With respect to options traded on U.S. exchanges, the SEC dealt with that by adopting a rule under which the Options Clearing Corp is considered the issuer of every option and the OCC’s Options Disclosure Statement is considered to be in the nature of a prospectus.

"Foreign exchanges have not sought to register their options. Thus, the risk disclosure statement that must be delivered to potential U.S. investors under the no-action letters does not have the same status as the OCC Risk Disclosure Statement. That means that for purposes of the Securities Act, anyone offering or selling these options to you must rely on an exemption from registration."

"So what you are saying is that you need an exemption in order to offer foreign equity options to me?" Mary Jane asks.

"That’s right. Rule 144A is a limited exemption from registration that allows securities to be offered to QIBs as long as the securities are not being offered in a public distribution. Our firm is prepared to rely on Rule 144A to trade foreign index options for the accounts that are QIBs.

"There is, however, an additional issue for single stock options. The SEC has said that options are deemed the equivalent of a purchase (long call, short put) or a sale (short call, long put) of the underlying security. That means that we need an exemption from the registration requirements for both the sale of the option and for the sale of the underlying security.

"Accordingly, there may be times when our firm must restrict your options trading because our firm is engaged in an investment banking transaction with the issuer of that stock. This is no different than when we restrict trading in a stock and its options in the U.S."

"If your firm restricts my trading in an option, I can just go to a broker in London to place my order, right?" asks Mary Jane.

Bob, grimacing, answers, "Mary Jane, I can’t tell you what a broker in London will or won’t do, but technically the foreign exchanges agreed in their representations to the SEC, and their no-action letters are based upon, undertakings that any actual options transactions will be done pursuant to SEC rule 15a-6 and in conformity with other applicable U.S. securities laws. That rule generally requires that these trades be effected through a U.S. broker acting as agent for the foreign broker. So unless the foreign broker considered your order to be completely unsolicited, the foreign broker would still need to go through a U.S. broker to accept your equity option orders.

"The CFTC’s rules here are quite different. Under Part 30, the CFTC has recognized ‘comparable’ regulatory regimes and doing so has allowed foreign FCMs to deal directly with futures customers in the U.S."

"So I pay two commissions for an equity option trade and just one for a Euribor trade?" asks Mary Jane.

"That’s correct," says Bob. "The SEC has specifically prohibited foreign exchanges from putting their trading screens in the U.S., so our firm has to send your order to our London affiliate for execution and that will add costs to the transaction. European regulators have asked the SEC to allow them to put their trading screens here but have not been successful. But, as I said before, the CFTC allows us to have direct access to Liffe’s futures and options on futures so you pay one commission."

Totally exasperated, Mary Jane says, "Well maybe I’ll just trade the single stock futures that Liffe offers."

"Ummm," says Bob, wishing this was over. "It’s true that the Commodity Futures Modernization Act removed the prohibition against trading single stock futures in the U.S., but foreign single stock futures, and narrow-based index futures for that matter, are still prohibited. Nobody is supposed to sell these to you."

"I still don’t understand. Why does the SEC make it so difficult for U.S. investors to manage the risks on their foreign equity portfolios and take advantage of listed products that have an active market?"

"There are a number of policy reasons that inform the SEC’s views," Bob explains. "These include accounting disclosure for foreign issuers, general disclosure and anti-fraud concerns and investor protection. While there may be alternatives to the current state of affairs, the SEC has a lot on its plate right now, and the fact is that because they aren’t under pressure from people like you to address these rules they have no incentive to move the bar."

"Thanks, Bob," Mary Jane replies. "Unfortunately, I also have more pressing issues than lobbying the SEC on foreign stock options. I’ll follow up with Ted, or maybe I’ll just move to London!"

Limited Access

The foreign exchanges listed below have received no-action letters from the Securities and Exchange Commission, under which they and their members may offer option products to "qualified institutional buyers" (a term defined in SEC Rule 144A) in the U.S.

EDX London and OM London Exchange Oct. 23, 2003

Tokyo Stock Exchange Nov. 15, 2002

Paris Bourse Dec. 6, 1999

Tokyo Stock Exchange Jul. 27, 1999

Osaka Securities Exchange Jul. 23, 1999

Monep Oct. 26, 1998

Borsa Italiana Sep. 1, 1998

Société de Compensation des Marches Conditionnels Jun. 17, 1996

London Internat’l Financial Futures and Options Exchange Mar. 6, 1996

Hong Kong Futures Exchange Sep. 26, 1995

London International Financial Futures Exchange May 1, 1992

London Traded Options Market Oct. 30, 1990

Source: Cleary, Gottlieb, Steen & Hamilton

[Tim/Mav 305]

I don't suggest anyone enter the Markets on a Bullish trade but, think Bear. Buy Puts if you wish to enter but, I would stay away from the Market UNLESS ... Think Commodities. Food, Oil. .. These will go up in time and you see it happening every week when you shop for food and buy gas to get their.

Your Post was Long Scandel. But, true. Hell no I did'nt read it all. I know what it says. Were Doomed...

The Stock Market is not designed for a everyday person. Is there a potential for profit ? Yes, but not for beginners. You will loose everything.

Forex trading is getting popular by people trying to get rich fast and despare. DO not do this. The RISK is High.

Your profits will be much higher putting an advertisement on Craigslist and buy Gold and Silver and have physical possesion. THAT IS STRONGER THAN THE DOLLAR.

Stay away from the Markets if you don't understand it. Just the Broker Fees will breck you.

(Yes, Former Stockbroker with a Currupt Firm) Get it

[Usui Takumi 1,562]

I don't suggest anyone enter the Markets on a Bullish trade but, think Bear. Buy Puts if you wish to enter but, I would stay away from the Market UNLESS ... Think Commodities. Food, Oil. .. These will go up in time and you see it happening every week when you shop for food and buy gas to get their.

Your Post was Long Scandel. But, true. Hell no I did'nt read it all. I know what it says. Were Doomed...

The Stock Market is not designed for a everyday person. Is there a potential for profit ? Yes, but not for beginners. You will loose everything.

Forex trading is getting popular by people trying to get rich fast and despare. DO not do this. The RISK is High.

Your profits will be much higher putting an advertisement on Craigslist and buy Gold and Silver and have physical possesion. THAT IS STRONGER THAN THE DOLLAR.

Stay away from the Markets if you don't understand it. Just the Broker Fees will breck you.

(Yes, Former Stockbroker with a Currupt Firm) Get it

?

[mawilson 2,133]

?

[Tim/Mav 305]

Like Scandel Said: If you don't UNDERSTAND the Lingo of Investments/trading. Then this post is not for you.

So, your QUESTION Marks indicate to me you should have never replied though I did not take that as a insult but a mark of: Do some Homework on the Stockmarkets and give a Intelligent reply.

Markets 101: Bullish - Make money when the Price Increases

Bearish - Stock looses money (Though you can make money if you purchased a Put)

Whats a Put and a Call? LOL Again, Like Scandel said. Only certain members can understand but in fact: It affects your life and family everyday.

So, don't tread on me

[웃 910]

Like Scandel Said: If you don't UNDERSTAND the Lingo of Investments/trading. Then this post is not for you.

So, your QUESTION Marks indicate to me you should have never replied though I did not take that as a insult but a mark of: Do some Homework on the Stockmarkets and give a Intelligent reply.

Markets 101: Bullish - Make money when the Price Increases

Bearish - Stock looses money (Though you can make money if you purchased a Put)

Whats a Put and a Call? LOL Again, Like Scandel said. Only certain members can understand but in fact: It affects your life and family everyday.

So, don't tread on me

Double ?

Edited November 12, 2011 by Lord Infamous

[Tim/Mav 305]

How RICH would you be TODAY if:

You bought Wal-Mart when it became OTC (Over-the Counter)

Mary-Kay when it was OTC

Intel

Microsoft

Opportunities deserve a good look but Americans are sceptic but Japan is not. They sponsor US start-ups

[scandal 951]

Your Post was Long Scandel. But, true. Hell no I did'nt read it all. I know what it says. Were Doomed...

Oh is that what it said?

I didn't thin it had anything to do with Doom, but what do I know?

Actually what I thought it said was that the CFTC has reasonable rules for Americans buying,say, STIR options but that the SEC has bizarre obstructionist rules preventing the trading of FTSE options. Both are listed on LIFFE, both are centrally cleared. The weirdest thing is they'll let you trade these options OTC without an exchange clearinghouse but not on the regulated LIFFE market where you can trade metals, Euribors, anything CFTC regulated.

The whole thing is warped. The SEC needs to get a grip. Maybe we should elect Rick Perry and have him dissolve the SEC and replace it with the CFTC.

[웃 910]

Like Scandel Said: If you don't UNDERSTAND the Lingo of Investments/trading. Then this post is not for you.

So, your QUESTION Marks indicate to me you should have never replied though I did not take that as a insult but a mark of: Do some Homework on the Stockmarkets and give a Intelligent reply.

Markets 101: Bullish - Make money when the Price Increases

Bearish - Stock looses money (Though you can make money if you purchased a Put)

Whats a Put and a Call? LOL Again, Like Scandel said. Only certain members can understand but in fact: It affects your life and family everyday.

So, don't tread on me

Options 101:

Credit Spreads

Basics

Credit spreads have a maximum profit potential.

Credit Spreads require level 3 options trading authority

Tip: If you think the stock is going to make a dramatic move up, you would be better playing a long call

But what is really cool is that you can make money with a credit spread even if the stock stays flat and may even take a small profit even if it goes down only a little bit

Spreads have a max loss potential

Spreads have a max profit potential

When playing options, you should ALWAYS have your stop set as soon as you place your order

The are two different types of Credit Spreads

Bull Put

i. Bull Put= stock should be trending up or at least sideways

ii. So the same rules would apply to playing a bull put spread as if you were buying a bullish stock (You would want to enter the trade at support and exit at resistance)

iii. You will most likely achieve the max profit in a Bull Put spread if the stock is trending up.

iv. Because one of the two positions in a bull put spread is naked, you should enter the long side first

v. You can then enter the short side without needing naked option writing approval

vi. many platforms allow you to make a single credit spread now where both are executed simultaneously

How to play a Bull Put spread

Buy

a put on a bullish stock, with a strike price below the current trading price of the stock.

Sell a put on the same stock with a strike price above the strike price that you bought the first put.

Example

a) Lets say a stock is bouncing off support at $54

b) You buy the 50 put and sell the 55 puts

c) When you buy the 50 puts- you pay .25

d) When you sell the puts at 55 you bring in 2.50

e) 2.50-.25=2.25/sh

f) Your max profit is your credit, so the max profit=225/contract

g) Max Loss = Difference between the spread less the net credit

h) 55-50=5.00

i) 5.00-2.25=$2.75/sh or -$275.00 /contract

j) If the stock closes 55.50 on exp date

i. Both puts expire worthless

ii. and you keep max gain of 225/contract

k) If the stock closes at 35

i. You would assume the max loss of $ 275/contract

l) The reason you get max gain is because both options expire worthless= $0.00 in commissions

m) Breakeven= Higher Strike price - Net credit= 55.00- 2.25=$52.75 assuming all options are worth their intrinsic value at expiration.

How to exit a trade early because we have made a profit

a) When we exit early, we have to physically close the trades=commissions

b) So let’s say the stock we spread traded is sitting at 55.00 within two weeks to expiration.

c) Now we have a profit, and even though it isn’t max profit we still grabbed 35-50% of our max profit

d) We should look to exit because the risk reward ratio starts to turn against us

e) We are holding something that might bring another 10-15% more but holding 50% gain to make that 10 –15%gain

f) I am not willing to give up a gain for the small added value it would bring

g) We entered the spread with a 2.25 credit, and we want out

a. so we buy back the $55 put and

it

costs

us $1.00 ($1 is the ask price we bought the $55.00 put we sold earlier)

b. and we sell the $50 put for +.15

c. this gives us a profit of 1.40 or 140/contract

$2.25 - $1.00 +$0.15= $1.40/sh or $140/contract

Bear Call

i. Bear Call Credit spread=Stock should be trending flat to down

ii. You want to enter when the stock is bouncing off resistance (just as if you were shorting a stock)

How to play a Bear Call

1. You Buy a call above the current

share

price

2. And you sell a call below the strike price you bought.

3. This will bring a credit into your account, just like the bull put spread did

Example

1. imaginary stock ZILL is trading at 76.00/share

2. You buy the $80 call for -.50

3. You sell the $75 call for 3.00

4. Net credit= 3.00-.50=2.50

5. Net credit is you MAX GAIN= 2.50

6. Assume ZILL drops dramatically to 60 on exp date, you would get the max gain.

7. MAX LOSS= Difference between the Strike Prices-Net Credit

8. max loss=$250/contract 80 – 75 =5 – 2.50 = 2.50/sh

9. Breakeven= Lower Strike Price+credit recieved= 75+2.50=$77.50 assuming all options are worth their intrinsic values at expiration.

Debit Spreads

1. Basics

a. These are very similar to credit spreads with a couple of exceptions

i. In a debit spread we pay out $$$$$$ first and collect after the trade is closed

ii. You buy a higher priced option while simultaneously selling a lower priced option

iii. Some debit spreads must be closed manually by expiration date.

2. Bull Call

a. Bull Call spreads allow you to make money on stocks that are trending up or remain sideways.

b. We enter the trade on a bounce off support and exit at resistance or exit once we make our spread profitable

c. The max profit is equal to the spread between the two strike prices minus the initial debit

d. Select an expiration date of 20-40 days away.

e. As a rule, if the maximum profit potential is at least 30% to 50% of the maximum loss potential, the spread is acceptable. To determine the Return on an investment you divide the maximum potential profit and divide it by the nest debit (max potential loss).

f. When volatility rises, buying an out of the money spread may be less attractive because premiums are higher.

g. You would attain the max profit at expiration if the stock closes above the sell call strike price ($37 in example below).

h. An out of the money spread unlike a bull put spread will only be profitable if the underlying stock price increases. Conservative investors should buy In The Money options. Aggressive investors should buy Out of the Money options.

i. The max profit would be the difference between the strike prices less the net debit.

j. If the stock closes in between the strike prices, you must exit the In The Money call manually. Do not expect your

broker

to sell your in the money option on expiration date

k. The max loss is the net debit

l. You can also exit early if your profit target has been reached

m. Assume the stock rises to 36.80 with a week or two until expiration (see example below)

i. The differences in the long and short call premiums will have changed

ii. We would buy back the 37.00 call for -.0.10

iii. And we would sell the 36.00 call for +0.85

iv. or a profit of .10

v. or 10.00/contract

vi. -.65 +.85 -.10=.10

How to Play a Bull Call Debit Spread.

If you cannot do this trade as a single transaction, always enter the BUY (LONG) side before selling the call.

1. We sell a call above the current trading price

2. We buy a call below the strike you sold

3. ENTER THE BUY FIRST OR YOU ARE NAKED

4. ALWAYS ENTER THE LONG SIDE FIRST

Example

1. Current stock price is at $36.70

2. We sell a 37 call for .20

3. We Buy a 36 call for -.85

4. This results in a -.65/share debit, or -$65 per contract

5. Max profit = 36 – 37 = 1, 1-.65 = .35 or 35/ per contract. Max profit occurs when the stock closes above the 37 strike price on expiration. Both calls expire in the money.

6. Max loss = 65/ contract= Net Debit

7. Assume Stock is at $34 on expiration date…

a. Both calls expire worthless and you assume max loss

8. To determine the breakeven point, take the net debit, multiply it by –1 and add it to the lower strike price.

In this case:

-.65 x –1= .65.

36.00 + .65=36.65

Exiting the Spread

1.Same Day Substitution- his describes the process that takes place when the option buyer exercises the short option, causing your broker to immediately exercise the long option to offset your obligation in the trade. This means you wil not have to buy the stock. Your broker will automatically liquidate your position. Always contact your broker prior to playing credit spreads to make sure they offer same day substitution.

2.If the stock closes through the spread (above the higher strike price) on expiration date, both calls will expire In The Money and you will achieve max profit and will need to take no other action if your broker offers same day substitution.

3. If on expiration date the stock closes between the two strike prices, the spread could break even or even be slightly profitable.

Bull Call Spread Review

*Find optionable stocks in a bullish to neutral trend with good fundamentals

* Conduct TA on those stocks. Concentrate on support and resistance.

*Buy a

call

option

option (either in or out of the money) with a strike price close to the current trading price of the stock. Then sell a call with a strike price above the strike price that is higher than the call you purchased. This transaction will create a debt. An extremely bullish investor would buy the call with a strike price above the current trading price of the stock.

*Enter the spread with a “buy to open” for the call with the lower strike price and a “sell to open” for the call with the higher strike price. If possible, enter the trade as a single position instead of legging into the trade one side at a time.

*Monitor the trade daily. Watch the price of the stock. If it drops unexpectedly, consider exiting the trade.

*Exit the spread by entering a “But to Close” order to exit the short call and a “sell to Close” order to exit the long call, by letting both options expire worthless, or by allowing the spread to be exercised.

Bear Put Debit Spreads

you sell call at a strike above the current trading price

you buy a call below the strike price you bought

:the stock should be trending UP or at least sideways

we are talking vertical spreads

You play a vertical spread for 20-40 days

its a short term trade

Bear = trending down

With a spread, you can make a profit even if the stock trends sideways

And may even break even if it the stock moves up a small amount

You would use a Bear Put spread in the same conditions you would play a

long Put.

: You would want to enter the trade at a bounce off resistance or a break of

Remember with any spread, one side of the trade is SHORTor NAKED

So you should ALWAYS enter the trade on the Long Side(Buy) first if you use

a single entry platform

You can then enter on the Short (Sell) side without needing Naked Option

Writing approval

The Long side will COVER the short side if the contract is assigned

unexpectedly

You can use spread stategies in any market condition, but remember, if you

are expecting your stock to move violently in either direction, you may be better off playing straight

calls or puts

How to Play a Bear Put Spread:

You buy a Put option on a bearish stock. This option should have a strike price that is higher than the strike price of the Put that will be sold in the next stepThen you sell a Put option with a strike price that is lower than the current trading price of the underlying stock.

example

Stock price= 49.12

Buy a put for 50.00 = -2.10

Sell a 47.50 Put= +.85

Net Debit= -$1.25/share or -$125.00/contract 2.10- .85= 1.25

Max Profit Potential= Difference between the spread minus the initial net debit

50.00 - 47.50 - 1.25 = 1.25/share or $125.00/contract

Maximum Loss= Net Debit

[n this case Max. Loss= 1.25

: No matter how far the stock rises, you cannot lose more than 125.00/contract

Breakeven Point= Upper Strike Price-Net Debit= $50-$1.25=$48.75

As a rule, if the max potential profit is at least 100% of the max potential loss , the spread is acceptable

When volatility rises, buying an out of the money spread will bring in higher premiums

Be careful though,

Volatility often rises prior to any major news. and the stock could move against you lightning fast and you lose

Lets assume the stock falls to 48 with 20 days till expiration

The premiums for both the long put and the short put wil have changed

If the difference between the two premium prices is larger than the net debit, you can close the trade for a profit

Its a good idea to have an optional profit target of 30-50% of the maximum potential gain

Exiting early lets you take gains sooner and enter another trade

Because a Bear Put Spread is a Debit spread, you pay up front so you must have the funds available in your account to make the trade

But there is no margin requirement as there is in a credit spread

stock is at 48.00

We buy back the 47.50 put = -$0.50

and we sell the 50.00 put for +$2.65

We entered the spread with a net debit of -1.25

2.65 - .50 - 1.25= +.90 or $90.00/contract

example 2:

Current stock= 72.45

We Buy the 70.00 put for -2.50

We sell the 65.00 put for +0.95

Net Debit= -1.55

Max Profit- 70.00 - 65.00 - 1.55 = 3.45

Lets assume the stock drops drastically to 58.00/share on exp date- you would get the max profit

Max Loss

The max loss is equal to the net debit

in this case tha max loss would be 155.00/contract

Return on Investment:

ROI= Max potential profit/Max potential loss

3.45/1.55=233%

which is well above the acceptable 100% ROI mentioned earlier

Assume the stock rises to 72.00 unexecpectedly and stays there until expiration

Since the stock closed above both strike prices, both options will expire out of the money : and the spread will realize the maximum loss : because both puts expire worthless

Exiting at Expiration

If the stock closed "through the spread" (below the lower strike price) on exp. date, both calls will expire In The Money, you will achieve max gain and will not need to exit the trade. That is how you make the max profit, because there are no commissions

Exiting If the Stock Moves Higher by Expiration:

[f on expiration day the stock closes below the higher strike price, but above the lower strike price, the spread could still break even or even be a little profitable

Break Even Price

Subtract the net debit from the higher strike price

70.00-1.55=68.45. As long as the stock fallss below 68.45 you can break even or make a small profit

Whenever the stock closes in between the stock prices you need to close the trade manually. This is very important:

To capture any value from the spread, you will have to sell the option you purchased (70) with a "Sell To Close" order and allow the lower strike price (65) to expire worthless

DO NOT EXPECT YOUR BROKER TO AUTOMATICALLY SELL YOUR IN-THE-MONEY OPTION SIMPLY BECAUSE IT STILL HAS VALUE ON EXPIRATION DATE

You must manually close the trade

[mawilson 2,133]

Oh is that what it said?

I didn't thin it had anything to do with Doom, but what do I know?

Yeah, I didn't get the gloom and doom vibe from your post either.

[Darnell 8,478]

gisting is for mentats.

[Tim/Mav 305]

Options 101:

Credit Spreads

Basics

Credit spreads have a maximum profit potential.

Credit Spreads require level 3 options trading authority

Tip: If you think the stock is going to make a dramatic move up, you would be better playing a long call

But what is really cool is that you can make money with a credit spread even if the stock stays flat and may even take a small profit even if it goes down only a little bit

Spreads have a max loss potential

Spreads have a max profit potential

When playing options, you should ALWAYS have your stop set as soon as you place your order

The are two different types of Credit Spreads

Bull Put

i. Bull Put= stock should be trending up or at least sideways

ii. So the same rules would apply to playing a bull put spread as if you were buying a bullish stock (You would want to enter the trade at support and exit at resistance)

iii. You will most likely achieve the max profit in a Bull Put spread if the stock is trending up.

iv. Because one of the two positions in a bull put spread is naked, you should enter the long side first

v. You can then enter the short side without needing naked option writing approval

vi. many platforms allow you to make a single credit spread now where both are executed simultaneously

How to play a Bull Put spread

Buy

a put on a bullish stock, with a strike price below the current trading price of the stock.

Sell a put on the same stock with a strike price above the strike price that you bought the first put.

Example

a) Lets say a stock is bouncing off support at $54

b) You buy the 50 put and sell the 55 puts

c) When you buy the 50 puts- you pay .25

d) When you sell the puts at 55 you bring in 2.50

e) 2.50-.25=2.25/sh

f) Your max profit is your credit, so the max profit=225/contract

g) Max Loss = Difference between the spread less the net credit

h) 55-50=5.00

i) 5.00-2.25=$2.75/sh or -$275.00 /contract

j) If the stock closes 55.50 on exp date

i. Both puts expire worthless

ii. and you keep max gain of 225/contract

k) If the stock closes at 35

i. You would assume the max loss of $ 275/contract

l) The reason you get max gain is because both options expire worthless= $0.00 in commissions

m) Breakeven= Higher Strike price - Net credit= 55.00- 2.25=$52.75 assuming all options are worth their intrinsic value at expiration.

How to exit a trade early because we have made a profit

a) When we exit early, we have to physically close the trades=commissions

b) So let's say the stock we spread traded is sitting at 55.00 within two weeks to expiration.

c) Now we have a profit, and even though it isn't max profit we still grabbed 35-50% of our max profit

d) We should look to exit because the risk reward ratio starts to turn against us

e) We are holding something that might bring another 10-15% more but holding 50% gain to make that 10 –15%gain

f) I am not willing to give up a gain for the small added value it would bring

g) We entered the spread with a 2.25 credit, and we want out

a. so we buy back the $55 put and

it

costs

us $1.00 ($1 is the ask price we bought the $55.00 put we sold earlier)

b. and we sell the $50 put for +.15

c. this gives us a profit of 1.40 or 140/contract

$2.25 - $1.00 +$0.15= $1.40/sh or $140/contract

Bear Call

i. Bear Call Credit spread=Stock should be trending flat to down

ii. You want to enter when the stock is bouncing off resistance (just as if you were shorting a stock)

How to play a Bear Call

1. You Buy a call above the current

share

price

2. And you sell a call below the strike price you bought.

3. This will bring a credit into your account, just like the bull put spread did

Example

1. imaginary stock ZILL is trading at 76.00/share

2. You buy the $80 call for -.50

3. You sell the $75 call for 3.00

4. Net credit= 3.00-.50=2.50

5. Net credit is you MAX GAIN= 2.50

6. Assume ZILL drops dramatically to 60 on exp date, you would get the max gain.

7. MAX LOSS= Difference between the Strike Prices-Net Credit

8. max loss=$250/contract 80 – 75 =5 – 2.50 = 2.50/sh

9. Breakeven= Lower Strike Price+credit recieved= 75+2.50=$77.50 assuming all options are worth their intrinsic values at expiration.

Debit Spreads

1. Basics

a. These are very similar to credit spreads with a couple of exceptions

i. In a debit spread we pay out $$$$$$ first and collect after the trade is closed

ii. You buy a higher priced option while simultaneously selling a lower priced option

iii. Some debit spreads must be closed manually by expiration date.

2. Bull Call

a. Bull Call spreads allow you to make money on stocks that are trending up or remain sideways.

b. We enter the trade on a bounce off support and exit at resistance or exit once we make our spread profitable

c. The max profit is equal to the spread between the two strike prices minus the initial debit

d. Select an expiration date of 20-40 days away.

e. As a rule, if the maximum profit potential is at least 30% to 50% of the maximum loss potential, the spread is acceptable. To determine the Return on an investment you divide the maximum potential profit and divide it by the nest debit (max potential loss).

f. When volatility rises, buying an out of the money spread may be less attractive because premiums are higher.

g. You would attain the max profit at expiration if the stock closes above the sell call strike price ($37 in example below).

h. An out of the money spread unlike a bull put spread will only be profitable if the underlying stock price increases. Conservative investors should buy In The Money options. Aggressive investors should buy Out of the Money options.

i. The max profit would be the difference between the strike prices less the net debit.

j. If the stock closes in between the strike prices, you must exit the In The Money call manually. Do not expect your

broker

to sell your in the money option on expiration date

k. The max loss is the net debit

l. You can also exit early if your profit target has been reached

m. Assume the stock rises to 36.80 with a week or two until expiration (see example below)

i. The differences in the long and short call premiums will have changed

ii. We would buy back the 37.00 call for -.0.10

iii. And we would sell the 36.00 call for +0.85

iv. or a profit of .10

v. or 10.00/contract

vi. -.65 +.85 -.10=.10

How to Play a Bull Call Debit Spread.

If you cannot do this trade as a single transaction, always enter the BUY (LONG) side before selling the call.

1. We sell a call above the current trading price

2. We buy a call below the strike you sold

3. ENTER THE BUY FIRST OR YOU ARE NAKED

4. ALWAYS ENTER THE LONG SIDE FIRST

Example

1. Current stock price is at $36.70

2. We sell a 37 call for .20

3. We Buy a 36 call for -.85

4. This results in a -.65/share debit, or -$65 per contract

5. Max profit = 36 – 37 = 1, 1-.65 = .35 or 35/ per contract. Max profit occurs when the stock closes above the 37 strike price on expiration. Both calls expire in the money.

6. Max loss = 65/ contract= Net Debit

7. Assume Stock is at $34 on expiration date…

a. Both calls expire worthless and you assume max loss

8. To determine the breakeven point, take the net debit, multiply it by –1 and add it to the lower strike price.

In this case:

-.65 x –1= .65.

36.00 + .65=36.65

Exiting the Spread

1.Same Day Substitution- his describes the process that takes place when the option buyer exercises the short option, causing your broker to immediately exercise the long option to offset your obligation in the trade. This means you wil not have to buy the stock. Your broker will automatically liquidate your position. Always contact your broker prior to playing credit spreads to make sure they offer same day substitution.

2.If the stock closes through the spread (above the higher strike price) on expiration date, both calls will expire In The Money and you will achieve max profit and will need to take no other action if your broker offers same day substitution.

3. If on expiration date the stock closes between the two strike prices, the spread could break even or even be slightly profitable.

Bull Call Spread Review

*Find optionable stocks in a bullish to neutral trend with good fundamentals

* Conduct TA on those stocks. Concentrate on support and resistance.

*Buy a

call

option

option (either in or out of the money) with a strike price close to the current trading price of the stock. Then sell a call with a strike price above the strike price that is higher than the call you purchased. This transaction will create a debt. An extremely bullish investor would buy the call with a strike price above the current trading price of the stock.

*Enter the spread with a "buy to open" for the call with the lower strike price and a "sell to open" for the call with the higher strike price. If possible, enter the trade as a single position instead of legging into the trade one side at a time.

*Monitor the trade daily. Watch the price of the stock. If it drops unexpectedly, consider exiting the trade.

*Exit the spread by entering a "But to Close" order to exit the short call and a "sell to Close" order to exit the long call, by letting both options expire worthless, or by allowing the spread to be exercised.

Bear Put Debit Spreads

you sell call at a strike above the current trading price

you buy a call below the strike price you bought

:the stock should be trending UP or at least sideways

we are talking vertical spreads

You play a vertical spread for 20-40 days

its a short term trade

Bear = trending down

With a spread, you can make a profit even if the stock trends sideways

And may even break even if it the stock moves up a small amount

You would use a Bear Put spread in the same conditions you would play a

long Put.

: You would want to enter the trade at a bounce off resistance or a break of

Remember with any spread, one side of the trade is SHORTor NAKED

So you should ALWAYS enter the trade on the Long Side(Buy) first if you use

a single entry platform

You can then enter on the Short (Sell) side without needing Naked Option

Writing approval

The Long side will COVER the short side if the contract is assigned

unexpectedly

You can use spread stategies in any market condition, but remember, if you

are expecting your stock to move violently in either direction, you may be better off playing straight

calls or puts

How to Play a Bear Put Spread:

You buy a Put option on a bearish stock. This option should have a strike price that is higher than the strike price of the Put that will be sold in the next stepThen you sell a Put option with a strike price that is lower than the current trading price of the underlying stock.

example

Stock price= 49.12

Buy a put for 50.00 = -2.10

Sell a 47.50 Put= +.85

Net Debit= -$1.25/share or -$125.00/contract 2.10- .85= 1.25

Max Profit Potential= Difference between the spread minus the initial net debit

50.00 - 47.50 - 1.25 = 1.25/share or $125.00/contract

Maximum Loss= Net Debit

[n this case Max. Loss= 1.25

: No matter how far the stock rises, you cannot lose more than 125.00/contract

Breakeven Point= Upper Strike Price-Net Debit= $50-$1.25=$48.75

As a rule, if the max potential profit is at least 100% of the max potential loss , the spread is acceptable

When volatility rises, buying an out of the money spread will bring in higher premiums

Be careful though,

Volatility often rises prior to any major news. and the stock could move against you lightning fast and you lose

Lets assume the stock falls to 48 with 20 days till expiration

The premiums for both the long put and the short put wil have changed

If the difference between the two premium prices is larger than the net debit, you can close the trade for a profit

Its a good idea to have an optional profit target of 30-50% of the maximum potential gain

Exiting early lets you take gains sooner and enter another trade

Because a Bear Put Spread is a Debit spread, you pay up front so you must have the funds available in your account to make the trade

But there is no margin requirement as there is in a credit spread

stock is at 48.00

We buy back the 47.50 put = -$0.50

and we sell the 50.00 put for +$2.65

We entered the spread with a net debit of -1.25

2.65 - .50 - 1.25= +.90 or $90.00/contract

example 2:

Current stock= 72.45

We Buy the 70.00 put for -2.50

We sell the 65.00 put for +0.95

Net Debit= -1.55

Max Profit- 70.00 - 65.00 - 1.55 = 3.45

Lets assume the stock drops drastically to 58.00/share on exp date- you would get the max profit

Max Loss

The max loss is equal to the net debit

in this case tha max loss would be 155.00/contract

Return on Investment:

ROI= Max potential profit/Max potential loss

3.45/1.55=233%

which is well above the acceptable 100% ROI mentioned earlier

Assume the stock rises to 72.00 unexecpectedly and stays there until expiration

Since the stock closed above both strike prices, both options will expire out of the money : and the spread will realize the maximum loss : because both puts expire worthless

Exiting at Expiration

If the stock closed "through the spread" (below the lower strike price) on exp. date, both calls will expire In The Money, you will achieve max gain and will not need to exit the trade. That is how you make the max profit, because there are no commissions

Exiting If the Stock Moves Higher by Expiration:

[f on expiration day the stock closes below the higher strike price, but above the lower strike price, the spread could still break even or even be a little profitable

Break Even Price

Subtract the net debit from the higher strike price

70.00-1.55=68.45. As long as the stock fallss below 68.45 you can break even or make a small profit

Whenever the stock closes in between the stock prices you need to close the trade manually. This is very important:

To capture any value from the spread, you will have to sell the option you purchased (70) with a "Sell To Close" order and allow the lower strike price (65) to expire worthless

DO NOT EXPECT YOUR BROKER TO AUTOMATICALLY SELL YOUR IN-THE-MONEY OPTION SIMPLY BECAUSE IT STILL HAS VALUE ON EXPIRATION DATE

You must manually close the trade

Thats quite a scientific evaluation. So take $1000.00 for a test try in the market and see what happens to the first 60% of it. GO FOR IT . Finding a web site is no indication you have any clues of Markets or even ####### your doing