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It’s been more than a week since the Philadelphia Eagles upset against the New England Patriots in Super Bowl LII that brought the first professional sports title to the city of brotherly love. But the Super Bowl is much more than just the apex of sporting achievements it is also the center stage for commercials. This year the price of a single commercial was more than 5 million dollar. WIth such a high prices, you would expect the companies to get 5 million bangs for their buck. Though billions of dollars are at stake, it is not clear how to measure the ROI.
One way to approach this problem is to see just how the stocks of the presenting companies have performed in the week following the airing of the most coveted spot in the media world.
Before we present the results, it’s important to discuss the method, especially in a week like the one we had in the markets: we compared the performance of the stocks to the performance of the S&P 500 ($SPY) in the same period. The bottom line: Companies that aired ads during the Super Bowl were less affected by the markets correction:
As we can see, when looking at the companies that presented in the Super Bowl as a whole, they outperformed the market by 0.96% which is 121% better than the S&P 500. As to individual stock performance, 13% (4 companies) had a positive outcome this week while only 9% of the S&P 500 stocks.
Comcast ($CMCSA), the parent company of NBC, the network that broadcast the game had several commercials for its movies and TV shows and could have expected to have a good week. But it is situated in the bottom third of stocks with a 6.59 decrease in its share value. This can be attributed to its short blackout during one of the commercial breaks.
Skyscraper - Big Game Spot [HD] - YouTube
On the other hand, Viacom (VIAB) one of its biggest competitors in the media sector was the second highest performer on the list with 1.98% increase.
One of the most talked ads during the broadcast was Tide with David Harbour in a meta reflective ad about ads, including the iconic spot series for “old spice”. unfortunately for Procter and Gamble ($PG) the hype didn’t reach the markets and the stock underperformed with a 5.42% decrease.
Tide | Super Bowl LII 2018 Commercial | It’s All The Tide Ads - YouTube
The best performing stock within those with Super Bowl ads is Kellogg’s ($K) with a commercial for Pringles starring Bill Header, gaining 2.79% from the previous week, and is now just 1% lower than before the markets started to shake.
We’re not suggesting you have to go and run an ad in the next Super Bowl, but having an ad in the Super Bowl might be a good measure (among others) when buying stock options. Who knows, we might add it as a filter in our scanner in the future 😉 .
(small update: The Vix gave more than 30% and faster than we projected. If you took our idea it might be good time to take some profits off the table)
Indeed an historical event, an event that can affect the lives of many. But the Eagles win over the Patriots in Super Bowl LII is old news by now . The media cycle has moved to the “downfall” of the stock market: the Dow Jones Industrial Average (DJIA) has suffered one of its largest loss in one day – that is in points (1,175). When looking on percentage loss, things look a bit different: the 4.6% put it somewhere in the 500th largest drop – but who will click on that?
The S&P isn’t different and though there isn’t a sign for panic. But by using the VIX indicator you get a better understanding on how the market might go:
As we can see, Vix is in the 4th highest value it has ever been. What is interesting here is that the other top 3 are some of the biggest economic crisis of recent decades. Does this mean that we are heading towards a meltdown in one or more sectors? This is less likely, and this is probably the market adjusting itself due to two recent trends:
Large amount of retail (and professional) volatility sellers
Abnormal recent gains.
In the short term we can expect to see an increase in the volatility, especially due to the extended period that the market didn’t have a correction. But in the medium and long term we are seeing this as a bullish market indicator.
This is something a bull will run into
The change in Vix was so extreme (an increase from 10-11 to about 40 in few days) that we can expect it to over shoot and correct to more ‘normal’ volatility.
Based on our back-test for the last 10 years, we can expect in the next 30 days a -26.97% decrease in volatility.
You can trade this on the VIX future or on the ETFs, but this will effect the entire market. You can use the bull put spread scanner to find the best trades for these market conditions.
Recently many users have shared stories with me about successes they had with our ‘buy cheap calls’ pre-defined report. This report is located on our scanner. The main component in that scanner is the ATR filter. So I thought it could be a good opportunity to share more information about the ATR filter in Option Samurai and how to use it.
What is ATR
ATR or Average True Range is a technical analysis indicator to measure volatility of an asset. Originally developed by J Welled Wilder for commodities, it has gained popularity among technical analysts and is now widely used. The goal of the indicator is to find the “true” movement range for a stock in order to assess its volatility.
The calculation of the True Range (TR) is:
TR = The maximum of:
Current High – Current Low
Yesterday’s close – Current High (Absolute value)
Yesterday’s close – Current Low (Absolute value)
True Range Example
The ATR is usually a 14 days average of the TR value.
ATR is a Volatility measure of the stock based on past price action. It is a much more intuitive measure than standard deviation for example.
Using ATR when trading options
One of the most important characteristic when trading options is the assumption for the asset volatility. When we use ATR we can standardize the volatility for different assets and compare trades on different stocks, although the different stocks have different volatility.
For example:
ATR Example – SPY AAPL GOOG
In the following example we can see search results for SPY, AAPL and GOOG.
SPY has a lower volatility from these stocks, and we can see that the ATR % for SPY is 0.58% (this means that average DAILY move of the SPY is 0.58%)
AAPL and GOOG have similar volatility in percentage ~1.4%.
If we would only look at the break even point, we can see that the BE point for SPY is 0.6% from the current price, while AAPL’s BE point is 1.36% away and GOOG is 0.7%.
When we take into consideration the stock volatility however, we can see that GOOG is most likely to pass BE point (GOOG daily range is 1.4% and the BE point is 0.7% – the daily range is twice the break-even point).
Although AAPL Break even is 1.36% and SPY BE point is 0.6%, when considering the volatility, we can see that BE point is 1 ATR away from both stocks.
This is the main power of using the ATR in option scanning – the standardization allows you to compare different stocks and different parameters and adjust the volatility. Because it takes into account the volatility, it is superior to regular percentage measures.
How to use the ATR in trading
The ATR will allow us to standardize volatility of different assets and look at distances in “ATR-units” which will allow us an ‘apples to apples’ comparison of different assets. We can use it in several ways:
1. Find cheap options
When we buy options, the option premium should be enough to cover the potential move of the stock so the option seller will have enough margin of safety to expect profit.
Using the ‘ATR VS Break-even Point‘ filter we can make sure that the premium we pay is relatively low compared with the stock volatility (see more in the example). Since we can’t lose more than the price we paid, buying cheap options can give a real edge in the market compared with buying the stock.
2. Choose the right strike to sell options
We can also use the ATR to find the right strikes to sell. Using ATR you can find strikes that are N amount of “ATR units” from current price. This means that the distance depends on the stock volatility – the more volatile the stock, the further away the strike will be.
Using the filter ‘ATR vs Strike’ you can easily find strikes that are far X amount of ATR units from current price. This saves you time and allows you to compare different trades for different stocks and ETFs.
3. Wide profit zone
When trading Iron Condors you can make sure that the ‘profit zone’ of the iron condor covers what you are looking for. There are 3 filters you can use:
ATR to Upper Breakeven
ATR to Lower Breakeven
Profit range ATR
These filters give you more control when scanning for Iron Condors, as you can control the distance to the upper break-even point, lower break-even point and the total width of the profit zone – all in “ATR units” (see examples below for usage).
Example 1: Using ATR when buying calls
In our predefind section you can find the ‘Buy cheap calls’ scanner. We discussed it’s edge in an previous blog post.
Buy Cheap calls scanner
This filter is looking to buy calls that have more than 15 days to expiration, max loss of less than 5% compared to buying the stock (serves as a stop loss) and break even point is less than 3% (meaning if the stock rises 3% by expiration the position is profitable.
The most important parts of this scan is no dividend (which adjust the price down) and ATR needs to be 3 times the Break-even point (ATR vs BE point). This increases the probability to exceed the break-even point and show profit.
Some more ideas on how to integrate this in your trading:
You can sort by ATR vs BE point to see the ‘cheapest’ opportunities
You can add the ATR vs BE point to your watchlists to see this data column in your results.
You can change the value from 3 to a higher or lower value in your screens to better adjust your results.
Iron condors are a very popular strategy. It allows users to enjoy the time decay of the options (increases the probability of profit), while benefiting from a limited risk trade.
In this example, we will use our Iron condor filter to check all possible combinations (hundreds of millions of option combinations) and find the best Iron Condors (IC) that fits our cretiria.
Below are the results for Iron condors that:
Up to 30 days to expiration, any IV rank and total option volume > 5000
IC profit is above $200, loss is below $5,000 and expected value is profitable
We added ATR measures: the break even point above should be more than 1 ATR, below needs to be more than 2 ATR and the entire range should be more than 5 ATR.
We also added the ATR percentage to the table to compare.
Results for top IC with more than 5 ATR range
This table shows us variety of results with different volatility. We can pick the strategies that best fit our risk criteria.
For example:
NTES trade has about 21% profit zone. About 10% to each side. The expected value is $302, which teaches us that this trade has high probability of profit. When analyzing this trade in ATR units: We can see that the Break evens are 3 ATRs on the upside and 2.5 ATR on the downside.
Due to the earning date, CMG allows for a 9 ATR profit range. 5 ATR on the upside and almost 4 ATR on the downside. Expected value is $248 and probability of profit is 73% (but this statistic is skewed due to the earning event prior to expiration (so this trade is not for everybody)
Some more ideas on how to integrate this in your trading:
You can sort by the ATR measures to make sure you have enough margin of safety (or no margin if you are buying straddle)
You can limit results to have more than X amount of ATR and high IV rank
Summary
The ATR is a technical measure of volatility of an asset. We use it in option trading in an effort to compare different trades on assets with different volatility. Using the ATR instead of normal percent measure helps us to save time as we can focus our analysis on the best trades (risk-reward wise) while taking into consideration the fact that different stocks have different volatility.
When selling options, we are looking to sell options that have the most ‘ATR units’ of distance from current price.
When buying options, we are looking to buy options that are the closest to the price (ATR-units-wise) and we do it by comparing the ATR to the break-even point and asking the ATR to be as big as possible compared to it.
The holiday season is coming down the back stretch and this year looks like it will be a winner. According to the CNBC All-America Survey, average holiday spending intentions will top $900 for the first time in the 12-year history of the poll, which is the widest margin on record.
Record spending numbers
CNBC conducts a survey of 800 Americans and found a surge in the percentage of Americans planning to spend more than $1,000, which is up to 29% from 24% in 2016. The margin of error according to CNBC is slightly more than 3%.
To take advantage of increasing holiday spending, traders are buying Wal-Mart ($WMT)and with implied volatility stable using a bull put credit spread, is a prudent way to generate revenue by betting this retail giant will experience a banner year.
You can now easily scan for option spreads using Option Samurai. Just as a refresher, a vertical option spread strategy is one where you purchase and sell two alike options (either 2-puts or 2-calls) simultaneously, that have the same expiration date. The only difference between the options will be the strike price and the premium. A vertical option that is a credit spread allows the seller of the spread to receive a credit, which means the premium of the option you sell is higher than the premium of the option you purchase.
When you look to sell a bull put credit spread, you are betting that a stock will not drop through a specific price before the expiration date. This means it can go lower or higher but will be a winner if it remains above a specific level. The price level you want to avoid is the sold put price, but even if the underlying stock declines below this level you can still make money.
Running an Option Samurai Scan
There are several criteria that are key to finding a robust Bull Put Credit Spread
Bull Put Spread scan
The Option Samurai Scan can include any symbol, but in the case of a stock you want to make sure the earnings are after expiration. You also want to make sure that the implied volatility that is priced into the vertical spread is at least above the lower quartile of its historical range. You can do this by making the implied volatility range in between 25% and 100%. If you want an out of the money bull put credit spread, make the range of “moneyness” less than zero.
The spread profit describes the amount of profit you would receive if you executed 1-contract of a WMT bull put credit spread, and both options expired worthless. You can construct this by using the spread profit above a specific level. The spread profit of $74 means that the price of the sold put (in this case the $92.5 put) minus the price of the purchased put (in this case $90.50) is $0.74.
Since the strike spread ($92.5 – $90.50) equals $2 and the premium you would receive is $0.74, the max loss is $1.26 for each contract or $74 for one contract of $WMT. You can alter the Max loss to make sure you only find spreads that have specific risk parameter.
Lastly, you want to make sure the spread expected value is profitable, or a specific minimum. Spread Expected Value, is a statistical measure that tries to predict the profit or loss of the strategy. It is calculated as the sum of all possible values each multiplied by the probability of its occurrence. The scan will also describe the profit ratio, which is the return you will receive if both options expire worthless.
The trade:
Sell WMT January 11, 2018 $92.50 Put at $0.90
Buy WMT January 11, 2018 $90.50 Put at $0.16
Your potential gain on the trade is $0.74. You broker will request margin of #contracts * 100 * ($92.5 – 90.5 + $0.74) or $74 per contract. Your return if both options expire worthless is 58.7% ($74/$1.26).
Your maximum loss is the different between the 2-strike prices ($2) minus the premium, = $0.74 or $126 per contract. Your breakeven level is $91.76 = $92.50. (short strike) minus premium of $0.74.
Alternative, you could also go to your dashboard and look for alternative but put spreads, using this scan as a guide. Go to Option Samurai
This article is the first in a series of educational articles that will describe some of the advanced concepts implemented in Option Samurai option scanner. In this article we will focus on Expected Value.
What is Expected Value
Expected value is a statistic measure that tries to predict the value of the strategy, assuming you could have executed it many times at different dates but with the same prices/distances etc. It is calculated by summing the payout at expiration multiplied by the probability of that payout.
The expected value is derived from: Stock price, option prices, Implied volatility, time to expiration, distance of strikes from last price, dividends and risk-free rate. Usually you are aiming to have the highest expected value possible, as it indicates a statistical edge.
Example: Expected Value of put spread
Put spread example
In this example we will see how the Expected value is calculated on a bull put spread. This spread is built with a short put (strike A) and a protective long put (strike B) where both options have the same expiration and A>B.
We can divide the spread to 3 ranges:
Maximum profit range (where the price is greater than A) – Range 1 in the example
Maximum loss range (where the price is lower than B) – Range 2 in the example
Between A and B the spread will show profit or loss that is linear changing depends on the stock price – Range 3 in the example
To calculate the expected value we add:
The probability of being above A * max profit (positive)
The probability of being below B * max loss (negative)
For the area between A and B we use log-normal distribution and multiply it by the payout.
The sum of the 3 components is the Expected value.
How to use Expected value:
After explaining what is expected value we get to the most important part: How can we use it to find better trades.
1. Filter according to Expected value
This is the most obvious and powerful way to use this value. With our option scanner you can instantly find only the profitable trades according to the expected value, in real time. This means that you only analyse trades where you have a statistical edge. This saves you time and in the long run helps your edge compound.
Expected Value filter in Iron Condor scanner
You can also set the expected value filter to be more than $100 or any other value to account for commissions and unexpected scenarios and even increase your edge.
2. Sort from max to min
After getting your results, you can sort by expected value to compare different strikes, expiration and tickers to find the optimal trade when taking into considerations all the different variables (profit, loss, liquidity, growth, trend, sentiment, IV etc).
The sorting helps you manage your time more efficient by looking at the trades with the highest edge first (Important note – The fact that the EV is positive, doesn’t mean you will necessarily make profit, it is just indicating there is an edge in this trade in your favor).
3. Create a ratio using expected value
A more advance way to use expected value would be to create a custom ratio unique to your trading style. The best way to do it is to export the results to excel using our export feature.
Export to Excel
After you have all the data in excel you can start playing with it. Some ratios for example:
Expected value / Max loss – This ratio combines EV (higher is better) and Max loss (lower is better). sorting the trades according to this ratio takes into account the worse case scenario when you analyse a trade
Expected value * IV rank (if credit strategy) or Expected value / IV rank (for debit strategy) – This ratio combines the EV with the Implied Volatility rank. It means that trades with high IV will get precedence if it is a credit strategy and Low IV trades will get precedence if it is a debit strategy.
Expected value * Growth rate – This ratio combines the EV (higher is better) with the fundamental measure of the company expected EPS growth (higher is better). This combines 2 measures from different ‘domains’ and gives precedence to higher growth
You can of course create more ratios that fits your style: Divide by days to expiration (EV per day), use PE (see how expensive the stock), div yield and much more.
Conclusion
Expected value is a statistical measure that tries to predict how profitable a strategy will be. It uses the market conditions, such as: option prices, implied volatility, stock price, dividends and more to give a dollar amount of the expected profit (or loss) of the strategy.
Though expected value gives a dollar value, it does not mean that this will be the profit from the trade. It is better to think of the EV as the integrated edge in the trade. Over many similar trades you are expected to collect this edge and increase your profits.
You can use the Expected value to:
Filter trades that have positive EV and have edge.
Sort by EV to save time and compare trades
Create your own custom ratios that will help you to uncover the trades that best fit you.
The major indexes continue to hit fresh all-time highs as the calendar flips into the last month of 2017. The combination of robust earnings, the potential for a new tax plan, and bullish sentiment have kept stock prices elevated and has weighed on implied volatility. In fact, S&P 500 volatility is near 52-week lows moving into December. As traders continue to climb a wall of worry, betting that S&P 500 index implied volatility will stabilize using a bull put credit spread, is a prudent way to generate revenue.
You can now easily scan for option spreads using Option Samurai. Our new scan results allow you to find the best possible vertical credit spreads along with straddles and Iron Condors. Just as a refresher, a vertical option spread strategy is one where you purchase and sell two alike options (either 2-puts or 2-calls) simultaneously, that have the same expiration date. The only difference between the options will be the strike price and the premium. A vertical option that is a credit spread allows the seller of the spread to receive a credit, which means the premium of the option you sell is higher than the premium of the option you purchase.
When you look to sell a bull put credit spread, you are not betting that a stock or ETF will move higher, you are in fact speculating that the stock or ETF will not drop through a specific price before the expiration date. The price level you want to avoid is the sold put price, but even if the underlying stock declines below this level you can still make money.
Running an Option Samurai Scan
There are several criteria that are key to finding a robust Bull Put Credit Spread
Bull Put Scan
The $UVXY ETF is a volatility ETF that looks to track the changes of the VIX volatility index, which is equivalent to the implied volatility of the at the money strike prices for the S&P 500 index. The ETF price is attempting to form a bottom despite stock prices surging to fresh highs.
The Option Samurai Scan can include any symbol, and in the case of a volatility ETF you don’t have to wait until an earnings release. You also want to make sure that the implied volatility that is priced into the vertical spread is at least above the lower quartile of its historical range. You can do this by making the implied volatility range in between 25% and 100%.
The spread profit describes the amount of profit you would receive if you executed 1-contract of a UVXY bull put credit spread, and both options expired worthless. You can construct this by using the spread profit above a specific level. The spread profit of $59 means that the price of the sold put (in this case the $13 put) minus the price of the purchased put (in this case $11.50) is $0.59.
Since the strike spread ($13.00 – $11.50) equals $1.50 and the premium you would receive is $0.59, the max loss is $0.91 for each contract or $91 for one contract of UVXY. You can alter the Max loss to make sure you only find spreads that have specific risk parameter.
Lastly, you want to make sure the spread expected value is profitable, or a specific minimum. Spread Expected Value, is a statistical measure that tries to predict the profit or loss of the strategy. It is calculated as the sum of all possible values each multiplied by the probability of its occurrence. The scan will also describe the profit ratio, which is the return you will receive if both options expire worthless.
For this trade you could
UVXY Chart
Sell UVXY December 8, 2017 $13.0 Put at $0.68
Buy UVXY December 8, 2017 $11.5 Put at $0.09
Your potential gain on the trade is $0.59. You broker will request margin of #contracts * 100 * ($13 – 11.5 + $0.59) or $91 per contract. Your return if both options expire worthless is 64.8% ($59/$91).
Your maximum loss is the different between the 2-strike prices ($1.5) minus the premium, = $0.91 or $91 per contract. Your breakeven level is $12.41 = $13 (short strike) minus premium of $0.59.
For this trade you want the UVXY to stay above 13 (2% from current price) until Dec 8th expiration.
Alternative, you could also go to your dashboard and look for alternative but put spreads, using this scan as a guide.
We Are very happy to announce the launch of the new version of Option Samurai. We will describe all the new features and how to use them in next posts and in our help section, but we want to describe some of the new features in this article:
Spreads Scanner:
Introducing the Spreads scanner
We’ve seamlessly integrated spreads scanner. Our platform now supports:
Bull call spread
Bull put spread
Bear call spread
Bear put spread
Our new scanner filters through tens of millions of options combinations to find the best spread. We can find the best spread while taking into considerations: Probabilities, profit/loss ratio, bid-ask spread, stock technical and fundamental data, insiders transactions and more.
Iron condors are very popular among option traders as they maximize the time decay while keeping the maximum loss of the strategy fixed and known. However it is hard to find the optimal legs for this strategy. By optimal we mean the maximum profit vs risk vs probability of achieving each of them happening.
This is why most traders resort to ‘fixed’ legs such as X% from stock price or Y delta. This means these traders are leaving profits on the table!
We believe we can do better: For every Iron condor we test all possible combination that fit your criteria and find the maximum expected value. We want to optimize the risk adjusted returns while taking into account the probability of the event manifesting.
Find Iron condors that Expected value is higher than 500$
Expected value (EV) is a statistical measures that tries to predict the value of a variable. In our case, it is a statistical measure that tries to predict the profitability of a trade. It is simply the payout the strategy will yield in different scenarios multiplied by the probability of this scenario. In other words, the sum of:
Probability of max profit * Max profit
Probability of max loss * Max loss
Probability of partial profit and partial loss * payout
There are many ways to estimate the probability of the events, we use the market prices of the stock and options to derive the probabilities, and use live data to constantly calculate and update them.
How to use expected value:
You can use EV to estimate the profit of a trade if you’ll trade it small and often.
You can use EV to compare different trades in the same stock
You can use EV to compare different trades on different stocks and use this as standardization and comparison value
The EV takes into account the profit, loss and probability and display it in one value which allows you to quickly make decisions and improve your trading.
We will add more blog posts describing how to get the most out of these features, but in the mean time -> don’t be afraid to contact us for help and questions.
Many more improvements
To keep this article manageable we haven’t described many of the other features we will be introducing such as: Straddles, better design and faster calculation, more option data, probabilities of profit, loss, upper or lower break-even and more!
Stay tuned and subscribe to our updates and Option Samurai to be in the loop of more new features.
In this article, we’re going to see how to choose an option for generating income. The strategy we’ll use is covered calls, which means we own a stock or will buy it then sell call options on the same stock. We’ll also further refine results by adding our own filter.
A covered call strategy has a neutral to bullish bias. In order for the strategy to succeed best, the stock price needs to stay below the call price. We’d rather go with the neutral part of that strategy since we don’t want our stock price going much below our entry price, if at all. For that, we’ll use a scanner that chooses only quality, safe stocks and is specific to covered calls.
Running The Scan
Click “Predefined” at the top of the Dashboard. Then select the scanner titled, ‘Safe covered calls (Profitable & good companies, growing, high yield, margin of safety)’.
Clicking the scanner title will run the scan. Note that each time you click a scan, it pulls in current market numbers. You should get output similar to the following:
Scan from dashboard – Safe covered calls results
Let’s see how to choose a covered call out of those listed. I’m going to break out each parameter/column that we’ll be looking at along with a summary next to it:
Stock Score – 10 is best. All have a score of 8 so there is nothing to compare here.
IV Rank – 100 is for option sellers. Basically, IV Rank is mean reverting. A high IV Rank will eventually come down, depressing premiums with it. That is why a high IV Rank is great for option sellers.
We can see that GE has a high IV Rank of 98.02%. While it would be great to sell a call option with that type of IV Rank, that isn’t the only criteria we’re considering. We still want to do a little further verification. This will include adding a “50 day moving average” filter.
Customizing A Predefined Scan
To add in our list of additional filters, click the “Edit/Duplicate” button in the top right of the results. To keep our scan focused on GE, CMG and MOS, we’ll add a symbol filter. Click the “ADD FILTERS” button.
Add filter
Type in “symbol” and click “Include symbols”.
Include symbols filter
This will add the “Include symbols” filter to the left. Click “Any” next to this filter and type in the three stock symbols separated by commas.
Type tickers in filter
We’re going to now add the 50 day moving average. Add another filter and type in “moving”. Click “Moving Average 50 Day”. For that filter, click “Any” and select “Above MA”.
Now click “RUN SCAN” and you should see only MOS.
Summary
Let’s summarize where we are. We want to write covered calls on safe stocks. To find related options, we ran the ‘Safe covered calls’ predefined list. We further refined the results by adding an additional filter.
The additional filter only strengthens our conviction that MOS is in fact a top contender for writing covered calls on. Now that we understand how to add filters to a predefined scan, we can add more filters based on our personal technical or fundamental requirements.
Give it a try! Go to your Dashboard, click on the same predefined scan, edit the results and add the symbols results to an “Included symbols” filter and then continue further refining the results with additional filters until the outcome has met all of your criteria.
Despite a smooth climb in stock prices that have continue to reach all-time highs, implied volatility has started to pick up as the calendar slides into the heart of the earnings season. Some of the financial results have been impressive, while others have been dismal, creating a binary market environment where prices surge or tumble. One way to take advantage of climbing implied volatility is to generate a position using a vertical credit spread.
Vertical Credit Spreads
There are two types of vertical spreads, credit and debit spreads. A vertical option spread strategy is one where you purchase and sell two alike options (either 2-puts or 2-calls) simultaneously, that have the same expiration date. A vertical option that is a credit spread allows the seller of the spread to receive a credit, which means the premium of the option you sell is higher than the premium of the option you purchase. A debit spread is one were you pay away a debit as the option you buy is more expensive than the option you sell.
For example, a vertical bear call credit spread would consist of:
Sell Call XYZ $50 November 17, 2017 ($1.00)
Buy Call XYZ $55 November 17, 2017 ($0.50)
Net Premium $0.50 per contract
When you sell a vertical call spread you are selling the lower call and purchasing the higher call and receiving a credit. The benefit of selling a bear call credit spread is the price of the underlying stock does not have to decline for you to experience a successful trade, it just needs to stay below the sold call strike price until the expiration date for you to receive the entire premium. This means you can have a winning trade if the price of the underlying stock moves lower, sideways or even against you.
Running an Option Samurai Scan
There are several criteria that are key to finding a robust vertical credit spread.
JD Stock Price
JD.com has been chopping around and has slid below support near the 200-day moving average ahead of its earnings which are scheduled to be released on November 13, 2017. Resistance is now former support near an upward sloping trend line which nearly coincides with the 200-day moving average $37.27. To find a bear call credit spread using Option Samurai, scan for an attractive covered call (until we will release the call spread filter in Dec). You can then protect the call with a purchase of a higher strike call, to form your bearish call spread.
The Option Samurai Scan can include any symbol, where the earnings date of the underlying stock is after the expiration of the option. This will eliminate unwanted volatility. You also want to find a stock that has a future PE ratio that is above 30, so you find a call on a stock that could be considered overvalued.
Option Samurai Scanned results
You also want to make sure that the implied volatility that is priced into the short option (which is the covered call), is in the upper half of its 52-week range. You can do this by making the implied volatility range in between 65% and 100% (in JD it’s 96.05%). You want the bid of the option to be at least $0.50, since you will have to purchase a protective call and want the net premium to be at least $0.25. When you sell a bear call credit spread you want the lower call to be an out of the money call. You can accomplish this by making the moneyness 1% to 10%. Lastly, you want the bid-offer spread to be relatively tight and less than $0.10.
(You can also add PE ratio is less than 30 and earning date is after expiration to limit the amount of relevant trades you’ll analyse)
For this trade you could
Sell JD November 2, 2017 $37.5 Call at $0.63
Buy JD November 2, 2017 $39.0 Call at $0.33
Your potential gain on the trade is $0.30. You broker will request margin of #contracts * 100 * ($37.5 – 39 + $0.30) or $120 per contract. Your return if both options expire worthless is 25% ($30/$120).
Your maximum loss is the different between the 2-strike prices ($1.5) minus the premium, = $1.20 or $120 per contract.
Alternative, you could also go to your dashboard and look for alternative covered call scans, using this scan as a guide.
(We plan on releasing our vertical spread scanner next month, so stayed tuned).
As Q3 earnings commence, U.S. stocks are hitting all-time highs, as low interest rates and the promise of deregulation and tax cuts are buoying riskier assets. If you think stock prices will continue to remain buoyed but don’t want to purchase shares ahead of earnings season, a great way to generate a position is by using a vertical option credit spread.
Vertical Credit Spreads
A vertical option spread strategy is one where you purchase and sell two alike options (either 2-puts or 2-calls) simultaneously, that have the same expiration date. The only difference between the options will be the strike price and the premium. A vertical option that is a credit spread allows the seller of the spread to receive a credit, which means the premium of the option you sell is higher than the premium of the option you purchase. For example, a vertical bull put credit spread would consist of:
Sell PUT XYZ $50 November 17, 2017 ($1.00)
Buy PUT XYZ $45 November 17, 2017 ($0.25)
Net Premium $0.75 per contract
When you sell a vertical put spread you are selling the higher put and purchasing the lower put and receiving a credit. When you sell a vertical call spread you are selling the lower call and purchasing the higher call receiving a credit. The benefit of selling a bull put credit spread is the price of the underlying stock does not need to rise, it just needs to stay above the sold put strike price until the expiration date for you to receive the entire premium.
Running an Option Samurai Scan
There are several criteria that are key to finding a robust vertical credit spread.
Samurai Scan results $WDC
Western Digital Corp ($WDC) has been chopping around in a relatively tight range ahead of its earnings which are scheduled to be released on October 25, 2017. Support is seen near the 50-day moving average at $85.62 and then again at the 200-day moving average at $83.00. To find a bull put spread using Option Samurai, scan for an attractive naked put. You can then protect the naked put with a purchase of a lower strike put, to form your bullish put spread.
$WDC Chart
The Option Samurai Scan can include any symbol, where the earnings date of the underlying stock is after the expiration of the option. This will eliminate unwanted volatility. You also want to find a stock that has a PE ratio that is below 30, so you are not getting stocks that do not have any earnings (In this case WDC has Future PE of 7.3 which makes it very cheap in Analyst eyes.
Additionally, stocks were analysts have recently upgraded their recommendation in the last month, means that expectations for earnings momentum is on the rise. You can do this by making the Analyst Recommendation Change from last month positive.
You also want to make sure that the implied volatility that is priced into the short option (which is the naked put), is in the upper half of its 52-week range. You can do this by making the implied volatility range in between 50% and 100%. You want the bid of the option to be at least $0.50, since you will have to purchase a protective put and want the premium to be at least $0.25. When you sell a bull put credit spread you want the naked put to be an out of the money put. You can accomplish this by making the moneyness -3% to -21%. Lastly, you want the bid-offer spread to be relatively tight and less than $0.25.
$WDC Bull Put Spread Trade
Sell WDC October 20, 2017 $83.0 Put at $0.60
Buy WDC October 20, 2017 $81.5 Put at $0.33 (You can buy a cheaper protection, but then the maximum loss is greater, for example Strike $80 Put at $0.16)
Your potential gain on the trade is $0.27 ($0.44 for the riskier trade). You broker will request margin of #contracts * 100 * ($83 – 81.5 + $0.27) or $123 per contract ($256 for riskier trade). Your return if both options expire worthless is 22% ($27/$123) – or 17% for the riskier trade.
Your maximum loss is the different between the 2-strike prices ($1.5) minus the premium, = $1.23 or $123 per contract (vs $256).