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As the following graph shows, the price of shares in Colliers International Group (CIGI) has clearly been on a bullish trend since the stock bottomed out at $58.51 on September 19, 2017. We can see that the 200-day moving average (in red) provided support when the price fell in February 2018, and that, throughout the series, the 50-day moving average (in blue) appears to act as a support level. In addition, the RSI (5) (the Relative Strength Index over 5 trading sessions) is on the rise. At the same time, the stochastic oscillator clearly has upward momentum, staying above 75 since February 2018. At this point in time, we have reached a major inflection point, with prices very close to their 50-day moving average while a bull triangle formation takes shape. The bull triangle is a technical formation representing a short pause in a prevailing trend. In this case, we expect prices to break out on the upside and head toward a target price of $105, if we apply the width of the triangle at its narrowest end.

Daily Chart for CIGI ($95.29, Friday, June 15, 2018)

An investor interested in profiting from this scenario could buy call options expiring on October 19, 2018, choosing the strike that would yield the best return if the price reaches $105.00 on expiration.

We will choose from among the following calls:

  • CIGI 181019 C 92 at $7.05
  • CIGI 181019 C 94 at $5.90
  • CIGI 181019 C 96 at $4.95
  • CIGI 181019 C 98 at $3.95

Position

Comparative table of call options

As the above table shows, given these four call options, it is CIGI 181019 C 94 at $5.90 that has the optimal combination of risk and return, offering a potential return of 86.44% if CIGI reaches the target price of $105.00 on October 19, 2018. We will therefore carry out the following transaction:

  • Purchase of 10 call options, CIGI 181019 C 94, at $5.90
    • Debit of $5,900

Profit and loss profile

Target price on the call options, CIGI 181019 C 94 = $11.00 ($105.00 – $94.00)

Potential profit = $5.10 per share ($11.00 – $5.90), for a total of $5,100

Potential loss = $5.90 per share (premium paid), or $5,900

Intervention

Even though the target price for CIGI is $105.00, our potential profit is tied to the $11.00 target price on the call options. Therefore, as soon as the price of the calls reaches $11.00, we will liquidate the position, even if CIGI has not yet reached the target price of $105.00.

Good luck with your trading, and have a good week!

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

The post Taking advantage of a bull triangle appeared first on Option Matters.

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Option Matters by Patrick Ceresna - 1w ago

There is no shortage of analysts offering alternating fundamental outlooks for BCE (TSX:BCE).  Some concerned with the business model and declining growth rates, others proclaiming the BCE dividend stream to be more sound than owning bonds.  Personally, as a trader I look for the tactical play where I can profit from key turning points in major stock trends. Here’s my perspective as to what I am looking for to catch the key turn around in the battered down stock.

First off, I generally feel that the selling in BCE has been predominantly driven not by company fundamentals but rather by interest rates.  As a secure high dividend paying stock, the company, like most high dividend paying securities, is considered a bond proxy.  Over the last year, we witnessed 5-year interest rates on Canadian Gov. bonds rising from 0.90% to over 2.30% back in May 2018.  The more than doubling of interest rates has been a serious drag on almost all higher yielding assets.

Why have rates been rising?  Many will point to rate differentials between the U.S., a strong Canadian economy that can absorb rate normalization and even an attempt to cool off the real estate market.  While those may have merit, to me it is all about inflation.  The way I look at it, all longer duration bonds are mechanically pricing in higher inflation expectations, which force interest rate higher, bonds lower, and pressuring the bond proxy stocks like BCE.

What is the driver of inflation expectations?  Well there are many, but none greater than oil prices.  Simply observe the chart below overlaying the performance of the 10-year yield on the Canadian government bonds and crude oil prices.

So, what am I getting at?

My speculation is that yields on the longer duration bonds are pricing higher inflation expectations due to rising oil prices and the bond proxy stocks are under pressure in that environment.  Its when we see oil peak out in prices, it will peak out interest rates, which will solidify the bottom the bond proxies which includes BCE.

So, has oil peaked?  We have definitely seen a short-term top that will take us into the OPEC meetings here in June, but will it be the 2018 high?  That has yet to been seen.

Furthermore, this raises the question of how one should position themselves when buying in BCE? Is it too early to buy the dip or do you risk missing a great buying opportunity by staying on the sideline?

In my opinion, this is a chance for us to utilize options as a strategic tool to enter the position.

Those new to exchange traded options, the purchase of a call secures you the right (but not the obligation) to buy the stock at a specific price over a specific period of time.

As shown in this scenario,

  • Our investor wants to secure the potential purchase of 1000 shares or just over $50K in investment.
  • June 6, 2018 BCE (TSX:BCE) is trading at $54.82
  • The July 20th, 2018 expiration BCE call option is asking $0.35 (9.2% implied vol)

Rather than take the risk of being early to the trade, our investor purchases 10 call options (each call securing the purchase of 100 shares) for $350.00 (10 x 100 x $0.35)

Our investor has defined his maximum risk to $350.00 while having the next 6 weeks to decide if they wanted to exercise their right to buy the shares at $55.00.  To me, it is all about the optionality of the trade.  If oil surges higher into the summer, and interest rates continue to rise, it is likely we are early and the calls will expire at a loss. In my opinion, this is acceptable as I will clearly have a better opportunity to buy BCE at better prices in the future.  Alternatively, if this proves to be the bottom in the stock, I will exercise my right to buy and have accumulated the position not far from 52-week lows.

Best part, Canadians can also execute this strategy in their registered accounts.

Thank you for reading.

The post Timing the Bottom on BCE appeared first on Option Matters.

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As the following graph shows, the price of shares in CGI Group Inc. (GIB.A) has reached an all-time high. We can also see that the RSI (Relative Strength Index) indicator and the stochastic oscillator (%K) are both in oversold territory. In the past, this has been followed by corrections that brought the stock price back down as far as the previous cyclical low. Given this history, it is very possible that the stock price could fall to around $75.

Daily Chart for GIB.A ($78.75, Friday, May 25, 2018)

An investor interested in profiting from this scenario could buy put options expiring on August 17, 2018, choosing the strike that would yield the best return if the price reaches $75.00 on expiration.

We will choose one of the following puts:

  • GIB 180817 P 78 at $1.86
  • GIB 180817 P 80 at $2.78
  • GIB 180817 P 82 at $4.05

Position

                    Option with the best leverage

As the above table shows, of these three put options, it is GIB 180817 P 80 at $2.78 that has the optimal combination of risk and return, offering a potential return of 79.86% if GIB.A reaches the target price of $75.00 on August 17, 2018. Consequently, we will carry out the following transaction:

  • Purchase of 10 put options, GIB 180817 P 80, at $2.78
    • Debit of $2,780

Profit and Loss Profile

Target price on the put options, GIB 180817 P 80 = $5.00 ($80.00 – $75.00)

Potential profit = $2.22 per share, for a total of $2,220

Potential loss = $2.78 per share, or $2,780

Intervention

Even though the target price for GIB.A is $75, our potential profit is tied to the $5 target price on the put options. Therefore, as soon as the price of the puts reaches $5, we will liquidate the position, even if GIB.A has not yet reached the target price of $75.

Good luck with your trading, and have a good week!

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

The post Selecting the Optimal Put Option appeared first on Option Matters.

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As can be seen in the following chart, the share price of ONEX Corporation (ONEX) has been weak enough to suggest that some caution may be necessary. The Relative Strength Index (RSI), which was recently in oversold territory, is trending downward. The same is true of the stochastic oscillator (%K).

Although the scope of the decline remains to be determined, an investor interested in acquiring some protection while taking advantage of the erosion of the time value of options could write a call option for each 100 shares held. With ONEX trading at $91.15 at the time of this writing, we will select call options expiring on September 21, 2018 with a strike of $92.

Position

  • 1,000 shares of ONEX are already held (current market price: $91.15)
  • Write 10 call options ONEX 180921 C 92 at $3.50
    • Credit of $3,500

Profit and loss profile

This out-of-the-money call option has no intrinsic value and a time value of $3.50 per share. Writing this call option provides protection against a 3.84% drop to the breakeven price of $87.65 ($91.15 – $3.50). In the event that the share price goes up, closing at or above the $92 strike on expiry of the options on September 21, the strategy’s maximum profit will be $4.35 per share, or 4.96% for the 130-day period (13.93% on an annualized basis). If the stock price is unchanged, the static return would be $3.50 per share, or 3.99% for the 130-day period (11.21% on an annualized basis).

Intervention

Since we expect the share price to fall but have no specific target for it, we will close the position if we can buy back the call options written at 10% to 20% of their initial price. Should this occur, we will need to analyze whether the right approach is to hedge the position again by writing more call options. Should the share price rise above the $92 exercise price, we need to buy back the call options at a profit or a loss, as the case may be, to avoid having them assigned and having to sell the underlying shares.

Good luck with your trading, and have a good week!

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

The post Using call options as a hedge appeared first on Option Matters.

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If you’ve been trading stocks, you should have a pretty good understanding of the mechanics of buying and selling. Getting started with options trading is fairly simple. Here are a few things to know to get started.

Step 1: Setting up an options account with your broker

The options account can be in a margin or registered account. There are a few differences when using one or the other. For instance, trading options in a registered account, you can 1) buy and sells calls and puts, 2) write covered calls. Other option strategies are not allowed due to CRA regulations. However, in a margin options account, you can perform all the option strategies out there.

Step 2: Pulling up an option chain is like getting a stock quote.

An option chain is the place to find all the strike prices and expiry dates available for trading. Here is a sample option chain (figure 1). Some options have weekly and long term expiration. There are call and put options. Call options give the holder the right to buy the stock at the strike price. Put options give the holder the right to sell the stock at the strike price. The strike price is simply the guaranteed price at which the option holder can buy (for a call) or sell (for a put) the underlying stock.

Fig.1 Source: m-x.ca

Step 3: Learning the option lingo

Buy to open means that you are buying an option to create a new position. In the stock world, it’s called a buy order.

Sell to close means that you are selling the option to close your existing position. In the stock world, it’s called a sell order.

Sell to open means that you are writing (or selling) an option that you do not possess. In the stock world, it’s called a short order.

Buy to close means that you are buying back the option that you had sold to close your position. In the stock world, it’s called a buy to cover order.

Step 4: Covered vs uncovered

When you sell to open (also known as writing) options, you are receiving a premium. In exchange, you are taking on an obligation. If you are assigned, your broker will need you to sell the underlying shares at the strike price (in the case of a call option). If you possess these shares in your account, then you are “covered”. If you don’t have the shares, you are “uncovered”.

On the other hand, if you sold a put, your obligation will be to buy the shares. Essentially, to be covered, you simply need to have sufficient funds or buying power to purchase the shares because the shares will be put to you at the strike price (when you are assigned).

Step 5: Option contract size

In most cases, buying 1 option contract gives you exposure of 100 underlying shares of the stock or ETF. When you enter an order, you cannot trade a fraction of an option contract (ex: 1.5 option contacts will not be accepted). Remember, 100 call options is not equal to 100 shares, it’s the equivalent to 10,000 shares!

Step 6: Options expire

When you trade options, you need to know that they will expire in the future. What this means is that you will only have the right to exercise the option before the expiry date. After that date, the option ceases to exist and you won’t see it in your account. Options expire on the 3rd Friday of the expiry month (except for weekly options, which expires every Friday). For example, you have a September option, this option will be valid until the 3rd Friday of September.

Step 7: Exercising an option

Only the option buyer can exercise an option. When a call option holder exercises the option, she is using her right to buy the stock at the strike price. When a put option holder exercises the option, she is using her right to sell the stock at the strike price. Exercises are done by calling your broker. Once the option holder exercises the option, the counterpart (aka the option writer) will be assigned. In this case, the option writer will be obligated to fulfill her obligations. Remember, you don’t need to exercise the option in order to realize the profit, because you can sell the option back on the market just like how you do with a stock.

There are so many benefits and usages with options, the sky’s the limit. If you wish to learn more about options and what they can offer. There are lots of educational material on the Montreal Exchange website.

Plus, MX will be hosting its 11th edition Options Education Day in Montreal on May 26th, 2018. We will have speakers showing you how you can get started with options, learn how to generate consistent income, use charts and technical analysis and combine this to different option strategies and so much more. For more information, visit the Options Education Day link to sign up!

Until next time, may the best trades be with you.

The post Beginner’s guide to Options trading appeared first on Option Matters.

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Learning how to trade options takes time and patience. Luckily, there are plenty of courses and tools to help investors through this process. Selling covered calls for income is a great way to dip your toes into the options market, before moving onto buying calls and puts. We will examine these 2 primary strategies that are suitable for beginners placing their first options trade. Use OptionsPlay to help you explore, analyze and visualize these strategies before trading. Understanding your risks and rewards prior to entering a trade is critical to success!

Selling Covered Calls:

Covered Calls is a basic strategy that adds no additional risk while generating income by selling calls against the stocks in your portfolio. It can be used in almost all market conditions and does not require a directional view to get started. Start with selecting shorter dated options (3-7 weeks from expiration) and strike prices that have a lower probability of being In-The-Money at expiration (20-30 Delta). Selling covered calls also does not require active daily monitoring of the position until near the expiration week. Watch our recorded webinar to learn more about this strategy and the best practices for Generating Income using Covered Calls.

Buying Calls & Puts:

With a strong directional view on a stock or ETF, buying calls or puts is a basic strategy to speculate on direction with limited risk. This can be used for breakouts, bounces off support or resistance levels for bullish or bearish views. Buying a call for bullish views, and puts for bearish ones is a simply way to get started. Select options that are roughly 1-2 months from expiration and use strike prices that are slightly in the money (60 Delta). Be sure to exit a trade prior to expiration once your directional view on the stock or ETF is either confirmed or invalidated. A very common mistake is holding onto a call or put for too long. View our recorded webinar on trading Trading Your First Option for tips and guidance.

There are many more things to learn about trading options, and having the right tools will make the process easier and more intuitive. Resources like the Montreal Exchange Reference Manual for Equity Options and OptionsPlay are great for the beginners starting out. Print out the infographic in this post to get started with your first options trade!

Plus, we’ll be at Montreal Exchange’s 11th edition of Options Education Day in Montreal on May 26th, 2018!

(Register now!)

It will be a jam-packed event showing you how to get started with options, manage your existing option positions and much more!  Swing by for a live demo!

The post Tips for Trading Your First Option appeared first on Option Matters.

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As the following graph shows, shares in Royal Bank of Canada (RY) veered into correction territory after peaking at $108.52 on January 22, 2018. At the current price of $97.98, the security is down by over 9.7%. With the RSI (Relative Strength Index) indicator on the rise and the stochastic oscillator (%K) indicating that the stock is oversold, all the conditions are in place for the price of RY to rally, given that we are still bullish on the market’s prospects in the long term. A realistic objective for the stock price would be the high of $104 reached in February.

Daily chart for RY ($97.98 on Monday, April 23, 2018)

An investor interested in profiting from this scenario could buy call options expiring on October 19, 2018, selecting the strike that would produce the best return if the stock reaches a price of $104.00 on expiration.

We will choose from among the following call options:

  • RY 181019 C 94 at $5.88
  • RY 181019 C 96 at $4.63
  • RY 181019 C 98 at $3.50

Position

Comparative Table of Call Options

As the above table shows, of these three call options, it is RY 181019 C 96 at $4.63 that has the optimal combination of risk and return, offering a potential return of 72.97% if RY reaches the target price of $104.00 on October 19, 2018. We therefore execute the following transaction:

  • Purchase of 10 call options RY 181019 C 96 at $4.63
  •                  $4,630 debit

Profit and loss profile
Target price on the call options RY 181019 C 96 = $8.00 ($104.00 – $96.00)
Potential profit = $3.38 per share, for a total of $3,380
Potential loss = $4.63 per share, or $4,630

Intervention
Even though the target price for shares of RY is $104.00, our potential profit is tied to the target price of $8.00 on the call options. Consequently, as soon as the price of the options reaches $8.00, we will liquidate the position, even if RY has not yet reached the target price of $104.00.

Good luck with your trading, and have a good week!

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

The post A Bullish Position to Optimize Risk-Reward appeared first on Option Matters.

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Trading and investing for ones self is challenging at best, let alone when you are making mistakes that could have been avoided. I am of course speaking from experience as I have paid my share of tuition thanks to falling victim to a few of the following blunders.

Using an all-purpose strategy

Options can be used under a variety of market conditions. It is important for investors to have a clear understanding of what they want to accomplish. When an investor understands the dynamics of the option market as well as current market conditions, they can construct an appropriate strategy to meet their unique objectives.

Remember that each strategy has several unique considerations and characteristics that may or may not be the most effective selection based on market conditions and specific objectives.

These considerations include:

  • Risk/reward
  • Impact of time depreciation
  • Impact of volatility
  • Liquidity (the ability to get in and out of the position effectively)
  • Commissions
  • Complexity

The reality is that each strategy will perform differently depending on market conditions.

Investors must:

  • Assess market conditions and determine objectives
  • Research available option strategies
  • Create a plan to manage the position
  • Execute the trade
  • Manage expectations accordingly

Taking the time to learn the unique characteristics of each strategy and subsequently selecting the “right tool for the job” can help swing the odds of a successful trade in your favor.

Buying “cheap” options

This was the first mistake I made during my formative years.  Many investors look to the options market as a way to leverage their capital.  As such, often the first and misguided approach is to purchase as many “cheap” options as possible.  Since options with Out-Of-The-Money strike prices are less expensive relative to At-the-Money and In-the-Money contracts, this tends to be where the novice option trader migrates.

Options are priced based on the probability of whether they are going to have an intrinsic value or in other words be “In-The-Money” on expiration.  The further away the strike price of the option is from the current stock price, the more likely it will expire worthless and as such, the contract is priced accordingly.

This also applies to expiration date selection. Short-term options are less expensive relative to longer dated options for the same reason.  It’s more challenging to forecast what is likely to happen to the share price of a stock over a longer period versus shorter.  The longer time allocated for something to happen, the greater the posibility it will happen. As such options expiring at further out expiration dates will be more expensive then shorter term options to compensate for that uncertainty.

By understanding that options are prices more or less expensive for a reason, the investor can make better, more educated decisions when it comes to strike prices and expiration date selection.

Ignoring implied volatility

Implied volatility (IV) is perhaps the most misunderstood and often overlooked pricing variable. Implied Volatility is the adjustment for risk and can be impacted by upcoming earnings and other company specific events as well as broader market/macro-economic considerations.

As risk and uncertainty increases in the underlying stock, the option price will increase to compensate for the risk.

The challenge is that this IV contraction and expansion will influence the option price even if the price of the stock does not move. For example, the chart below references the purchase of a Call option during a period of high implied volatility.  Note that 3 days later, while the shares appreciated in value, the volatility contraction complete negated the influence of the stock move, resulting in a loss.

This demonstrates that you can be right about the stock move, but if you ignore IV, you may end up less profitable or even at a loss.  By understanding IV and whether is high or low comparative to historical levels, you can be sure to choose an appropriate strategy.

Plan Your Actions

While the above common mistakes only represent a select few pitfalls to watch out for, having a well thought out trading plan before you act will help you identify these potential traps this ensuring that you:

  • Choose appropriate contract and strategies
  • Make less emotional decisions
  • Feel in control
  • Manage your risk and lock in profits

And ultimately put the odds better in your favour.

The post Option Trading Mistakes to Avoid appeared first on Option Matters.

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Over the last few years I have not been shy about my conviction that the gold bear market has ended.  There is no denying that the December 2015 lows for gold bullion at $1050.00 are now history, but the enthusiasm for the shiny metal has been left for the diehards as most of the speculative money has turned its attention to cryptocurrencies and cannabis stocks.  Will the glitter return to gold and usher in a new opportunity for investors to profit? One Wall Street legend certainly thinks so.

Jeffrey Gundlach from Doubleline Funds, who has been crowned the new “Bond King” has taken a firm stance on the metal.  Speaking at John Mauldin’s Strategic Investment Conference back in March, he made a strong case for the yellow metal.

Here is what he had to say:

We’re also at the juncture in gold, not surprisingly, because it is negatively correlated with the dollar. We see that gold broke above its downtrend line, it’s got the same look. But now we see a massive base building in gold. Massive. It’s a four-year, five-year base in gold. If we break above this resistance line one can expect gold to go up by, like, a thousand dollars. Will it happen? Well it’s not happening right now but it’s a very interesting juncture. It’s a great time to be buying gold straddles. Because one way or the other this baby’s got to break in a big way.


Source: tradingview.com

It’s a great time to buy gold straddles? 

While Jeffrey’s call on gold appears bullish, what he more accurately is suggesting is that gold is winding up for a very big move and that move could arguably be a break lower as easily as a break higher.  I found it very interesting that he referenced an options straddle as a way to implement the trade. Those not familiar with strategy can find a great summary provided by the Montreal Exchange HERE.

For more sophisticated traders, turning to the options markets on gold futures is always an interesting consideration, but for most retail investors, they turn to the derivative of trading their view on gold through the gold mining companies that readily trade on the main stock exchanges.  Does the same opportunity apply to gold miners?

I would argue that the opportunity is even more asymmetric.  The gold bullion price rally in the first half of 2016 saw the price rise from $1050.00 lows toward $1375.00 for a 30% rise.  During that same time, the iShares S&P/TSX Global Gold Index ETF (XGD) more than doubled in price rising from the low $7.00 range to almost reaching $18.00 a share.

The observation being that the miners have through history demonstrated to be more volatile and more responsive, which is ideal for a trader opening a option straddle position.  Obviously, the implied volatility being priced into the option partly discounts this, but it does not change the fact that an extraordinary move in gold, to the magnitude Jeffrey Gundlach suggests, presents a compelling speculation for big returns.

Assuming an investor was motivated by Gundlach’s bold call on gold and wanted to put on a straddle, how would the trade potentially look using iShares S&P/TSX Global Gold Index ETF (XGD).

Breakdown:

  • iShares S&P/TSX Global Gold Index ETF is trading at $12.00 (April 20, 2018)
  • The March 2019 $12.00 call option is $1.20
  • The March 2019 $12.00 put option is $1.15
  • The net cost of the straddle (buying the call and the put) is $2.35

The first observation is that it appears to be a rather large percentage outlay at around 20% of the cost of the shares.  But that needs to be put into context.  As seen on the chart below, that the implied volatility on the XGD options remain on the bottom of the 1-year range, which at the most basic level suggests more favorable volatility risks as a spike in implied that normalizes back to the historical mean would improve the profitability of the straddle.


Source: Interactive Brokers

The other consideration is putting the context of a potential range of a breakout in the XGD.  While the 2017 calendar year was defined by a relatively narrow range of $3.00 (between $11.41 low to $14.51 high), the 2016 year could arguably be a more accurate example of what the XGD is capable of if a breakout was to occur.  In 2016 the XGD had a +$10.00 range (between $7.68 low to a $17.70 high).  Will Jeffrey Gundlach’s bold call be proven right?  It will certainly be one of the more interesting themes of the year to watch.

The post Is Gold Breaking Out of its 4-Year Consolidation? appeared first on Option Matters.

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Traders are very opinionated and have their own view on everything. This is why we have a market of buyers and sellers. Otherwise, everyone would be on the same side of the trade. This behaviour is built over time from experience and knowledge. You can do it too. For example, you are able to tell if the stock is trending up or down by looking at the price movements in the following chart. As traders, we are trained to identify the trends and have an opinion on the stock’s direction. The next step is to pull the trigger, you can either buy the stock, short the stock (if you think it is dropping), or use options. By using options, you benefit from better risk management. When you commit yourself to a long option trade, your risk is predefined. Even in case of the company’s bad press overnight, the stock’s gap down at the open will not leave you with an irrecoverable losing position because you will not lose more than the premium paid for the option.

Source: TMXMoney.com

To get started, you need to find out the expiries and strike prices that are at your disposal for trading. This information can be found in an option chain. If you are new to options, this is an option chain on iShares S&P/TSX 60 Index ETF (ticker: XIU).

Source: m-x.ca

In an option chain, you find all the available option strike prices and expiries that are at your disposal for trading. The option chain is composed of:

• Bid price (price at which buyers are willing to buy at);
• Ask price (price at which sellers are willing to sell at);
• Last price (price of the last trade if there was one or previous day’s closing price);
• Implied volatility (the stock’s volatility that the marketplace is “implying” embedded into the option price);
• Open interest (total number of open or outstanding options); and
• Volume (traded volume of the given day). Even if there is no volume, options can be bought and sold at any given time as long as there is a bid or ask.

 
Let us go back to the theme of this article, the Da Vinci Code and the option chains. Every day, traders inject their prices and views into the options market and all this valuable information is encrypted into the option chains. Since option prices are embedded with a time value component, we can extrapolate how much a stock is expected to move before a specific date. This will not tell you the direction (up or down) of the stock, but rather by how much it will move. Once you decrypt this information, it will be up to you to agree or not with the market.

Here are the steps and we use XIU as an example:
As of the close on Wednesday January 10th, 2018, XIU was trading at $24.25.
1. Lookup XIU’s option chain. We use Feb 2018 expiry as an example.
2. Find the strike price that is closest to the price of the underlying. (We are fortunate to have a strike price identical to the XIU price.)
3. Take the ask prices of the Feb 16 2018 $24.25 call and put options, and add them up:
$0.30 + $0.27 = $0.57.
4. For the call option, take the ask price from the next higher strike price. In this case, we use the $24.50 strike price and the $0.17 ask price.
5. For the put option, take the ask price from the lower strike price. Thus, use the $24.00 strike price and use the $0.19 ask price.
6. If we add up both ask prices from steps 4 and step 5, we get $0.36 ($0.17 + $0.19).
7. Add the results from step 3 and 6 and divide it by 2: ($0.57 + $0.36) / 2 = $0.465.

 
Decryption:

This means that the participants in the options market are expecting XIU to move + or – $0.465 by February 16th, 2018. Remember, this can be up or down $0.465 from the current price of $24.25. Based on this information, you know by how much XIU could move. This is how you decrypt the option chains. This method should be taken with a grain of salt because bursts of volatility in the market could affect the model. Until next time, may the best trades be with you.

The post The Da Vinci Code: The hidden messages within the option chains appeared first on Option Matters.

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