The objective of the Option Sleuth is educate the investor on how a managed option strategy as part of a diversified portfolio can generate additional income and boost returns.
There are two basic types of options: the call and the put.
A call is an option contract that gives the holder the right to buy the underlying security at a specified price for a certain, fixed period of time.
A put is an option contract that gives the holder the right to sell the underlying security at a specified price for a certain, fixed period of time.
Option contracts may be opened as a buy (long positions) or a write (short positions).
The following common option strategies are defined in terms of a net long position, however each strategy may also be opened as a net short position.
• Buy a call
Outlook on the underlying equity: Positive
Potential gain: Unlimited
Potential loss: Limited to price paid for call
• Buy a put
Outlook on the underlying equity: Negative
Potential gain: Limited to the value of the equity
Potential loss: Limited to price paid for put
• Buy a call spread (buy a call and sell a higher strike call)
Outlook on the underlying equity: Positive
Potential gain: Limited to spread value less price paid
Potential loss: Limited to price paid for spread
• Buy a put spread (buy a put and sell a lower strike put)
Outlook on the underlying equity: Negative
Potential gain: Limited to spread value less price paid
Potential loss: Limited to price paid for spread
• Covered call (buy equity, sell higher strike call)
Outlook on the underlying equity: Positive
Potential gain: Varies
Potential loss: Limited to value of equity less price received for call
This week's featured book on options trading:
The Volatility Edge in Options Trading
by Jeff Augen
FT Press (January 2008)
From the publisher: In The Volatility Edge in Options Trading, leading options trader Jeff Augen introduces breakthrough strategies for identifying subtle price distortions that arise from changes in market volatility. Drawing on more than a decade of never-before-published research, Augen provides new analytical techniques that every experienced options trader can use to study historical price changes, mitigate risk, limit market exposure, and structure mathematically sound high-return options positions. Augen bridges the gap between pricing theory mathematics and market realities, covering topics addressed in no other options trading book. He introduces new ways to exploit the rising volatility that precedes earnings releases; trade the monthly options expiration cycle; leverage put:call price parity disruptions; understand weekend and month-end effects on bid-ask spreads; and use options on the CBOE Volatility Index (VIX) as a portfolio hedge. Unlike conventional guides, The Volatility Edge in Options Trading doesn’t rely on oversimplified positional analyses: it fully reflects ongoing changes in the prices of underlying securities, market volatility, and time decay. What’s more, Augen shows how to build your own customized analytical toolset using low-cost desktop software and data sources: tools that can transform his state-of-the-art strategies into practical buy/sell guidance.
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