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:
Trading Option Greeks: How Time, Volatility, and Other Pricing Factors Drive Profit
by Dan Passarelli
Bloomberg Press (June 2008)
From the publisher: Veteran options trader Dan Pasarelli explains a methodology for option trading and valuation in this timely volume on option greeks. With an introduction to option basics as well as chapters on spreads, put-call parity and synthetic options, trading volatility, and advanced option trading, Trading Option Greeks holds new pertinent information on how the greeks can drive profit.
The greeks (delta, gamma, theta, vega, rho) are tools to measure changes in an option's value based on corresponding changes in:
• Volatility
• Time to expiration
• Underlying price
• Interest rates
Using these tools can lead to more accurate pricing and trading and alert the option trader to a range of opportunities.
Financial Resources
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