Spread trading an introductory guide to trading options in nine simple steps

P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford Spread Trading i P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding The Wiley Trading series features books by traders who have survived the market’s ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics Whether a novice trader, professional, or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future For a list of available titles, visit our web site at www.WileyFinance.com ii P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford Spread Trading An Introduction to Trading Options in Nine Simple Steps GREG JENSEN John Wiley & Sons, Inc iii P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford To my friends and colleagues at Spread Trade Systems Copyright C 2009 by Greg Jensen All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our web site at www.wiley.com Library of Congress Cataloging-in-Publication Data: Jensen, Greg, 1973Spread trading : an introduction to trading options in nine simple steps / Greg Jensen p cm Includes index ISBN 978-0-470-44368-2 (cloth) Stock options Options (Finance) I Title HG6042.J46 2009 332.63 2283–dc22 2008052151 Printed in the United States of America 10 Screenshots courtesy of optionsXpress, Inc © 2008; optionsXpress, Inc is not affiliated with, does not endorse, is not endorsed by, does not sponsor, is not sponsored by, does not control, is not controlled by Greg Jensen Screenshots and information contained therein are for educational and informational purposes only, and are not intended to constitute a recommendation by optionsXpress, Inc to sell, buy, hold or otherwise act with respect to any financial product Any symbols displayed therein are illustrative only and any information therein was believed to be reliable at the time that it was made available and may now be out of date Both options and online trading have inherent risk and may not be suitable for all investors Please read Characteristics and Risks of Standardized Options iv P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford Contents Acknowledgments ix About the Author x Introduction STEP ONE Understanding the Long and Short of ‘‘Call’’ Options in the Market CHAPTER Lon and Shorty 11 CHAPTER Let’s Make a Deal 15 CHAPTER Trading Rights and Obligations 19 CHAPTER Some Key Terms Make Sense! that Almost 21 CHAPTER Strike One 25 CHAPTER Strike Two 29 CHAPTER Time Travel 35 CHAPTER R&R and Time Travel for Lon 37 CHAPTER R&R and Time Travel for Shorty 43 CHAPTER 10 How Lon and Shorty Came Out on Their Deal 49 v P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford CONTENTS vi STEP TWO Understanding the Long and Short of ‘‘Put’’ Options in the Market CHAPTER 11 Bulls, Bears, and Stags 53 CHAPTER 12 The Put: Reaching a Different Trade of Rights and Obligations 57 CHAPTER 13 Strike One 61 CHAPTER 14 Strike Two and Time Travel 67 CHAPTER 15 R&R for Lon 69 CHAPTER 16 R&R for Shorty 75 CHAPTER 17 The Big Picture CHAPTER 18 How Lon and Shorty Came Out on Their Deal So Far 79 83 STEP THREE Ramping Up the Possibilities CHAPTER 19 CHAPTER 20 Did You Know that There Are a Lot of People Trading Options? 87 Did You Know You Can Actually Buy and Sell Your Options to Other People ? 97 CHAPTER 21 Did You Know You Can Vastly Increase Your Return on Investment? 109 CHAPTER 22 Did You Know that You Never Want to ‘‘Make As Much Money As Possible’’? 115 Best of All: Did You Know You Can Combine Option Instruments? 119 CHAPTER 23 P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford vii Contents STEP FOUR Getting a Few Basics in Place CHAPTER 24 More Time Travel 131 CHAPTER 25 What Is an Option Worth? 135 CHAPTER 26 Strike Three 143 CHAPTER 27 Choosing Stocks 147 CHAPTER 28 Reading the Tea Leaves (1) 155 CHAPTER 29 Reading the Tea Leaves (2): Stock Trends 165 Getting the Final Pieces in Place 183 Fun, Fun, Fun! 197 CHAPTER 30 CHAPTER 31 STEP FIVE Understanding Two Basic Option Trades CHAPTER 32 Insuring Your Investment 209 CHAPTER 33 Shorty Heaven: Selling Your Way to Profits 221 STEP SIX Moving from Option Trading to Spread Trading CHAPTER 34 CHAPTER 35 Trading in Surround Sound: The Fundamental Spread Trade 231 The Two Basic Ways to Make Money in Spread Trading 245 P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford CONTENTS viii STEP SEVEN Understanding Bullish Spread Trades CHAPTER 36 The Bull Call 253 CHAPTER 37 The Bull Put 265 CHAPTER 38 Bull vs Bull 273 STEP EIGHT Understanding Bearish Spread Trades CHAPTER 39 The Bear Call 279 CHAPTER 40 The Bear Put 287 CHAPTER 41 Bear vs Bear 295 STEP NINE Getting Started CHAPTER 42 Lifting the Fog 303 CHAPTER 43 The Launch 311 APPENDIX Answers to End-of-Chapter Reviews 319 Index 335 P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford Acknowledgments hey told me I have to this acknowledgments page It’s for thanking people “without whom this book could not have been written.” (“Without whom”? Who talks like that?) Apparently, I’m supposed to thank a bunch of people who aren’t even the author Like my colleagues at Spread Trade Systems Yeah, right The only things I ever heard from them about this book were, “No, you can’t file a personal injury claim for writer’s cramp.” For this they deserve thanks? I’m also (at least judging by other books) supposed to thank my wife for something like “endless support and patience.” But other than to threaten me every once in awhile, Heather didn’t lift a finger I didn’t talk to her much about the book anyway because I’m in trouble with her She says I never listen to what she says (or something like that—I don’t remember) So, sorry Heather; no thanks for you There’s also a rumor going around about a guy named Duane Boyce, who supposedly helped me out by doing little jobs like making the book something that could actually be read Some people seem to think he deserves some “credit.” And Mrs Kimberly White—who seemed like such a nice, amusing girl until we started talking about acknowledgments—I know she helped rewrite some parts, but, hey, she already got her thanks: she actually gets paid for what she does as an editor It’s either acknowledgments or money, people Okay, so I stole jokes from Dave Barry, James Gordon (a law professor, no less), Joe Glenn, and George Durrant But that’s their fault If they didn’t want people to steal their jokes they never should have told them I thank my golfing buddy, however, who helped me write this book by helping me shoot in the 70s (He says if it ever gets hotter than that, I shouldn’t go out at all.) That gave me lots of time to write last summer He of all people deserves the credit for this book Thanks, Stu! T G.J ix P1: JYS fm JWBT074-Jensen March 30, 2009 14:35 Printer: Courier Westford About the Author reg Jensen is cofounder of Spread Trade Systems, an industry leader in investment education A Registered Investment Advisor, Jensen earned his degree in business management, with an emphasis in finance, from Utah State University Over the last decade, he has helped thousands learn how to prosper in the stock market through spread trading G x P1: OTA app JWBT074-Jensen March 26, 2009 13:10 Printer: Courier Westford APPENDIX: ANSWERS TO END-OF-CHAPTER REVIEWS 328 ‘sentiment’ of the market by looking at the VIX and at the total put-to-call ratio In both sentiment indicators, higher numbers tell us the market is basically bearish, and lower numbers tell us the market is basically bullish At the extremes, both indicate that the market may be ready to change its current direction.” CHAPTER 29 ANSWERS Bullish Bearish Stagnant Mid-April 2007 Mid-April 2007 The 5-day EMA was already above the 20-day EMA; it had already crossed over Late April 2007 Very early January Early to mid-January 10 Mid-January 11 Early January; that’s the first time we get buy signals from all three technical indicators 12 About $57.50 13 About $62.50 CHAPTER 30 ANSWERS $4 QNQUF $4,000 ($4 10 contracts 100 (shares per contract)) Any of these: place a long put, open a long put, open a long put position $3.70 QNQUF $1,850 ($3.70 x contracts 100 (shares per contract)) Any of these: short a put, open a short put, place a short put, open a short put position P1: OTA app JWBT074-Jensen March 26, 2009 13:10 Printer: Courier Westford Appendix: Answers to End-of-Chapter Reviews 329 Option writer 10 The Saturday following the third Friday of the month 11 Buying; selling 12 $2; $400 ($2 100 (shares per contract)) 13 $1.80; $360 ($1.80 100 (shares per contract)) 14 Early assignment 15 200 16 The strike price: $35 17 $3 ($40 market price – $35 strike price $5, minus $2 debit he paid to open the contract, which equals a net profit of $3 per share) 18 $600 ($3 per share 200 shares) 19 $35: the strike price 20 $360 ($1.80 per share credit 200 shares) 21 $6.80 ($5 per share by selling $1.80 per share from the credit) 22 $1,360 ($6.80 per share 200 shares) 23 Worthless; credit; his shares; debit 24 Close; bid; assigned 25 Assigned; receive 200 26 Assigned; receive 200; assigned 27 Buying; to close; ask 28 Sell to close 10 contracts of Nextall calls, with a December expiration and a strike of 45 (symbol of NUFLQ), at a bid price of $10.75; owns; call; selling 29 Sell to open contracts of Plum puts, with a June expiration and a strike of 32.50 (symbol PEMLZ), at a bid price of $6.50 CHAPTER 32 ANSWERS $91.91 $3.60 $95.51 ($91.91 stock price $3.60 debit) $5.51 ($95.51 cost basis – $90 strike price) $86.40 ($90 strike price – $3.60 debit) $64.74 $1.75 P1: OTA app JWBT074-Jensen March 26, 2009 330 13:10 Printer: Courier Westford APPENDIX: ANSWERS TO END-OF-CHAPTER REVIEWS $66.49 ($64.74 stock price $1.75 debit) $3.99 ($66.49 cost basis – $62.50 strike price) 10 $60.75 ($62.50 strike price – $1.75 debit) 11 $3.50 12 $68.24 ($64.74 stock price $3.50 debit) 13 $5.74 ($68.24 cost basis – $62.50 strike price) 14 $59 ($62.50 strike price – $3.50 debit) CHAPTER 33 ANSWERS July 2008 40 $34.57 ($38.47 stock price – $3.90 credit) $34.57 ($38.47 stock price – $3.90 credit) $5.43 ($40 strike price – $34.57 cost basis) Option goes in the money and we are assigned: we sell our shares at $40 and keep the credit we received CHAPTER 34 ANSWERS $14.85 $19.35 $99.50 ($104 stock price $14.85 debit for the long put – $19.35 credit for the short call) Make $3.875 ($99.50 cost basis – $103.375 long put strike) $10.50 ($110 short call strike – $99.50 cost basis) The short call goes in the money and we get assigned $19.30 $28.90 $179.63 ($189.23 stock price $19.30 long put debit – $28.90 short call credit) 10 $5.37 ($179.63 cost basis – $185 long put strike) 11 $15.37 ($195 short call strike price – $179.63 cost basis) 12 Short call goes in the money and we get assigned P1: OTA app JWBT074-Jensen March 26, 2009 13:10 Printer: Courier Westford Appendix: Answers to End-of-Chapter Reviews 331 CHAPTER 35 ANSWERS There are two basic types of trades One is a credit trade, where we buy and sell options that will give us a net credit to start with That net credit is our profit, and we simply want the options to expire worthless That way, we simply keep the credit without being forced to either buy or sell shares—which is what we would have to if the options were exercised Another type of trade is a debit trade, where we buy and sell options that will give us a net debit to start with In this case, we specifically want the value of our long option—the one we bought—to increase in value so that we can close our deal for a 20 to 25 percent profit.” In both cases, we are combining options in order to give ourselves a chance to make money while reducing risk Both options are critical to our trade One is the way we make money; the other is the way we limit risk We simply manage the spread between them CHAPTER 36 ANSWERS October; it’s the only expiration month with at least 45 days to expiration 45 strike; it’s the nearest out-of-the-money strike price 50 strike; it’s further out of the money than the long call strike, but not more than $5 $1.90 ($5.10 debit for the long call – $3.20 credit for the short call) $3.10 ($5 spread between the strike prices – $1.90 net debit) Close both legs of the trade when we reach a 20 percent ROI, which means 20 percent higher than the net debit $2.28 (1.2 $1.90) August; it’s the only expiration month with at least 45 days to expira- tion 27 strike; it’s near the money, which increases the likelihood of the option going in the money 10 28, 29, 30, 31 are all possible; all are further out of the money than the long call and none creates a spread greater than $5 For learning purposes, let’s look at two of these strike prices, 28 and 31 11 $0.44 ($1.73 debit for the long call – $1.29 credit for the short call) 12 $0.56 ($1 difference between strike prices – $0.44 net debit) P1: OTA app JWBT074-Jensen March 26, 2009 332 13:10 Printer: Courier Westford APPENDIX: ANSWERS TO END-OF-CHAPTER REVIEWS 13 $1.18 ($1.73 debit for the long call – $0.55 credit for the short call) 14 $2.82 ($4 spread between the strike prices – $1.18 net debit) (Notice that the risk/reward ratio of the trade with a $1 spread is $ 44/$.56, and the risk/reward ratio of the trade with a $4 spread is $1.18/$2.82.) 15 Close both legs of the trade when we reach a 20 percent ROI, which means 20 percent higher than the net debit 16 $0.53 (1.2 $0.44) 17 Close both legs of the trade when we reach a 20 percent ROI, which means 20 percent higher than the net debit Thus, 1.2 $1.18, which equals $1.42 CHAPTER 37 ANSWERS July; it’s the only month with 30 or fewer days until expiration 70 strike; it’s the nearest strike that is out of the money 65 strike; it’s the next strike price and gives us no more than a $5 spread $0.65 ($1.10 credit for the short put $0.45 debit for the long put) $4.35 ($5 difference between the two strike prices – $0.65 net credit) $0.65 (the net credit) Both options expire worthless in 30 days; we keep the net credit July; we want no more than 30 days until expiration Either 180 or 175; both are out of the money Let’s go with 175 10 170; it’s the next strike price and gives us no more than a $5 spread 11 $1.55 ($6.05 credit for the short put $4.50 debit for the long put) 12 $3.45 ($5 difference between the two strike prices – $1.55 net credit) 13 $1.55 (the net credit) 14 Both options expire worthless in 30 days; we keep the net credit CHAPTER 38 ANSWERS The bull call is a debit trade That means the long call is the primary instrument and is placed near the money or slightly out of the money The short call is the limiting instrument and is placed one or two strikes further out of the money This trade makes profit as the P1: OTA app JWBT074-Jensen March 26, 2009 13:10 Printer: Courier Westford 333 Appendix: Answers to End-of-Chapter Reviews spread between the two options grows This trade is for a bullish trend and it needs time value The bull put is a credit trade That means the short put is the primary instrument and is placed out of the money The long put is the limiting instrument, and is placed further out of the money This trade makes profit by the net credit we start with This trade is for stagnant to bullish trends and needs a short time frame CHAPTER 39 ANSWERS July; it’s the only expiration month with 30 or fewer days 60 strike; it’s far enough out of the money to provide some safety, and it gives a much higher credit than the 65 strike gives 65 strike; it’s further out of the money $1.26 ($1.95 credit for the short call – $0.69 debit for the long call) $3.74 ($5 spread between the two strike prices – $1.26 net credit) Both options expire worthless in 30 days; $1.26 per share July; it’s the only expiration month with 30 or fewer days 60 strike; it’s far enough out of the money to provide some safety, and it gives a much higher credit than the 62.50 strike gives Either 62.50 or 65 strike; both are further out of the money than the short call strike, and neither creates a spread greater than $5 Let’s go with the 65 strike for purposes of illustration 10 $0.45 ($0.65 credit for the short call – $0.20 debit for the long call) 11 $4.55 ($5 spread between the two strike prices – $0.45 net credit) 12 Both options expire worthless in 30 days; $0.45 per share CHAPTER 40 ANSWERS September; it’s the only month that gives us a minimum of 45 days 60 strike; the closest strike that’s out of the money 55 strike; we want the spread to be no more than $5 $1.15 ($1.70 debit for the long put – $0.55 credit for the short put) $3.85 ($5 spread between the two strike prices – $1.15 net debit) $1.38 (20 percent higher than the net debit—thus 1.2 $1.15) P1: OTA app JWBT074-Jensen 334 March 26, 2009 13:10 Printer: Courier Westford APPENDIX: ANSWERS TO END-OF-CHAPTER REVIEWS October; it’s the only month that gives us a minimum of 45 days 28 strike; it is near/at the money $0.87 ($1.49 long put strike price – $0.62 credit for the short put) 10 $2.13 ($3 spread between the two strikes – $0.87 net debit) 11 $1.04 (20 percent higher than the net debit—thus 1.2 $0.87) CHAPTER 41 ANSWERS The bear put is a debit trade That means the long put is the primary instrument and it is placed slightly out of the money The short put is the limiting instrument, and it is placed further out of the money The bear put makes profit as the spread between the two options grows This is effective for a bearish trend and needs time value The bear call is a credit trade That means the short call is the primary instrument and it is placed out of the money The long call is the limiting instrument and it is placed further out of the money The bear call makes profit because of the net credit we start out with This is effective for stagnant to bearish trends and needs a short time frame P1: JYS ind JWBT074-Jensen March 30, 2009 14:43 Printer: Courier Westford Spread Trading: An Introduction to Trading Options in Nine Simple Steps By Greg Jensen Copyright © 2009 by Greg Jensen Index Italicized page numbers refer to information contained in tables or figures adjustments, 125, 126, 241 assignment, 189–90, 193 automatic, 192, 193 early, 191, 193 at–the–money strike price, 27–28 See also strike price attitude, in spread trading, 315–16 bear call bear put compared to, 295–98, 297 bearish and stagnant trends and, 280, 284, 295, 296, 298 combination of long call and short call in, 280, 280, 284 credit trade, 280, 284, 295, 298 example of, 282–84 help in remembering, 303–6, 306 limiting instrument in, 281, 284, 295, 298 limiting risk in, 280–81, 283 long call in, 281, 284, 295, 298 net credit in, 282, 283, 284, 295, 298 primary exit in, 284, 284 pluses and minuses of, 297–98 primary instrument in, 280, 284, 295, 298 reward in, 283, 284, 295 risk in, 283–84, 284 short call in, 280, 284, 295, 298 strike price of long call in, 282–83, 284, 295, 298 strike price of short call in, 280, 284, 295, 298 summary of, 284 time frame in, 280–81, 282, 284, 296, 298 bear put bear call compared to, 295–98, 297 bearish trend and, 287, 292, 298 combination of long put and short put in, 287–88, 288, 292 debit trade, 287, 292, 295, 296, 298 delta and, 288, 289 example of, 288–92 help in remembering, 303–6, 306 limiting instrument in, 287, 296, 298 long put in, 287, 296, 298 mechanics of closing, 291–92 net debit in, 287, 289–90, 292, 298 non-ownership of stock in, 287 pluses and minuses of, 297–98 primary exit in, 291, 292 primary instrument in, 287, 296, 298 reward in, 290–91, 292, 297 risk in, 289–90, 292 short put in, 287, 296, 298 strike price of long put in, 288, 292, 298 strike price of short put in, 289, 292, 298 summary of, 292 time frame in, 287, 288, 292, 297, 298 Bear Stearns, 70–71 bearish, 53–54 bearish signals See also technical indicators and protective put, 215 335 P1: JYS ind JWBT074-Jensen March 30, 2009 14:43 336 bearish trend, 120, 122, 166 bear call and, 280, 284, 296, 297 bear put and, 287, 292, 297, 297 long put and, 123, 124 protective put and, 211 technical signals for, 172–76, 173, 174 “best in industry” factor in choosing stocks, 153 bid/ask prices, 90 debit/credit amounts and, 90–92 long and short options and, 90, 92–93 on option chain, 90, 92, 94, 95 time frame and, 97, 98 breakeven price on long call, 38–39 bull call bull put compared to, 273–76, 275 bullish trend and, 253, 261, 276, 279 combination of long call and short call in, 253, 254, 261 debit spread trade, 253, 261, 273–76 delta and, 259 example of, 255–58 help in remembering, 303–6, 306 how profit is generated in, 258–61 limiting instrument in, 256, 276, 279 long call in, 256, 276, 279 mechanics for closing, 260–61, 261 net debit in, 257, 261, 279 non-ownership of stock in, 253 primary exit in, 258, 261 primary instrument in, 256, 276, 279 pros and cons of, 275–76 reward in, 257–58, 261 risk in, 257, 261 short call in, 256, 276, 279 strike price for long call in, 253, 255–56, 261, 276, 279 strike price for short call in, 256–57, 261, 276, 279 summary of, 261 time frame in, 255–56, 261, 276 bull put bull call compared to, 273–76, 275 bullish and stagnant trends and, 268, 276, 269, 287 combination of long put and short put in, 266, 266, 269 credit spread trade, 265, 269, 273–76 Printer: Courier Westford INDEX example of, 266–69 help in remembering, 303–6, 306 limiting instrument in, 266–67, 276 limiting risk in, 265–66 long put in, 266–67, 276 net credit in, 268, 269, 276 primary exit in, 268, 269 primary instrument in, 265, 276 pros and cons of, 275–76 reward in, 268, 269 risk in, 268–69, 269 short put in, 265, 276 strike price for long put in, 267, 269, 276 strike price for short put in, 266–67, 269, 276 summary of, 269 time frame in, 266, 269, 276 bullish, 53, 54 bullish trend, 120, 122, 166 bull call and, 253, 258, 261 bull put and, 265, 268, 269 factor in choosing stocks, 147 long call and, 121, 124 technical signals for, 169, 170, 172 buy signals, 172 See also technical indicators buy to close (BTC), 192–93 buy to open (BTO), 185, 191 call, 17, 21 calls See also long call, short call on option chain, 90 market price and value of, 97–100, 121 strike price’s relationship to debit/ credit amounts in, 31, 61 strike price’s relationship to market price in, 26–27, 27 tracking performance of, 197–201 collar trade balance of risk and reward in, 238–39 combination of covered call and protective put in, 231, 232, 242 cost basis of, 235, 236, 242 example of, 232–36, 238–39 fundamental spread trade, 248 limiting instrument in, 231 long put in, 231 owning stock in, 231, 242 P1: JYS ind JWBT074-Jensen March 30, 2009 Index as philosophy of trading, 240–41, 248, 314 primary exit in, 241, 242 primary instrument in, 231 reward in, 236, 238–39, 242 risk in, 234, 235–36, 238–39, 242 short call in, 231 strike price for long put in, 232, 242 strike price for short call in, 232–34, 242 summary of, 242 time frame for long put in, 232, 242 time frame for short call in, 232–34, 242 trends and, 234, 242 combining See also spread trading eight variables to consider in, 125 cost basis collar trade and, 235, 236, 242 covered call and, 224, 227 long call and, 38 long put and, 70 protective put and, 212–13, 216 covered call, 117 balancing credit amount with time frame in, 223 cost basis in, 224, 227 cost basis of stock and, 223 credit in, 222–24, 226 example of, 223–25 exits for, 222, 226–27, 227 owning stock in, 221, 227 quarterly earnings report and, 226 reward in, 225, 227 risk in, 224, 227 selling at bid price, 223, 227 short call in, 221, 227 strike price in, 222, 227 summary of, 227 time frame in, 222–23, 227 when to use, 225–26, 227 credit, 23, 23 See also credit spread trades, debit/credit, net credit collar trade and, 232, 232–34, 235, 238–39, 242 covered call and, 223–24, 226, 227 short call and, 44, 80 short put and, 76–77, 80 14:43 Printer: Courier Westford 337 credit spread trades bear call, 280, 284, 295–98 bull put, 265, 269, 273–76 calculating reward and risk in, 307–8, 307 net credit and, 246, 247 outcome desired in, 246, 247 selling strategy in, 245–46, 247 credit trade, 23, 64, 186 debit, 22–23, 23, 30 See also debit/credit, debit spread trades, net debit collar trade and, 235, 239, 242 as insurance premium, 69 long call and, 39–40, 80 long put and, 58, 62, 64, 69–73, 80 protective put and, 210–14, 216 debit/credit bid/ask prices and, 90 strike prices for calls and, 31–32 strike prices for puts and, 63 time frame for calls and, 35 time frame for puts and, 67 debit spread trades bear put, 287, 290, 292, 295–98 bull call, 253, 261, 273–76 buying strategy in, 246 calculating reward and risk in, 306–8 net debit and, 246, 247 long option growth in, 246, 247 debit trade, 23, 64, 185 debt-to-equity ratio factor in choosing stocks, 149, 151, 152, 183, 184 delta, 101–2 bear put and, 288–89 bull call and, 255–56, 259–60 out-of-the-money strike prices and, 144 Dow Jones Industrial Average market indicator, 156, 157, 183, 184 due diligence, 151, 183 early assignment, 191, 193 earnings growth factor in choosing stocks, 148, 151–52, 183, 184 earnings per share (EPS), 148 P1: JYS ind JWBT074-Jensen March 30, 2009 14:43 338 earnings reports, covered call and, 226 protective put and, 215–16 equity growth factor in choosing stocks, 148, 151–52, 183, 184 exit(s) bear call and, 284, 284 bear put and, 291, 292 bull call and, 258, 261 bull put and, 268, 269 collar trade and, 241, 242 covered call and, 222, 226–27, 227 decided in advance, 115 protective put and, 211, 216, 216–17 expiration, 23, 193–94 on option chain, 91 exponential moving average (EMA), 169, 170 bullish signal and, 170, 172 bearish signal and, 172, 173 extrinsic value, 138, 139 See also intrinsic value, option value fear, 209 spread trading and, 311–12, 315–17 gambling, 209, 315, 317 greed, 116, 315, 317 hope, negative characteristic, 174, 201, 237, 315 vs spread trading, 237 implied volatility, 136–37 institutional ownership, factor in choosing stocks, 154, 183, 184 insurance long put as, 69–70, 101 in-the-money strike price See also strike price for calls, 25–26, 28 breakeven price and, 41 market price and, 26, 27, 27, 32–33, 63 risk and, 29–31 in general bid/ask prices and, 94–95 Printer: Courier Westford INDEX on option chain, 94–95 option value and, 135–36 risk and, 94–95 for puts market price and, 63 risk and, 63 intrinsic value (of company) calculation of, 149–51 factor in choosing stock, 149, 183, 184 intrinsic value (of option), 138–39, 139 See also extrinsic value, option value liquidation value, 148 long, 22, 75 See also long call, long put long call, 23 See also calls, short call bear call and, 281 bearish or stagnant trend and, 53–54, 168 breakeven price and, 38–39 bull call and, 256, 279 bullish trend and, 53, 121, 124, 124, 165 buy low/sell high formula and, 26, 62–63 capital requirements and, 121 cost basis in, 38 desire for underlying stock movement in, 105 expressions used for, 188 features of (complete list), 104 features of (partial list), 23, 80 loss in, 100 profit in, 99, 102–3 recouping losses in, 40 reward in, 39, 41 right to sell, 99–100 rights in (complete list), 104, 109 rights in (partial list), 19, 80 risk in, 39–40, 41, 53–54, 121, 124 time decay and, 168 time frame and, 41 ways to end, 190–93 long options See also long call, long put advance decision of profit goal in, 115 profit goal in, 115–16 long put, 64 See also protective put, puts, short put bear put and, 287 bearish trend and, 123, 124, 168 P1: JYS ind JWBT074-Jensen March 30, 2009 14:43 Index bull put and, 266, 267 bullish or stagnant trend and, 168 buy low/sell high formula and, 62–63 collar trade and, 231–36, 242 cost basis in, 70 desire for underlying stock movement in, 101, 105 expressions used with, 188 features of (complete list), 104 features of (partial list), 80 loss in, 101 profit in, 101, 102–3 protection and, 101, 123 reward in, 70–73 rights in (partial list), 58 rights in (complete list), 104 right to sell, 101, 103 risk in, 73, 123–24, 124 time decay and, 68 time frame in, 67–68 market makers, 90–91 market sentiment indicators of, 156, 160–62, 184, 184 moving average convergence/ divergence (MACD), 170, 172 bullish signals and, 170, 172 bearish signals and, 172, 173 multiple, 150 naked call risk in, 117, 123, 221–22 short call and, 116–17 Nasdaq market indicator, 156, 159, 183, 184 near-the-money strike price See also strike price calls and, 28 protective put and, 210 tracking effects of, for calls, 198–99 tracking effects of, for puts, 201–2 net credit, 246, 247 See also credit spread trades bear call and, 282–84, 295, 297, 304, 307 bull put and, 268–69, 269, 274–75, 304, 307 reward and, 307, 307 net debit See also debit spread trades Printer: Courier Westford 339 bear put and, 287, 289–90, 291, 292, 297, 304, 306, 307 bull call and, 257–58, 261, 275, 279, 304, 306, 307 risk and, 290, 307–8, 307 obligations, 20, 23 in short call and short put, 80, 106 OHLC bars, 169, 171 option, 21 exercise of, 190–93 worthless expiration of bear call and, 284, 295–96 bull put and, 268, 269, 274–75 covered call and, 222, 227 credit trades and, 245–46, 304 long call and, 191, 193 short call and, 105, 111 short put and, 101, 105, 111 optionable factor in choosing stocks, 152, 183, 184 option chain, 64 elements of, 89–94 option contract, 21, 186 option exchange, 185, 187, 189–90 option instruments, 79, 80, 82, 106, 247 See also long call, long put, short call, short put option symbol, 186–87 option trading advantages of, over owning stock, 109–11 combining instruments in, 120 hieroglyphics in, 194–95 how both parties can profit in, 49–50, 83–84 how to build competence in, 205 mechanics of, 184–87 ownership of underlying stock and, 109 questions to ask in, 126 option value extrinsic, 138–39, 139 implied volatility and, 136–37, 139 in-the-money strike prices and, 135–36 intrinsic, 138–39, 139 out-of-the-money strike prices and, 135–36 P1: JYS ind JWBT074-Jensen March 30, 2009 14:43 340 Printer: Courier Westford INDEX option value (Continued) stock price and, 97–103 time value and, 137 option writer, 187 out-of-the-money strike price See also strike price for calls, 27, 28 market price and, 27, 32–33 risk and, 29–31 short call and, 222 tracking the effects of, 198–99 in general intrinsic value and, 138 on option chain, 94 option value and, 135–36 usual placement of trades at, 143–45 for puts, 68 risk and, 77 tracking the effects of, 201–2 selling at bid price and, 212, 216, 217 stock ownership in, 210 strike price in, 210, 216 summary of, 216 technical signals and, 212, 217 time frame and, 210, 216 when to use, 215, 216 puts See also long puts, short puts market price and value of, 100–1, 123–24 on option chain, 90 strike price’s relationship to debit/credit amounts in, 63 strike price’s relationship to market price in, 62–63, 63, 123–24 tracking performance of, 201–4 put-to-call ratio measure of market sentiment, 161–62, 184, 184 paper trading, 197 importance of, for all option trades, 205, 314 P/E ratio, 150 preparation, elements of, 312–15 primary exit(s) See exit(s) profit goal bear put and, 291, 297, 298 bull call and, 258, 274, 275 debit trades and, 246–47, 274, 275, 297, 298 long call and, 115–16 long put and, 212 protective put See also long put, puts bearish potential and, 211 buying at ask price and, 212, 216 buying to open and, 211, 216 cost basis of, 212–13, 216 debit trade, 211, 216 example of, 210–14 as insurance, 210 long put as, 69–70 long term expectation for stock in, 211 primary exit in, 211, 216, 216–17 reward in, 213–14, 216 right to sell, 211 risk in, 214–15, 216 risk to investment after selling, 217 selling to close and, 211–12, 216, 217 relative strength index (RSI), 169, 170 bearish signal and, 170, 172 bullish signal and, 172, 173 resistance, 176–78, 178 return on invested capital (ROIC) factor in choosing stocks, 148, 151, 152, 183, 184 reward bear call and, 283, 284, 295 bear put and, 290–91, 292, 297 bull call and, 257–58, 261 bull put and, 268, 269 collar trade and, 236, 238–39, 242 covered call and, 225, 227 long call and, 39, 41 long put and, 70–73 net credit and, 307, 307 protective put and, 213–14, 216 short call and, 44, 111 short put and, 75, 111 rights, 19–20, 23 long call and short call and (complete list), 106 long call and short call and (partial list), 80 risk bear call and, 283–84, 284 bear put and, 289–90, 292 bull call and, 257, 261 P1: JYS ind JWBT074-Jensen March 30, 2009 14:43 Index bull put and, 268–69, 269 collar trade and, 234, 235–36, 238–39, 242 covered call and, 224, 227 debit/credit amounts and, for calls, 30–31 debit/credit amounts and, for puts, 63, 67 long call and, 39–40, 41, 53–54, 121, 124 long put and, 73, 123–24, 124 net debit, 290, 307–8, 307 protective put and, 214–15, 216, 217 short call and, 44–46, 123, 124 short put and, 76–77, 124, 124 time frame and, for calls, 35 time frame and, for puts, 67 sales growth factor in choosing stocks, 148, 151–52, 183, 184 sell signals, 172 See also technical indicators sell to close (STC), 191 sell to open (STO), 186 short, 22, 75 See also short call, short put short call See also calls, long call avoiding selling shares in, 116 balance between time frame and credit amount in, 46 bear call and, 280, 284, 295 bull call and, 256 bullish trend and, 55 buying back to close, 192–93 buying back, in bull call, 260–61, 261 collar trade and, 231–36, 238–39, 241, 242 covered call and, 117 credit received in, 23, 23, 111, 121, 168 expressions used with, 187 features of (complete), 104 features of (partial), 80 naked call and, 116–17 obligations in, 20, 23, 80, 104 outcome desired in, 100, 103, 111 reward in, 44, 111 risk in, 44–46, 123, 124 slightly bearish or stagnant trend and, 54, 120, 121, 122, 123, 124, 167 stock movement desired in, 105, 112 Printer: Courier Westford 341 stock ownership with, 123 time frame and, 45–46 short put, 64 See also long put, puts bear put and, 287, 296 bearish or bullish trend and, 124 bull put and, 265 buying back, in bear put, 291–92, 292 credit received is profit in, 75–76, 111, 124, 168 expressions for, 188 features of (complete), 104 features of (partial), 80 limit of profit in, 124 obligations in, 58, 80, 104 outcome desired in, 103, 111 reward in, 75, 111 risk in, 76–77, 124, 124 slightly bullish or stagnant trend and, 120, 124, 124, 168 stock movement desired in, 105, 113 time frame and, 77 slightly bearish trend, 120, 122, 167 covered call and, 227 short call and, 121, 124 slightly bullish trend, 120, 122, 165 short put and, 124, 124 spread defined, 237, 248 spread trading, 1–2, 120 See also bear call, bear put, bull call, bull put, collar trade beginning questions about, 2–4 buying strategy in, 245–46, 247 See also debit spread trades combination of option instruments in, 120, 125–26 eight variables to consider in, 125 increased control in, 237–38, 312 reduced fear in, 237 selling strategy in, 246, 247 See also credit spread trades stagnant trend, 54, 122, 165 bear call and, 280, 284, 296, 297 bull put and, 265, 268, 269 short call and, 121, 124 short put and, 124, 124 Standard and Poor’s 500 (S&P 500) market indicator, 156, 158, 183, 184 stock market basic concepts of, 4–6 P1: JYS ind JWBT074-Jensen March 30, 2009 14:43 Printer: Courier Westford INDEX 342 stock price option price and, 97 call strike prices and, 26–27, 27 call value and, 97–100, 121 put strike prices and, 62–63, 63, 123–24 put value and, 100–101, 123–24 stocks factors in choosing, 147, 154, 183, 184 strike price, 21 See also at-the-money, in-the-money, near-the-money, out-of-the-money bear call and, 282–83, 284, 295 bear put and, 288–89, 292 bull call and, 253, 255–57, 261, 279 bull put and, 266–67, 269 collar trade and, 232–34, 242 conventions used in speaking and writing of, 189 covered call and, 222, 227 debit/credit amounts for calls and, 30–32 debit/credit amounts for puts and, 62, 63 expressions used for, 189 on option chain, 89 protective put and, 210, 216 stock price for calls and, 26–27, 27, 30–33 stock price for puts and, 62, 62–63, 63, 123–24 tracking effects of, for calls, 198–201 tracking effects of, for puts, 201–4 trending in the money/out of the money, 33 support, 176–78, 177 technical indicators, 168–76, 184, 184 as buy and sell signals, 172, lack of certainty with, 176 theta, 132 time decay, 132–33 time frame See also time decay, time value bear call and, 280–81, 282, 284, 296 bear put and, 287, 288, 292, 297 bid/ask prices and, 97, 98, 131–33 bull call and, 255–56, 261 bull put and, 266, 269 collar trade and, 232–34, 242 covered call and, 222–23, 227 debit/credit amounts for calls and, 35 debit/credit amounts for puts and, 67–68 long call and, 41 long put and, 67–68 option value and, 131–33 protective put and, 210, 216 risk and, 133 risk for calls and, 35 short call and, 45–46 short put and, 77 tracking effects of, for calls, 199–201 tracking effects of, for puts, 202–4 time value, 131–32 See also time decay, time frame trends bearish, 120, 122, 166 bullish, 120, 122, 166 general indicators of, 156, 158, 159, 183, 184 indicators of, 156 option instruments and, 165 slightly bearish, 120, 122, 167 slightly bullish, 120, 122, 165 stagnant, 54, 122, 165, 167 technical indicators of, 168–76, 184, 184 virtual trading See paper trading volatility index (VIX) measure of market sentiment, 160, 160–61, 184, 184 volume factor in choosing stocks, 153, 183, 184 wishes, 316–17 ... Jensen, Greg, 197 3Spread trading : an introduction to trading options in nine simple steps / Greg Jensen p cm Includes index ISBN 978-0-470-44368-2 (cloth) Stock options Options (Finance) I Title... prosper in the stock market through spread trading G x P1: OTA intro JWBT074-Jensen March 31, 2009 15:34 Printer: Courier Westford Spread Trading: An Introduction to Trading Options in Nine Simple Steps. .. to start from scratch I want to give you the basics of making money in the stock market, and I want to it in a way that anyone can understand (In other words, I’m going to explain I P1: OTA intro