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**Options:**

**What is an Option?**

Options are financial instruments that can provide you with the flexibility you need in almost any investment situation you might encounter. Options give you options by giving you the ability to tailor your position to your own situation. Options are labeled derivatives because they derive from some other security. Options are much more volatile than equities and the risk of losing returns is much greater than with equities; however the potential reward is also much greater.

Option Strategies:

There are many option strategies that The Oxen Group recommends:

· Long Call

· Long Put

· Short Call

· Short Put·

· Bear Call Spread

· Bull Put Spread·

·

**Long Call**

When you buy a call option you have the right but not the obligation to purchase a certain security at a specified strike price in a certain period of time (the time period ends on the expiration date)

**Max Profit**

Assume we found a stock that is trading for $100 and we think the stock is going to climb in the near future. We could purchase a 100 strike call options for $1. Now the call option does not have any intrinsic value until the stock price reaches $101. For now the option is only worth $0 intrinsic value and $1 time value.

If the stock price closes above the strike of the call option + the premium paid on the expiration date, a profit will be made.

Example: XYZ stock trades at $100, and we purchase the 100 strike call option for $1. If XZY stock closes at $103 on the date of expiration the total profit = Stock Price – Strike price – Premium Paid – Commissions = $103-$100-$1 = $2 profit – commissions.

**Max Return**

The max potential return for call options is unlimited

Now the max return is calculated as:

(The price you sold the call option) – (the price you purchased the call option)/ (the price to purchased the call option)

In our example where XYZ stock closed at $103 on option expiration, the return would be calculated as followed:

If the stock closes at $103 on option expiration our call option will be worth the stock price – the strike price = $3 – the premium paid ($1) = $2

Return = ($2-$1)/$1 = 100% (you doubled your money!)

Note: We can lose 100% of our money by purchasing an options contract if the contract expires worthless on expiration.

**Max Loss**

The max loss is limited to the amount we paid for our call option contract. In this example we lose the $1 we paid (since typically option contracts have a multiplier of 100 shares a $1 option contract means a $100 loss if expired worthless). The risk of a max loss should not be taken lightly. Investors seem to overlook the fact that options can lose their entire value. What is most frustrating is that the call option buyer could be 100% correct on the direction of the stock price, but in the time frame that the call option exists the stock remains neutral, or worse the increases to $101 but we still lose the entire value of the option.

We can lose 100% of our money by purchasing an options contract if the contract expires worthless on expiration.

**Breakeven Point**

To breakeven on the trade we need the stock price to close on the date of expiration at or above the strike price + the premium paid. In this case the breakeven point is $100 strike + $1 premium = $101 breakeven point.

**Long Put**

When you buy a put option you have the right but not the obligation to sell a certain security at a specified strike price in a certain period of time (the time period ends on the expiration date)

**Max Profit**

Assume we found a stock that is trading for $100 and we think the stock is going to decline in the near future. We could purchase a 100 strike put options for $1. Now the call option does not have any intrinsic value until the stock price reaches $99. For now the put option is only worth $0 intrinsic value and $1 time value.

If the stock price closes below the strike of the put option – the premium paid on the expiration date, a profit will be made.

Example: XYZ stock trades at $100, and we purchase the 100 strike put option for $1. If XZY stock closes at $94 on option expiration the total profit = Strike Price – Stock Price – Premium Paid – Commissions = $100-$94-$1 = $5 profit – commissions.

**Max Return**

The max potential return for put options is almost unlimited (until stock reaches $0)

Now the max return is calculated as:

(The price you sold the put option) – (the price you purchased the put option)/ (the price to purchased the put option)

In our example where XYZ stock closed at $94 on option expiration, the return would be calculated as followed:

If the stock closed at $94 on option expiration our put option will be worth the strike price – the stock price = $100-94 = $6 – the premium paid ($1) = $5

Return = ($5-$1)/$1 = 400% (made four times your money!)

Note: We can lose 100% of our money by purchasing an options contract if the contract expires worthless on expiration.

**Max Loss**

The max loss is limited to the amount we paid for our put option contract. In this example we lose the $1 we paid (since typically option contracts have a multiplier of 100 shares a $1 option contract means a $100 loss if expired worthless). The risk of a max loss should not be taken lightly. Investors seem to overlook the fact that options can lose their entire value. What is most frustrating is that the put option buyer could be 100% correct on the direction of the stock price, but in the time frame that the put option exists the stock remains neutral, or worse the declines to $99 but we still lose the entire value of the option.

We can lose 100% of our money by purchasing an options contract if the contract expires worthless on expiration.

**Breakeven Point**

To breakeven on the trade we need the stock price to close on the date of expiration at $99. The strike price – the premium paid = breakeven point. In this case the breakeven point is $100 strike - $1 premium = $99 breakeven point.

**Short Call**

A short call option is a strategy that is betting that the stock will trade neutral to bearish in the specified time frame of the option. With a short call option you have the obligation to sell the stock at a certain strike price by a specified period of time.

**Max Profit**

The max profit is achieved when the stock price closes at or below the strike price.

The potential gain is limited no matter how far the stock drops.

**Max Return**

Return is difficult to measure it’s based on the brokers margin requirements. Assume we sell a call option on XYZ stock that trades at $50 and the call option premium was $1.50. The margin requirement is 20%. In this case we are liable of up to $1000 risk on the trade. Thus, a $1.50 (which is $150 with a 100 share multiplier) is a 15% return is we’re risking just $1000

**Max Loss**

If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money, with a potential unlimited loss!!!

**Breakeven Point**

Breakeven Point = Strike Price of Sold Call + Premium Received

Example: We sold the 93 strike call option on XYZ stock for $1. XYZ stock closes at $94 on the date of expiration.

**Short Put**

A short put option is a strategy that is betting that the stock will trade neutral to bullish in the specified time frame of the option. With a short put option you have the obligation to buy the stock at a certain strike price by a specified period of time.

**Max Profit**

The max profit potential of a short put is limited no matter how higher the stock increases in value during the life span of the option contract.

**Max Return**

Just as with the short call option a short put requires a certain margin set by a brokerage house. Let’s say we sell a 100 strike put option on a stock trading at $100 and the margin requirement is 20%. This means that we are as risk of a $20 of the stock price. Since American equity options have a multiplier of 100 shares we would require $2,000 margin to sell the 100 strike put option.

Example:

XYZ stock is trading at $100.

We sell the 100 strike put option for $2.00 (remember the 100 share multiplier makes this option contract really worth $200).

We are at risk for 20% of the value of the stock in case of a decrease. This means we would need at least $2000 in our account to initiate this trade.

**Max Loss**

The max loss of selling a put option is nearly unlimited. The most a stock can go down is to zero, however if the short put is on a high value stock, the downside potential could be drastic.

**Breakeven Point**

The breakeven point for a short put option is the strike price – the premium received.

Example:

XYZ stock is trading at $45 when we sell the 44.50 strike put for $0.25. This means that our breakeven point is the strike price – the premium received = 44.50-0.25 = 44.25

**Credit Spreads**

A credit spread is a term used to define an option strategy where the investor does not pay for a trade but instead is paid for taking on risk.

__Bear Call Spread__

The bear call spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will remain neutral or decline moderately in the near term.

The bear call spread option strategy is also known as the bear call credit spread as a credit is received upon entering the trade.

Bear Call Spread Set Up

Sell 1 Lower Strike Call Option

Buy 1 Higher Strike Call Option

Example: **Oct’28 GLD 159/160 Bear Call Spread **

**Sell an Oct’28 159 strike call for $1.12**

**Buy an Oct’28 160 strike call for $1.00**

**In the end we have a net credit of $0.12**

**Thus we say: Oct’28 GLD 159/160 Bear Call Spread Sold for $0.12**

Bear Call Spreads can be implemented by buying a higher strike call option and selling a lower strike call option on the same stock/ETF with the same expiration date

**Max Profit**

The maximum gain attainable using the bear call spread options strategy is the credit received upon entering the trade. To reach the maximum profit, the stock price needs to close below the strike price of the lower striking call sold at **expiration date** where both options would expire worthless.

The formula for calculating maximum profit is given below:

**Max Profit = Net Premium Received – Commissions Paid****Max Profit Achieved When Price of Underlying <= Strike Price of Short (Sold) Call Option**

**Example: Oct’28 GLD 159/160 Bear Call Spread Sold for $0.12**

**Max Profit = $0.12-commissions =$12-commission**

**Max Return**

The max return can be viewed in two ways; Return on Margin, and Return on Risk

__Return on Margin:__

The margin requirement for a spread that has a $1 width (GLD example: $160-$159 = $1 width) is $100 ($1*100 shares)

Thus if we receive $0.12 on $100 margin we calculate a return as follows: $12/$100 = 12%

If we take into account commissions of $0.70/contract at Interactive Brokers then your return on margin looks like this.

We were paid $0.12 for selling the Nov’19 159/160 bear call spread. However, we were charged $0.70 to buy 1 call option and charged $0.70 to sell 1 call option = $1.40. If we decide to exit the trade early instead of letting the spread expire worthless then we will be charged once again $1.40 for buying back the call option we sold, and to sell the call option we bought.

In this case return on margin is = $12-$(1.40*2)/$100 = 9.2%

__Return on Risk__

The actually money at risk (the most we can lose) is only $100-$88. Why? When we sold the GLD 159/160 bear call spread for $0.12, $12 was deposited into our account. We’re getting paid $12 to risk $88 worth of our money. This may not sound like a winning strategy, however due to the high probability that our bear call spread will expire worthless over time this can become a winning and profitable strategy.

Thus, if we’re risking a total of $88 in our account then the total potential return on risk is $12/$88 = 13.63%.

However, if we take into account commissions the trade may look like this =

$12-($1.4*2)/$88 = 10.45%

**Max Loss**

If the stock price rise above the strike price of the higher strike call at the expiration date, then the bear call spread strategy suffers a maximum loss equals to the difference in strike price between the two options minus the original credit taken in when entering the position.

The formula for calculating maximum loss is given below:

**Max Loss = Strike Price of Long Call – Strike Price of Short Call – Net Premium Received + Commissions Paid****Max Loss Occurs When Price of Underlying >= Strike Price of Long Call**

**Example: Oct’28 GLD 159/160 Bear Call Spread Sold for $0.12**

**Max Loss: 160-159 – $12 + commissions = -$88 + commissions**

**Breakeven Point**

The security price at which break-even is achieved for the bear call spread position can be calculated using the following formula.

**Breakeven Point = Strike Price of Short Call + Net Premium Received**

__Bull Put Spread__

The bull put spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will remain neutral or increase moderately in the near term. The bull put spread options strategy is also known as the bull put credit spread as a credit is received upon entering the trade.

Bull Put Spread Set Up

Sell 1 Higher Strike Put Option

Buy 1 Lower Strike Put Option

Example: **Oct’28 GLD 159/160 Bull Put Spread **

**Sell an Oct’28 160 strike put for $1.12**

**Buy an Oct’28 159 strike put for $1.00**

**In the end we have a net credit of $0.12**

**Thus we say: Oct’28 GLD 159/160 Bear Pull Spread Sold for $0.12**

Bull put spreads can be implemented by selling a higher strike put option and buying a lower strike put option on the same stock/ETF with the same expiration date

**Max Profit**

If the stock price closes above the higher strike price on expiration date, both options expire worthless and the bull put spread option strategy earns the maximum profit which is equal to the credit taken in when entering the position.

The formula for calculating maximum profit is given below:

**Max Profit = Net Premium Received – Commissions Paid****Max Profit Achieved When Price of Security >= Strike Price of Short (Sold) Put Option**

**Example: Oct’28 GLD 160/159 Bull Put Spread Sold for $0.12**

**Max Profit = $0.12-commissions =$12-commission**

**Max Loss**

If the stock price drops below the lower strike price on expiration date, then the bull put spread strategy incurs a maximum loss equal to the difference between the strike prices of the two puts __minus__ the net credit received when putting on the trade.

The formula for calculating maximum loss is given below:

**Max Loss = Strike Price of Short Put – Strike Price of Long Put + net Premium Received – Commissions****Max Loss Occurs When Price of Underlying <= Strike Price of Long Put**

**Example: Oct’28 GLD 160/159 Bull Put Spread Sold for $0.12**

**Max Loss = 160-159+0.12(premium received) + commissions = -$88 + commissions**

**Breakeven Point**

The break-even price that is achieved for the bull put spread position can be calculated using the following formula.

**Breakeven Point = Strike Price of Short Put – Net Premium Received**

**Example: Oct’28 GLD 160/159 Bull Put Spread Sold for $0.12**

**Breakeven Point = $160-$0.12 = $159.88**

Information is Courtesy of www.theoptionsguide.com