Archive for October, 2009

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Choosing the Best Options Broker

October 6th, 2009

Different people have different criteria when choosing a broker… For me, the key factor is commission… Ya, although they always say, you shouldn’t choose a broker based on commission, I find it hard to agree…

Commissions can easily take up a huge percentage of your profits, especially if you are doing options combination that involves multiple leg (such as an Iron Condor), you would want to watch your commission.

Else, even if you sold the options for a $1 profit and they all expire worthless, you’ll find that your profit may only be about 50 cents after commissions. If you did not take this into account when you calculate your odds in trading, a supposedly profitable trading system can easily end up being non-profitable.

So, which broker do I use?

Personally, I use thinkorswim… for a number of reasons

1) They have one of the most user-friendly platform with lots of tools to facilitate my trading.

2) They only require an opening minimum of $3500… a comfortable amount when I was starting out… I would definitely not want to risk $10, 000 when I was still a beginner…

3) They let you trade any options combination you like… This is unlike some brokers that may restrict you from selling naked CALLs (not that I do something so risky, but I just like the freedom)… Or sometimes, some brokers only allow new traders to buy options… which is total bu**shit in my opinion, an absolute loss-loss situation….

4) Their commission is not the lowest, but the beauty is, they actually offer to match the commission of most major web-based brokers (such as E*Trade, optionsXpress etc)… (Unfortunately, they do not match two of the lowest commission brokers out in the market: InteractiveBrokers and OptionsHouse*)…

Nonetheless, I am happy with the choice that I’m given at thinkorswim… So, in order to compare which commission rate I should use, I created a spreadsheet to compute the commissions for each broker based on the number of contracts I expect to trade… The winner so far is Schwab (for 15 contracts)…

Actually, Schwab is the best for me because I couldn’t qualify for thinkorswim EX/RATES #1, cos that requires me to have $25,000 in my account… I’m not there yet, but maybe, just maybe…. soon I’ll reach that amount…

*Btw, if you trade more than 12 contracts each time, and you are a US citizen, OptionsHouse offers the lowest commission (other than Interactive Brokers which has a absolutely complicated platform as they are more geared towards professional traders)… too bad I’m not a US citizen… maybe I should negotiate with thinkorswim for OptionsHouse’s rates…

Anyway, I’ve attached the Excel File that I use here…. Feel free to use it…

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Another Profitable Options Strategy – The Credit Spread

October 5th, 2009

Today, I’m going to talk about another options strategy… the CREDIT SPREAD. This is actually a directional strategy, which means you have to be either bullish or bearish about a stock.

Let’s start with an example… Suppose you are a big iPhone fan and are extremely bullish about Apple (AAPL). You looked at the chart and identified strong support at $148.28. You believe that there is no way AAPL is going to fall below $148.28. In that case, you can choose to sell the nearest OTM Put, which is the $145 Put. In order to protect yourself from any unexpected plunge in the stock, you buy an even lower OTM Put, which is the $140 Put.

Example of a AAPL Bull Put Spread

Example of a AAPL Bull Put Spread

Let’s just suppose you sold the $145 Put for $2.70 and bought the $140 Put for $1.20. What you’ve done is you’ve just sold a Bull Put Spread. Since the $145 Put that you sold is more expensive than the $140 Put, this spread is actually a credit spread; you earn premium upfront (($2.70 – $1.20)*100 = $150 per lot in this case).

If you are right and AAPL never trades below $145 for the entire period till expiry day, both the $145 and $140 Put options will expire worthless and you are a few hundred bucks richer.

However, if you are wrong (say Steve Jobs is suddenly ousted from AAPL again) and the stock price plunges to $100 on expiry date, your lose is limited. This is because although you will be forced to buy AAPL stock at $145 now, you can turn around and sell that same stock at $140, since you bought a $140 Put to protect yourself. Thus, your loss is only limited to $500 for every Put you sold.

But wait! Remember you earned a premium of $150 on that fateful day when you decided to sell the spread? This means your loss is actually $500 – $150 = $350 per lot (excluding commissions). That’s not half as bad as if you had not bought the $140 Put. In which case you would have lost ($145 – $100)*100 per lot… Even after deducting the premium that you earned, you would still have lost $4500 – $270 = $4230 per lot…

That’s the merit of doing a credit spread, as opposed to selling a naked option (i.e. selling an option without buying another to protect yourself)… Better safe than sorry.

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What are Options Greeks? – Part 4: Gamma and Rho

October 3rd, 2009

The gamma of an option indicates how the delta of an option will change relative to a 1 point increase in the underlying asset. It is actually the “Delta of the Delta”…

For those Physics experts out there, we can say that
“Delta is to Velocity, as Gamma is to Acceleration”…

For Math experts, Delta is actually is the First Derivative of the Option Price (w.r.t. to Stock Price), while Gamma is the Second Derivative.

For everyone else… let me try to explain gamma with a hypothetical example

Suppose AAPL is currently trading at $190. Let’s look at how the price of a $205 CALL option will likely change when AAPL’s stock price changes

Understanding Gamma

Understanding Gamma

From the table above, you’ll notice that the delta of an option changes at a different rate depending on how far the current stock price is from the option’s strike price. The further it is, the less the delta will change.

For instance, when the current stock price changes from $190 to $195 (a $5 change), the delta increased by 0.3. In contrast, when it changes from $200 to $205 (a $5 change as well), the delta increased by 0.15. This is because the delta of an option changes at the greatest rate when the option is at-the-money (highlighted in yellow).

Since the delta of an option changes at a different rate, the gamma is a measure specifically designed to measure this rate of change of delta.

As a tool, gamma can tell you how “stable” your delta is. A big gamma means that your delta can start changing dramatically for even a small move in the stock price. Personally, I don’t really worry too much about gamma when I trade… This may not be the best way to trade… but it has worked well for me and I really love to keep things simple… So… gamma? What gamma….????

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The last option greek to discuss is Rho…

Rho is an estimate of how much the theoretical value of an option changes when interest rates move 1.00%. For example, suppose a call option of stock ABC has a value of 2.1 with a Rho value of .19. If interest rates increase from 5% to 6%, then the price of the call option, theoretically at least will increase from 2.10 to 2.29.

Among all the Greeks, Rho is the least used… and it has the least effect on options price… so, naturally, I never looked at Rho when I trade…

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Posted in Options Trading, Options Trading Education

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