noob questions, help a brotha out

Most people that trade options use spreads. However there are a lot that use the options leveraging and trade single options in lieu of stock. Of the people that trade options in lieu of stock most of those will tell you go deep in the money to get a delta of 1. Meaning the option value move $1 for every $1 the stock moves. This makes your option P/L graph look almost exactly the same as if you had bought the stock.

In my personal opinion though IF you are going to use options in place of stock you might be better off going with an option that is ITM but not too deep. I would look for an option with a high Delta (.80-.95) that still had a Gamma > 0 (about .2 - .6 is good). It also helps if your Gamma > Theta. This way if the stock price moves in your favor then your profit line has some acceleration room still and if it moves against you the loss level will immediately start decelerating. What this does is set you up so that with a significant stock swing your reward is greater than your risk. Also with ITM options the time decay (Theta) will be a lot lower than OTM options.

NOTE: I do not personally trade this way (I use spreads of one kind or another) but this is how I would trade this way, if I ever chose to.

 

So if one owned 2000 shares of a stock tonight and the company was to report earnings tommorrow after the close; would buying 20 put contracts at the same strike price that the stock is trading at tommorrow before the close completely hedge the loss realized in the shares if the company missed?? say the 2000 shares dropped two dollars per share immediately after the earnings report...........would the puts the next morining be worth $4,000.00 more?? And do the options trade at the same times of day as stock shares??

Thanks in advance

 

First off option strikes are usually in $2.50 or $5 increments. For instance right now Visa (V) has the following strikes available for April expiration: 45, 50, 55, 57.50, 60, 62.50, 65, 67.50, 70, 72.50, and 75 (there might be more above 75 or below 45 but no more in between). This means getting an option exactly at the price the stock is at is not easy and has to be timed when the stock is AT a valid strike.

A good earnings strategy for a stock that you own is what is know as a collar. Lets say you owned 2000 shares of Visa (since I already listed the strikes) and earnings was next week. Since Visa is currently trading at $61.61 (I am assuming you bought at this price) and you want to preserve as much of that as possible you would buy 20 April $60 strike Puts for $1.75 premium per share. Now you want to try and recoup some of the premium cost so you can write a covered call at a strike you would be ok selling your stock at. In our example you might be happy selling your Visa stock at $67.50 so you could write 20 covered call contracts at the $67.50 strike for .45 per share. This effectively makes your puts cost 1.30 per share.

If earnings suck and the stock plummets to $2 per share you only lose the difference between what you bought the stock at and the strike of the puts plus the cost of the NET premium paid. in the case the NET premium was $1.30/share and the difference between your purchase price of the stock and the strike is $1.61 so you MAX loss is $2.91/share.

If earnings are great and the stock skyrockets to $70 per share then you make the difference between the call strike price and your stock purchase price minus the NET premium for the Puts. in this example you get $5.89 from the stock + the call minus the put premium of $1.30 for a MAX profit of $4.59 per share.

 

Maverickz: what if I'm not caring about trying to recup. the premium for the cost of the puts...........will the increase in the value of the 20 contract of puts equal the loss on the 2000 shares the next time the options are avail. to be traded or would I have to wait until the puts are ready to expire for them to gain all the value that the shares lost. I'm holding 1000 shares of RIMM from 118,50 and 1000 shares from 119.97 all purchased in December 2007. If I buy 20 April puts tommorrow during the day at a strike price of 120 will they make the several thousand dollars up that the shares will drop tommorrow night if they give lousy guidance??

Thank you for your help

 

One more thing to add on the Collar idea. If you would be happy selling the stock at the $67.50 you could write the covered call as a longer term contract and net a higher premium. For instance if you went out to the June time frame (assuming you plan on holding the stock that long) you could get $3.00 for the June 67.5 call. This would make your net premium for the put $1.25 PROFIT. If you did that then the P/L for the trade would be as follows:

If earnings suck and the stock plummets to $2 per share you only lose the difference between what you bought the stock at and the strike of the puts MINUS the PROFIT of the NET premium EARNED. in the case the NET premium was $1.25/share and the difference between your purchase price of the stock and the strike is $1.61 so you MAX loss is $0.36/share.

If earnings are great and the stock skyrockets to $70 per share then you make the difference between the call strike price and your stock purchase price PLUS the NET premium for the Puts. In this example you get $5.89 from the stock + the call PLUS the put premium of $1.25 for a MAX profit of $7.14 per share.

NOTE: that your stock position would be unprotected once the April Puts expired unless you either bought more puts OR set a stop loss point.

 

Buying protective puts is never profitable. This is done for the same reason as buying an insurance policy on your car. To protect you from loss.

The short answer to your question is NO. The Delta on the 120 Puts is -.48 which means your options will only improve in value by $0.48 for every $1 your stock depreciates.

Long answer in next post...

 

is the delta part of the QUOTE??? so if I bought 40 contracts I would be porotected then.......right?

 

In your case the average price per share of your 2000 RIMM shares is $119.24. The current price is $117.48. This means you are already down $1.76/share. If you buy the 120 Puts (currently listed at $8.95 per share) you will immediately be $8.19 in the hole. Which means the stock would need to move at least that much in your favor just to break even but it would limit your risk to that $8.19 per share.

In this case if the stock did ANYTHING other than rise above $120 per share. You would exercise the option and make the difference between the strike and what you bought the stock for ($120 - $119.24 = $0.76/share) minus the premium paid of $8.95 for a net LOSS of $8.19. Why would you do this? Because, if the stock kept dropping like I said the other post the stock value will drop faster than the option value increases so your losses will continue to grow.

If the stock climbed over $120 per share you will still be in the loss category until the price gets over $128.19. In this range you can choose to exercise your option and take a loss less than the $8.19 it would be if the price is below $120 or keep the stock, let the option expire and lose the $8.95 and hope the stock keeps moving in your favor.

 

Thanks maverick for your explanation........I've learned much about stocks but obviously know NOTHIN!(just like the FED) about options. I was thinking that one contract of puts covered 100 shares of stock and cost $8 or $9 or whatever the last price of the option was when I bought it.............I didn't realize that the price of the option had to be paid for EACH OF the 100 shares the contract covered. So each contract is 800 or 900 dollars rather than 8 or 9 dollars

 

Well if you bought 40 Puts, you would effectively be long 2000 shares and short w/options 4000 shares. This would make your P/L graph look like a soup bowl with break even points around $112.70, and $123.36. As long as the stock was OUTSIDE of that range you would make money and you would lose money if it stayed in between those ranges.

If you are going to play with option you should download this free tool and play with it and graph out your P/L on various trades. This will help you a LOT in understanding how various stock+ options positions work.

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