Rookie Advice

Discussion in 'Options' started by pkm, Apr 12, 2011.

  1. pkm

    pkm

    Hello,

    I am a novice options trader jumping in at the deep end and need some advice from some experts just to clarify things in my head!

    I have bought some May 28 Put options in a company (SIL) at a cost of 0.75 cents. 20 contracts at a cost of $1500 dollars (plus fees). SIL is currently trading around the mid 29s.

    My thinking is that if SIL get's down to the breakeven price of 27.25 then i will use this Put as a hedge against a share trade at which point i will purchase 2000 shares in SIL in the hope that it will shoot back up again.

    Clearly if SIL doesn't move down then it's a loss - which i presume can only be a maximum loss of $1500?

    If this works out as anticipated am i right in thinking that there would be no loss on this trade for the lifetime of the option and i have effectively insured the trade (albeit in the future)? If the trade continues downwards then the loss in the shares will be offset by the gain in the options? If the trade moves up then there will be gains on the shares and a loss of $1500 on the options?

    As the option moves closer to expiry it devalues. If the option is in the money will it always be worth the intrinsic value of the share up to the point of expiry? So say SIL went down to 22.25 the option value at that point should be a profit of $5 per share. Is this true right up to expiry or do i need to sell a few days prior or am i overlooking something?

    I hope this is clear enough for you to understand - i think i'm right but i just need clarification as it's a complicated trade for a first timer!!!

    Cheers
     
  2. jkgraham

    jkgraham

    I'm new to option trading as well. Everything you wrote appears correct to me. Now that I can use Think or Swim's probability of touching graph, it appears that the PoT $27.25 by April 16 is 28% and PoT by May 21 is 75%.

    The videos that I am using to learn option trading mentioned a strategy similar to yours but they would start by buying a stock and a Put at the current price. If the stock moved down the Put would increase in value to a point where they could sell the put for a gain then apply the profit toward buying 100 more shares and another put at the lower price.

    If the stock moved up they would at some point sell the Put (for a loss) and buy a new Put at the new price as insurance on the gains.

    This worked if the stock had enough volatility.
     
  3. PKM,

    I think you have it basically correct if I'm understanding it correctly, but I question a few items:

    1. If you wanted to hedge right from the start, you could have done that and bought ATM such as 28 or even 29 puts, but instead it seems like you are expecting a down move, then purchase shares, then expecting it to go back up. It might require quite a bit of luck to get the direction and timing correct a few times.

    2. You mention "...am i right in thinking that there would be no loss on this trade for the lifetime of the option and i have effectively insured the trade...". Remember though that those options are just May options - so the life of the options is just til May 20th. My point being that that isn't a ton of time - I think you are aware of this, but just remember that even if this part of it works, the position isn't ensured forever - just til May expiry.

    As far as if SIL went way down such as to 22.25, yes, the value would be there - the Bid/Ask should show prices such as 5.00/5.25 or whatever and you can close it out whenever you want. You should be able to hold it right up to expiry, but nothing wrong with closing a few days in advance either.

    JJacksET4
     
  4. pkm

    pkm

    Thanks for the prompt replies - i was a little unsure so it really helps just to get confirmation that i have the fundamentals correct with regards to options and the trade!

    I realise that i could have purchased ATM options but my goal was to achieve the maximum amount of contracts for the money within the boundaries of where i believed the share will go. I was anticipating a drop so OTM seemed to offer this at greater value.

    I also realise that May options don't leave a huge amount of time for the share to trade greatly to the upside but if things happen as i expect then we should hopefully see another push upwards in the precious metals market soon. Hopefully sooner rather than later!

    ...and as you say - a bit of luck wouldn't go a miss!!

    Thanks again...
     
  5. 27.25 is the expiration break even price. If SIL there this week, you should have at least a double and possibly more. If you're bullish, book the gain and buy the May 28 (or later) calls. Personally, I'd scale out of the long put position on the way down. Given that B/A spreads are wide, I'd put in a few orders at wishful thinking prices. May 28p is 1.15 x 1.45. Sell order for 5 (or whatever number you're comfortable with) at 1.40 ?

    There are a number of other things you could do.

    You could start scaling into the short stock position now. Or start buying May 29 calls, creating a long strangle.

    The Apr 28p is .20 x .45. Sell order for 5 (or more) at .40 creating some calendars. Unlikely to be filled but if you get it, 3+ days to exp and you nab 40 cts which puts a big ding in your May put cost basis. Make sure to keep more long May 28's than short Apr 28's in case SIL heads south.

    I'd lean to booking profits on the May 28's or taking a flyer on some calendars (sell some Apr 28's). What's best depends on your risk tolerance, profit objective, outlook for underlying, etc.

    As always, execute no trade unless under the supervision of a knowledgeable adult at home :)
     
  6. jokepie

    jokepie


    Nab the profits when you see price stablizing on the down side !!
    You are already in A trade. Manage ITS risk accordingly.
    Rest are assumptions as of NOW.