Advanced Option Strategies for
the Active Investors
Disclaimer
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S&P/TSX 60 VIX Index - VIXC
• Plotting the volatility the S&P/TSX 60
• A measure for volatility for Canadian stocks.
Periods of Low Implied Volatility
• Cheap cost to open straddles and strangles.
• Only effective if anticipating higher volatility.
• You have to stay closer to at-the-money in collars
as there is little premium on the covered call
component.
Periods of High Implied Volatility
• Ideal environment for Debit Spreads.
• Expensive for opening straddles and strangles.
• Must consider Butterflies and Condors to reduce
cost for expensive premium.
Call Debit Spread
Call Debit Spread
• Also called the Bull Call Spread
• Buy 1 Call
• Sell 1 Call at a higher strike price.
Bull Call Spread
• Either the outlook is:
Moderately bullish
Opening positions in very volatile markets.
• Short option offsets the cost of the trade and
reduces the break even point of the position.
• Reduces the potential loss if the underlying stock
moves adversely.
• Lose the potential to profit beyond sold strike.
Contract Selection
• Choose an expiration date that allows the stock
enough time to make the anticipated move.
• At-the-money and in-the-money strikes are more
conservative but priced higher.
• Out-of-the-money strikes are less expensive, but
require a much more significant move higher to be
profitable.
Example Using Goldcorp
G is at $46.05. Investor has bullish outlook.
Bull Call Spread on Goldcorp
• G at $46.05 (November 25, 2010)
• January expiration (57 days till expiration)
• Buy 1, January $46.00 Call - $2.13(ask)
• Sell 1, January $50.00 Call - $0.67(bid)
• Net cost basis $1.46
Risk Graph
Break Even = $46.00 + $1.46 = $47.46
$246.00
$0.00
$35.00 $40.00 $46.05 $47.46 $50.00 60.00
-$146.00
Maximum Profit : $254.00
Maximum Loss : $146.00
Profit/Loss
Price at Long Short Net Spread
expiration $46 Call P/L $50 Call P/L P/L
$60.00 $1187.00 -$933.00 $254.00
$55.00 $687.00 -$433.00 $254.00
$50.00 $187.00 $67.00 $254.00
$47.46 -$67.00 $67.00 $0.00
START $46.00 -$213.00 $67.00 -$146.00
$45.00 -$213.00 $67.00 -$146.00
$40.00 -$213.00 $67.00 -$146.00
Example Using Goldcorp
Put Debit Spread
Put Debit Spread
• Also called the Bear Put Spread.
• Buy 1 Put.
• Sell 1 Put at a lower strike price.
Bear Put Spread
• Outlook is moderately bearish.
• Short option offsets the cost of the trade and
reduces the break even point of the position.
• Reduces the potential loss if the underlying
moves adversely.
• Lose downside profit potential beyond sold strike.
Example Using Goldcorp
G is at $46.05. Investor has bearish outlook.
Put Debit Spread on Goldcorp
• G at $46.05 (November 25, 2010)
• January expiration (57 days)
• Buy 1, January $46.00 Put - $2.06(ask)
• Sell 1, January $42.00 Put - $0.58(bid)
• Net cost basis $1.48
Risk Graph
Break Even = $46.00 - $1.48 = $44.52
$252.00
$0.00
$35.00 $40.00 $44.00 $46.05 $50.00 55.00
-$148.00
Maximum Profit : $252.00
Maximum Loss : $148.00
Profit / Loss
Price at Long Short Net
expiration $46 Put P/L $42 Put P/L Spread P/L
$55.00 -$206.00 $58.00 -$148.00
$50.00 -$206.00 $58.00 -$148.00
START $46.00 -$206.00 $58.00 -$148.00
$44.52 -$58.00 $58.00 $0.00
$42.00 $194.00 $58.00 $252.00
$40.00 $394.00 -$142.00 $252.00
$35.00 $894.00 -$642.00 $252.00
Example Using Goldcorp
Long Strangles and Straddles
Trading Volatility
Long Straddles and Strangles
• Requires the purchase of a call and a put
simultaneously.
• Both are volatility trades.
• Anticipating a sharp move in either direction.
• Higher break even as a result of the two
premiums being purchased.
Long Straddle
• Same underlying security.
• Buy a call and buy a put.
• Same strike.
• Same expiration.
Straddle Example
• Stock XYZ is trading at $40.00 a share.
• Investor expects that the stock will be
considerably volatile.
• Investor wants to capitalize on a big move
irrespective of the direction.
• 6 month $40.00 Call is Asking $3.00
• 6 month $40.00 Put is Asking $3.00
Straddle Example
• Buy $40.00 Call at $3.00
• Buy $40.00 Put at $3.00
• Net cost is $6.00
• The “$40.00 straddle” cost $600.00 representing
the maximum risk.
• Break even on the trades is below $34.00 and
above $46.00
Straddle Example
Profit
$20.00 $30.00 $40.00 $50.00 $60.00
Loss
Straddle Example
Long Long Net Profit
Stock Price
$40 Call P/L $40 Put P/L P/L
$60.00 $17.00 -$3.00 $14.00
$50.00 $7.00 -$3.00 $4.00
$45.00 $2.00 -$3.00 -$1.00
$40.00 -$3.00 -$3.00 -$6.00
$35.00 -$3.00 $2.00 -$1.00
$30.00 -$3.00 $7.00 $4.00
$20.00 -$3.00 $17.00 $14.00
Example Using Goldcorp
G is at $46.05.
Investor anticipates a potential volatile move.
Example Using Goldcorp
• RIM is at $46.05 (November 25, 2010)
• Buy April $46.00 Call at $3.55 (140 days)
• Buy April $46.00 Put at $3.45 (140 days)
• Net cost is $7.00
• The “$46.00 straddle” cost $700.00 representing
the maximum risk.
• Break even on the trade is below $39.00 and
above $53.00
Example using Goldcorp
Long Long Net Profit
Stock Price
$54 Call P/L $54 Put P/L P/L
$60.00 $10.45 -$3.45 $7.00
$55.00 $5.45 -$3.45 $2.00
$50.00 $0.45 -$3.45 -$3.00
$46.00 -$3.55 -$3.45 -$7.00
$40.00 -$3.55 $2.55 -$1.00
$35.00 -$3.55 $7.55 $4.00
$30.00 -$3.55 $12.55 $9.00
Example Using Goldcorp
Long Strangle
• Same underlying security.
• Buy a call and buy a put.
• The put is at a lower strike price then the call.
• Same expiration.
Strangle Example
• Stock XYZ is trading at $40.00 a share.
• Investor expects that the stock will be considerably
volatile.
• Investor wants to capitalize on a big move
irrespective of the direction.
• 6 month $44.00 Call is Asking $1.25
• 6 month $36.00 Put is Asking $1.25
Strangle Example
• Buy $44.00 Call at $1.25
• Buy $36.00 Put at $1.25
• Net cost is $2.50
• The “$36/$44 strangle” cost $250.00 representing
the maximum risk.
• Break even on the trades is below $33.50 and
above $46.50
Strangle Example
Profit
$20.00 $30.00 $40.00 $50.00 $60.00
Loss
Strangle Example
Stock Long Long Net Profit
Price $44 Call P/L $36 Put P/L P/L
$55.00 $9.75 -$1.25 $8.50
$50.00 $4.75 -$1.25 $3.50
$45.00 -$0.25 -$1.25 -$1.50
$40.00 -$1.25 -$1.25 -$2.50
$35.00 -$1.25 -$0.25 -$1.50
$30.00 -$1.25 $4.75 $3.50
$25.00 -$1.25 $9.75 $8.50
Example Using Goldcorp
G is at $46.05
Investor anticipates a potential volatile move.
Example Using Goldcorp
• G is at $46.05 (November 25, 2010)
• Buy April $48.00 Call at $2.75
• Buy April $44.00 Put at $2.54
• Net cost is $5.29
• The “$44/$48 strangle” cost $529.00 representing
the maximum risk.
• Break even on the trades is below $40.71 and
above $51.34
Example Using Goldcorp
Summary
• Anticipating a sharp move in either direction.
• Profit from a sharp move regardless of which
direction it goes.
• Have a higher break even as a result of the two
premiums being purchased.
Ratio Straddles
• Same underlying security.
• Have a deliberate bias higher or lower.
• Buy 1 call for every 2 puts – bearish bias.
• Buy 2 calls for every 1 put – bullish bias.
• Same strike.
• Same expiration.
Ratio Straddle Example
• Stock XYZ is trading at $40.00 a share.
• Investor expects that the stock will be considerably
volatile and probably crash.
• Investor wants to capitalize on a big drop in the
stock, but wants to build in a hedge.
• 3 month $40.00 Call is Asking $1.50
• 3 month $40.00 Put is Asking $1.50
Ratio Straddle Example
• Buy 1 $40.00 Call at $1.50
• Buy 2 $40.00 Put at $1.50
• Net cost is $4.50
• The “$40.00 ratio straddle” cost $450.00
representing the maximum risk.
Ratio Straddle Example
Profit
$20.00 $30.00 $40.00 $50.00 $60.00
Loss
Ratio Straddle Example
Stock Long Long Net Profit
Price $40 Call P/L $40 Put P/L x2 P/L
$55.00 $13.50 -$3.00 $10.50
$50.00 $8.50 -$3.00 $5.50
$45.00 $3.50 -$3.00 $0.50
$40.00 -$1.50 -$3.00 -$4.50
$35.00 -$1.50 $7.00 $5.50
$30.00 -$1.50 $17.00 $15.50
$25.00 -$1.50 $27.00 $25.50
Collars
Putting your trade on a leash
The Collar Strategy
• Also known as the Hedge Wrap
• Creating a position that limits the downside and
the upside.
• Ideal for existing positions that have already
moved up and only have a marginal upside left.
• Involves a combination of two strategies.
The Collar Strategy
• The first component involves a covered call.
• We generate a cash flow for capping our upside.
The Collar Strategy
• The second component involves buying a
protective put.
• We use the proceeds from the covered call to buy
the protection.
The Collar Strategy
• When do we use this strategy?
• If you are optimistic on the investment but you
have short-term concerns.
• The concerns can be technical or fundamental.
• What makes the strategy effective is that it is
volatility neutral.
Collar Example
• Stock XYZ is trading at $40.00 a share.
• Investor likes the stock but has short-term concerns.
• Investor wants to buy the stock and collar it.
• 1 month $42.00 Call is Bidding $0.25
• 1 month $38.00 Put is Asking $0.25
Collar Example
• Buy 100 shares at $40.00.
• Sell the $42.00 Covered Call for $0.25.
• Buy the $38.00 Put for $0.25.
• Net cost is $40.00 for the stock and $0.00 cost for
the collar.
• Downside risk to $38.00.
• Upside potential to $42.00.
Collar Example
Profit
$20.00 $30.00 $40.00 $50.00 $60.00
Loss
Collar Example
Stock Short Long Net Profit
Stock P/L
Price $42 Call P/L $38 Put P/L P/L
$50.00 $10.00 -$7.75 -$0.25 $2.00
$45.00 $5.00 -$2.75 -$0.25 $2.00
$42.00 $2.00 $0.25 -$0.25 $2.00
$40.00 $0.00 $0.25 -$0.25 $0.00
$38.00 -$2.00 $0.25 -$0.25 -$2.00
$35.00 -$5.00 $0.25 $2.75 -$2.00
$30.00 -$10.00 $0.25 $7.75 -$2.00
The Calendar Collar
• Creating a position that limits the downside and
the upside.
• Ideal for positions about to bullishly breakout.
• Involves a combination of two strategies.
The Calendar Collar
• The first component involves a longer-term
out-of-the-money covered call.
• We generate a cash flow for capping our upside.
The Calendar Collar
• The second component involves buying a
short-term at-the-money protective put.
• We use the proceeds from the covered call to buy
the protection.
The Calendar Collar
• When do we use this strategy?
• If you are optimistic on the investment but you
have short-term concerns.
• What makes the strategy effective is that it is
volatility neutral.
The Calendar Collar
• Stock XYZ is trading at $40.00 a share.
• Investor likes the long term stock potential but
has short-term concerns.
• Investor wants to buy the stock and collar it.
• 3 month $42.00 Call is Bidding $1.00
• 1 month $40.00 Put is Asking $1.00
The Calendar Collar
• Buy 100 shares at $40.00.
• Sell the 3-month $42.00 Covered Call for $1.00.
• Buy the $40.00 Put for $1.00.
• Net cost is $40.00 for the stock and $0.00 cost for
the collar.
• Downside risk to $0.00 for the stock and buy back
risk of the call.
• Upside potential to $42.00.
Rolling an Option
Adjusting Existing Trades
Managing Spread Positions
• As the position approaches expiration, the short
option will be:
Out-of-the-money
○ Position to expire.
In-the-money
○ It needs to be closed, rolled or exercised.
Rolling Spreads
• Stock is at $50.00
• Buy 10x 3month Calls at $50.00 - $1.50 ask
• Sell 10x 3month Calls at $52.00 - $0.50 bid
• Cost $1.00 Debit.
Rolling Spreads
• In the first week the stock rallies to $52.50
The technical potential looks more positive.
• Consider:
A vertical roll.
Exit early.
Hold till expiration.
Rolling the Short Call
• Stock is at $52.50 a week later.
• 3month $52.00 Bid/Ask $1.50-$1.60.
• 3month $54.00 Bid/Ask $0.65-$0.75
Vertical Roll
Stock is at $52.50
• Buy 3month $52.00 at Ask = $1.60
• Sell 3month $54.00 at Bid = $0.65
• $1.60 - $0.65 = $0.95 Debit
Cost you $0.95 to open the upside potential for
another $2.00 upside.
Just Closing the Position
Stock is at $52.50
• Sell the 3month $50.00 - $3.10
• Buy the 3month $52.00 - $1.60
• Sell for a $1.50 credit or $0.50 profit.
