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"When And How To Buy The Dip"
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The market has been giving amazing entry opportunities for the savvy trader. Options have the potential to turn savvy trading into leveraged positions!
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Tomorrow, you could begin doubling your account every single month starting with one letter.
The letter will come from a 20-year trading professional named Ian Cooper. He says, “In 2017, following my trades you would be doubling even tripling your account some months. Let me show you how.”
He will show you exactly what to do... and he’ll give you the blueprint for just $1.
The purchase of an index put option carries with it the right to take a short index futures position; the value of an index put option can be expected to increase with falling prices for index futures contracts.
Let’s say that in January you believe the stock market will fall. With the March Mini S&P futures price at 935.00, you purchase a mini S&P Index March 800 put at a premium of 2200, or $1,100. The March index futures contract declines to 850.00. Reflecting a decrease in the underlying futures price, the put option increases to 4500, or $2,250, realizing a profit of $1,150, which is the difference between the premium paid originally and the current premium. Or you may hold the put option, hoping for an even greater increase in premium – while recognizing that the time value of the option usually diminishes as the time to expiration approaches.
Using Put Options with a Long Index Futures or Stock Position
This strategy is also called “marrying a put” to your position, in this case a long S&P future (but this strategy can be used in numerous commodities). Buying put options in conjunction with a long futures position can set limits to the potential loss, or lock in profits from an already profitable futures position.
The purchase of the put, in effect, guarantees a selling price for the long index futures position. The long put position provides insurance against a drop in the stock market and lower index futures prices, thereby placing limits on the loss that might occur from the long futures or stock position alone. The decision concerning which put option to buy depends on your risk tolerance.
Using an Option as a Future
One way of using an option instead of a future is to buy a deep-in-the-money option. In other words, with the S&P trading at 990, I may look to buy a 980 or 985 call (if I am bullish). The option strike price I choose should cost less than the margin requirement for the futures. So, if the margin for the S&P is $12,000, I would want to purchase the 980 call for less than 4800 points (4800 points times $2.5 = $12,000). The advantage of using deep-in-the-money options is that I will never incur a margin call and my loss is limited to whatever I’ve paid for the option. The “delta” of the option will be almost 1, which means that the option will move like a futures contract. It will not move point for point like the futures contract will, but your trade-off here is limited loss. Make sure that there is fair liquidity in the option you are trading. This will mean that you will generally be buying the quarterly options as opposed to the serial or monthly options.
Profiting from a Stable or Declining Market
The writer (seller) of an index call option receives payment (the premium) from the buyer of the option in return for the obligation of taking a short position in the futures contract at the exercise price, if the option is exercised. Actually, when an option is exercised, an option writer is randomly chosen and “assigned” to take the short futures position. The call writer’s risk is unlimited, while the call buyer’s risk is limited; and the call writer’s profits are limited, while the call buyer’s profits are unlimited. Note that an option writer can buy in the contract at any time before expiration or assignment to liquidate the obligation. Be sure you understand and can bear the risk involved in writing uncovered call options.
The principle reason you write call options is to earn the premium. In periods of stable or declining markets, call writing can mean an attractive cash flow from a relatively small capital investment. You hope that, at expiration, the settlement price of the futures contract will be at or below the exercise price of the option. The option will then expire worthless – and you keep the entire premium.
Call options can also be written as an alternative to placing a sell order above the market price. The net result should be comparable, if prices rise, and if the percentage increase in value of the stock matches the percentage increase in the market as a whole. But if the prices fail to rise, or if they decline, writing a call has an advantage over having placed a sell order above the market. The advantage is the option writer retains the premium. This is because the option will not be exercised.
Income and Limited Protection
Writing a call option against a long futures position is a strategy that can produce an attractive return over the margin required if the stock market stabilizes or rises only slowly. The long futures protects the short call in a rising market to assure that the writer keeps the premium received (less intrinsic value if the call is sold in-the-money). If an out-of-the-money call is sold and the futures price rises, but not through the strike, the premium plus the futures gain will both be profitable at expiration.
The premium also gives limited protection against a drop in the futures price. The risk is that the futures price might decline by more than the premium received, and the investor may experience a net loss.
An example of this would be if an investor owned 1.1 million dollars worth of stock and, for any number of reasons, does not wish to sell stocks. By writing 4 at the money S&P 500 December 1140 call options against his portfolio he would collect about $68,400 that can be considered a hedge against a loss in his portfolio, if stock prices do decline. Of course, if the market rallies strongly the option position would result in a large loss that may or may not be offset with the increase of the underlying portfolio’s value.
Option Expiration Week
Actually, this can be done the Friday before option expiration week or the Monday of expiration. This strategy is designed to take advantage of the normal upward bias the stock market displays during the expiration period. The strategy is simple and straight forward; buy a slightly out-of-the-money call at the close on Friday or on the opening on Monday. Because these options expire in just a few days they are not extremely expensive.
As an example, on a Monday April 13th, 2012 the S&P opened at 1118.30. You could have purchased either the April 1120 call or the 1125 call that morning. By the end of the week the S&P closed at 1130.10. As long as you paid less than 1000 for the 1120 call or less than 500 for the 1125 call you would have a profitable trade.
If you don’t want to play around with the time premium you can just buy the S&P, but you then have greater risks and margin requirements. To reduce that concern you can either go long a Mini S&P or buy a Dow futures contract. You still must use money management on this trade, don’t put it on and forget about it.
The Night Before Quarterly Expirations
Most seasoned traders have known the strategy above for some time now, but this next strategy is known by only a handful of traders. This is nothing short of a pure gamble and it can only be done on the quarterly expirations or “triple witch expirations.” Near the close on the Thursday of expirations week buy the closest call or put option (sometimes both are reasonably priced) on the S&P. Since you are trading stops on the expiring S&P at the close on Thursday, there is nothing for you to do on Friday but wait and see if you made any money. The final settlement price of the S&P is not finalized until all 500 stocks in the S&P are opened the next morning. To find out if you made any money, you will have to get your broker to call down to the floor for the final quotation. This is usually available by 11:00AM, CST. If the market has settled in your favor you have absolutely nothing to do, quarterly option expirations settle in cash not futures. So, if you made $1,000 it will just be credited to your account, and if you were wrong about the direction the money has already been deducted from your account when you purchased the option so there are no additional charges in your account balance. Do not sell any naked options this way! Since you are virtually at the mercy of the markets, you should not leave yourself open to a loss that you can do nothing about to protect yourself.
The two strategies discussed above are truly just another form of gambling and should not be done on a regular basis. It is fun to do once in a while, but they should not be your core investment plan.
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