Manual de Opciones

8/4/2019 Manual de Opciones

1/16

The Motley FoolOptions EdgeHandbook 2011

BY JEFF F ISCHER


2/16

O p t i O ns Ed g E H a nd b O O k

t h e m o t l e y f o o l | o p t i o n s e d g e h a n d b o o k | p a g e 2

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welCome .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

wh y op Tion s? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

B uyin g Calls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

B uyin g p uTs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

s e l l i n g C o v e r e d C a l l s . . . . . . . .. . . . . . .. . . . . . .. . . . . . . .. . . . . . .. . . . . . .. . . . . . . .. . . . . . . 5

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8 T i p s f o r w r i T i n g ( o r s e l l i n g ) p u T s . . . .. . . . . . .. . . . . . . .. . . . . . .. . . . . . .. . . . 7

syn Th eT iC lon gs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

w r i T i n g s T r a d d l e s . . . . . . .. . . . . . . .. . . . . . .. . . . . . .. . . . . . . .. . . . . . .. . . . . . . .. . . . . . .. . . . 1 1

w r i T i n g s T r a n g l e s .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

o p T i o n s g l o s s a r y . . . . . . .. . . . . . .. . . . . . . .. . . . . . .. . . . . . .. . . . . . . .. . . . . . .. . . . . . .. . . . . . . 1 6


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wc

Dear Fellow Investor,

The market gyrations of the past few years created a unique investing landscape. One tha

has many investors looking beyond traditional buy and hold for the kinds of opportuni

ties that can make you substantial amounts of money in shorter periods of time...

Options Edge 2011 is a perfect primer for the moments of crisis and

opportunity ahead!

This handy guide (we designed it so that you can print it out and keep it) will give you

the tools to make money in shorter periods of time, generate income, leverage returns

and squeeze out some of your portfolio risk. In short, this handbook could be your first

step to building wealth faster and more assuredly than at any point in recent history!

And its part of a bigger opportunity were extremely excited to tell you about. Youll

discover all the details in a very special invitation that will be put into your hands on

Monday, December 13.

Keep your eyes on your inbox!

Kindest regards,

Jeff Fischer

Advisor, Motley Fool Options

Hee o Oo Ee Hboo 2011!


4/16



WHy OptiOns?

Options are ideal for generating income, protecting profits, and most importantly, earning

outsized gains! They can generate returns in flat markets, cushion the blow of down

markets, and be outstanding performers in decent markets. So basically, whatever your

investment goals, options can be a powerful addition to your portfolio.

And its important for you to know that I advocate trading options as an investor, not as

a speculator. In other words, every option trade we make should be based on thorough

analysis of the underlying stock and its value. That way, the option is simply a way tol

everage what we know about a stock.

WHat arE OptiOns?

Stock options formally debuted on the Chicago Board Options Exchange in 1973,

although option contracts (the right to buy or sell something in the future) have been

around for thousands of years.

Applied to stocks, an option gives the owner the right, but not the obligation, to buy or

sell an underlying stock at a set price (the strike price) by a set date (the expiration date)The option contract allows you to profit if a stock moves in your favor before the contract

expires. Not all stocks have options -- only those with enough interest and volume.

There are only two types of options: calls and puts. A call appreciates when the underly-

ing stock rises, so you buy a call if you are bullish on that company. A put appreciates

when a stock declines. You buy a put if you believe a stock will fall or to hedge a stock

that you already own. One way to remember this is: call up and put down...

By the way, theres an options glossary in the back of the handbook for you to use at any

point!

Next, lets walk through the most common options trades: buying calls, buying puts

selling covered calls, and selling puts.

sTraTegy why

B CWhen you believe a stock will rise significantly over time and

you want to leverage your returns or minimize capital at risk

B ptTo short a position, or to hedge or protect a current long

holding

s C C

(sell to open)

To earn income on shares you already own while waiting for

your desired sell price

s pt

(sell to open)

To get paid while waiting for a lower share price (your desired

buy price) on a stock you would be happy to buy

Buying Calls

Investors often buy call options rather than buying a stock outright to obtain leverage

and potentially increase returns several-fold. Call options work as controlled lever-

age, enhancing your possible returns while limiting your potential losses to only what


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Aside from betting against a position with puts, you can also buy

puts to protect an important position in our portfolio, one that you

dont want to sell yet for any number of reasons. When a stock

being protected -- or hedged -- in this way declines for a while, the

puts will increase in value, smoothing out returns.

I tend to buy puts on stocks that I believe are due to decline over

the coming months or even years. You may also use puts to hedge

long positions that you own, or to short sectors and indexes in a

small portion of your portfolio. I often buy puts rather than short

something outright to limit my risk.

sElling COvErEd Calls

Now our overview moves from the act of buying options to

instead, selling them to others. Selling -- or writing -- options is

what we do most, because it can be consistently lucrative and the

odds are stacked in our favor.

Any qualified investor can sell to open an option contract. Whenyou do so, you dont pay the premium; instead, as the contrac

writer,you get paid. All cash generated from your option selling

is paid immediately to you.

Covered simply means that we own the underlying stock at the

same time. Writing covered calls is one of the most conservative

options strategies available. In fact, most retirement accounts

allow you to write covered calls. Theyre generally used to gener-

ate income on stock positions while waiting for a higher share

price at which to sell the stock.

Heres an example of a covered call. Suppose you own 1,000

shares of a stable, blue-chip stock. Its trading at $56, but youthink it is fairly valued around $60 and you would be happy to sel

at that price. So you write $60 call options on the stock expiring a

few months ahead, and you get paid up front to do so.

If the stock does notexceed $60 by your options expiration, you

keep your shares andyouve made money on the call options. You

could then write more calls if you wanted to for more income. If

the stock is above $60 by expiration and you havent closed out

your call option contract, youd sell your stock at $60 via the

options. Your actual proceeds on the sale would include the option

premium you were paid. So you sold your shares at the pric

you wanted to andreceived extra cash for doing so. This income

really adds up as you write covered calls again and again.So, writecovered calls when:

You would sell a stock that you own at a higher price, and

youre not worried about it declining too much in the mean-

time. Write calls at your desired sell price, collect the dough

and then kick back and wait. Rinse and repeat, month after

month, when you can.

You believe a stock you own is going to stagnate for a while

you invest (which is usually a much smaller amount than a stock

purchase would be). Because each option contract represents 100

shares of stock, an investor can control -- and benefit from -- many

shares of stock without putting a lot of capital at risk. When you

make the right call, youll enjoy higher returns than you would

have if you had used that money to buy the actual shares.

Lets look at an example. Imagine that a stock that you know well

has been hit hard and now trades at $27 per share. You believe

the shares will rebound in the coming months or year. The market

offers $30 call options on the stock that expire in 18 months for

$1.50 per share. Therefore, 10 contracts, representing 1,000 shares

of the stock, will cost you $1,500 plus commissions. This option

contract gives you, its owner, the right to buy 1,000 shares of the

stock at $30 any time before expiration.

If your stock starts to rise again, your options will increase in

value, too. Suppose the stock recovers all the way to $32 after a

few months. Your options value would likely at least double to $3

or higher per contract. Youve made 100% in a few months. If youhad simply bought the stock, youd only be up 18.5%.

Of course, there is a flip side. Suppose your stock continues its

decline to the abyss. Even 18 months later, its below $20, so your

options expire worthless -- though hopefully you sold them at

some point along the way to recoup part of your investment. The

good news is: youve saved a lot of money compared to if you had

bought the stock instead.

I like to buy longer-term call options on well-valued stocks that I

believe will pay off handsomely over the coming months or years.

Its a way to take more meaningful positions in stocks I believe

in -- without risking mounds of capital. This is useful if yourelacking capital or just dont feel like risking it all in a stock.

As with any investment, you should only invest what you can

afford to lose, since a stock can easily work against you over a set

amount of time and make your call worthless. Where real oppor-

tunity can be lost is when your timing is wrong. Your options

might expire before the stock rebounds, causing you to lose your

option money and miss the stocks eventual rebound. Thus, we

aim to buy longer-term calls in positions in which we have high

confidence and that have near-term catalysts.

Buying putsNext up, the antithesis to call options: puts.

Buy put options when you believe that the underlying stock will

decline in value. Buying puts is an excellent tool for betting

against highly priced or troubled stocks, or even entire sectors.

With put buying, your risk is again limited to the amount that you

invest in stark comparison to traditional short selling, where your

potential losses are unlimited.


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but you dont want to sell it right now. Write calls to make the stagnation more

profitable.

You want to cushion a stock that is in decline, but that youre not ready to sell yet.

Tread carefully here so you dont get sold out at too low a price.

When you write covered calls,you must be prepared to give up your shares at the strike

price. Approximately 80% to 90% of options are not exercised until expiration, but they

can be exercised early, so the call writer has to be prepared to deliver the shares.

That means that if the $56 stock in the example above suddenly soars to $70, youd

still have to sell at $60. This is the biggest downside to covered calls -- lost potential if

a stock price rises. The other risk is that a stock may fall sharply after hovering around

your desired sell price for a while, forcing you to wait longer for your sell price. But in

this case, at least youve earned option income.

Even though covered calls are low risk, you should use them only on stocks you know

well. You could even set up some covered call-only positions -- buying a stock just to

write calls on it.

sElling puts

Note: to sell (or write) puts, you must have a margin account. You wont actually need

to use margin -- which entails high risk-- but you must be margin-approved, have ample

buying power (cash, in our margin-free strategy).

Selling puts -- also referred to as selling naked puts or writing puts -- is a favorite strategy

of mine to seed a portfolio. There may be plenty of stocks that Id like to buy at the start,

but Id prefer to snag them at lower prices. Put options are an excellent way to potentially

buy a stock at your desired, lower share price and get paid an option premium while

waiting for that price, whether it arrives or not.

Lets turn to an example: A top-rated stock we found on Motley Fool CAPS and

researched thoroughly is trading at $39, but our analysis suggests that we shouldnt buyit above $35. The $35 put options expiring four months out are paying $3 per share. We

sell to open the put contracts and get paid $3 per share to make the trade, giving us a

potential net purchase price of $32 before commissions. A few things could happen here.

Scenario 1: The stock could stay above our $35 strike price; the options we

sold would expire. We didnt get to buy the stock at the price we wanted, but at

least we made money on the options we sold.

Scenario 2: The stock could fall below $35 by expiration. In this situation,

our broker would automatically buy the stock for our account, giving us a start

price of $32 before commissions because we still keep the option income --thats -- even lower than our $35 desired buy price!

Scenario 3: The stock may tank to $29 soon after we sell the puts, but then

climb back above $35 by expiration. In this case, we most likely would not

have had the shares sold to us during this brief decline because about 80% of

options are exercised only at expiration, not before. So we wont own the shares,

and well have missed our buy price and the stocks rebound -- but we did get

paid the premium, at least, and can try again.

when To wriTe Covered Calls

You would sell a stock that you own at

a higher price, and youre not worried

about it declining too much in the

meantime. Write calls at your desired

sell price, collect the dough, and thenkick back and wait. Rinse and repeat,

month after month, when you can.

You believe a stock you own is going to

stagnate for a while, but you dont want

to sell it right now. Write calls to make

the stagnation more profitable.

You want to cushion a stock that is in

decline, but that youre not ready to sell

yet. Tread carefully here so you dont

get sold out at too low a price.


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Scenario 4: The companys CEO flees to Bermuda

and the stock is only at $16 by our options expiration.

We didnt have the heart to close our losing option posi-

tion, and we still have hope, so we wait and the shares are

put to our account at $35 (minus our option premium)

upon expiration. This is the worst-case scenario -- were

down 50% to start. But we own the stock now and canhope it rebounds. Of course, assuming that we would

have bought the stock outright when it hit our $35 buy

price, as we had considered, we would be down even

more than we would be with this strategy.

You should most often sell puts when a stock you follow closely

and want to own is, alas, above your desired buy price. You should

sell puts on it at lower strike prices, prices that you believe are great

levels at which to buy. Either you eventually get to buy the stock at

your desired price via the puts, or you keep writing puts if the situ-

ation merits it, earning more income each time while you wait. You

may also sell puts when a stock you already hold a partial positionin is above the price where youd like to buy more. You can write

puts as you wait to average in at lower prices. This is a great tool for

allocation and averaging into a position.

Writing puts on stocks you know well and want to own at lower

prices can be an excellent tool for income and for securing lower

buy prices, butyou must be prepared to buy the stockshould it fall

below your strike price. At all times, you must maintain the cash

or margin (for us its always cash and we recommend you follow

that rule, too) to buy shares if they are put to you.

Its important that you only write puts on stocks that you under-

stand well and will be happy and ready to buy at the prices youre

targeting. The risks of writing puts include the fact that the stock

could soar away without you. In many cases, its better to just buy

a great stock once youve found it. The other risk, of course, is

that a stock falls sharply and youre stuck owning it. The biggest

risk with selling puts, as with all options, is when investors rely

on margin instead of cash.

Lets review...

Call opTion puT opTion

ot b

The right, but not obli-gation, to b a stockat a set price (the strikeprice); calls appreci-ate as the stock rises(remember: call up)

The right, but not obliga-tion, to a stock at a setprice (the strike price); putsappreciate as the stock falls(remember: put down)

ot t(or seller)

The obligation to sell astock at the strike price;must hold the stockin the account. Thisis called a coveredposition.

The obligation to buy astock at the strike price;must have the buyingpower at the ready (pref-erably in cash) in case thestock declines

ot bBelieves the underly-ing stock will rise

Believes the underlyingstock will fall

ot t(or seller)

If the stock rises, isready to sell sharesat the strike price,keeping the premiumpaid for writing theoption

If the stock falls, isready to buy it at thestrike price, keeping thepremium received forwriting the option

8 tips fOr Writing (Or sElling) puts

Always choose a strike price at which youd be happy to

buy the stock.

Focus on strong businesses that youd be excited to own

for the long term.

Write out-of-the-money puts, meaning your strike

price is below the stocks current share price.

Verify that the option premium payment makes the trade

worthwhile.

Remember, you often wont get to buy the stock; youll

just get option income. Thats why we sometimes write

puts on stocks in which we already own partial positions.

Put writers do not collect dividends paid by the underly-

ing stock.

Never overextend yourself by writing too many puts.

Brokers allow put writing on margin, but we write puts

when we have the cash to buy the stock.

Vary the expiration dates among your individual option

holdings so they dont all fall in the same month -- this

staggers your risk.

You may write in-the-money puts with strike prices

above the current share price when youre especially

bullish on a stock and want to capture more upsidepotential with its options. This strategy also increases the

odds that you get to buy the stock. When you write in-

the-money puts, the guidelines in our table dont apply.

Put writing is a bullish, or at least neutral, strategy. When you

write a put, youre saying you believe the underlying stock

will eventually increase in price (hopefully after youve bough

shares), or at least hold steady -- meaning youll earn income on

your puts when they expire.


8/16



Lets use an example: Assume youre bullish on the health-care company, Kinetic

Concepts (NYSE: KCI). The stock increased lately, so youre not as anxious to buy it.

If the shares fell to $35 or so, however, youd be happy to buy. Rather than just sit and

wait, you can write (remember, thats sell to open) the $35 strike price put options

Youll get paid while you wait, and youll potentially get that lower buy price.

Before placing this trade, make sure you have the cash (or, for experienced investors,

ample buying power) in your account to buy a minimum of 100 shares of Kinetic. You

can then write $35 puts that expire in a few months. Lets say the puts pay you $2 per

share, and you write two contracts representing 200 shares of Kinetic. Youre paid $400

(minus commissions) up front. And now you wait (cue theJeopardy theme).

If Kinetic Concepts ends this time period above $35, your options simply expire, and

you keep the $400. You can then write new puts if youd like. If Kinetic dips below $35

at the options expiration, the puts you wrote will be exercised, and youre on the hook

to buy 200 shares of Kinetic at a strike price of $35. Including the option premium you

received, your start price is actually $33. Nice! Now you own shares at an attractive start

price and can wait for appreciation.

So, you write puts when:

Youre ready and willing to buy a stock at a lower price and

You dont believe the stock will soar away from you in the meantime (otherwise

youd just buy the stock), or

You just want to make income writing puts. You dont believe a stock will drop

to your buy price, but if it does, youd still be happy to buy it.

WHat Can gO WrOng?

Sounds perfect, doesnt it? Youre paid to potentially buy a stock you wanted to buy

anyway -- and at a price you like. Thats beautiful.

But every investing strategy has some risk. In this case, assume Kinetic Concepts doesnt

fall below $35 by the time your option expires, but instead jumps to $45 over the next

few months. You miss out on a several dollar stock gain for only a $2 gain in the put

options, and you still dont own shares. Now what do you do? It might be a tough call.

Kinetic could also drop to $30 soon after you write your puts, but then climb back to $38

just as your puts hit their expiration date. Because almost all options are exercised only at

expiration, you wont get the shares, and you will have missed your buy price. Of course,

you keep the $2 option premium and can write new puts.

Theres also the scenario that the stock drops and doesnt come back up for a long time.

If Kinetic fell to $25, your options would be far underwater. In this case, you must be

ready to just buy the stock at your net price of $33 and wait for a rebound. At least youre

getting a much lower start price than if you had simply bought the stock outright on dayone.

So, Fools, whenever you write puts, be confident that you want to own the stock for the

long haul.

when To wriTe puTs

Youre ready and willing to buy a stock

at a lower price and

You dont believe the stock will soar

away from you in the meantime

(otherwise youd just buy the stock), or

You just want to make income writing

puts. You dont believe a stock will drop

to your buy price, but if it does, youd

still be happy to buy it.


9/16



Are you confident about a stock, but reluctant to pony up the cash to buy it today? A

synthetic long may be just the ticket.

This option strategy works nearly the same as owning the underlying stock outright

except you dont need to pay up front. Usually, youll set up a synthetic long on a stock

if you foresee a strong catalyst for appreciation in the next 18 months or so. As the stock

price goes up, your options gain value along with it, sometimes to a much greater degree

Earlier, you discovered that when you buy options as opposed to selling (or writing)

them you aim to profit from the option itself, rather than getting the underlying equity

involved (unless its to your benefit). The synthetic long allows for the best of both

worlds: On the options you buy in this strategy, your upside potential is unlimited; on the

options you sell, the worst-case scenario is that you end up buying the underlying stock

at a price of your choosing. This makes the synthetic long an especially attractive trade

for bullish investors.

Buy Calls, sEll putsTo initiate a synthetic long, you buy a call option and concurrentlysella put option on

the same underlying stock or exchange-traded fund. For a true synthetic long, the calls

and puts will have the same expiration date and strike price, although there are attractive

variations that youll discover below.

When you buy a call, you believe that the underlying stock is going to appreciate consid

erably over the life of your option. If it does, the call usually gains value dramatically. If

the stock does notappreciate, however, your calls will move toward expiration with less

and less value, finally ending with little or no value.

That is always the risk of buying options. You need to be correct by the expiration date or

the option wont maintain value, and you could lose your whole investment. This poten-tial loss is much easier to stomach, though, if you use income from a put sale to buy your

calls. This is exactly what you do to set up a synthetic long position. Lets see an example

BullisH On autOdEsk? gO syntHEtiC lOng!

Suppose you have a bullish long-term stance on 3-D software leaderAutodesk(Nasdaq

ADSK). You believe the business will be on the upswing again within 18 months, so

youd like to set up a synthetic long position to benefit.

With the shares trading around $12.50 (as of March 13), you would buy the January

2011 $12.50 call options on Autodesk for $3.80 per contract, and concurrently sell (or

write) the January 2011 $12.50 put options for $3.50. Your net cash outlay is just $0.30

per share. Once you make these trades, if Autodesk begins to appreciate, both your callsand puts will start to show gains in your portfolio, in effect mirroring the stock or even

outperforming it. If Autodesk appreciates to, say, $20 by sometime in 2010, your calls

will gain 100% to 200%, and your puts will be well on their way to becoming a 100%

cash gain, too.

On the flipside, lets suppose Autodesk continues to suffer from soft sales, and shares drif

lower to $10 or $11 for the next year or longer. In that case, your call options will slowly

lose value, and your put options put you on the hook to buy shares at $12.50. Given tha

you paid a net $0.30 to set up your synthetic long, your net start price on Autodesk will

synTheTiC longs aT a glanCe

Synthetic longs are best when youre bull-

ish on a strong business, at least somewhatbullish on the market overall, and expect a

catalyst over the next 18 months or so.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Typically, you should use the longest-dated

LEAPs (Long-Term Equity Anticipation

Securities) you can find so youll have the

largest window of time to be proven correct;

refrain from initiating short-term synthetic

longs that expire in nine months or less.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

You must be ready to buy the underlying

stock if it falls below your put options strike

price.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Remember the three possible outcomes

with a synthetic long: (1) the stock increases

and both your options make money; (2)

the stock decreases enough that youre

obligated to buy it via your put options; or

(3) the stock stagnates, in which case both

your options may simply expire, and youre

back where you started.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

A true synthetic long uses the same strike

price and expiration date for both calls and

puts; you can split the strikes, however, to set

up a more defensive or aggressive synthetic

long, depending on your preference.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Once your thesis has largely played out and

youve earned money on your calls, con-

sider taking your profit on the calls; use the

underlying stocks valuation and your options

approaching expiration date as guides.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Using a synthetic long option strategy on a

dividend-paying stock does not entitle you

to the dividend payment.

sttc l


10/16

t h e m o t l e y f o o l | o p t i o n s e d g e h a n d b o o k | p a g e 1 0


Tip of The Trade

Target healthy businesses with attractively

valued stocks, and your put writing

strategy should leave you happy, whether it

generates income or you end up buying the

stock. Write puts on stocks youd like to ownat cheaper prices, or on stocks that wont

likely decline (but youd happily own if they

did) to generate income. If you really want

to own a stock, though, buy at least some

shares outright.

be about $12.80 per share. This is the only number youll ultimately care about if your

trade is underwater. Youre ready to buy Autodesk at a net $12.80, and you can then hold

the shares and hope for a recovery. Your synthetic long didnt make you any money, but

ideally it bought you shares of a good company.

splitting tHE strikEs

Setting up a synthetic long with identical put and call strike prices near a stocks current

share price is the norm (because youre looking to approximate a stock purchase today),

but it may not be the most comfortable choice for you. For more downside protection,

you may consider splitting the strikes as you set up a synthetic long. In this case, you

still use calls and puts that expire during the same month, but you use different strike

prices.

Using Autodesk as the example, lets say you decide to write the January 2011 $10 put

options instead of the $12.50 puts. The $10 puts pay you $2.50 per share. With that

income, you can then buy the January 2011 $15 call options (instead of the $12.50 calls

from the first example) for about $2.80 per share. The net cost is the same just $0.30

per share but you have more downside protection when you split the strike this way.

If Autodesk declines, you dont need to buy it until it is $10 or lower, and your net start

price will be $10.30.

What do you sacrifice? You now need Autodesk to appreciate by a greater degree (com-

pared to buying the $12.50 calls) by January 2011 for your call options to appreciate

meaningfully or at all.

WHEn tO ClOsE a syntHEtiC lOng

If all goes well, the underlying shares will appreciate for you well before your options

near expiration, at which point based on the valuation of the stock and the amount

of time left in your options you should start to consider taking your profit in your

call options (unless you prefer to exercise them in order to own the stock at your callsstrike price). At the same time, your put options are on the path to expire for the full cash

payment.

Usually, youll use synthetic longs to profit from the options themselves over the course

of your investing thesis typically, around 18 months. Only rarely will you exercise the

calls and turn them into a stock position if the options are successful. On the flip side,

when the position works against you and you need more time for your thesis to material-

ize, youll be ready to buy the shares and hold them.

BOttOm linE On syntHEtiC lOngs

When youre bullish on a stock and want to invest without spending capital today, setting

up a synthetic long position is a sensible alternative. The strategy can reward you withhandsome profits on two options at once, with unlimited upside on the call options or

it nets you shares of a stock that you should be happy to buy at a lower price.


11/16



Sometimes a stock or the market as a whole just takes a nap, and buying or even

shorting isnt likely to land you a profit. But by writing (sell to open) straddles, you can

generate income from a steady stock, or simply from decreasing volatility, as the marke

calms down or catches up on some Zs.

sEtting up tHE tradE

A straddle involves an identical number of calls and puts with the same strike price and

expiration date on the same underlying stock or index. As you know, you buy the calls and

puts to profit in either direction from high volatility. Inversely, writingthe calls and puts is

a way to profit from low or declining volatility. How? Simply by collecting option premium

payments on either side of a potentially sleepy position. There are risks, however.

unCOvErEd straddlE Writing

When writing an uncovered straddle, you usually dont intend to get the underlying stockinvolved. Youre just looking to profit on the value erosion of the options you write, and

youll plan to buy to close them (or let them expire) once youve earned your targeted

profit. (Note: You need a margin account to write an uncovered straddle.)

As an example, suppose a recently volatile stock just announced earnings, and you expect

its volatility will now all but cease. The options still pay well, though, so youd like to

capture the option premium as income. The stock is trading at $25, so you write $25 calls

and $25 puts and get paid $2 for each contract thats $4 total in option premiums per

straddle. This means as long as the stock ends the expiration period between $21 and $29

($4 above or below $25), youll at least break even before commissions and in most

cases, earn a profit on the trade. (call this the profit range.)

For example, if the stock ends the period at $27, the puts you wrote expire

(giving you the full $2 value), and the calls break even, so the trade pays

you $2 per share overall.

If the stock ends lower in your profit range, lets say $23, the calls expire

and the puts break even, so you profit $2 per share overall here, too.

However, outside your profit range, its another story. You face unlimited potential losses

as the stock rises above $29 per share, and you facing growing losses (along with an

obligation to buy the stock and wait for a recovery) the further it falls below $21.

As the table on the next page shows, the maximum profit from an uncovered straddle

occurs when the stock ends exactly at the strike price; you keep the entire $4 per share

you were paid in this example. Your total profit declines as the stock moves away from

the strike price in either direction which is why you want minimal volatility wheneveyou write straddles.

Take a minute to study the table and grasp how this works. As the stock rises, the naked

(or uncovered) calls you wrote increase in value, working against you. As the stock

declines, the puts you wrote work against you, but youll still profit anywhere between

$22 and $28, and break even at $21 or $29. Remember, you were paid $2 for each cal

and put, or $4 total. But since you wrote the options, your desired outcome is that their

value goes to $0, or as low as possible:

why wriTe a sTraddle?

You believe a stock or index is going to hold

steady.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

You believe a stock that was recently vola-

tile will calm down considerably.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

You believe the markets overall volatility is

going to decrease.

wriTing sTraddles: The BasiCs

Write (sell to open) an equal number of

puts and calls on the same stock or index.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Use the same strike price and the samemonth of expiration on both options.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The strike price with a straddle is at-the-

money: as close to the current underlying

stock price as possible.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

When you write an uncoveredstraddle, you

dont own the underlying stock, so your risk

is high (more on this in a minute).

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

When you write a coveredstraddle, you

own the stock, lowering your risk. Here the

straddle works like a covered call strategy

but your returns are potentially goosed with

additional put-writing income.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The most you can earn writing straddles is

what the options pay you initially.

wt st


12/16



To help achieve a successful uncovered straddle, you want the

widest possible profit range (in other words, you want to capturegenerous option premiums). In this example, the range is signifi-

cant $4 in either direction assuming the underlying stock

isnt exceptionally volatile and your options expire in two to

five months (rather than longer). But remember, the trade creates

unlimited potential losses outside the profit range.

One way to greatly mitigate that risk: When you write your

straddle, use some of your option proceeds to simultaneously buy

far out-of-the-money calls and/or puts, too with strike prices

at the two ends of your profit range (for this example, you might

buy $30 calls and $20 puts; or just buy calls to protect you on that

side and be ready to buy the stock via your written puts if it falls).

Doing so, youve hedged and covered your written straddle,and because buying these options generally costs little, youll

still begin with a net credit from your option writing and keep

that profit if the stock stays in a now slightly tighter range. For

example, if you paid $0.80 total for the protective calls and puts,

your profit range decreases by that amount on either side of the

strike price. If you dontbuy protective options initially, be ready

to do so if the trade starts to work strongly against you.

Given that a steady stock can suddenly make a big move for any

number of reasons, its risky to write uncovered straddles withou

this added protection. However, another route is to simply own the

underlying stock outright. Lets take a look.

COvErEd straddlE Writing

Owning the underlying stock takes away all of the naked calloption risk when writing a straddle. In fact, a covered straddle

writing strategy is basically a covered call strategy, but it generally

offers more profit potential because youre also writing puts on the

stock. The key difference with a straddle is that both options are

at-the-money, so youre more likely to see your options exercised

As with a covered call, its important that youre ready to sell your

stock if it rises. And as with writing puts, you need to be ready

to buy more stock if it declines (or close the options early). The

benefits of writing a covered straddle are two-fold:

Your profit can be higher and your profit range wider than

with a mere covered call.

You have more ways to close your options profitably

and still keep your stock if you like.

Continuing the earlier example, lets assume you want to write

a straddle on a steady $25 stock but in this case, you own the

underlying shares. You write $25 calls and puts, getting paid $2

each, with the same expiration date. Since you own the stock, no

matter how high it climbs, youre covered on that side of your

trade. Lets consider some potential outcomes:

You end up selling your stock via the covered calls, but

you keep the $4 option premium you were paid on the puts

and calls, netting a sell price of $29 (compared with just$27 if youd only done a covered call and not a straddle)

The stock declines below $25. You end up buying more

shares, but at a net $21 given the option premiums you

were paid. Youve added to your existing stock holding.

The stocks holds steady, around $24 to $26. You can buy to

close both the calls and puts by expiration and capture much

of the profit while keeping your existing shares. Nice!

Finally, as an example of the added flexibility here

Assume the stock increases to $28 by expiration, and you

decide you want to keep your shares. Since you were paid

$4 per share in option income, you could close your calls

for $3, still have a $1 per share profit on your straddle, and

keep your stock. If you had only written covered calls and

not a straddle, youd need to book a loss if you wanted to

keep your stock.

taking fOllOW-up aCtiOn

Writing uncoveredstraddles requires keeping a close tab on your

sToCk priCeaT expiraTion

endingCallvalue

ending puTvalue

your ToTalprofiT pershare

$20 and lower $0$5 and higheras the stock

falls

($1) and wors-ening as the

stock falls

$21 $0 $4 Break-even

$22 $0 $3 $1

$23 $0 $2 $2

$24 $0 $1 $3

$25(the strike price)

$0 $0 $4

$26 $1 $0 $3

$27 $2 $0 $2

$28 $3 $0 $1

$29 $4 $0 Break-even

$30 and up

$5 andhigher asthe stockrises

$0($1) and wors-ening as thestock rises


13/16



trade. If the stock is moving sharply against you in either direction,

you may want take action to limit your losses. One way to do so

is to close the losing side of your straddle when the stock reaches

your break-even price. In this example, if the stock rises to $29,

you might close your call options for a loss and let your puts go,

presumably to expiration, keeping your overall losses marginal.

If the stock falls, just be ready to buy it via your puts. Uncoveredstraddles dont usually lend themselves to rolling forward (to a

later expiration date), rolling up (to higher strike prices), or rolling

down (to lower strike prices), so you cant depend on these defen-

sive follow-up moves being available to you. As mentioned above,

if you buy out-of-the money protective calls (and puts, if you like)

when you set up your straddle, your potential profit on the straddle

is lower, but you wont need to consider follow-up action.

Writing covered straddles is much less risky and requires less

upkeep, but you still want to keep a watchful eye on your strategy,

since only your calls are truly covered. You need to be ready to

accept more shares if the stock falls below your puts strike price.

For this reason, some investors will use a lower strike price onthe puts they write, providing more leeway but once you start

to stagger strike prices on your calls and puts, youre not using a

straddle anymore, youre using astrangle.

BOttOm linE On Writing straddlEs

Youre not likely to write uncovered straddles without using some

protective options as well. Writing covered straddles, however, is a

sensible way to increase option profits on a covered call strategy as

long as youre also willing to buy more shares if need be. With this

strategy, you have another tool to profit no matter what the market

throws your way in this case, even if the market goes nowhere.


14/16



You write (sell to open) a covered strangle to profit when a stock stays within a wide

price range -- or, if it doesnt, to get a better buy price on new shares or a higher sell price

on existing shares. Its a great strategy.

rECap: straddlE vs. stranglE

Straddle: Use puts and calls, on the same stock, with the same expiration date and strike

price (one at-the-money).

Strangle: Use puts and calls, on the same stock, usually with the same expiration date bu

with differing strike prices (both out-of-the money).

A strangle is similar to a straddle: Youre using call and put options on the same underly

ing stock or index, typically with the same expiration date. As with a straddle, you buy

a strangle to profit on high volatility. Inversely, you write a strangle to profit when a

stock stays within a predetermined price range or is relatively stable. The bonus: Writing

a strangle offers more flexibility than writing a straddle because you split the strikes-- set it up with a different strike price on your calls than on your puts -- and you use

strike prices that are out-of-the-money, or well above or below the stocks current price

giving you more room to profit. Lets take a look.

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sEtting up tHE tradE

To write a covered strangle, sell to open puts and calls, both options out-of-the moneyand usually with the same expiration date. However, the number of puts you write i

dependent on how many additional 100 share blocks youd like to potentially buy, and the

number of calls you write will depend on how many 100 share blocks you already own

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15/16



when its near the high of your expected range and then writing

puts when its nearer the low end.

Writing a COvErEd stranglE

Writing a covered strangle (also called a short strangle) is a way to

profit on a stock you own and would be willing to either buy moreof or sell at the right price. Writing strangles can be superior to

writing straddles because splitting the strike prices provides more

flexibility and room for profit.. The options wont pay as much as

a straddle, but the stock has more room to roam.

For example, say you own shares of a retail stock and youre

willing to buy more if the shares decline meaningfully (potentially

doubling your position, well suppose); or, youre willing to sell

your existing shares higher. With the retailer recently near $14,

you could write the $13 puts expiring in six months for $1, and

write $15 covered calls expiring at the same time for $1 as well,

collecting $2 in total option premiums (or 14% of the current share

price).

Consider the possible outcomes:

The stock ends the expiration period between $13 and

$15: You keep the whole $2 per share the options paid

you -- great income -- and keep your shares, and can

consider your next move.

The stock increases above $15 by expiration: Youre on

the hook to sell your existing shares for a net $17, includ-

ing the $2 the options paid you.

Shares fall below $13: Youre obligated to buy new shares

at a net $11, again including the $2 the options paid you.Youve now doubled your ownership, and lowered your

cost basis. (It might be time to write covered calls!)

Of course, in most cases you could also buy to close your

options early or upon expiration, and still have a profit on the

combined option trades assuming the stock hasnt moved too dra-

matically (in this case, as long as its between $11.10 to $16.90).

As you can see, a covered strangle can give you a wide profit

range, and its more powerful and flexible than a covered call

strategy alone -- as long as youre ready and willing to buy more

shares if it comes to that. As with any time you write puts, you

need to be confident in the stock or ETF youre exposing yourselfto and ready to buy it. With a covered strangle, you also must

be ready to sell your existing shares if they increase in price.

However, given how much the two combined options pay you,

you also have more flexibility -- or possibility -- to close your

options early if you wish, keep your shares, and still have a profit.

Writing unCOvErEd stranglEs

Some daring investors write uncovered strangles when they

strongly believe a stock wont break above or below a certain

(generally wide) price range, aiming to profit via option premi-

ums on both ends. Were unlikely to partake in this risky strategy

without buying calls to protect ourselves -- otherwise, the losses

can be unlimited.

BOttOm linE On Writing stranglEsWriting a covered strangle is a way to generate option profits on a

position if you already own at least 100 shares, would be happy to

add at least 100 more shares at a lower price, or sell your existing

shares at a higher price. More flexible than just writing covered

calls, strangle-writing can provide a wide window of profit using

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Call option: A call option is the right to buy the underlying stock

at a set price (the strike price) at or before the options expira-

tion date. A call rises in value as a stock rises and declines in value

when the stock falls.

Delta: The amount that an options price will change with any

change in the underlying share price.

Gamma: A measure of risk in an option based on the amount

that the delta will change with a $1 change in the stock (we dont

concern ourselves much with delta or gamma, since were much

more concerned about the underlying value of the equity were

targeting, but theyre still good things to know).

In the money: This term is used when an option has intrinsic

value. Call options are in the money when the underlying stock is

above the calls strike price. Put options are in the money when

the underlying stock is below the options strike price (a stock is

at $22 and the put option has a strike price of $30, allowing the

holder to sell the stock at $30).

Intrinsic value: This is the value of an option if it were to expire

immediately. Its an options value in direct proportion to the

underlying stocks current price. If a call option gives the owner

the right to buy a stock at $10, and the stock is trading at $12, the

options intrinsic value is the difference: $2. The option may actu-

ally be priced at $3, with $1 of time value (see below) because it

doesnt expire for a few months, and much could change by then.

LEAPS (Long-Term Equity Anticipation Securities): These

are simply stock options that, when first offered, expire at least

two years in the future. We like LEAPS because they give you a

relatively long time for an investment thesis to play out.

Option contract: Each option contract represents 100 shares of the

underlying stock. A contract is quoted at the price for just one share,

so you need to multiply it by 100 to get the full value. So, if you buy

two option contracts for $1.50 each, it actually represents 200 (2 x

100) shares of stock, and would cost you $300 ($1.50 x 200).

Out of the money: This is the opposite condition as in the

money. Here, an option has no intrinsic value, only time value.

This occurs when, for example, a stock is trading at $8 and a call

option has a strike price of $10.

Premium: Not unlike an insurance premium, the value paid for an

option contract is called the premium. The more volatile a stock

is, generally the higher the premium on its options. Also, all else

equal, the longer until an option expires, the higher the premium

it commands, accounting for more unknowns.

Put option: A put option is the right to sella stock at a set price

at or before the options expiration date. A puts value increases

as a stock falls.

Strike price, expiration, and exercise: Every option has a strike price and expiration date (which is always the third Friday o

a month, after the market closes). The strike price is the value

at which the underlying stock can be bought or sold. When an

option is converted into a stock transaction, the option has been

exercised.

Time-value premium: This is the price of an option above its

intrinsic value. Its the value placed on an option purely to accoun

for unknowns and expected volatility between now and expiration

Time value declines as expiration draws closer.

Writing a contract: Selling a new option contract (opening a posi

tion) is usually called writing a contract; the brokerage command

to do so is usually sell to open, just as when you short a stock

The new option seller is called the option writer; to close the

position, the trade command is called buy to close.

ot g

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