Imagine that you are going to get married and wish to buy a house in 1 year time, you do not have the cash you need to buy a house. Assuming that the housing market is in good time and you expect that the house price will be increased soon, what can you do?

If there is a kind of contract that you can buy to reserve the house at certain price for a period of time, isn’t that good? To purchase this contract, you simply pay fraction of the total house price, let say 1% which is $1000 out of the total value of $100K (assuming this is the house price).

Now you have the right to exercise the contract and buy the house at 100K within 1 year time frame. Your contract will be expired and become worthless after that. The story does not end here, if the house price increased from $100K to $110K 3 months later, you have suddenly change your mind for not buying that house anymore, you have the choice to sell this contract away at $1K (the original price) + $10K (the increase value) = $11K with the gain of $10K.

In the end of the story, you simply earn the difference without forking out the $100K lump sum in the first place, this is what we call “leverage”.

Before learning more, you need to familiar with certain terminology:

Option has the following characteristics:

1. Options give you the right to buy or sell an instrument without any obligation.
2. If you are buyer of an option, you have the right to exercise the option, but you are not obligated to buy (when option is a call) or sell (when option is a put) the underlying instrument.
3. If you are seller of an option, you are obligated to deliver, or to purchase the underlying instrument at the predetermined price if the buyer exercises the right to deliver or to sell.
4. Options are only valid for a specified period of time, you lose your right to buy or sell the underlying instrument after the expiration date. Options expire on the Saturday following the third Friday of the expiration month.
5. Options are available at different strike prices that reflect the price of the underlying instrument.

Your Roles in Options Trading:

1. Buyer of Call Option
2. Buyer of Put Option
3. Seller of Call Option
4. Seller of Put Option

There are basically 4 types of participants in options trading, which are listed below.

Buyer roles are quite simple to be understood, but a seller or writer roles could be quite complicated.

Sellers receive credits for selling options. The credit is the amount of money equal to the option premium that you have sold.

As a seller of options, you faced the risk of being assigned when there is more seller than buyer in the market. The benefit of being a seller is that you received the payment first, to close the position, you simply buy it back. Therefore, instead of buy low sell high, you sell high then buy low to earn a gain.

Conclusion:

Options are one of the derivatives that provide better leverage but it can carry high risks at the same time. To be a savvy trader, you need to study the risk involved and the benefit of using the call and put option. I hope that you have a better idea what is the option now.

Resources:

You may download the Characteristics and Risks of Options from the Options Clearing Corporation website:

http://www.optionsclearing.com/publications/risks/riskchap1.jsp

You know that company X is reporting its earning tomorrow before market open tomorrow, and from the past history results you know that the earning results will drive the stock movement drastically. But you do not know whether it will beat the earning estimated by the analyst or not, though many said yes, but the bad market situation now could impact the financial results of the company as well. You have no clue how is the results likely become, but you know one thing, the stock will swing a lot after the result is announced, therefore you set up a straddle options strategy. Hoping that the stock will make huge move and you will reap some profit from the trade.   

source: shoofy stock  used under: CC

Straddle is one of the most popular volatility strategies, to set it up, you simply buy the call and put at the same strike price with the same expiration date.

Volatility strategy is applied when you wish to make a profit whether the stock moves up or down, you simply don’t care where is the direction of the stock, but it needs to be impulsive move.

How to Set Up a Straddle Strategy:

1. Buy a call of company A at strike price B and expiration date of C
2. Buy a put of company A at strike price B and expiration date of C

Doesn’t it sound too simple?

Steps:

-          Look for stock that going to make any news announcement soon like earning report, merger and acquisition news, trial case, and etc. You can set up this strategy 1 week before or 1 day before the news release, depends on situation

-          Observe the stock pattern before the news release, if it has been too volatile, this strategy may not be effective as you may be buying high price options.

-          You are looking for low implied volatility options when you are buyer, if the stock move explosively, the implied volatility is high and it will drive one of the options price higher, and you earn from the difference.

Things to watch out:

1. If the stock moves side up, your option price will fall by the time decay when it near expiration date, the time is decreasing and you will incur a loss at the end of the day.
2. You need to buy at the strike price that closest to the current stock price, the best case is ATM – at the money.
3. Find stock that at the range of above 30 or below 80, options with high strike price has very high premium which sometimes is hardly affordable.
4. Set up the straddle only when big things is happening soon, of course, those that you are aware of, like earning report, fed announcement, or any news announcement that impact that particular company share price.
5. Set up the strategy with options that is 2 months away from expiration, preferably 3 months, so that you have options contain better time value.
6. Exit the trade if the news does not really impact the share price, either in positive or negative way.
7. Find stock that is forming a consolidation pattern, because it has lower volatility, the options premium will be cheaper when you buy them. If the stock has been volatile before the news, the option premium may become high, the options premium may suddenly drop a lot after the news is released, resulted in loss.
8. Take note of the bid/ask spread, if the gap is too wide, the set up will be not effective as well. This is normally due to the low liquidity that leads to low open interest.

Exit Strategy:

I would recommend exiting the strategy by selling both the call and put together. Some people like to catch the reversal and hoping to reduce the loss of the remaining option, this is possible, but quite exhausting, and the trend most likely continue after the news is made. 

Risk:

Your maximum risk is the premium that you purchase the call and put options, therefore it is capped.

Reward:

Your maximum reward is uncapped, because the stock can jump up to sky high or drop to bottom.

Disadvantages:

-          Straddle can be quite costly as you need to buy both the call and put at the same time

-          Significant movement of the stock is required, if the stock moving sideway or range bound could cost you money by eating up the time value of the options.

-          Both the call and put options premium may suddenly drop drastically after the day the news is announced, this is because people are no longer excited by it, and the volatility has dropped.

The market ended up higher due to the majority believe that the stimulus plan by Obama will be helpful to boost the market. DOW jones industrial average rose 217.52 points on friday, vast major sector follow the trend especially the basic material, financial market and transportation. 

The very bad job market resulted in 598,000 job lost, which believed it is the worst since 1974, and the jobless claim was hit 7.6% last month. 

US senate would likely to pass the stimulus bill of more than 780 billion dollar to pump into the market to make sure the situation will not be worsen as another great depression. 

MasterCard Inc (MA) became one of the biggest winner this week, by beating the analyst expectation of its earning, the share was rosen up $6 before the market open and was up $14 again during intraday trading, resulted in $20 rise in one single day. MasterCard easily beat the estimates, its profit was $1.87 a share in the fourth quarter, beating the $1.62 average estimate of 21 analysts, it is so far the world second largest credit card network.  

In Japan, irregardless of loss, the world most profitable automaker - Toyota (TM) share managed to inch higher after the drip before its bad earning result on friday.  Toyota reported a loss of $164.7 billion yen, or USD $1.8 billion, down USD$5 bilion the same period a year ago. To reduce cost, Toyota has announced to cut its temporary work force from 9000 to 3000. 

Swiss Re, one of the world insurer giant which based in Zurrich, got $2.6 billion capital infusion from Berkshire Hathaway. Warren Buffet has so far invested $5 billion in Goldman Sach and $3 billion in General Electric since the financial crisis began. Despite that it has reported close to $1 billion swiss franc net loss in 2008, Swiss Re believed that it will continued to deliver strong Property & Casualty results.   

Most of the tech and financial stock was up higher on the fifth trading day this week as well. 

Oil price remain at the $40 per barrel level now, it was dip below $39 after the job data released on thursday, worried that the demand will be suffered by the slow economy.

Gold has risen to $914 per troy ounce, Platinum has risen $22 to $1004 per troy ounce. 

Top News 

Feb 2, 2009 Week :-

1. MasterCard Rises After Beating Estimates on Pricing 
2. Oil slips to $39 after jobs report
3. Job loss: Worst in 34 years
4. Toyota losses mount, Volvo suffers Q4 loss
5. Madoff’s Mass. hit exceeds 456 victims
6. Swiss Re gets capital boost from Berkshire Hathaway

Market was risen and tumbled again last week, resulting in about 100 points down from previous week. As we are going to enter another earning season next week, let’s look at some important companies that worth to take a look. 

Earning watch and Economic Data for next week:

Monday: 

Personal Income Index is expected to fall again. With lesser income, spending is expected to fall as well which deepen the economy.

Tuesday: 

1. DOW – DOW Chemical, a diversified company that provide chemical, plastic and agricultural products. Jim Cramer has called to dump this babe if the CEO has not gone. DOW Chemical has cut 400-500 Jobs near its Midland, Mich Headquarter. This babe is only posting $0.07 compare to $0.84 earning the quarter last year.
2. MRK – Merck & Co is expected to post earning of $0.74 compare to $0.80 same quarter last year.
3. MOT – Motorola has been cutting it workforce since last year, and looking for buyer for its mobile phone division.
4. DIS – Walt Disney is expected to post earning of $0.52 compare to $0.63 previous year After the Market Close. 
5. YUM – YUM Brand, the company for KFC, Pizza hut, Taco Bell, LJS and A&W is expected to post earning of a penny better than previous year - $0.45 vs. $0.44 after the market close. 

Pending Home Sales Index expected to remain the same after sliding 4% the previous month.

Wednesday: 

1. KFT – Kraft Food is posting the same earning compare to previous year $0.44 before Market Open. 
2. CSCO – Cisco is expected to post $0.30 per share compare to $0.38 a year ago after the market close. 

EIA Petroleum Status report will be out 10.30am on Wednesday.

Thursday:

1. MA – Master Card is expected to post a earning better than previous year, $1.63 compare to $0.89 last year. The earning announcement will be made before market open on Thursday.

Jobless rate expected to rise further as many companies have been slashing stuff. Jobless rate has risen to 7.5% in January to be the highest in 16 years.

Friday: 

1. TM – Toyota had announced losses since last year end. Automobile has been one of the worst industries since last year.  Toyota was posting $2.55 previous year, the earning expected to be worsen after the financial crisis and bad economy. 

Neutral strategy is one of the advantages of options trading. The objective of the strategy is to neutralize one of the Greeks, in the case of Delta Neutral Strategy; obviously we are trying to neutralize the Delta. Such a strategy has no effective exposure to changes in the price of the underlying asset. The Delta of the option or the underlying asset will be hedged away. 

Delta neutral is very important concept for Options Trading. The net delta of the option strategy, including position of the underlying asset, is neutral and has no market bias. 

The delta of the underlying asset, for example stock, is 1.00 if you long the stock. And at-the-money option will have a delta of close to 0.50. Therefore, to construct a Delta Neutral strategy, simply long 1 share (delta=+1.00), and sell 2 call options (delta= -0.5 - 0.5 = -1.00), it will give you a delta neutral position.

Delta Characteristics: 

1. Options that deep in the money have Delta close to 1.00. 
2. Options that deep out of the money have Delta close to 0.00. 
3. Option at-the-money has Delta of close to 0.50. 
4. If you short the call option or underlying asset, the Delta becomes negative.
5. Put options have negative delta.
6. The delta of the underlying asset is 1.00 constantly.
7. Delta of the options increases as the option goes further in-the-money; It decreases as the option goes further out of the money.

Some important points to be remembered: 

1. If you buy a share, your delta is +1.00, if you short a share, your delta become -1.00. 
2. If you buy an At-the-money call, your delta is close to +0.50. On contrary, if you sell an At-the-money call, your delta is close -0.50. This applies to Put option with different polarity. 
3. It is difficult achieve a delta zero position in reality, but you need to start a position close to delta zero, therefore you initialize a Delta Neutral position. 
4. You need to have options of at least 30 – 60 days remaining before expiration to mitigate the risk of time-decay.
5. If your position does not moves that much that able to shift the position delta or moving sideway, close the entire position. The time decay will eat away the time value in the option you buy, unless you are the seller instead of buyer of options.

Delta Neutral Strategy set up examples: 

1. Only Options

a. Straddle - Buy an ATM call (delta: 100 x +0.50 = +5.00) and buy an ATM put (delta: 100 x -0.50 = -5.00)

b. Strangle - Buy an Out the money call and buy an Out the money put, which both has the very close delta

2. Stock + Options

a. Buy 100 shares (delta: 100 x +1 = +100) and buy 2 ATM puts (delta: 2 x 100 x -0.50 = -100)

b. Buy 100 shares and sell 2 ATM calls, which have the same delta position as above example. 

c. Obviously, you can do the opposite by shorting the stock and buy the call options, but this strategy may involves a lot of risk which not suitable for beginner trader. Besides, you may need to be careful of the margin trading regulation before you choose to short the position.

How does Delta Neutral Strategy make profit? 

• The main advantage of Delta Neutral strategy is that you are able to make a profit without taking any directional risk. 
• You need to adjust the delta back to zero when the market move so much that shifting your position delta.
• Therefore your aim is to adjust the position constantly by selling or buying the options or underlying asset in order to make profit by doing these adjustments.

“Today I say to you that the challenges we face are real. They are serious and they are many. They will not be met easily or in a short span of time. But know this, America: They will be met.”  - US President, Barrack Obama’s inaugural speech

DOW slumped about 4 percent today due to economy worries irregards to the inauguration day of President Barrack Obama. DOW Jones Industrial Average has broken through support line and moving towards the 7500 support level. S&P lost 5.28% and Nasdaq lost 5.78%.

Barrack Obama has become the 44th US President and he had delivered a very strong and greatest speech ever on his inauguration day. Even so, his positive speech did not change the course of market direction and the fundamental of the economy issue still remains. 

In the midst of UK bank announce bail out plan, US bank share has been impacted as well, Bank of America, Citigroup, and JP Morgan chase has slipped over 20% on wednesday. 

Nevertheless, Obama’s speech has delivered a strong message to United State and to the world that Changes is needed for better and hopeful tomorow.  

Highlight of Obama’s Inaugural Speech: 

About Government 

“The question we ask today is not whether our government is too big or too small, but whether it works — whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified. Where the answer is yes, we intend to move forward. Where the answer is no, programs will end. And those of us who manage the public’s dollars will be held to account — to spend wisely, reform bad habits, and do our business in the light of day — because only then can we restore the vital trust between a people and their government.”

About Economy & Infrastracture: 

“For everywhere we look, there is work to be done. The state of the economy calls for action, bold and swift, and we will act — not only to create new jobs, but to lay a new foundation for growth. We will build the roads and bridges, the electric grids and digital lines that feed our commerce and bind us together. We will restore science to its rightful place, and wield technology’s wonders to raise health care’s quality and lower its cost. We will harness the sun and the winds and the soil to fuel our cars and run our factories. And we will transform our schools and colleges and universities to meet the demands of a new age. All this we can do. And all this we will do.”

About Prosperity: 

“that a nation cannot prosper long when it favors only the prosperous.”

About Defense:

“With old friends and former foes, we will work tirelessly to lessen the nuclear threat, and roll back the specter of a warming planet. We will not apologize for our way of life, nor will we waver in its defense, and for those who seek to advance their aims by inducing terror and slaughtering innocents, we say to you now that our spirit is stronger and cannot be broken; you cannot outlast us, and we will defeat you.”

About Leadership: 

“To those leaders around the globe who seek to sow conflict, or blame their society’s ills on the West: Know that your people will judge you on what you can build, not what you destroy. To those who cling to power through corruption and deceit and the silencing of dissent, know that you are on the wrong side of history; but that we will extend a hand if you are willing to unclench your fist.”

To watch Obama inauguration Speech

DOW JONES Industrial Average down 2.94%, Nasdaq down 3.67% and S&P down 3.35% today due to slumping retail sales. Oil price was stabilized at $37, Gold down to $808, other precious metal prices declined as well.

As mentioned earlier in previous post, More Red Alert to come, the market sentiment has started to turn sour, it is only a matter of time and what will pull the trigger. 

I have been praying hard for my trade for QQQQ to be bearish, this was one of the toughest trade I have been through, the total loss could be summed up to USD2K if the market really goes up, though it is unlikely to happen at the momemt. Market was up during year end mainly due to window dressing, and investor injected money to the market to boost up the market sentiment for a short while. 

Then the market started to pull back after more realistic results is out like the jobless claim, retail sales, and also more and more bad earning report will be shown up. Now its back to reality and face the fact of the recession and bad economy. 

My Trade on QQQQ: 

• Strategy: Bear Call Spread (28/30) x 20 (I have accumulate position over a period of time) 
• Total Sell price: 1.10
• Total Buy price: 0.9 
• Profit/Loss: ~ + USD400 

DOW JONES Industrial Average Analysis:

• DJIA has been tumbled for the 6th day after the red alert shown on Jan 7, 2009.
• Next Support at 8100, very close to today closing price, next session may be able to hold up by support line

MACD and Slow Stochastic show there is more room to go down further, Bearish volume is continue build up.

News to Watch: 

• Apple’s Jobs to take medical leave
• Wall Street slides on retail sales slump, corporate weakness

DOW has down 125 points as market concern about more bad earning coming on the way. 

DOW JONES is currently below almost all the moving average from 200 to 10, which show very bad sign again, as this situation may worsen further if there is no good news coming up soon.

Attempt to break the support at 8400 is on the way and it may plunge below 8000 points within this week.

The aluminium giant -  Alcoa (AA) has posted more than expected loss for Q4 last year due to declining aluminium price. Alcoa is planning to cut the workforce of 13% or 13,500 by the end of the year to stay competitive. 

Aluminium price has continue to declined since July 08 peak of USD3000/tonne to USD1475/tonne currently.  

More Earning to watch: 

• Tue: Infosys (INFY), Linear Tech (LLTC) 
• Wed: Xilink Inc (XLNX) 
• Thur : Genetech (DNA) AMC, Intel (INTC) AMC, JPMorgan Chase (JPM) BMO 
• Fri : Johnson Control (JCI) 

Market took dive again yesterday but mix for today as bad jobless claim results arise, bad retail and consumer data, as well as more concern about 2009 outlook and bleak economy. In the last few market check post, I have warned that the rise could be a bull trap and the outlook is bad within short term in the post of Market Check Dec 17 - FED rate cut.

Although President-elect Obama’s stimulus plan is thorough but can the plan boost up the market immediately? It is a big question. Of course, it takes time for the market to recover. Will the $300 million of tax cut for individual and business works? How about the total $775 billion stimulus package?

No doubt, this is one of the drawback of the current financial system. The financial cycle will definite happen and it will change the course of the world economy and make the world economy rebalance once again. 

DOW is hitting road block after enjoy almost close to a week of uptrend. Market start to focus on the bad news again, especially the bad job market.  

stochastic is heading south, and MACD is slowly crawling back to bearish zone. 

Resistance is clearly seen at 9000 level. 

Moving forward, the consumer and retail data will be getting worst, so what’s your take for the market direction?

I guess it is quite clear for you …:)

News you need to know: 

- The Bank of England has cut its rate to 1.5% from 2.0% yesterday try to boost economy. 

- Crude oil stay at $40 level

- Gold has risen $13 to $854 today

Happy Trading !

I love free tool and free information are available in the internet and nowadays, most of the crucial financial data are available simply access to the internet. One of my favorite sites for stock analysis is by using MSN Money Central. It is totally free tool and the site is comprehensive for whatever financial and technical information you need about stock. 

On the welcome page of Money Central, you will see the get quote column box, simply enter the symbol of the listed company that you are looking for, the information of the company will appear in front of you. On the left side of the list, go to fundamental, you will be able to get all the financial data here.

One of the most comprehensive way to do your stock search is by using the “Deluxe Screener“. On the left side column, under “finding stock”, click on stock screener, then custom search. Install the “Deluxe Screener” (Yes, it is absolutely free!), and you will see something on the screen like this after the installation complete. 

Under the field name, you choose different category like financial condition, company basic, Investment Return, Price ratio, Dividend, and etc. Under each category, you can choose the specific information you need.

For example, I have chosen Net Profit Margin under Profit Margin category, and my operator is “ >= ” value of “ 20%”. Under the field description, the tool explained clearly the Net Profit Margin means “The latest 12 months’ net income from total operation divided by the latest 12 months’ sale.” Then, click on “Run Search”. The tool is able to find out look for specific information you need.

Now go a step further, let’s search for some specific information:

I have save the screener name called Paul2, under this file, my search are as follow:

• 1.      Return on Equity => 15%
• 2.      Debt to Equity Ratio <= 0.9
• 3.      Payout- 5 year avg >= 30%
• 4.      Avg Daily Vol. Last Quarter >= 1 million
• 5.      Last Price >= 40
• 6.      Total Share Outstanding <= 1 billion
• 7.      Industry Name – Display only
• 8.      P/E Ratio – Display only
• 9.      % Institutional Ownership – Display only

As you can see some of the items are only for display because I do not really want to limit the search but I would love to know this information from the search results. 

Now click on “Run Search” and the result is out! Some interesting companies appear in the list like BA, NUE, MMM, MON, RTN which I am more familiar with. You can further study the companies by going in to the details of their financial report and news to decide which your focuses to invest or trade are.

With this, now you are close to become a professional trader!