WHAT IS RISK?

DEFINING RISK FOR TRADERS

Options were designed as risk-reducing tools, yet most people begin trading options by adopting high-risk strategies.

Why does that happen?

·         Overconfidence. Traders tend to concentrate on profits and ignore the chance of losing money.

·         Some strategies "feel" safe. When investing a small sum, traders ignore the fact that they will lose money at least 90% of the time.

·         It is easy to forget that a string of small losses adds up.

·         Traders do not look at risk in enough detail.

DEFINING RISK

The term "risk" can be defined from different points of view:

A dictionary tells us that risk is 

·         A situation involving exposure to danger. For traders, that danger is a monetary loss.

·         The possibility that something bad or unpleasant (such as an injury or a loss) will happen.

·         The potential of losing something of value, compared with the potential to gain something of value. 

As a trader, I recommend using the last definition because it forces you to consider what you have to gain and compare it with what you have to lose.

In other words, do not make a trade when risk is too high for the potential gain.

INTRODUCTION TO CALENDAR SPREADS

TIME SPREADS

DEFINITION: A calendar spread is a position with two options; buy one option and sell another. Both options are calls or both are puts, with the same underlying asset and strike price, but different expiration dates.  Buying the option that expires later, is BUYING the calendar spread.  Buying the option that expires earlier, is SELLING the calendar spread. Traders almost always buy calendars because the margin requirement is steep for sellers (For margin considerations, the short option is considered to be naked, or unhedged). 

At one time, it was common to refer to calendar spreads as 'time spreads.'

Example 

     Buy 10 IBM Jul 18 '14 100 calls
     Sell 10 IBM Jun 20 '14 100 calls

The calendar is commonly used when the trader believes that the:

·         Underlying stock will be priced near the strike price at, or near, expiration. 

·         Implied volatility of the longer-term option will increase over the lifetime of the trade.

Note: The options do not have to expire in consecutive weeks or months.

The distance between expiration dates is immaterial; the only requirements for a calendar spread are that the underlying asset and strike price are identical.

How does the calendar earn a profit? 

The calendar spread takes advantage of the fact that options with shorter lifetimes decay more quickly than options with longer lifetimes. Thus, all else being equal, as time passes both options lose value, but the spread value increases.

The world is not quite that simple.  If the rate of time decay were the only factor, calendars would be profitable almost all the time.  Other factors affect the calendar spread. The two primary factors are:

1. STOCK PRICE. The calendar reaches is highest value when the underlying stock is priced exactly at the strike price as expiration arrives. The data in the table below illustrates the point.

ASSUMPTIONS: IBM is $XXX per share; date: Jun 18, 2014, 4:00 PM ET;  Implied Volatility is 45.

NOTE: When IBM is $100 or less, the Jun 100 call expires worthless and the value of the Jul 100 call is the value of the calendar spread.

When IBM is above $100, the Jun call is in the money.  For the values in the table, assume that the IBM Jun 100 call is bought at parity (the option's intrinsic value, or the amount by which it's in the money) and the IBM Jul 100 call is sold at it's value.

 

IBM Price	88	92	96	100	104	108	112
Jun 100	$0.00	$0.00	$0.00	$0.00	$4.00	$8.00	$12.00
Jul 100	$0.93	$1.80	$3.13	$4.97	$7.32	$10.13	$13.31
Spread	$0.93	$1.80	$3.13	$4.97	$3.32	$2.13	$1.31

 Look at the data in the bottom row.  The value of the spread is highest when the stock is near the strike price and steadily decreases as the stock moves away from the strike in either direction.

ADJUSTING A LOSING TRADE

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RISK MANAGEMENT
When you own a directional trade that is not working (i.e., the price of your underlying asset is moving in the wrong direction or too much time has passed), eventually you must do something to mitigate risk. The basic choices are: exit the entire position, reduce the size of the position, or make a trade that reduces risk Such trades are known as adjustments.
For example, an adjustment may be necessary when you sell a put spread and the stock price falls:
Bought 5 XYZ Jul 15 '16 80 puts
Sold     5 XYZ Jul 15 '16 90 puts
The stock was $96 when the trade was made, but now (two months prior to expiration day) XYZ is $91.
It is reasonable to be nervous about the future value of this position. The position is long (i.e., Delta is positive) and getting more positive (due to negative Gamma) as the price falls. You already are losing money and that loss will increase if the stock price continues to decline. It is time (or perhaps it is already past time) to do something about risk.
In this scenario, it may seem that the best strategy is to sell call spreads (to turn the position into an iron condor) to gain negative delta. It is true that this adjustment offsets a portion of your downside risk because if the market continues to fall, the call spread will lose value and provide some gains to offset the expanding loss from the original put trade. What makes call selling so attractive is that it provides positive theta, and all premium sellers love positive theta. Also, adjusting the put side in this scenario locks in a loss -- and traders hate doing that. It feels much better to sell calls so that the trader can make money from the adjustment, even though the entire position continues to bleed and little has been done to alleviate the amount of money at risk.
However, the primary attractiveness of selling call spreads as an adjustment is that it increases the potential reward. When your trade is underwater, it is tempting to make an adjustment that has the chance not only to recover the current loss, but to add additional profits. Please, ignore that temptation. 
When a trader is already long delta because he/she is short naked puts and the stock is falling, the same principle applies. I urge that trader not to sell calls or calls spreads as an adjustment method. It is far more effective to adjust the put position because that is where risk is.

THE RESERVE BANK OF INDIA SLASHED REPO RATE BY 25 BASIS

The Reserve Bank of India slashed repo rate (at which banks borrow money from the RBI) by 25 basis points but kept cash reserve ratio and statutory liquidity ratio unchanged.
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DIVIDENDS AND COVERED CALL WRITING

EXERCISING A CALL OPTION FOR THE DIVIDEND

QUESTION

"In covered call writing, the ex-dividend date can be more important than the expiration date. If the call is exercised, there is no dividend for the covered call writer. It is possible to have a negative return."

 REPLY
When the call owner exercises and collects the dividend, you should NEVER have a negative return. If you discover that you have no profit (or very little profit), then you did not collect a sufficient premium when writing the call option. In other words, you made a serious error.
FOR EXAMPLE:

Stock is $52 per share and pays a $0.50 dividend.
Ex-dividend date comes before the call option -- the one that you sold -- expires.
Let's assume that

·         You write a call (any expiration month) with a $50 strike price

·         You are assigned an exercise notice and sell your shares at $50

·         You do not collect the dividend

Then - you still earn a profit anytime that you sell the call and collect a premium that is more than $2.00 (the option's intrinsic value) -- as long as you are eventually assigned an exercise notice.
It is a very big mistake to sell any option when there is no profit potential. Never depend on collecting the dividend when the option is significantly in the money.  Sure, you may collect the dividend, but do not count on doing so. The option sale -- all by itself -- must be enough to guarantee a profit if you are ever assigned an exercise notice. If the stock price declines and the option expires worthless, then no profit is guaranteed because there is risk of losing money with any strategy that involves stock ownership because it may undergo a large price decline.

RBI CUTS REPO RATE BY 0.25 % TO 6.50 %

The Reserve Bank of India slashed repo rate (at which banks borrow money from the RBI) by 25 basis points but kept cash reserve ratio and statutory liquidity ratio unchanged.

IRON CONDOR: PRE-TRADE CONSIDERATIONS

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IRON CONDOR TRADING
Question from a reader: How can I discover the type of iron condor that is suitable for my personal comfort zone?
Reply: There are several items to consider when using this strategy. You will discover that there is no blueprint for an exact, rule-based position that suits your needs. You can afford to be flexible when trading the iron condor.
UNDERLYING
Diversification is important for any investor, and especially when selling premium (i.e., collecting cash for an option spread). If you prefer to trade individual stocks, I suggest owning four or five simultaneous positions.  
I prefer to trade index options because that eliminates the risk of trading individual stocks which are always susceptible to an unexpected news release.  Another benefit is that trading a single iron condor on an index makes it much easier to manage risk (i.e., adjust positions) -- if and when the market is undergoing a significant price change.

SBIN STRAP STRATEGY FOR RBI CREDIT POLICY

BUY 2 LOTS  210 CALL  @4

BUY 1 LOT 180  PUT    @3

Total investment=22000

Pay off table:

CASH-SECURED PUT OPTIONS

SELLING NAKED PUTS
Selling puts is not a high-risk strategy. It is no more risky than buying stock.
Despite everything you may have heard to the contrary, put selling is a strategy worthy of consideration by almost every investor who buys stock. The very bullish trader who expects to see a large upward change in the stock price represents the single class of investor who should not sell puts.
PRUDENCE
The so-called "prudent investor" is told that buying stocks is a good and conservative investment idea. That investor is also told that selling put options is far too risky. Let's compare two investors who make a trade today:
·         The stock buyer pays for the investment in three days, when the trade "settles." If the stock price moves higher, the trader earns a profit. If the stock price declines, the stockholder incurs a loss. Very straightforward and easy to understand.
·         The put seller collects cash upfront when making the sale. He/she puts up collateral (to meet the margin requirement) to guarantee his/her ability to pay for the stock -- if and when it becomes necessary. If the option expires worthless, the collateral is released and the trader keeps the cash premium as the profit.
In other words, the stock buyer pays for shares at the time of the trade and the put seller promises to pay for stock at a later date. They each have the same risk: If the stock price undergoes a steep decline, each loses money.  This is not a risky proposition for the put seller who understands that he must not sell more than one put for each 100 shares he is willing to own.
Selling too many puts is a risky proposition, but selling too many represents poor risk management skills by the trader. it is not a reflection on the prudence of the strategy.
The put seller agrees (a binding contract) to pay $30 (the strike price) for shares at a later date, but only if he is required to do so. He collects $100 (premium, or option price) for accepting this obligation.  If the stock rallies, both earn a profit. However, the stock holder's potential gain is unlimited while the put seller cannot earn more than the $100 premium that he collected.

OPTIONS FOR BUSY INVESTORS

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OPTION STRATEGIES FOR LONG-TERM INVESTORS
BOTH INVESTORS AND TRADERS CAN USE OPTIONS.
The generally accepted difference between investors and traders is that investors make portfolio changes far less often and that they have the time and patience to allow their investments to grow. In other words, investors are not interested in instant gratification whereas traders prefer to make a trade, collect a quick (a few minutes to perhaps a couple of weeks) profit and exit the position.
Traders seek stock-market profits by selling as soon as a profit target is met. They never get married to a position. Nor do they have loyalty to the company whose stock they own. They often ignore the nature of the company itself, relying on charts to make buy/sell decisions. Some traders own positions for as little as a few seconds, while others may wait as long as two months for a position to work. 
There is also another major difference. Trading is a full-time job because there is a continuous need to monitor positions and to make important decisions.
Investing is something that anyone can undertake. Don't misunderstand. It is not a simple process. Instead it requires that an investor finds the time to do the necessary work for making important decisions. Unless you want to pay someone to manage your portfolio by buying mutual funds (a poor choice), ETFs (a good choice) or hiring a financial advisor, the successful individual investor does his/her homework. 
INVESTORS tend to hold positions for years, decades, or even an entire lifetime. As a consequence, they make few investment decisions. Investor portfolios should be examined on a regular basis (at least yearly) with the goal of unloading stocks that no longer deserve a spot in the portfolio. Alas, that seldom happens and many buy and hold investors believe in holding forever.
Timing is not a big issue because paying a few cents more per share, has little effect on the long-term results.

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