Risk mitigation.

[TradingDemystified]

Excellent example. Are you able to go into a bit of detail about the differences between 1 and 2?

I imagine that with option 2, there is more margin requirement since you're selling an option, and not buying an option which is fairly cheap. Also, I think I've read that buying puts vs. selling calls won't example move the same way. (ie. if a put gains 20 cents, the call, that you're short, can go up in value more than 20 cents).

For number 2, if the contract goes down, and hence loses value as you say, and is of limited protection, this should be ok since you're already making much more on holding the original CL contract anyway... right? Just trying to understand how selling a call is different from buying a put.

I guess going into more detail would clarify some things here.

Let's do an example, for the /CL trading at 50, the 50 put trading at 0.75 and the 51 call trading at 0.30

1) You have /CL and buy a the 50 put.
Since you incurred a 0.75 debit for buying the put, if CL goes to 51 you only make 0.25 per contract (1-0.75).
If it goes to 51.75 you have 1 in profit since your /CL made you 1.75 but you had to pay the 0.75 for the put
If /CL stays at 50 you have the /CL providing you with zero but the debit for the put makes this an overall loser
If /CL goes to 45 the put gives you the right to sell it at 50 so you only lose the 0.75 that you paid for the put
Keep in mind that during the life of the option the put will increase or decrease so you don't need to exercise your options. You can just buy and sell to close

2) You have /CL and sell a 51 call
You receive right away the 0.30 for selling the call. If /CL goes to 51 you made 1 on your /CL contract plus 0.30 in the call you sold.
If it goes to 55 you make only 1 on your /CL because you gave up on profits beyond 51 (someone else has the right to call the futures contract away from you at 51). You still get to keep your 0.30 from the sale of the call. Total Profit: 1.30
If it stays at 50 /CL gives you no profit but you keep the premium you collected. Profit: 0.30
If it goes to 49 you lose 1 because of your /CL but you keep the premium from the call. Total loss=0.70 (the limited protection is the 0.30)T
If it goes to 45 you lose 5 on your /CL but keep the 0.30 from the premium. Total loss=4.70

I imagine that with option 2, there is more margin requirement since you're selling an option

No, because you own the underlying which in this case it's the futures contract. It is a covered transaction.

Hope it helps or at least didn't confuse more

 

[TradingDemystified]

You want to gain up to 51, and not lose below 50. That adds up to a 50/51 callspread. All other permutations are just more expensive ways to implement it.

This is true, in which case he doesn't even need to own the underlying.

 

[Gotcha]

I guess going into more detail would clarify some things here.

Let's do an example, for the /CL trading at 50, the 50 put trading at 0.75 and the 51 call trading at 0.30

1) You have /CL and buy a the 50 put.
Since you incurred a 0.75 debit for buying the put, if CL goes to 51 you only make 0.25 per contract (1-0.75).
If it goes to 51.75 you have 1 in profit since your /CL made you 1.75 but you had to pay the 0.75 for the put
If /CL stays at 50 you have the /CL providing you with zero but the debit for the put makes this an overall loser
If /CL goes to 45 the put gives you the right to sell it at 50 so you only lose the 0.75 that you paid for the put
Keep in mind that during the life of the option the put will increase or decrease so you don't need to exercise your options. You can just buy and sell to close

2) You have /CL and sell a 51 call
You receive right away the 0.30 for selling the call. If /CL goes to 51 you made 1 on your /CL contract plus 0.30 in the call you sold.
If it goes to 55 you make only 1 on your /CL because you gave up on profits beyond 51 (someone else has the right to call the futures contract away from you at 51). You still get to keep your 0.30 from the sale of the call. Total Profit: 1.30
If it stays at 50 /CL gives you no profit but you keep the premium you collected. Profit: 0.30
If it goes to 49 you lose 1 because of your /CL but you keep the premium from the call. Total loss=0.70 (the limited protection is the 0.30)T
If it goes to 45 you lose 5 on your /CL but keep the 0.30 from the premium. Total loss=4.70



No, because you own the underlying which in this case it's the futures contract. It is a covered transaction.

Hope it helps or at least didn't confuse more

Excellent example. I will spend some time going over this. It wasn't even my original question, and as the OP says, it all seems far too complex right now, but I do enjoy learning as much as I can for use one day.

 

[truetype]

This is true, in which case he doesn't even need to own the underlying.

You have snatched the pebble.

 

[murray t turtle]

I told myself once I would never get involved with options, because they are scary and I don't understand them. My brain doesn't compute them properly.

But I understand they can help mitigate risk. So let us envision a scenario, and I need help with this from the option gurus here. Music to listen to while we work this out.

I enter a position long in May CL at 50.00, one contract.

My target to exit is 51.00. This will give me $1,000 profit. How can I use an option to...

A) Protect the profits as the price goes up from entry...

B) Stave off losses if the price goes down from entry...

C) Possibly make profit on both the underlying and the option, no matter which way the price moves?

What I do not get, aside from options in general, is what happens when you choose an option when you already have ownership of the future underlying the option.

The thing I am not getting in my head, is entering an option when you already have ownership of the underlying future. I suppose this is what they call an "option on futures"?

Am I making sense or are these just dumb questions? Anyone? Help? I do not like my current method of risk-mitigation, it is too much risk exposure. Options might be a good solution. I just dunno'.

%%
The questions make sense. IBD newspaper puts, a put call ratio chart below S&P chart.i seldom study that anymore, i have, in the past. Many think TX TEA is correlated with S&P/SPY. NOT really correlated , oil does not have earnings.AS far as like buying insurance, the best buy is no insurance, or HI deductible. Or if you want a TRAINWRECK like ACA, get a no deductible health policy===========================================If you were wanting to trade smaller, DRIP, GUSH + stuff like that could work.......

 

[Overnight]

I guess going into more detail would clarify some things here...

...Hope it helps or at least didn't confuse more

See Gotcha and Octopode? This is why voice would make it easier. Now to convince the rest of the crew. My brain is fubar on this option concept, lol!

 

[CBC]

I enter a position long in May CL at 50.00, one contract.

My target to exit is 51.00. This will give me $1,000 profit. How can I use an option to...

A) Protect the profits as the price goes up from entry...

B) Stave off losses if the price goes down from entry...

C) Possibly make profit on both the underlying and the option, no matter which way the price moves?

Hey overnight. You're basically asking people the general question on how to trade. Hedging is the specific term for this particular method.

A) I don't understand exactly how you would "protect the profits." Or what you are attempting here. So I can't help with this.

B) This is where the basic term hedge begins and where basically you are going to start trading. You have mentioned 1 contract and I suggest you stick with this until you start to become profitable.

You are attempting to perform the risk free trade. Market goes in your favor you make a stack of cash, the market moves against you, then you lose nothing........

Sounds pretty simple however as I'm sure you probably know it AIN'T that simple. You need to work stuff out.

Incase you havn't started with this strategy, you may not have already realized you first and main problem you will encounter and this is the time decay factor of the option.... what if the market is relatively flat during your trade then moves against your futures position? Won't the option have lost time value and the option not offset the loss of the futures position? In which case your risk free trade has just gone out the window?

 

[CBC]

C) Possibly make profit on both the underlying and the option, no matter which way the price moves?

Ok, so the way this works is you can use the option to offset the future or use the future to offset the loss on the option. Offsetting the option is in general more profitable in IMO because it carrys more risk (bigger chunk of option premium, that you can lose).

Now what your trying to say with this is you would like to profit a lot in one direction and a little bit in the other direction.

So as the system works, you can offset the option with the future and you can offset the future with the option, this can't be done 1 part future and 1 part option. So you have to weight the trade correctly which ur gonna have to figure out. Because either the trade is weighed so that the future offsets the option, the option and future are the same, or the option offsets the future. Its basically a straddle trade made up of a future position and an option position.

 

[punisher]

*sighs* The analogy is not helpful, lol

I think that his analogy was spot on. You may have the greatest insurance in the world, but that peace of mind comes at a price. It's never free. Hedges are never free. It's exactly like buying insurance, they costs money to buy (therefore lowers your profits or increases loss) but prevents from catastrophic events.

You can hedge open position (for a fee) to protect only against big adverse moves, or you can hedge position for most moves but you will significantly limit your upside. But you always have to take the risk in order to make any potential profit. No way around it.

I'm an aspiring (but yet horrible) trader so take it for what it's worth.

I looked into options once upon reading/hearing/watching how great trading can be with them. While options offer a lot of different ways to play the markets as compared to pure up/down directional play with futures, my main take away and the reason I did not proceed further are the following:

1. Options or not, you have to have an opinion on what the market might do next.
2. Time and Volatility (and other Greeks) play extremely import role in the options world further complicating the trade.

While with options (or option combinations) you can play markets in many different ways: directional up/down moves, play ranges, play sideways-to-up/sideways-to-down, breakaway from the range etc, there is no way around that you have to have an opinion first and then it either works out or not (then you lose money). Therefore no one can tell you what "should you do" unless you're ready to accept they have crystal ball and know what's going to happen next.

And as pointed in #2, time and imp.volatility play extremely important role in playing options. They allow you to play that the volatility may go up/down, or that market moves or does nothing within your timeframe of interest and combinations of time/vol. The problem though, is that you need to get #1 and #2 right in order to make money with options.

Because futures require to only get one thing right (direction) I decided to stick with them for now.

By the way, be wary of those stories how much money you can make selling options. Sure you can, but only until one day you puke out big time. Selling options is akin to being insurance company. The difference is that insurance companies operate/survive based on some fundamental principles which are: massive number of insured (events) and that those events are uncorrelated.

 

[TradingDemystified]

The difference is that insurance companies operate/survive based on some fundamental principles which are: massive number of insured (events) and that those events are uncorrelated.

Why wouldn't you be able to have several uncorrelated (as much as possible) events (trades) where you are risking only a small part of your portfolio on each (say less than 1% per trade)? then let the probabilities play themselves out using eventual mean revertion of volatility as a solid foundation for your trades.
At a number of trades approaching those specified by the central limit theorem you should be able to make whatever edge you have play out.

Of course one of the obstacles to this is that during crashes all correlations go to one (see 2008) so there's that