Q&A

Explore Your Options

Got a question about options? Tom Gentile is the chief options strategist at Optionetics www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it on the STOCKS & COMMODITIES website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C.

Tom Gentile of Optionetics

CALENDAR STRATEGY

How dependent is a calendar strategy on sideways movement?

A sideways-moving market is important, but not as important as the volatility of the options that are being used to create the calendar spread. The best calendar spreads I have seen in the markets have two important traits:

1. The options volatility of the month sold is higher than the month bought. This is referred to as volatility skew. Since volatility is the mean reverting, these usually come back together.

2. Rising volatility is also good for a calendar spread, since your profit comes from the value left in the option that was purchased. I have seen stocks that have broken up or down and the calendar spread was still profitable because of the perception of the future built into the long options.

BLACK-SCHOLES MODEL

How is the Black-Scholes model used differently for futures options and stock options? - Minkacha Mosha

Without getting too technical, there are differences when trading futures as opposed to stocks, and the dividend comes into play with some stock options.

Since the dividend payout directly reflects the stock price, that in turn will relate more or less (delta) to the options price. So the Black-Scholes option pricing model has a dividend adjustment field to incorporate this. The Black model does not include dividends, and is the model most used by futures traders.

MONEY MANAGEMENT OF OPTION SPREADS

What are some money management tips for credit and debit spreads? Specifically, when should I get out when a spread goes against me? - Bob Maclaurin

First, a spread is already in place as a way of managing risk. I use a time stop in place of a price stop for two reasons. First, since most of my spreads cost around 2.50 or less, I'm happy with taking the price risk, although I rarely take a 100% loss.

The second reason I use the time stop is that if I expect a certain stock to rise or fall within a set time frame, I always go out a month or more past that time frame. That way, if the stock doesn't move by my allotted time, I can exit my spread with at least 30 days to expiration. In most cases I still have premium in the spread.

GETTING INVOLVED WITH OPTIONS

What is the best way for a beginner to get involved with trading options? I have the capital and feel comfortable with the risks involved, so it's mostly a matter of building up my confidence in my trading ability. I would like to trade options as a complement to my other investments, such as mutual funds, stocks, and so on. - DD

The first thing to do is maybe pick up a good book on options trading, or you can scan Yahoo! for options-related material. There is also plenty of good information on our site at Optionetics.com.

Another thing you need to do is take a good look at your current trading and identify exactly how options might be an alternative or a complement to your style. I am a systems trader, so before trading a stock system with options I try to determine if I am going to get a decent enough reward-to-risk ratio (versus the original system with stocks). For example, it's tough for a daytrader to use options as a replacement for stocks because of liquidity, the spread, and the commissions. On the other hand, most position traders can find a use for options.

[Optionsites.com is another good source of information, and includes a list of books on options. See our review in this issue on page 117. - Ed.]

EXPRIRATION MONTHS

What is the rationale underlying the confusing options expiration months cycles? What would be wrong with having one only? Thank you kindly - Fiorenzo Primavori, Genoa, Italy

You have no idea how many times I ask that same question myself. The answer, I am told, has to do with symbols: If every optionable stock had options for every month, the symbol process would be increased at least by a factor of four, which could cause problems. The cycles were created to reduce the number of option symbols in place at one time.


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Originally published in the October 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.