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 your question to our website at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. |
Tom Gentile of Optionetics |
AVOIDING ASSIGNMENT
Suppose I use a spread by selling a 50 call and buying a 55 call. If the stock starts approaching 50, at what price should I buy back the 50 call to avoid assignment? How else can I hedge this situation for limited losses?
Assignment happens when you have very little or no time value remaining in the options contract. Time value will drop toward zero when an option is in-the-money and running out of time. Very deep in-the-money options also have very little time value.
In rare instances, an out-of-the-money option will get assigned, but it doesn't happen often. Assignment might occur, for example, if weekend news is expected to affect the stock to the downside after expiration day.
However, you are at risk of assignment if the option is in-the-money at or near expiration, with little or no time value. If you want to avoid it, close out the position. On the other hand, if there is time value remaining, the option will probably not be assigned. A good rule of thumb is if the time value drops to 1/4 points or more, assignment is unlikely.
REVERSE CALENDAR SPREAD
I understand calendar spreads, but what is a "reverse" calendar spread?
Some people refer to the reverse calendar spread as selling a calendar spread. The calendar spread involves the purchase of a long-term option and the sale of a short-term option. Both options have the same strike price. The calendar spread takes advantage of time decay because short-term options lose value at a faster rate than long-term options. The long-term option hedges, or covers, the short option. Therefore, brokers generally don't consider this trade to be naked or an uncovered sale of an option.
In the reverse spread, the strategist will buy an option with an earlier expiration, simultaneously selling one with a more distant expiration date. For example, you might buy an XYZ January 2007 80 call and sell an XYZ January 2008 80 call.
In the reverse calendar spread, the short option is covered as long as the long option is still trading. The January 2008 option is covered through the expiration of the January 2007 option. However, the January 2008 option has a longer expiration than the option covering it, and most brokers will consider it naked. The only way to be covered on a short option is to buy an option with the same or a longer expiration.
ROLLIN', ROLLIN', ROLLIN'
What is the difference between "rolling up," "rolling down," and "rolling out"?
Rolling out refers to switching an option for the same option that expires at a later date. For example, if a strategist owns the September 35 call, the position can be rolled out by closing the September 35 call and buying a December 35 call. Rolling out makes sense when the strategist maintains the same outlook for the stock, but wants to buy more time as expiration approaches.
Rolling up occurs when the strategist substitutes a call option with the same expiration date for a call with a higher strike price. For instance, the strategist owns the September 35 call and rolls up the position by closing out the September 35 call and buying a September 40 call.
Rolling down, on the other hand, involves trading a put option for a put with a lower strike price. For example, if you hold the September 50 put, the position can be rolled down by closing out the September 50 put and buying a September 45 put. Rolling up and down makes sense when the strategist has the same outlook for the stock, but wants to book profits from a winning position.
PUT OPTION DILEMMA
I purchased an August 35 put that expires today. The stock is at $43.00. Do I need to close the trade or let it expire? I'm unclear about assignment.
Only option sellers run the risk of assignment. Since you own the put option, you decide whether to exercise it. You have a right to put (or sell) the stock to the option seller for $35.00 a share. However, exercise would not make sense in this situation: because you own the shares, you can sell them in the market for $43.00. Therefore, this put option has no value and will expire worthless.
EXPIRATION MONTHS AND STRIKE PRICE
When are new months and strike prices created for options contracts?
Options expire in one of three cycles: January, February, or March. Each cycle includes options with expirations from two to eight months. For example, at the beginning of the year, options expiring in the January cycle have options that expire in January, April, and July. October is added later in the year, when the February options expire and March becomes the current month. In addition, options also have expirations in the current month and the next month. Therefore, at the beginning of the year, options on the January cycle have expiration months of January, February, April, and July. More strikes appear when traders call the broker and ask for them; new strike prices are continually added, based on customer demand.
Originally published in the November 2005 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2005, Technical Analysis, Inc.
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