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 |
UNDERSTANDING OPTION SYMBOLS
I know stock symbols usually have three- or four-letter symbols. Why do options have five-letter symbols?
Stocks can have one-, two-, three-, four-, or even five-letter symbols. For example, the symbol for Citigroup is C, for Coca Cola it is KO, and International Business Machines is IBM. Option symbols consist of three pieces of information and have between three and five symbols. The first part is the option root symbol, which is often the same as the ticker for the stock. The root symbol for Citigroup is C. In the case of a four-letter stock, the root symbol is shortened to three letters. The stock symbol for Microsoft is MSFT and the option root symbol is MSQ.
The second part of the symbol is the expiration month. Since there are 12 months and therefore 12 expirations in the option market, there are a dozen each monthly symbols for calls (A-L) and puts (M-X). Figure 1 shows how puts and calls are assigned letter symbols based on their expiration months.
The final part of the option symbol is the strike price. Each strike price (at five-point increments) has a unique letter. Figure 2 shows how it works. Options with a strike price of 10 (or 110) will have a B at the end of their symbol. Options with a strike price of 27.5 will generally have a Y at the end of theirs.
So let's put it together with an example. What is the symbol for the Citigroup September 55 call option? We know the root symbol is C. The symbol for a September call option is J and the letter for the 55 strike price is K. So, the symbol for the Citigroup September 55 call is CJK. On the other hand, if we are looking at the Microsoft September 55 call, the symbol would be MSQJK.
Sometimes option symbols don't seem to make sense and that might be due to a variety of factors including contract adjustments because of a merger, unusual strike prices (at one-point increments, say), or stock splits. Fortunately, most brokerage firms don't require that investors know the symbols to trade options. Nevertheless, option symbols are useful to know because each option contract has a unique symbol and that information can be used to view quotes or charts and place trades. They can also be useful when discussing specific contracts with oldtimers like me.
PROFIT & LOSS ON DEBIT SPREADS
I want to confirm my understanding on the upsides and downsides of debit spreads. I recently bought a bear put spread when the underlying stock was at $83. I bought the September 80 put for $4.50 and sold the September 75 put for $2.80. The debit in my account is $1.70. What is my maximum risk and gain?
As the name suggests, the bear put spread is a strategy that works well in a bearish market and when the stock is expected to fall. It generally consists of selling an at-the-money (ATM) put option and simultaneously selling an out-of-the-money (OTM) put. The cost of the ATM put will be greater than the sale from the OTM and that means the trade will cost money. Funds will be debited from the account. For that reason, this type of spread is sometimes called a debit spread.
In this example, the stock is at $83, an OTM option is bought, and a further OTM put is sold. The premium received for selling the short put for $2.80 offsets some of the cost of the long put, which is purchased for $4.50. The net debit is $1.70 (or $4.50 minus $2.80). The net debit is also the risk of the trade. For example, if the stock is bullish instead of bearish and stays above $80 a share, both options expire worthless. The debit is lost.
The maximum profit occurs if the stock falls below the lower strike price. At that point, the short put might be assigned to the spread holder and they will be asked to buy the stock for $75 a share. However, they also own the 80 put, which gives them the right to sell (100 shares of the stock for every put contract) for $80 a share. Consequently, they pocket $5.00 per spread. Subtract the initial debit, and the profit is $3.30 ($5.00 $1.70). The maximum profit from a debit spread is the difference between the two strike prices minus the debit paid for entering the spread.
Some debit spreads are established using OTM options and can be established for very small debits. The result is less capital risk, but also smaller odds of reaching maximum profit potential. On the other hand, debit spreads using ATM and in the money (ITM) options might cost more to initiate, but have higher probabilities of obtaining the maximum profit. So using deep OTM options is a very aggressive play, while using Itm contracts is a bit more conservative.
The maximum risk and reward discussed here apply to the spread at expiration. The risk and reward will look different when the options have life remaining, which is due to time value. The best way to view the potential profit and loss of a spread over time is with risk graphs, which are available through some of the more advanced option trading platforms and some software programs.
Originally published in the October 2007 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.