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 |
CRUDE AWAKENING
Crude oil keeps moving to record highs, but I don't think it can stay above $100 a barrel for much longer. However, I don't trade commodities or futures. Do I have any other options if I think crude is going to fall during the second half of the year?
If you don't want to trade futures, you can play crude oil in a few different ways -- directly and indirectly through your brokerage account. Indirectly, you can often profit from moves in oil through options on energy-related companies like Exxon Mobil (XOM) or Halliburton (HAL). Since the profits of oil and oil drilling companies are related to the price of oil (the higher the better), their stock prices are sensitive to changes in the oil markets. If you expect oil to see a dramatic decline, you might short shares of oil companies or create bearish trades using options.
You can also trade indexes and exchange traded funds (ETFs) that track baskets of energy-related stocks. The Oil Service Holdrs (OIH), for example, is a fund that tracks the performance of Halliburton and 15 other oil drillers. The OIH is very liquid and the puts and calls are also actively traded. Shares can be bought or sold short. Meanwhile, the options allow investors to play industry trends.
The PHLX Oil Service Index ($OSX) and the Amex Oil Index ($XOI) are examples of indexes that have listed options and can be used to play the next move in crude oil. These indexes also track groups or baskets of major oil companies. However, unlike the Oil Service HOLDRs, the OSX, and XOI don't have listed shares and, as a result, can't be bought or sold. The only way to trade them is with options.
A third way to play crude oil is with the US Oil Fund (USO). The fund started trading in April 2006 and, unlike the other indexes and ETFs, it does not track the performance of oil or oil service companies. Instead, the USO invests in oil futures that trade on the New York Mercantile Exchange as well as options on oil futures and forward contracts. The fund is almost a pure play on crude oil. In addition, the options are actively traded. Therefore, not only can you play the next move in crude by purchasing or selling short the USO, but you can also create a variety of other bullish or bearish strategies with USO puts and calls.
DELTA DEFINED
I'm confused. Delta is defined as the amount by which an option moves in relation to a $1.00 move in the underlying. I have also heard that delta is a probability. Probability of what? Thanks for any insight.
Delta is one of the greeks that all aspiring option traders should understand. The numbers are available through most brokers or websites that specialize in option trading. The first important thing delta tells us is: How much will my option change in value if the stock moves higher or lower? For example, if I have a call option with a delta of +0.5, the option will increase 50 cents in value for every $1.00 increase in the stock price. Since put options increase in value as a stock falls, puts have negative deltas. For example, a put option with a delta of -0.25 will decrease in value for every $1.00 increase in the stock price.
Deltas are also important for understanding the overall price changes in strategies that include more than one security. For example, if I own 100 shares of stock, how many puts with -0.25 deltas due I need to protect my position? Since 100 shares of stock has a delta of +1.00, four puts will protect the entire position (+100 + 4 x -0.25 = 0). When the overall position delta is zero, the overall position is delta neutral and will not change in value when the price of the stock changes.
Finally, delta also reflects the odds of an option expiring in-the-money (ITM). For example, a put option with a delta of -0.25 is said to have a 25% probability of finishing expiration Itm, or where the strike price is above the stock price. For that reason, out-of-the-money options will have smaller deltas than in-the-money options.
MARKET BREADTH
I have heard people talk about market breadth, but am not sure what it means and why it matters.
The term market breadth is used in more than one way, but it is most often used with reference to the trading on the New York Stock Exchange (NYSE). Specifically, breadth is the number of advancing shares compared to the number of declining shares. For example, if 2,200 stocks advanced and 1,100 declined, breadth is 2:1 positive. The numbers are available in most stock charting software and a variety of financial-related websites.
Traders use breadth in two ways. First, it is used to determine if the underlying tone of the market is bullish or bearish. If breadth is consistently negative, the tone of the market is weak or bearish. Second, breadth is used to confirm the rise and fall in the major averages like the Dow Jones Industrial Average. If, for example, the DJIA makes a series of new highs, but market breadth begins to deteriorate and/or turn negative, the new highs probably won't stick. Instead, traders want to see market breadth staying strong and/or improving to confirm that the new high in the DJIA has legs.
Originally published in the May 2008 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2008, Technical Analysis, Inc.
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