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 |
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.
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