Stock Option Strategy
A stock option is a derivative; this is a financial instrument with a value that is reliant upon or derived from an underlying asset. The derivative itself is a contract between two or more parties and the value derives its price from a movement in the underlying asset’s price; for a stock option, that means stock.
We employ data miners that filter through a stock database and deliver trading opportunities based on a form of Factor Investing. There are strict criteria. Each company selected must be either highly overvalued or undervalued. The marketplace must also be liquid enough to maneuver in and out of trades.
Once a list is compiled, an analysis is performed to assess Implied and Historical Volatility. The numerical figure and the relationship between each will define whether or not the stock option’s price is cheap or expensive, for the strike price we have selected. It will indicate whether we should sell or buy the stock option.
The numerical figure attributed to the current volatility, in relationship to past volatility, will help our team develop a future outlook on the performance of a trade. This, alongside the “Greeks” assists traders develop a trade utilizing both Call and Put options.
The two different types of contracts are Calls and Puts.
Using the Greeks to Monitor Positions
“Greek” is a term used in the options market to describe different dimensions of risk involved in taking on an option’s position. These variables are represented with greek symbols; there are 5 altogether and each is defined by a numerical value that measures change in the stock option and its underlying asset.
Delta: represents the rate of change between the options price and a $1 change in the underlying asset’s price.
Theta: represents the rate of change between the option price and time, or time sensitivity.
Gamma: represents the rate of change between an option’s delta and the underlying asset’s price.
Vega: represents the rate of change between an options value and the underlying asset’s implied volatility.
Rho: represents the rate of change between an options value and a 1% change in the interest rate.
The two most important Greeks are Delta and Vega. The easiest way to interpret each is as such:
Delta: for each $1 tick upwards in the stock, the option’s value will change by a set numerical figure. For example, let’s say a stock ticked up $1 from $127 to $128. The option is worth $5.60. It has a delta of 60. When the stock ticks up $1, the option’s value ticks up $.60 cents.
Vega: vega is the same as delta, but instead of tracking the underlying stock’s price movement, it tracks the change of volatility. For each movement up or down in volatility, the option’s value will change by a set numerical figure.
The Truth About Stock Options
It is true that stock options are capable of delivering 500, if not 1000% return on an investment in only a few weeks. However, this is not our objective. The cost of employing such trades can be deathly to the client’s capital; we are not gamblers who are trying to hit it big at a local casino. We are professional traders. Without the most superlative managers who understand the deep implications of facing loss with stock options, investors could lose their entire principle.
Delta Hedging to Help Prevent Loss
For this reason, this strategy is an active management position that seeks to Delta Hedge on a day-by-day basis. To acquire high returns while mitigating the downward price movements in a position, hedging is employed to day trade for profits. This process helps neutralize loss in the position, and as a consequence, may also disable profit potential.
The implementation of this strategy is an opportunity to make money when markets go down. Unlike traditional stock trading, options enable you to bet on the downward movement of a stock and collect money. By using Delta Hedging and daily active trading, investors can create higher profits than alternative investments.
Breaking Down Options Trading
Stock Options are known as the most comprehensive and difficult investment instruments to understand. There is a good reason for this. They are indeed complicated and that’s why we’re going to break them down for you even more, in this next article.
Delta Hedging to Help Prevent Loss
Delta Hedging is an options strategy that aims to reduce the risk associated with price movements in the underlying stock. This approach uses options to offset risk to either a single other option holding or an entire portfolio of holdings.
Call vs. Put Options
If you buy an options contract, it grants you the right, but not the obligation to buy or sell an underlying asset at a set price on or before a certain date. A call option gives the holder the right to buy a stock and a put option gives the holder the right to sell a stock.
There are numerous advanced strategies that our traders employ to generate both protection and profit in a portfolio: such as a married put, bull call spread, protective collar, long call butterfly spread and iron condor.
Factor Investing and Stock Options Trading
Factor investing is known as the third pillar to investing because of both active and passive characteristics. The method by which stocks are chosen correlates to the intensity of a measurable factor. We use this same method when we filter through stocks for stock option trading opportunities.
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