Advanced Options Trading in C#

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Advanced Options Trading
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Figure 54 Commdity Exchange, Inc (CMX or COMEX) gold chart Powered by Option Vue 6
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Gold option chain Powered by Option Vue 6
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implied volatility to the chart to show where volatility is in relation to the market movement In this case, gold experienced the highest volatility as the market fell from the 2008 rally and then decreased, but remained elevated over historical levels in the early 2008 level shown on the chart Given the current chart and volatility, let s look at the call options available (see Figure 55)
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Selling Options 107
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The option chain for June gold shows that we have 56 days remaining in the option Our upper level of resistance on this market is just above $1, 000 per ounce, so ideally we would like to get close to that level with our breakeven Implied volatility at around 32 percent is not as high as it has been for this market, but it is elevated over the standard mean implied volatility If we look speci cally at the 965 call options in June gold, we can see a market price of $3090 with the underlying trading at 92770 Selling the 965 call option with a premium of 3090 gives us a breakeven of $99590 on the June futures 96500 3090 99590
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The breakeven price is below the contract high for June gold It is in what we consider to be a defendable area, since there is a recent high on June above the currently selected strike price and time is on your side with fairly aggressive time value decay The option model for this trade (see Figure 56) shows the pro t-andloss projection of selling ve June gold 965 calls at 3090
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$ 32K 16K OK 16K 32K 48K 64K 80K 96K 67500 72500 77500 82500 87500 92500 97500 1,02500 1,07500 1,12500 1,17500 Profit/loss by change in GC June futures price
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June gold option model Powered by Option Vue 6
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Advanced Options Trading
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With this trade we have captured a premium of 3090 with multiplier for gold options at $100 per point The total premium captured would be $3,090 5 options equaling $15,450 You can see in the model that we maintain maximum premium below the price of $965 on the underlying and that the solid line does not cross the breakeven until 99500 Beyond that point, the losses on just ve gold call options can add up to substantial amounts of money quickly If a sharp move higher was to happen shortly after the trade was applied, the position would lose quickly as you can see from the dotted line representing zero time value decay As time moves forward and the position has roughly 30 days left (represented by the dashed line), the point where the option position breaks even is higher on the underlying futures, but again the position can begin losing quickly without risk control There are some important lessons to be learned from this gold trade Selling a call premium in high implied volatility in this market during 2008 would have been the wrong choice When volatility was the highest, the market was near the low points for the year in price As volatility began to decrease, the futures market rallied signi cantly and the volatility trend continued downward Volatility is not an indicator of price; it is an indicator of price uctuation
Short Option Risk Management
Short options have a high risk pro le because the risk is not limited When you are taking small gains from the market, you cannot afford to have large losses, and proper management can help keep the inevitable short option loss to a minimum There are some management techniques for risk that are different from purchased options:
Selling Options 109
Monetary stops: With the unlimited risk of selling an option premium, it is important to know how much you are willing to risk for the premium you have captured If are selling an option for $500 per option, it is ludicrous to risk $5,000 for that $500 maximum pro t Who would do that It happens all the time, and unfortunately some short option traders lose and lose big for a very small pro t potential Most often a monetary stop of two to four times the premium sold is recommended If that amount is outside your risk pro le for the option sale, you should not be naked short trading the option A monetary stop of some sort is recommended for all short option positions as a safety valve unless you have a hard price stop for technical support or resistance Decide your monetary risk and stick to it with a hard stop Volatility stops: Follow the volatility stop guidelines laid out previously In working with volatility stops on short options, you are going to be protecting against increases in implied volatility Price stops: As with long options, you can determine a price stop on your option based on the trade of the underlying futures If you are selling a call option and the underlying futures have a resistance level above your position that would be considered a change in trend or breakout, then use that price to calculate a theoretical value for the option at that price It is best to do this assuming zero time value decay and zero negative volatility change The price stop should be physically placed in the market as an order unless you are using a monetary stop as your safety net If you are selling a put premium, unless you are willing to risk to an
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