Option Investor
Updates

WHAT MAKES OPTIONS MOVE?

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There are many option traders who arbitrarily buy and sell options -- having no concept of how much, and why, an option may move at any given time. This is (or should be) an important consideration in your decision making process.

Many option traders not only listen to, but also deify, the Larry, Moe and Curly talking heads on CNBC. Before the traders can say, "I'm an idiot," they're buying puts or calls and praying for a market move in a particular direction. When a stock moves up, so does its option. When the stock goes down, so does its option. But why? Most traders don't know. Well, it's about time they learned. So, here goes . . .

The Big "D" = Delta
XYZ stock is trading at $48 and you own the $45 call with two weeks left to expiration. If XYZ goes up $3.00 tomorrow, how much will the option increase in value? If XYZ goes down $4 tomorrow, how much will the option value decrease? It all depends on the Delta of the stock. You may have heard the term before, but do you know how it works?

The "Delta" of an option is the amount an option will move up or down based on a $1 move in the underlying security. On the surface, that's a pretty simple concept. A rule of thumb will tell you that if XYZ is trading at $45 and you own the $45 call, the value of the $45 call will increase by about $.50 when XYZ stock increases by $1.00. That's a good starting point, but there is a lot more involved.

But First . . .
To fully understand the concept of "Delta," you must first understand the concepts of in-the-money (ITM), at-the-money (ATM), and out-of-the-money (OTM). Here's a brief review.

If you own a $45 call and . . .
a) XYZ is trading at $45, it is considered to be at-the-money.
b) XYZ is trading at $47, the call has $2 of intrinsic value and is considered to be in-the-money (by $2).
c) XYZ is trading at $41.50, it is considered to be out-of-the-money by $3.50.

If you own a $45 put and . . .
a) XYZ is trading at $45, it is also considered to be at-the-money.
b) XYZ is trading at $47, the put is considered to be $2 out-of-the-money.
c) XYZ is trading at $41.50, it is considered to be in-the-money by $3.50.

Back To Delta
Let's look at a real time example: At this writing, Bank of America (BAC) is trading at $85.01.

Month Strike Call/Put Price Delta Gamma
Sept. $85 Call $1.75 .53 .091
Sept. $85 Put $2.40 .47 .093
If BAC goes up $1 tomorrow, to $86, what happens?
a) The value of the $85 call (which is close to ATM) will increase about $.53 (Delta) to $2.28.
b) The value of the $85 put will decrease about $.47 (Delta) to $1.28.

Now, something else has happened. With BAC now trading at $86, the value of the Delta has also changed. The measurement for the amount of change in the Delta is called the "Gamma." The Gamma is the amount of change you can anticipate in the Delta for every $1 increase/decrease in the underlying stock.

With BAC at $86 . . .
a) The $85 call now has a new Delta of about .62 (.53 + .09) and a new Gamma of about .20.
b) The $85 put will also have a new Delta of about .38 (.47 - .09) and a new Gamma of .13.

Notice that the Gamma of the call increases more rapidly than the Gamma of the put. Why? Because the put is out of the money.

You will notice that, when an option goes further in-the-money, the higher the Delta becomes and the more a call buyer will participate in additional upward movement of the stock. The Delta increases at a more rapid rate the further it goes into the money. Not only does the Delta increase, but so does the rate of change of the Gamma.

For instance, remember that, with BAC at $86, the $85 call has a new Delta of .62. When BAC moved from $85 to $86 the Gamma was .09. At $86, the new Gamma of .17 (estimate).

If BAC moves from $86 to $87 . . .
a) The $85 call will increase to about $2.90 ($2.28 + $.62), the new Delta may be about .82 and the new Gamma about .28.

By now your head should be spinning. This is TMI (too much information) for one session. And, in all honesty, it's really more than you need to know to place decent trades. Remember in school when they had you dissect a frog? In the course of your life, how many frogs have you dissected? Relatively few, I suspect (unless you eat frog-legs). In other words, some of the knowledge is not entirely necessary.

In this instance, all you really need to keep in mind is that an option will go up faster the further it moves into the money. Knowing that Delta and Gamma exist and where to find the numbers are usually enough. With a good online broker, that information should be only a few mouse clicks away.

Plus, you should know that, if you happen to own a put and a call at the same strike price (straddle), the option that is moving in-the-money will appreciate in value more rapidly than the option that is moving out-of-the-money will lose value. The Delta does play an important part in calculating adjustment points in calendar spreads. That, however, is the subject for another session.

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JULY POSITIONS
CPTI JULY Position #1 - RUT Iron Condor - 630.41
We sold 12 RUT July 580 puts and bought 12 RUT July 570 puts for a credit of $.80 ($960). Then we sold 12 RUT July 670 calls and bought 12 RUT July 680 calls for a credit of $.50 ($600). Our total credit and profit potential is $1.30 ($1,560). The maximum profit range is 580 to 670. Maintenance requirement: $12,000.

This position was suggested on Thursday, June 2 with the RUT trading near 620.

CPTI JULY Position #2 - OEX Iron Condor - 559.91
We sold 15 July OEX 535 puts and bought 15 July OEX 525 puts for a credit of $.45 ($675). Then we sold 15 July OEX 585 calls and bought 15 July OEX 595 calls for a credit of about $.75 ($1.125). Our total net credit and profit potential is $.95 ($1,420). Maximum profit range of 535 to 585. Maintenance is $15,000.

This position was suggested on Wednesday, June 8 with the OEX trading near 565.

CPTI JULY Position #3 - SPX Bull Put Spread (1/2 of Iron Condor) - 1191.57
We sold 15 July SPX 1125 puts and bought 15 July SPX 1110 puts for a credit of $.60 ($900). Our net credit and profit potential for this bull put spread is $900. Maintenance: $22,500. If we have an opportunity to put on a bear call spread, to complete our Iron Condor, at a safe and profitable level, we will. But, we're not going to force anything or compromise our safety.

This position was suggested on Thursday, June 9 with the SPX trading near 1193.

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AUGUST POSITION
CPTI AUGUST Position #1 - SPX Bull Put Spread (1/2 of Iron Condor) - 1191.57
We sold 12 Sell 12 SPX August 1140 puts and then bought 12 SPX August 1125 puts for a credit of $1.30 ($1,320). The market moved down in the morning and we were able to get filled at $1.30. Some CPTI traders who were late to the dance got even more.

This position was suggested on Thursday, June 23 with the SPX trading near 1200.

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ONGOING STRATEGIES
ZERO-PLUS Strategy - July SPX Iron Condor - 1191.57
In my Feb. 8, 2004 column, I outlined a strategy based on an initial investment of $100,000. $74,000 was spent on zero coupon bonds maturing in about seven years at a value of $100,000. The principal $100,000 investment is guaranteed. We're trading the remaining $26,000 to generate a "risk free" return on the original investment.

This year, we're going to use the entire $26,000 of extra cash as maintenance for some Iron Condors. That should enable us to generate substantially more profit on this "no risk" strategy.

In May, we placed an SPX Iron Condor with a total net credit was 2,000. It expired worthless. Our new cash position is: $29,500 + $2,000 (May Profit) = $31,500

July Zero Plus Position: SPX Iron Condor.
We soldl 15 July SPX 1125 puts and bought 15 July SPX 1110 puts for a credit of $.50 ($750). Then we sold 15 July SPX 1255 calls and bought 15 July SPX 1270 calls for a credit of about $.50 ($750). Our total net credit and profit potential is $1.00 ($1,500). Our maximum profit range is 1125 to 1255. Maintenance is $22,500. Remember to adjust the number of contracts to your account size.

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QQQ ITM Strangle - $36.97
We own 10 January 2007 $42 puts and 10 January 2007 $32 calls at a total cost of $14,600. Only $4,600 is at risk as the other $10,000 of intrinsic value will always be there. We then sold the March $36 puts and $38 calls, taking in a total of $1.10 ($1,100). If all goes well, the QQQQs will close somewhere between $36 and $38. We will then sell the April near term options, etc. etc. The objective is to sell premium every month for the next 22 months. When all is said and done, we should be able to show a very nice profit.

We rolled out of the June $37 calls into the July $37 calls and took in a net credit of $.35. We rolled out our June $36 put to the July $37 put for a net credit of $.20. That means we have taken in a total of $.55 ($550). Our current short positions are the July $37 puts and $37 calls. Our new total of generated premium is $4,400 ($3,850 + $550).

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CPTI SUMMER SEMINAR DATE: JULY 16 & 17 -- PHILADELPHIA, PA

WHAT ARE YOU WAITING FOR? WE'VE HAD 29 OUT OF 31 PROFITABLE MONTHS!

WANT TO ACHIEVE SUCCESS WITHOUT STRESS? OF COURSE YOU DO!! USE OUR CPTI WEALTH-BUILDING TECHNIQUES!

Spots are filling up fast. There are still some left for my July Philadelphia CPTI seminar. They probably won't last long, so be proactive! That means GOYA. Contact me at mparnos@optioninvestor.com and I'll reserve a spot for you. He who hesitates may be SOL.

The dates and locations are:
July 16/17 - Philadelphia, PA

Send me an email at mparnos@optioninvestor.com and I'll forward you all the details. Don't be left out! The spots are filling up fast. It'll be a weekend you'll never forget! SERIOUS OPTION TRADERS ONLY! Directional trader converts welcome! The price is right and it will be an experience you'll never forget.

You should really try and make one of these seminars, if you can. With what you learn, you'll see a substantial increase in your trading results. If you've already signed up, I'll see you there. If you haven't signed up, what are you waiting for?

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HAPPY TRADING!
Remember the CPTI credo: May our remote batteries and self-discipline last forever, but mierde happens. Be prepared! In trading, as in life, it's not the cards we're dealt. It's how we play them.

Mike Parnos, Your Options Therapist and CPTI Master Strategist

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Couch Potato Trading Institute Disclaimer
All results reported in this section are hypothetical. While the numbers represented here may have been achieved or beaten by our readers, we make no representation that any individual investor achieved these exact results. The tracking for the plays listed in this section uses closing prices for the day the newsletter is published and it is not meant to imply that any reader actually received those prices or participated in these recommendations (even though many do). The portfolio represented here is hypothetical and for investment education purposes only. It is only an illustration of what type of gains a knowledgeable trader might receive utilizing these strategies. If you don't get close to these results, guess what? It isn't the fault of the strategies.

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