The "Daily Call" From Option Alpha

Latest Episodes:

#510 - Why Do Option Traders Lose? Feb 14, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "Why do options traders lose?" The simple answer to this is that all options traders lose at some point and what I mean by this is that all options traders will have a losing trade. In fact, if you find somebody that says they've never had a losing trade, please turn and run in the opposite direction as fast as possible. There is nobody in existence that has never had a losing trade that is professionally trading.

What I find as being some of the culprits of why people generally lose overall, not just on a couple of trades, but overall after making lots and lots of trades, ends up being some of the very basic foundational elements that we've discussed previously here on this podcast. Things like position-sizing ends up again, being the number one reason why people lose on their trades. They're over-allocated in a leveraged product which options trading contracts are leveraged products. They're over-allocated and they end up rolling the dice and basically getting into a trade that just goes the wrong direction. Now, they could've had the best of intentions in the world, they could've had a trade that always "wins" and never loses, but at some point, it's going to come back around to bite them in the rear end.

Position-sizing is basically the Grim Reaper for investors. You don't really know that position-sizing is important until it comes to basically take your portfolio and then you realize at that point how important position-sizing is. But even other things that we talk about like portfolio diversification among ticker symbols ends up being a leading cause of investors and traders to lose money. Being over-allocated in a certain number of sectors or industries and not diversifying across a broad spectrum of different trades, not choosing the right option strategy ends up being again, detrimental to your success. A lot of times, people will try option-buying strategies and they might find success early on, but ultimately, they're going to give up a lot of that success in just a slow drip of the bucket in their portfolio value back by continuing to buy these option strategies that are going to basically not make any money, net expected profits.

We also see that people end up being too emotional. We get a lot of this fight back against the market mentality that I see often which is again, very detrimental, this idea that – "I know. The market should go down. It's never done this before. This is totally crazy." But this happens all the time. Markets do and perform moves that nobody's ever seen multiple times throughout the year. It rallies faster and stronger. It stays more neutral than we thought it would. We don't ever see these types of drops and then rebounds or pops and then drops. I've heard it so many times now having done this for over 10 years that the only constant that we know is that the market's going to surprise us, so why do we continue to be surprised by this?

These are some of the things that I mentioned end up being things that end up killing options traders and lead a lot of traders to lose money on positions. I think if you realize that you're going to have losing trades, but you can control things like position size, diversification, option strategy, you know that the probabilities are going to work out in your favor. It's just going to be a matter of time. You're doing the right things. You're performing the right activities and doing them in the right sequence. It's just a matter of time that the profits end up starting to kick in and kind of overshadow some of the smaller losers that you end up having. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#509 - How Much Does It Cost To Buy A Put Option? Feb 13, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer a question which is – "How much does it cost to buy a put option contract?" Now, this answer obviously depends on the ticker symbol that you're trading, how far you are from expiration, the implied volatility, the liquidity, the activity in the option contract that you're trading. There's a lot of things that kind of go into this, but I want to do is just kind of show you broadly the range that you could potentially find yourself in for buying a put option contract. As a reminder, we generally do not suggest that you buy option contracts. As long-term, it's a net-net losing investment compared to selling options or selling option strategies. Even risk defined option strategies do a better job of mitigating risk than buying a put option contract.

But put options can be widely variable in price. I'm just looking at an option chain right now for Google which is ticker symbol, GOOGLE and the at the money put options for next month's expiration are around $2,600. Yes, one single individual put option contract in Google right now is $2,600. Now, if you compare this to something that's a lower-priced security like USO which is trading around $11 compared to Google trading multiple hundreds of dollars, the at the money option contract on the put side for USO is $35. Now, does this mean that the put option contract in USO is a better deal? Maybe. Maybe not. Not necessarily. It has nothing to do with the value of the option contract reflective of the likelihood that you're going to make money. That's a different kind of mentality that you have to get into when you start trading options as opposed to trading stocks. $2,700, $2,500 put option contract in Google might actually be a better trade than the $35 put option contract that you could buy in USO. There's a lot of things that kind of go into this, but you can't just look at the value of contracts as a standalone and say, "Okay. Yes, these contracts are cheap, therefore, they are a better investment." Oftentimes, the cheapness of a contract is related to its likelihood of success or payout in the future.

And the reason I bring this up is because recently, we've been getting a lot of questions from people asking why we don't just buy cheap put option contracts. Like – "If it doesn't cost much to get into these, then why don't we just buy them?" Well, it's the same reason we don't buy lottery tickets. Lottery tickets are insanely cheap. You can buy a lottery ticket for $1, but you could buy a million lottery tickets because they're all cheap all over the place, in different gas stations, in different locations of the country, different States, but that doesn't make them any better of an investment than say buying these put option contracts that are cheap as well. What I want people to get away from this is really, that the cost of the option contracts has a lot of factors that go into it, many of which we describe in all of our free training and courses on Option Alpha, but it's much more than just the face value or the surface level price of the option contract and as we saw, the ranges could be wildly different depending on what product and ticker symbol you're trading and how far out you are from expiration, etcetera. Hopefully this helps out. As always, if you have any questions, let us know and until next time, happy trading.

#508 - How Does A Bond Differ From A Stock? Feb 12, 2019

Show notes

Hey everyone. This is Kirk here again at Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "How does a bond differ from a stock?" If you've just started investing or even if you've been investing for a little while now, you might hear these terms and think that they're interchangeable, bonds and stocks, stocks and bonds, but the reality is that they are quite different from one another. The only similarity that they actually share is that in many cases, they are structured investments and you can just as easily buy a bond as you can buy a share of stock. But at that point, they start to diverge just a little bit in some of their qualities and I wanted to go through that quickly here on today's podcast.

One of the major differences between stocks and bonds is that stock ownership is a second or third level ownership in a company compared to bondholders. What we typically refer to as bondholders is having kind of seniority bond-holding position or a seniority position in a company, so whereby, if a company was to go bankrupt or go into liquidation mode, the bondholders would get paid first and then stockholders get paid after that. Depending on the corporate structure and if a company actually has debt that's been issued through bonds or they just have equity through stock, then that structure might be a little bit different, but in many cases, bondholders serve a more seniority role or position when a company goes through liquidation. In that case, it carries a little bit less risk. If a company is going to be liquidated, the bondholders get paid first and whatever's left is divided up among the stockholders.

Bonds are also structured products. When you typically hear about a bond, it has a defined face value, sometimes $1,000 in face value to purchase the bond and a defined structure of payments, so a coupon or interest rate of say 5% per year for the next five years or the next 10 years, 5% per year, so a very structured and logical process by which the bonds are issued. Stock on the other hand, does not have that. Stock is ownership in the underlying company and in many cases, that ownership is being traded at a much faster pace and the fluctuations in value happen at a much greater magnitude as the company starts to generate money and starts to work its business model. Stocks can be paid dividends, but those dividends are never assured and sometimes those dividends can rise, sometimes they can go away, so stock ownership is generally considered to be a little bit more risky.

Now, this doesn't mean that bonds don't trade and don't increase or decrease in value. Sometimes what we see happening is that bonds will start trading at a discount to their face value if we start to see that other investments that are of the same risk caliber as the particular bond that you're trading right now have a better or higher payout. Let's say you bought a bond originally at a 5% coupon or interest rate and now, the company offers the same potential bond for now a 6% interest or coupon. Well, your old bond that you had previously purchased is now potentially worth a little bit less money. It's going to trade at a discount because an investor coming in could buy the new face value bond of $1,000 for 6%. Why would they ever buy your face value of $1,000 for a 5% coupon? That bond that you had originally bought first is now going to trade in at a little bit of a discount.

That's how they kind of move and shake and ebb and flow in the market, but again, there's a lot of little nuances and differences in bonds. Hopefully I just covered some of the broad strokes and highlights of these two different classes of investing. I think when you think about building out portfolios, whether you're trading options or whether you're trading actual stocks and bonds, having exposure to both of these classes is really, really critical. What we do here at Option Alpha is we typically have a bond type position on at all times where we're trading options around bond prices and we like to have that type of exposure in our portfolio because it helps diversify the rest of our positions and reduce volatility overall. As always, if you have any questions, let me know and until next time, happy trading.

#507 - Do All Stock Shares Pay Dividends? Feb 11, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "Do all stock shares pay dividends?" The simple answer to this is no, not all stocks pay dividends. In fact, many stocks choose not to pay dividends as a means to keep capital in the business and continue to fuel new investment, new ventures, new other business lines or products, etcetera. Now, most companies actually or some companies do pay dividends and a lot of companies pay dividends and it's a means to give money back to shareholders, basically to reward shareholders and stockholders for their investment in the company. Oftentimes, a company might pay an annualized dividend of 5% or 6% and they may have a leveled dividend or they may start to increase that dividend over time.

My opinion on this is always been that I think generally, companies that end up paying dividends could potentially better serve their potential equity holders by just simply buying back stock and reducing the float, increasing the share price in that form. Sometimes paying dividends is good because you have the ability to offload capital and offload some of the net profits from the business, but from a shareholder's standpoint, income from dividends is capped and taxed at a much higher basis. Especially if you don't need to take the money necessarily, you're much better off potentially putting it in stocks that don't pay dividends or that use stock buyback programs as a means to increase the share price. In fact, one guy who does this oftentimes and alludes to this all the time is Warren Buffett. He has never paid a dividend or I guess the one time that if he ever did pay the dividend, he was basically asleep at the wheel and didn't know it happened. But he has often said that dividends are a less inefficient way to get money back to shareholders. A more efficient way to do it is to simply buy back stock and then reduce the float, increase the share price as a result.

Hopefully this helps out. Hopefully it helps spark some discussion communication. If you have any questions, as always, please let us know and until next time, happy trading.

#506 - What Happens When You Buy A Put Option? Feb 10, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "What happens when you buy a put option?" When you buy a put option contract, you are exchanging the money that you paid for the put option contract in exchange for the right, but not the obligation to sell stock in the future at the strike price that you determined. With a put option contract, you give somebody else money or capital and that other person is the put option seller and in exchange, you are buying a right from them. They have an obligation now to deliver the stock to you, to purchase stock from you and you have a right to sell stock to them at a predetermined strike price in the future and that's pretty much all that happens. Whenever you get into these long put option contracts now, you have the choice of whether you want to exercise your right or not. You can basically transfer your risk by getting out of the contract or removing the contract, buying it back or selling it back in the open market or you can choose to exercise that agreement with the put option seller and take delivery of short shares from them or sell shares that you have at a preexisting price.

Most people use put option contracts as a means to hedge long stock positions. What somebody might do is that if they're long stock, they might buy a put option contract, so that if the stock starts to go down, they've already basically predetermined their sale price with the put option seller and they don't lose any additional money below that strike price. Now, again, this comes at a cost and many times, put option contracts tend to cost much more than call option contracts because stocks can and often do fall much more violently and in a much more bigger fashion than they do rise and rally. Generally, we see put option premiums or the premium that you paid to the option seller to be a little bit more than the call side premium. Hopefully this helps out just with some general put option basics, but if you have any questions, as always, please let us know and until next time, happy trading.

#505 - Why I Prefer Candlestick Charts Over Line Charts Feb 09, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to be talking about why I personally prefer candlestick charts over line charts. And again, this is a personal preference actually in that somebody asked me this in the community which is why I'm answering it here on the daily call podcast. But I generally prefer candlesticks because that's really how I learned. I originally learned a little bit about investing and trading prior to heading to New York and then when I was in New York, actually, most people when I was in New York and doing a rotation on a trading desk, used candlestick charting. And so, it was just commonplace to use that as kind of like the baseline fundamentals of how we would analyze and look at stocks and securities. That's really how I learned. And I actually prefer candlestick trading for a number of different reasons, but I think that visually, it's just a little bit more appealing. It tells a little bit more of a story once you learn how candlesticks work in general and just the differences between the open, low, high, low of the day and the close, etcetera. I think it sometimes can be a little bit telling. Not all the time, but a little bit telling as to potentially where the stock might go in the coming days or weeks based on the price action of the day.

A line chart just showing the close of the day does not really give us a lot of descriptive information. Again, this is not to say that candlestick trading and candlestick charting is 100% accurate or even close or better than 50/50, but it might in some cases, give you a little bit of an insight as to the dynamic of the markets during a particular trading day. What I look for when I am looking at charts is really the ones that stick out like a sore thumb, the candlesticks that are these big huge candles which mean that the stock opened, rallied all day and then fell at the end of the day and closed near the open and that to me, signals that the market could potentially be a little bit weak and might be more willing to roll over just a little bit more. Again, to me, this is a personal preference. It's not something that you have to do, but it's just how I learned and how I trade and it's actually reflective in most of the videos that we do here at Option Alpha. As always, if you have any questions, let me know and until next time, happy trading.

#504 - How To Avoid Option Assignment Feb 08, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to talk about how to avoid option assignment. I'm going to let you in on a little secret. There's actually only two ways to avoid option assignment. The first way seems pretty logical and easy and that's to be a long call option buyer or a long put option buyer. When you're an option buyer, you don't have the possibility of being assigned on those contracts because it's up to you to decide if you want to exercise your option contract or not. The other way to avoid option assignment is simply just not trade. And I know this seems intuitive and might sound a little bit crazy, but the reality is if you don't want to ever deal with assignment or being exercised on a contract, then just simply don't trade option contracts. Option assignment and options exercise is part of this business. It is going to happen at some point to you if you are an option seller and you have to learn how to deal with it.

Now, as we've showed in many of our weekly podcast case studies, (and on the website, we also have a bunch of case studies on assignment and video tutorials that we posted) option assignment is not always bad. It gets a really bad rap because people think that it's immediately the kiss of death, but it's not. In fact, many times and most of the time when we get assigned, it actually ends up turning around and becoming a favorable position in our portfolio. There's no way necessarily to avoid assignment as an option seller. Now, one way you can mitigate the risk as an option seller is to just simply manage your contracts the week before expiration. We know from the last two podcast that we've done here on the daily call that most option assignment happens near the week of expiration and in fact, the last couple of days of options expiration. If you want to avoid being assigned, take a look at that extrinsic value and make sure that you either close, adjust or roll your option contracts around the week before expiration. This generally will get your contract out of the assignment window and leave you with a position that you can still manage without having to deal with the stock. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#503 - The #1 Reason Not To Be Afraid Of Early Assignment When Selling Options Feb 07, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to talk about the number one reason not to be afraid of early assignment when selling options. Now, we briefly touched on this actually in the last daily call podcast, show number 502, but I wanted to dig into it just a little bit more here today because a lot of times, we get people who are afraid to sell options especially when the option contracts go in the money early in the expiration cycle and they think to themselves – "Well, I'm selling options and the option contract went in the money, so that has to mean that an assignment is coming soon and I'm going to be assigned either a long or short stock in this underlying position and I can't deal with that." The reality is though, is that you have to pay attention to the extrinsic value of the option contract that you're selling. Now, I say this because you can definitely look at this and you should pay attention to this, but is it something that you need to check every single day? Absolutely not. You just have to understand conceptually what I'm trying to describe here.

But when an option contract is priced, there's two pricing components. You have the intrinsic value which is the value should the contract be assigned or exercised immediately (that's one part of the options price) and then the other component is extrinsic value, so time and volatility. And so, when there's a lot of time left until expiration, then the extrinsic value of a contract can be really great. And this is why you should not be afraid of early assignment, is because of this extrinsic or time and volatility value still left in the option contract. Remember that if an option buyer on a long call or a long put were to exercise their contract, they're basically forfeiting the right to any of the extrinsic premium that's left in the contract. All they're doing is saying, "Hey, I just want to exercise my contract and capture the intrinsic value." But they would be stupid and dumb to do this because they're giving up the extrinsic value of the contract. Instead, a better alternative for them is just simply to sell back their contract in the open market and not take delivery or take assignment of the underlying stock. And so, this is why we see option contracts actually traded a lot more heading into expiration as opposed to actually being assigned or exercised.

Again, the number one reason why you should not be afraid of early assignment especially when you're selling options contracts is because of the extrinsic value. If there's still a lot of extrinsic value for an option contract, it's highly unlikely that that contract is going to be assigned early. Most option assignment happens the week of expiration, even the last few days of expiration and this makes sense logically because at that point, now, extrinsic, time and volatility value of a contract is now whittled down to something close to or at zero. There's no benefit necessarily to holding onto the option contract because all that's left is intrinsic value and at that point, assignments start rolling in. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#502 - Why You Should NOT Exercise Your Options Early Feb 06, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to be talking about why you should not exercise your options early. I recently got an email from somebody and they wanted to know if it was a good idea to exercise their long call option early. They had bought a long call option ahead of earnings. The company had great earnings and now, the stock was really moving higher. And so, they wanted to know – "Hey, look. Should I exercise my long call option, take delivery of the stock because I made frankly, a guess in a lucky trade that the stock went the direction I thought it was going to move and it made a big move, so now, do I want the stock?"

The answer to this question is almost emphatically no, you do not want to exercise your option contracts early because what you give up if you're a long option buyer during early exercise of your contract is you give up the extrinsic value that is still left in option contracts. Remember, option contracts are comprised of two different value components. You have intrinsic value, the value that you would get if you were to exercise immediately which we understand intuitively and then you have the extrinsic value of the contract which is the time and volatility value that's still left. In this case, this person was still more than 30 days from expiration and a lot of the value in the contract was still tied up in extrinsic time value for the next 30 days. Should they exercise the contract early, they would basically be forfeiting that premium to the market. Instead, a better alternative would've just been simply to sell back the long call option, capture all of the intrinsic value, as well as the extrinsic value of the contract. This is also why we don't see contracts that go in the money ahead of expiration get immediately assigned or exercised.

A common thing that I see a lot with new traders when they start trading and they start selling spreads or iron butterflies or iron condors is that the stock may go in the money and breach one of their short call options or short put options and immediately, they think to themselves – "Well, now that it's breached my short call and my short put, I'm going to get assigned on these contracts." But it's not always the case. In fact, it's rarely the case because if they were to be assigned, then the long call option buyer on the other end would be forfeiting all of the extrinsic value in that contract. This is why we see most assignment happen the week of expiration and more importantly, the last couple of days of expiration because at that point, most of the option contract's extrinsic value has whittled away and is now down and near zero. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#501 - What Happens When Options Expire? Feb 05, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question, "What happens when options expire?" Options expiration can sometimes be a little bit confusing for people, especially if you're new to options trading. Even if you've been trading for a little while and you haven't yet come upon an options expiration where you have to deal with contracts that are either in the money or out of the money, it can sometimes lead investors to kind of roll their eyes and wonder what's going to happen.

When options expire, there's only two things that could potentially happen. Either your option contract is out of the money or your option contract is in the money. If your option contract is out of the money, then the option contract simply expires worthless. And so, whether you are shorting that contract or you're long that contract, if the contract ends the expiration period out of the money, then the contract expires worthless and there's nothing that you need to do. You don't need to take any action. You don't need to reverse the trade. It just simply disappears from existence. If the option contract however, is in the money, then the option contract will automatically be assigned or exercised by the broker and this again, leads to proper risk parameters and risk control. When you're heading into expiration and you notice that you have an option contract in the money, I generally say that you should decide what you want to do with that and not go through the options expiration assignment and exercise process. But if you happen to let a contract go or you forget about a contract or don't roll or close the position and it goes through options expiration, then again, the brokers will assign or exercise those in the money contracts automatically. That means that if you are long let's say a call option, then you will automatically get assigned long stock. If you are short a put, you'll automatically get assigned, etcetera, etcetera.

At expiration, again, the biggest thing that you have to worry about (and I say "worry about") is just – Is your contract that you're trading (whether you're long or short) in the money, near expiration or at expiration? If it is, then you should probably look to close the position before or roll the position before because if you let it go through expiration, it's going to be assigned or exercised and while that's not a bad thing, it just creates more chaos in your account because you have to deal with now, long or short stock depending on which side of the contract you were trading on. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

Our TOPPODCAST Picks

Follow Us

Stay Connected

The “Daily Call” From Option Alpha

Related Podcasts

Links

Stay Connected