Options and Candlestick Coaching â Level 3
Options and Candlestick Coaching – Level 3 Session 4 – Diagonals
Presented by Dave Forster – Nison Certified Options Trainer ™
Diagonal Debit Spreads Bull Call Calendars & Bear Put Calendars
www.nisonoptionsacademy.com
Spread Review Every option spread contains one or two of the basic types of spreads that more advanced spreads consist of: Vertical Spreads – Have two different strikes i.e. higher and lower strikes for the bought and sold options hence the name verticals with the same expiration period for both strikes 2. Calendar Spreads – Have the same strikes for the bought and sold options with two different expiration periods hence the name calendars What is a diagonal then? It combines a vertical and calendar spread with a spread with different strikes and different expirations 1.
Example Long ABC April 70 Call at $3.10 Short ABC February 75 Call at $1.20 www.nisonoptionsacademy.com
Diagonals Background There are 4 types of potential diagonals with names similar to the 4 types of vertical spreads: • • • •
Bull Put Calendar Bear Put Calendar Bull Call Calendar Bear Call Calendar
The easiest to manage of these 4 types are the bear put calendar and bull call calendar so we will discussing these two debit diagonals
www.nisonoptionsacademy.com
Diagonal Differences
Benefits • • •
•
•
Can benefit from two directional movements – up and sideways or down and sideways Offer a fairly wide profit and loss area on a risk graph similar to a calendar spread Can be a longer term trade by allowing for the trade to be repeated into further expirations if the short option expires Higher probability of success Can benefit from implied volatility increases
www.nisonoptionsacademy.com
Diagonal Differences
Disadvantages • • •
•
•
High Cost Less Certainty of what premium will be received when selling short options against the long in the future Requires more careful management and typically more time than other spread trades Long leg is susceptible to volatility crunch – If the long option is bought at periods of high IV and IV goes down over time, the long may lose more money than the shorts take in in premium Potential risk of assignment if the short option goes ITM. If the short leg goes ITM it can lose more money than the long can make www.nisonoptionsacademy.com
Bull Call Calendars Buy ATM lower strike (95) call 3 or more months out Sell higher strike (100) call (front month expiration) Which of these two strikes will be more worth more? So we will be buying the more expensive lower strike call and selling the cheaper call: Result is net cost to you hence a debit call spread Concept: Buy a longer term call to stay in a trade for one or multiple expirations but short call reduces both risk and reward
Buy 1 XYZ 90-day or longer 95 Call @ 3.50 Sell 1 XYZ 30-day 100 Call @ .75 Max Risk is Net Debit (2.75) At expiration: Maximum Profit = Varies based on short option, IV changes, plus if future short options are sold, these add to profitability. Use a risk graph or options calculator Breakevens for the downside and upside can’t be done in a single equation. Delta and implied volatility are the primary inputs. Use a risk graph tool. Breakevens also change as more short options are sold. www.nisonoptionsacademy.com
Bull Call Calendar - P & L Graph Buy 1 XYZ 90-day or longer 115 Call (7.91) Sell 1 XYZ 30-day 120 Call 1.50
BE @ 97
www.nisonoptionsacademy.com
Considerations for choosing strike prices for bull call Calendar
Think of bull call calendar as a long call trade with a lower cost and the ability to continue to lower the cost by selling short calls over time.
Stock is at support area @ 45 with resistance at 50 •Buy 45 call 90 days or longer to expiration •Sell 50 call in front month or weekly (to lessen cost of trade and thereby reduce the trades risk) Using resistance: • Higher strike should be resistance area. • Rationale: Max profit (at expiration) when higher strike price (short) of spread is reached. www.nisonoptionsacademy.com
Bull Call Calendar Uses • Good to use if your view is that IV is low and may rise • Lessens time decay issues involved with buying outright call. • Selling calls lessen the cost of a trade. • More important for market to rally than with bull put spread but less important than a bull call spread • Can be a good alternative to an outright buy when there is a target move of 5% to 10% so premium on short call is worth selling and you don’t expect to give up too much upside potential. • Can also leg into this spread after a favorable move buying the long option first and later selling a short call. www.nisonoptionsacademy.com
Bull Call Calendar Cautions • Selling a call helps lessen cost of outright trade, but trade has capped upside potential • The short call sold can potentially lose more than the long option can gain since the short option can change in value faster • The short call premium should be at least 10% or more of the cost of the long option to ensure that it’s worth selling. • Implied volatility decreases can lessen the value of the long option more than short premium can cover it. www.nisonoptionsacademy.com
Bear Put Diagonal spreads Buy ATM higher strike (130) put ~ 90 days to expiry Sell lower strike (125) put (front month or weekly) Which of these two strikes will be more worth more? So will be buying the higher strike more expensive put - and selling the cheaper put: Result is a debit spread Concept: Buy a longer term put to stay in a trade for one or multiple expirations but short put reduces both risk and reward
Buy 1 XYZ ~ 90-day 130 put @ 2.45 Sell 1 XYZ 17-day 125 put @ .55 Max Risk is Net Debit = 1.90 At expiration: Maximum Profit = Varies based on short option, IV changes, plus if future short options are sold, these add to profitability. Use a risk graph or options calculator Breakevens for the downside and upside can’t be done in a single equation. Delta and implied volatility are the primary inputs. Use a risk graph tool. Breakevens also change as more short options are sold.
www.nisonoptionsacademy.com
Bear Put Calendar - P & L graph Buy 1 SPY 86-day 145 Put @ 4.91 Sell 1 SPY 23-day 140 Put @ .77
www.nisonoptionsacademy.com
Considerations for choosing strike prices for bear Put calendar spreads
Think of bear put calendar as a long put trade with a lower cost and the ability to continue to lower the cost by selling short puts over time.
With the market at resistance area @ 45: Buy a 45 put around 90 days to expiry Sell a 40 put in the front month or weekly at a support area Using resistance: • Higher strike put should be resistance. • Rationale: Max profit (at expiration) when underlying price is at lower strike (short) since the short put would expire worthless and keep entire credit plus allow for additional selling of short puts and allow for long put gain www.nisonoptionsacademy.com
Bear put calendar cautions • Selling a put lessens cost of outright trade, but this limits profit potential • Spreads reach max profit at the short put strike which may occur before expiration • If expected to move down more than 7-10%, a long put may be a more ideal trade
• Two legs, so extra commissions and two bid ask spreads to deal with. • Can be harder to close in a hurry.
www.nisonoptionsacademy.com
Types of diagonals & implementation Strategy
When to Use
Bear Put Calendar
You have a downside support level and target or want to be in a trade longer term
Bull Call Calendar
Implementation
Buy a longer term put and sell a shorter term put with a lower strike and shorter expiration. Chart shows resistance, Buy a longer term but not sure if it will call and sell a break through or want to shorter term call be in a trade longer with a higher strike term and shorter expiration. www.nisonoptionsacademy.com
When to use outrights vs. diagonals For outrights look for charts with (we are ignoring IV):
Potential move that doesn’t want to limit profit potential as with a spread. Higher confidence support (for calls) or resistance (puts) will hold (as compared to diagonal spreads where if I have less confidence may want to be able to leg out if I switch forecast or directional bias) For outright buys... a big fast move works best but if the trend isn’t very strong, a diagonal can benefit from slightly bearish or bullish trends since the time decay will help. Outrights need room to move while diagonals benefit from box ranges and clear support/resistance www.nisonoptionsacademy.com
Chart Challenge
1) What is the most recent candle signal displayed below? 2) What support or resistance seems strong here? 3) Given what you know about options now, you can choose a directional trade or non-directional i.e. range-bound trade. Which type would you choose ? 4) What is the stop? 5) Which option strategy would you do and why ?
www.nisonoptionsacademy.com
Chart Challenge 1) What is the most recent candle signal displayed below? 2) What support or resistance seems strong here? 3) Given what you know about options now, you can choose a directional trade or non-directional i.e. range-bound trade. Which type would you choose ?
4) What prior candle signals can be a guide for how to structure a trade? 5) Which option strategy would you do and why ?
www.nisonoptionsacademy.com
Chart Challenge 1) What are the most recent candle signal(s) displayed below? 2) What support or resistance seems strong here? 3) You can choose a directional trade or non-directional i.e. range-bound trade. Which type would you choose ?
4) Where should a stop be placed? 5) Which option strategy would you do and why ? www.nisonoptionsacademy.com
Chart Challenge 1) What is the most recent candle signal displayed below? 2) What support or resistance seems strong here? 3) You can choose a directional trade or somewhatdirectional i.e. profitable up and sideways or down and sideways trade. Which type would you choose ? 4) Where should a stop be placed? 5) Which option strategy would you do and why ?
www.nisonoptionsacademy.com
Presented by Dave Forster – Nison Certified Options Trainer ™
Diagonal Debit Spreads Bull Call Calendars & Bear Put Calendars
www.nisonoptionsacademy.com
Spread Review Every option spread contains one or two of the basic types of spreads that more advanced spreads consist of: Vertical Spreads – Have two different strikes i.e. higher and lower strikes for the bought and sold options hence the name verticals with the same expiration period for both strikes 2. Calendar Spreads – Have the same strikes for the bought and sold options with two different expiration periods hence the name calendars What is a diagonal then? It combines a vertical and calendar spread with a spread with different strikes and different expirations 1.
Example Long ABC April 70 Call at $3.10 Short ABC February 75 Call at $1.20 www.nisonoptionsacademy.com
Diagonals Background There are 4 types of potential diagonals with names similar to the 4 types of vertical spreads: • • • •
Bull Put Calendar Bear Put Calendar Bull Call Calendar Bear Call Calendar
The easiest to manage of these 4 types are the bear put calendar and bull call calendar so we will discussing these two debit diagonals
www.nisonoptionsacademy.com
Diagonal Differences
Benefits • • •
•
•
Can benefit from two directional movements – up and sideways or down and sideways Offer a fairly wide profit and loss area on a risk graph similar to a calendar spread Can be a longer term trade by allowing for the trade to be repeated into further expirations if the short option expires Higher probability of success Can benefit from implied volatility increases
www.nisonoptionsacademy.com
Diagonal Differences
Disadvantages • • •
•
•
High Cost Less Certainty of what premium will be received when selling short options against the long in the future Requires more careful management and typically more time than other spread trades Long leg is susceptible to volatility crunch – If the long option is bought at periods of high IV and IV goes down over time, the long may lose more money than the shorts take in in premium Potential risk of assignment if the short option goes ITM. If the short leg goes ITM it can lose more money than the long can make www.nisonoptionsacademy.com
Bull Call Calendars Buy ATM lower strike (95) call 3 or more months out Sell higher strike (100) call (front month expiration) Which of these two strikes will be more worth more? So we will be buying the more expensive lower strike call and selling the cheaper call: Result is net cost to you hence a debit call spread Concept: Buy a longer term call to stay in a trade for one or multiple expirations but short call reduces both risk and reward
Buy 1 XYZ 90-day or longer 95 Call @ 3.50 Sell 1 XYZ 30-day 100 Call @ .75 Max Risk is Net Debit (2.75) At expiration: Maximum Profit = Varies based on short option, IV changes, plus if future short options are sold, these add to profitability. Use a risk graph or options calculator Breakevens for the downside and upside can’t be done in a single equation. Delta and implied volatility are the primary inputs. Use a risk graph tool. Breakevens also change as more short options are sold. www.nisonoptionsacademy.com
Bull Call Calendar - P & L Graph Buy 1 XYZ 90-day or longer 115 Call (7.91) Sell 1 XYZ 30-day 120 Call 1.50
BE @ 97
www.nisonoptionsacademy.com
Considerations for choosing strike prices for bull call Calendar
Think of bull call calendar as a long call trade with a lower cost and the ability to continue to lower the cost by selling short calls over time.
Stock is at support area @ 45 with resistance at 50 •Buy 45 call 90 days or longer to expiration •Sell 50 call in front month or weekly (to lessen cost of trade and thereby reduce the trades risk) Using resistance: • Higher strike should be resistance area. • Rationale: Max profit (at expiration) when higher strike price (short) of spread is reached. www.nisonoptionsacademy.com
Bull Call Calendar Uses • Good to use if your view is that IV is low and may rise • Lessens time decay issues involved with buying outright call. • Selling calls lessen the cost of a trade. • More important for market to rally than with bull put spread but less important than a bull call spread • Can be a good alternative to an outright buy when there is a target move of 5% to 10% so premium on short call is worth selling and you don’t expect to give up too much upside potential. • Can also leg into this spread after a favorable move buying the long option first and later selling a short call. www.nisonoptionsacademy.com
Bull Call Calendar Cautions • Selling a call helps lessen cost of outright trade, but trade has capped upside potential • The short call sold can potentially lose more than the long option can gain since the short option can change in value faster • The short call premium should be at least 10% or more of the cost of the long option to ensure that it’s worth selling. • Implied volatility decreases can lessen the value of the long option more than short premium can cover it. www.nisonoptionsacademy.com
Bear Put Diagonal spreads Buy ATM higher strike (130) put ~ 90 days to expiry Sell lower strike (125) put (front month or weekly) Which of these two strikes will be more worth more? So will be buying the higher strike more expensive put - and selling the cheaper put: Result is a debit spread Concept: Buy a longer term put to stay in a trade for one or multiple expirations but short put reduces both risk and reward
Buy 1 XYZ ~ 90-day 130 put @ 2.45 Sell 1 XYZ 17-day 125 put @ .55 Max Risk is Net Debit = 1.90 At expiration: Maximum Profit = Varies based on short option, IV changes, plus if future short options are sold, these add to profitability. Use a risk graph or options calculator Breakevens for the downside and upside can’t be done in a single equation. Delta and implied volatility are the primary inputs. Use a risk graph tool. Breakevens also change as more short options are sold.
www.nisonoptionsacademy.com
Bear Put Calendar - P & L graph Buy 1 SPY 86-day 145 Put @ 4.91 Sell 1 SPY 23-day 140 Put @ .77
www.nisonoptionsacademy.com
Considerations for choosing strike prices for bear Put calendar spreads
Think of bear put calendar as a long put trade with a lower cost and the ability to continue to lower the cost by selling short puts over time.
With the market at resistance area @ 45: Buy a 45 put around 90 days to expiry Sell a 40 put in the front month or weekly at a support area Using resistance: • Higher strike put should be resistance. • Rationale: Max profit (at expiration) when underlying price is at lower strike (short) since the short put would expire worthless and keep entire credit plus allow for additional selling of short puts and allow for long put gain www.nisonoptionsacademy.com
Bear put calendar cautions • Selling a put lessens cost of outright trade, but this limits profit potential • Spreads reach max profit at the short put strike which may occur before expiration • If expected to move down more than 7-10%, a long put may be a more ideal trade
• Two legs, so extra commissions and two bid ask spreads to deal with. • Can be harder to close in a hurry.
www.nisonoptionsacademy.com
Types of diagonals & implementation Strategy
When to Use
Bear Put Calendar
You have a downside support level and target or want to be in a trade longer term
Bull Call Calendar
Implementation
Buy a longer term put and sell a shorter term put with a lower strike and shorter expiration. Chart shows resistance, Buy a longer term but not sure if it will call and sell a break through or want to shorter term call be in a trade longer with a higher strike term and shorter expiration. www.nisonoptionsacademy.com
When to use outrights vs. diagonals For outrights look for charts with (we are ignoring IV):
Potential move that doesn’t want to limit profit potential as with a spread. Higher confidence support (for calls) or resistance (puts) will hold (as compared to diagonal spreads where if I have less confidence may want to be able to leg out if I switch forecast or directional bias) For outright buys... a big fast move works best but if the trend isn’t very strong, a diagonal can benefit from slightly bearish or bullish trends since the time decay will help. Outrights need room to move while diagonals benefit from box ranges and clear support/resistance www.nisonoptionsacademy.com
Chart Challenge
1) What is the most recent candle signal displayed below? 2) What support or resistance seems strong here? 3) Given what you know about options now, you can choose a directional trade or non-directional i.e. range-bound trade. Which type would you choose ? 4) What is the stop? 5) Which option strategy would you do and why ?
www.nisonoptionsacademy.com
Chart Challenge 1) What is the most recent candle signal displayed below? 2) What support or resistance seems strong here? 3) Given what you know about options now, you can choose a directional trade or non-directional i.e. range-bound trade. Which type would you choose ?
4) What prior candle signals can be a guide for how to structure a trade? 5) Which option strategy would you do and why ?
www.nisonoptionsacademy.com
Chart Challenge 1) What are the most recent candle signal(s) displayed below? 2) What support or resistance seems strong here? 3) You can choose a directional trade or non-directional i.e. range-bound trade. Which type would you choose ?
4) Where should a stop be placed? 5) Which option strategy would you do and why ? www.nisonoptionsacademy.com
Chart Challenge 1) What is the most recent candle signal displayed below? 2) What support or resistance seems strong here? 3) You can choose a directional trade or somewhatdirectional i.e. profitable up and sideways or down and sideways trade. Which type would you choose ? 4) Where should a stop be placed? 5) Which option strategy would you do and why ?
www.nisonoptionsacademy.com
