## No lack of OPTIONS

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- PebbleTrader
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- rushN4
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I found here something on Delta Trading. Maybe some will find it usefull

http://www.barchart.com/education/pdf/D ... Course.pdf

It is a reprint from "The Delta Trading Strategy" It was initially published in 1994 by The Ken Roberts Company

http://www.barchart.com/education/pdf/D ... Course.pdf

It is a reprint from "The Delta Trading Strategy" It was initially published in 1994 by The Ken Roberts Company

- PebbleTrader
- rank: 1000+ posts
**Posts:**1633**Joined:**Fri Nov 12, 2010 2:15 am**Reputation:**1**Gender:**

- PebbleTrader
- rank: 1000+ posts
**Posts:**1633**Joined:**Fri Nov 12, 2010 2:15 am**Reputation:**1**Gender:**

OPTIONS TRADING: BACK TO GOLD

Now that we have read through the basics, let's examine a few possible

trades. Suppose a few months ago we had suspected that Gold prices were

ready to move up, but we did not want to take the risk of entering a

futures contract trade. Gold was trading at $420 an ounce. We decided to

buy an option.

PUT AND CALL

First question: What would we want to buy, a PUT or a CALL?

We would, of course, wish to buy a CALL option. A CALL gives us the right

to buy the futures contract at a specific price, called the STRIKE PRICE. A

PUT would give us the right to sell at a specific price, and we would use a

PUT if we thought prices were going down. But we think they are going up.

So we purchase a CALL option. That was the easy question. The next two

questions are going to take a little more review and discussion.

STRIKE AND PREMIUM

Next question: What STRIKE PRICE should we purchase and how much

PREMIUM will we pay?

If we look in Investor's Business Daily or The Wall Street Journal, we see

there are many possible STRIKE PRICES, all with different prices, or

PREMIUMS. Which one do we want? There is a STRIKE PRICE every $20,

that is at 400, 420, 440, 460 an ounce and so on. The closer the STRIKE

PRICE is to the current trading price, the higher the PREMIUM and the more

the option costs (remember, the PREMIUM is the cost of the option). The

further the STRIKE PRICE is above the current price of Gold, the lower the

PREMIUM for buying the option. We might think of each STRIKE PRICE

option as a different commodity. While prices will move in similar

directions, each will behave a little differently.

Exactly how much each Gold option costs depends on how likely traders in

the market believe it is that the price of Gold will reach and exceed the

STRIKE PRICE of the option. If we purchase the 460 STRIKE Gold option

when Gold is trading at $420 an ounce, Gold will have to move up over $40

an ounce before our option would be worth using. There is no sense in

using our option to buy Gold at $460 an ounce if we can simply go out and

buy Gold on the market at a price less than that. But if Gold does move up,

say to $480 an ounce, we can profitably exercise the option. We have the

right to buy it at $460! We can exercise our option and buy the Gold at

$460 (our set STRIKE PRICE), and then if we wish, immediately sell it back

at the current market rate of $480. By doing this, we pocket a profit of $20

per ounce. Each Gold CALL option gives the right to buy one futures

contract of 100 ounces, so we would be able to make a quick $20 an ounce

on 100 ounces, or a total of $2,000 ($20 x 100 ounces)! To determine our

net profit on this transaction, we must deduct from the $2,000 we receive

at sale, the original cost or PREMIUM, we paid for the option.

Now that we have read through the basics, let's examine a few possible

trades. Suppose a few months ago we had suspected that Gold prices were

ready to move up, but we did not want to take the risk of entering a

futures contract trade. Gold was trading at $420 an ounce. We decided to

buy an option.

PUT AND CALL

First question: What would we want to buy, a PUT or a CALL?

We would, of course, wish to buy a CALL option. A CALL gives us the right

to buy the futures contract at a specific price, called the STRIKE PRICE. A

PUT would give us the right to sell at a specific price, and we would use a

PUT if we thought prices were going down. But we think they are going up.

So we purchase a CALL option. That was the easy question. The next two

questions are going to take a little more review and discussion.

STRIKE AND PREMIUM

Next question: What STRIKE PRICE should we purchase and how much

PREMIUM will we pay?

If we look in Investor's Business Daily or The Wall Street Journal, we see

there are many possible STRIKE PRICES, all with different prices, or

PREMIUMS. Which one do we want? There is a STRIKE PRICE every $20,

that is at 400, 420, 440, 460 an ounce and so on. The closer the STRIKE

PRICE is to the current trading price, the higher the PREMIUM and the more

the option costs (remember, the PREMIUM is the cost of the option). The

further the STRIKE PRICE is above the current price of Gold, the lower the

PREMIUM for buying the option. We might think of each STRIKE PRICE

option as a different commodity. While prices will move in similar

directions, each will behave a little differently.

Exactly how much each Gold option costs depends on how likely traders in

the market believe it is that the price of Gold will reach and exceed the

STRIKE PRICE of the option. If we purchase the 460 STRIKE Gold option

when Gold is trading at $420 an ounce, Gold will have to move up over $40

an ounce before our option would be worth using. There is no sense in

using our option to buy Gold at $460 an ounce if we can simply go out and

buy Gold on the market at a price less than that. But if Gold does move up,

say to $480 an ounce, we can profitably exercise the option. We have the

right to buy it at $460! We can exercise our option and buy the Gold at

$460 (our set STRIKE PRICE), and then if we wish, immediately sell it back

at the current market rate of $480. By doing this, we pocket a profit of $20

per ounce. Each Gold CALL option gives the right to buy one futures

contract of 100 ounces, so we would be able to make a quick $20 an ounce

on 100 ounces, or a total of $2,000 ($20 x 100 ounces)! To determine our

net profit on this transaction, we must deduct from the $2,000 we receive

at sale, the original cost or PREMIUM, we paid for the option.

Last edited by PebbleTrader on Wed Feb 27, 2013 3:28 pm, edited 1 time in total.

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- PebbleTrader
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VOLATILITY

How much PREMIUM will we have to pay for our Gold CALL option?

Remember, to obtain the profit in the above example, the price of Gold had

to move from $420 per ounce to $480 per ounce, and this is a pretty big

move. So how much is that option with a 460 STRIKE going to cost us to

begin with? Well, that depends on how likely traders in the market think it

is that Gold will make a big move up. If the price of Gold has been rather

steady, and there have been few major moves, traders will figure the

chances of Gold making a big move upwards are rather small. It will not

cost very much to buy a Gold option with a STRIKE PRICE way beyond

what traders think it is likely to be worth during the life of the option. This

perception of how active a market is and how likely it is to make a big

move is called the "VOLATILITY" of the market the sixth word in our

glossary of option trading. When VOLATILITY in a market is low, it means

prices are very stable and big moves in price seem unlikely. When

VOLATILITY is high, the market is making big price moves.

Under circumstances where VOLATILITY is low, the person selling the

option to us figures it unlikely he will actually have to deliver on the option

he figures prices seem pretty stable and are not likely to go up above the

STRIKE PRICE, or not very much above the STRIKE PRICE. So if Gold is

selling for $420 an ounce and prices are stable (low VOLATILITY), we may

have to pay only a very small PREMIUM for the 460 STRIKE option, as little

as $50 or $100. The more active prices have been, and the more likely it

appears that Gold may move up to the $460 per ounce STRIKE PRICE of

our option, the more the option will cost.If prices have been very active,

that is, very VOLATILE, and moving upward, the option PREMIUM could be

several hundred dollars.

Either way, if prices actually do reach $480 an ounce, we can exercise our

option and pocket the $2,000. Our net profit on the trade is this amount,

$2,000, minus the PREMIUM we paid for the option. If we paid a low

PREMIUM of $100 for the option, our net profit was $1,900, twenty times

the capital we risked! If we paid a PREMIUM of $400, as we would have

during the Spring of 1987, when prices were VOLATILE, and the PREMIUMS

therefore higher, we still would have had a net profit of $1,600, or an

800% gain. In either case, if we had been wrong about the direction of the

price move, the most we could have lost was the PREMIUM we originally

paid.

Please note, you don't have to exercise your profitable option. You can sell

it to someone else for a nice profit.

So back to the first part of our question, what option STRIKE PRICE should

we buy?

The answer depends partly on how much we want to spend on the option

PREMIUM. The STRIKE PRICES closest to the current trading price of Gold

will always be the most expensive. These are the options most likely to pay

off. Some STRIKE PRICES will even be below the current price of Gold, for

example, a 400 strike option when Gold is at $420. These options that are

already "in-the-money" are the most expensive. The 400 STRIKE option

gives one the right to buy Gold at $400 an ounce when it is currently selling

for $420 an ounce. This option will cost at least as much as the $20 an

ounce it is already worth (its current "intrinsic value").

Generally it is best to buy the option with a STRIKE PRICE one or two steps

away from the current market price of the futures contract. In this case

when Gold is trading at $420 an ounce, it is probably best to buy the 440

STRIKE PRICE option. If VOLATILITY is high, we might want to consider the

460 STRIKE option, but we must always remember that the farther away

the option STRIKE PRICE is from the current price of Gold, the less likely it

is that we will make money on the option. When we buy a distant STRIKE

PRICE (a "far-out-of-the-money" strike), we pay less money, and have

less risk, but we usually also have a lower chance of making a profit.

How much PREMIUM will we have to pay for our Gold CALL option?

Remember, to obtain the profit in the above example, the price of Gold had

to move from $420 per ounce to $480 per ounce, and this is a pretty big

move. So how much is that option with a 460 STRIKE going to cost us to

begin with? Well, that depends on how likely traders in the market think it

is that Gold will make a big move up. If the price of Gold has been rather

steady, and there have been few major moves, traders will figure the

chances of Gold making a big move upwards are rather small. It will not

cost very much to buy a Gold option with a STRIKE PRICE way beyond

what traders think it is likely to be worth during the life of the option. This

perception of how active a market is and how likely it is to make a big

move is called the "VOLATILITY" of the market the sixth word in our

glossary of option trading. When VOLATILITY in a market is low, it means

prices are very stable and big moves in price seem unlikely. When

VOLATILITY is high, the market is making big price moves.

Under circumstances where VOLATILITY is low, the person selling the

option to us figures it unlikely he will actually have to deliver on the option

he figures prices seem pretty stable and are not likely to go up above the

STRIKE PRICE, or not very much above the STRIKE PRICE. So if Gold is

selling for $420 an ounce and prices are stable (low VOLATILITY), we may

have to pay only a very small PREMIUM for the 460 STRIKE option, as little

as $50 or $100. The more active prices have been, and the more likely it

appears that Gold may move up to the $460 per ounce STRIKE PRICE of

our option, the more the option will cost.If prices have been very active,

that is, very VOLATILE, and moving upward, the option PREMIUM could be

several hundred dollars.

Either way, if prices actually do reach $480 an ounce, we can exercise our

option and pocket the $2,000. Our net profit on the trade is this amount,

$2,000, minus the PREMIUM we paid for the option. If we paid a low

PREMIUM of $100 for the option, our net profit was $1,900, twenty times

the capital we risked! If we paid a PREMIUM of $400, as we would have

during the Spring of 1987, when prices were VOLATILE, and the PREMIUMS

therefore higher, we still would have had a net profit of $1,600, or an

800% gain. In either case, if we had been wrong about the direction of the

price move, the most we could have lost was the PREMIUM we originally

paid.

Please note, you don't have to exercise your profitable option. You can sell

it to someone else for a nice profit.

So back to the first part of our question, what option STRIKE PRICE should

we buy?

The answer depends partly on how much we want to spend on the option

PREMIUM. The STRIKE PRICES closest to the current trading price of Gold

will always be the most expensive. These are the options most likely to pay

off. Some STRIKE PRICES will even be below the current price of Gold, for

example, a 400 strike option when Gold is at $420. These options that are

already "in-the-money" are the most expensive. The 400 STRIKE option

gives one the right to buy Gold at $400 an ounce when it is currently selling

for $420 an ounce. This option will cost at least as much as the $20 an

ounce it is already worth (its current "intrinsic value").

Generally it is best to buy the option with a STRIKE PRICE one or two steps

away from the current market price of the futures contract. In this case

when Gold is trading at $420 an ounce, it is probably best to buy the 440

STRIKE PRICE option. If VOLATILITY is high, we might want to consider the

460 STRIKE option, but we must always remember that the farther away

the option STRIKE PRICE is from the current price of Gold, the less likely it

is that we will make money on the option. When we buy a distant STRIKE

PRICE (a "far-out-of-the-money" strike), we pay less money, and have

less risk, but we usually also have a lower chance of making a profit.

Last edited by PebbleTrader on Wed Feb 27, 2013 3:32 pm, edited 1 time in total.

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- PebbleTrader
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TIME IS MONEY

The third question: Which EXPIRATION time should we choose for our

option purchase?

In answering this question always remember: TIME IS MONEY! The more

distant the EXPIRATION DATE (the longer the period we have to exercise

the option), the more we will pay for the option (the higher the PREMIUM

will be). The reason for this is simple:No one knows, to the best of my

knowledge, what the future will bring. It is possible to make reasonable

guesses about the near future based on current circumstances, but about

more distant events we will always be ignorant. The farther into the future

our CALL option to buy Gold extends the more distant the EXPIRATION of

the option the more that option will cost.

The EXPIRATION DATE of each option is set by the exchange where it is

traded. Each futures contract has multiple different delivery months

throughout the year. Usually these are spaced one, two, or three months

apart, and we can trade options on any of these coming months. When

trading options, always discuss with the broker the exact EXPIRATION

DATE of the option. We must know how much time remains until

EXPIRATION, because this is our period of opportunity. We should note that

the option frequently will expire in the month before the futures delivery

date. For example, an option on February Gold futures will expire in

January. By selecting options on futures contracts with deliveries nearer or

further away in time, we can pick an EXPIRATION DATE for the options

contract that is anywhere from thirty or less days away, to many months

away.

FACTORS THAT AFFECT THE PREMIUM BEFORE EXPIRATION

Every day we own the option, chances increase that something will happen

to change the price of Gold. Given "enough" time be that months or even

years it is very likely something WILL happen to drive the price of Gold up

and make our option very lucrative. This is called the "TIME PREMIUM." A

large part of the PREMIUM we pay for an option consists of this "TIME

PREMIUM," the chance that something unknown and unexpected will

happen to change prices and make the option profitable. The more time

until EXPIRATION of the option, the more chance there is that

circumstances and prices will change. In purchasing an option, we pay the

person selling the option for his willingness to accept the risks of time and

those unknown events which may make the option a good investment for

us.

If nothing happens and prices stay the same, the person who sells us

the option wins and pockets all, or part of our money. We have lost the

PREMIUM we paid, but nothing more. If, however, things do change, and

prices move as we thought they might when we bought our option, then we

pocket the profits. That's why we bought the option in the first place!

The more VOLATILE the market, the more we will pay for time.

VOLATILITY implies there is a greater chance that things will change, given

enough time. So our PREMIUM will go up. When we buy an option, we are

truly buying time, and all the chances that time offers. The more time we

buy, the more we will pay. How much time to buy (how distant an

EXPIRATION) depends on our market strategy. With most trading

strategies, it is unwise to buy an option much more than 90 days long. The

PREMIUM paid for an option longer than this is usually just too high.

Sometimes, time does cost too much!

If only a few days remain until EXPIRATION, options with a STRIKE PRICE

far removed from the current trading price of the futures will be essentially

worthless. This happens when the STRIKE PRICE is so far away from the

current trading price that it is impossible, given current VOLATILITY, for

prices to move to or beyond the STRIKE PRICE in the option's remaining

time. As the EXPIRATION DATE of an option approaches, and the time

remaining to exercise the option decreases, the PREMIUM (cost) of the

option will usually decrease. When the time remaining until EXPIRATION is

short, there will be very little "time value" in the PREMIUM paid for the

option. When there is little "opportunity time" left in the option, we pay little

for it.

WHAT HAPPENS AS EXPIRATION APPROACHES

As the EXPIRATION DATE for the option approaches, the PREMIUM cost of

the option will reflect more and more the intrinsic value of the option. Time,

and the opportunity value of time, has wasted away. If the option is "far-

out-of-the-money" (the STRIKE PRICE is distant from the current price of

the futures), the PREMIUM will be very small. This happens when traders

decide there is very little chance prices will reach the STRIKE PRICE of the

option and give it value in the time remaining until EXPIRATION.

Some options will be "in-the-money" as EXPIRATION approaches. For a

CALL option, this means that the STRIKE PRICE is less than the current

trading price of the future. For example, a Gold option with a STRIKE

PRICE of 460 is "in the money" when Gold is trading at 480. In this

instance, the option is worth at least $20 an ounce, because it grants the

right to buy Gold at $460 an ounce (the STRIKE PRICE), $20 an ounce

below the current market price of Gold futures. This is called the intrinsic

value of the option the amount it is worth in cash if it is exercised. As

EXPIRATION nears, the PREMIUM of an "in-the-money" option will approach

its intrinsic value, and there will be no additional time value added to the

PREMIUM. At EXPIRATION, the value of the option is equal to its intrinsic

value. For an option which is "out-of-the-money," there is NO intrinsic

value. The value of the "out-of-the-money" option is based on its time, or

opportunity, value the chance that time will change prices and give it

intrinsic value. As time passes, the chance of this happening diminishes,

and this value disappears. At EXPIRATION, there is no time left, and the

"out-of-the-money" option is worthless. When trading options we must

always remember, TIME IS MONEY.

For each trading month of a futures contract, there will be a number of

options with different STRIKE PRICES. Each of these should be viewed as a

slightly different commodity. While they will all undergo changes in value

based on changes in the price of the futures, they will change at different

rates and in different amounts, depending on how close the STRIKE PRICE

of each is to the current trading price of the futures. Options on different

trading months of futures move differently in value because of differences

in their times until EXPIRATION. There are relationships between all the

options on a given futures contract since they all vary in a specific related

way with the futures prices, but it can take some time and study to

visualize these relations.

The third question: Which EXPIRATION time should we choose for our

option purchase?

In answering this question always remember: TIME IS MONEY! The more

distant the EXPIRATION DATE (the longer the period we have to exercise

the option), the more we will pay for the option (the higher the PREMIUM

will be). The reason for this is simple:No one knows, to the best of my

knowledge, what the future will bring. It is possible to make reasonable

guesses about the near future based on current circumstances, but about

more distant events we will always be ignorant. The farther into the future

our CALL option to buy Gold extends the more distant the EXPIRATION of

the option the more that option will cost.

The EXPIRATION DATE of each option is set by the exchange where it is

traded. Each futures contract has multiple different delivery months

throughout the year. Usually these are spaced one, two, or three months

apart, and we can trade options on any of these coming months. When

trading options, always discuss with the broker the exact EXPIRATION

DATE of the option. We must know how much time remains until

EXPIRATION, because this is our period of opportunity. We should note that

the option frequently will expire in the month before the futures delivery

date. For example, an option on February Gold futures will expire in

January. By selecting options on futures contracts with deliveries nearer or

further away in time, we can pick an EXPIRATION DATE for the options

contract that is anywhere from thirty or less days away, to many months

away.

FACTORS THAT AFFECT THE PREMIUM BEFORE EXPIRATION

Every day we own the option, chances increase that something will happen

to change the price of Gold. Given "enough" time be that months or even

years it is very likely something WILL happen to drive the price of Gold up

and make our option very lucrative. This is called the "TIME PREMIUM." A

large part of the PREMIUM we pay for an option consists of this "TIME

PREMIUM," the chance that something unknown and unexpected will

happen to change prices and make the option profitable. The more time

until EXPIRATION of the option, the more chance there is that

circumstances and prices will change. In purchasing an option, we pay the

person selling the option for his willingness to accept the risks of time and

those unknown events which may make the option a good investment for

us.

If nothing happens and prices stay the same, the person who sells us

the option wins and pockets all, or part of our money. We have lost the

PREMIUM we paid, but nothing more. If, however, things do change, and

prices move as we thought they might when we bought our option, then we

pocket the profits. That's why we bought the option in the first place!

The more VOLATILE the market, the more we will pay for time.

VOLATILITY implies there is a greater chance that things will change, given

enough time. So our PREMIUM will go up. When we buy an option, we are

truly buying time, and all the chances that time offers. The more time we

buy, the more we will pay. How much time to buy (how distant an

EXPIRATION) depends on our market strategy. With most trading

strategies, it is unwise to buy an option much more than 90 days long. The

PREMIUM paid for an option longer than this is usually just too high.

Sometimes, time does cost too much!

If only a few days remain until EXPIRATION, options with a STRIKE PRICE

far removed from the current trading price of the futures will be essentially

worthless. This happens when the STRIKE PRICE is so far away from the

current trading price that it is impossible, given current VOLATILITY, for

prices to move to or beyond the STRIKE PRICE in the option's remaining

time. As the EXPIRATION DATE of an option approaches, and the time

remaining to exercise the option decreases, the PREMIUM (cost) of the

option will usually decrease. When the time remaining until EXPIRATION is

short, there will be very little "time value" in the PREMIUM paid for the

option. When there is little "opportunity time" left in the option, we pay little

for it.

WHAT HAPPENS AS EXPIRATION APPROACHES

As the EXPIRATION DATE for the option approaches, the PREMIUM cost of

the option will reflect more and more the intrinsic value of the option. Time,

and the opportunity value of time, has wasted away. If the option is "far-

out-of-the-money" (the STRIKE PRICE is distant from the current price of

the futures), the PREMIUM will be very small. This happens when traders

decide there is very little chance prices will reach the STRIKE PRICE of the

option and give it value in the time remaining until EXPIRATION.

Some options will be "in-the-money" as EXPIRATION approaches. For a

CALL option, this means that the STRIKE PRICE is less than the current

trading price of the future. For example, a Gold option with a STRIKE

PRICE of 460 is "in the money" when Gold is trading at 480. In this

instance, the option is worth at least $20 an ounce, because it grants the

right to buy Gold at $460 an ounce (the STRIKE PRICE), $20 an ounce

below the current market price of Gold futures. This is called the intrinsic

value of the option the amount it is worth in cash if it is exercised. As

EXPIRATION nears, the PREMIUM of an "in-the-money" option will approach

its intrinsic value, and there will be no additional time value added to the

PREMIUM. At EXPIRATION, the value of the option is equal to its intrinsic

value. For an option which is "out-of-the-money," there is NO intrinsic

value. The value of the "out-of-the-money" option is based on its time, or

opportunity, value the chance that time will change prices and give it

intrinsic value. As time passes, the chance of this happening diminishes,

and this value disappears. At EXPIRATION, there is no time left, and the

"out-of-the-money" option is worthless. When trading options we must

always remember, TIME IS MONEY.

For each trading month of a futures contract, there will be a number of

options with different STRIKE PRICES. Each of these should be viewed as a

slightly different commodity. While they will all undergo changes in value

based on changes in the price of the futures, they will change at different

rates and in different amounts, depending on how close the STRIKE PRICE

of each is to the current trading price of the futures. Options on different

trading months of futures move differently in value because of differences

in their times until EXPIRATION. There are relationships between all the

options on a given futures contract since they all vary in a specific related

way with the futures prices, but it can take some time and study to

visualize these relations.

Life is just a journey

- PebbleTrader
- rank: 1000+ posts
**Posts:**1633**Joined:**Fri Nov 12, 2010 2:15 am**Reputation:**1**Gender:**

- PebbleTrader
- rank: 1000+ posts
**Posts:**1633**Joined:**Fri Nov 12, 2010 2:15 am**Reputation:**1**Gender:**

HOW TO MAKE THREE TIMES MORE MONEY

Back to our example. Gold is trading at $480, and the April CALL options

with a 500 STRIKE PRICE have a PREMIUM of $4.50 an ounce, or $450 per

option ($4.50 per ounce x 100 ounces = $450). We examine the last two

days' prices on The Wall Street Journal, and calculate that the DELTA of

this April 500 Gold CALL option is 0.25 (its PREMIUM has been changing 25

cents for every dollar change in Gold prices). With our $2,000 we buy four

options, at a total cost of $1,800, and save the $200 change. The total

DELTA of our position is 1. We will initially make one dollar for every dollar

change in the price of Gold. (For the technically advanced student only:

These following calculations are made with a market VOLATILITY of 15%,

interest rates at 6%, and 60 days until EXPIRATION but don't worry about

these technical comments.)

The price of Gold begins to move up, as we hoped. It quickly reaches $490

an ounce let's say this happens in the next two weeks and our options now

have 45 days until EXPIRATION. As the price moves up, remember the

DELTA of our options is also increasing. At $490, the DELTA on each of our

options has increased to 0.35. We own four options, so the total DELTA of

our position is 1.40 (4 x 0.35 = 1.40).Now for every dollar increase in the

price of Gold, we will be making $1.40 on our option position!! And what

happens when the price hits $500 an ounce, the STRIKE PRICE of our

options? The DELTA on each option is now 0.5, and the total DELTA of our

position is 2 (4 x 0.5 = 2.0). We are now making $2 for every $1 increase

in the price of Gold, or twice as much as we would make had we bought a

futures contract!

As the price of Gold continues to rise, we make more and more for each

dollar move as the DELTA of our options increases. If the price reaches

$540, the DELTA of each option will be over 0.90, and our total position

DELTA will be 3.6. We will be making $3.60 for every $1 increase in the

price of Gold now we own the profit power of four-hundred ounces of Gold,

instead of the single one-hundred ounce futures contract we might have

been able to purchase using our original $2,000 as margin!

FUTURES VS DELTA OPTIONS POSITION

EVERY PICTURE TELLS A STORY

Figure 2, above, shows the profit curve for this DELTA OPTIONS trade. The

line marked with the "+" indicates the profit/loss potential of a single

futures contract. Notice it is a straight line, for every dollar change in the

price of Gold, up or down, there is a $100 profit or loss. When the price

rises from $480 to $540, we make $6,000, or $60 per ounce on 100

ounces. When the price falls to $420, we lose $6,000.

Now notice the profit line of the DELTA OPTIONS trade. It is a curved line,

and a line curved in a very favorable way. As the price goes in the

direction of our trade, we make more and more. When the price moves

against the trade, downward, we lose incrementally less, until our

maximum loss of $1,800 the amount of our original investment is reached.

If the price of Gold moves up to $540, we will make over $14,000, well

over twice as much as with a single futures contract. When the market

drops suddenly, and against our expected projections, we lose a maximum

of $1,800, the amount of capital we chose to risk, and far less than we

might lose on a futures contract. There is never a chance of a margin

CALL. Our risk is defined and totally limited, and our profit potential,

depending on how far Gold prices move up, is doubled, tripled, or

ultimately, nearly quadrupled! A wizard once said that magic is simply

power discovered unexpectedly. Here resides the magic of DELTA:

Unexpected and unlimited power to pro fit, amazingly allied with total and

predictable control of risk. Used in the right way at the right time, this is a

magic that can make futures-trading "wizards" rich!

THE COST OF MAGIC

As you must see, this is a most powerful tool. Unfortunately, there is no

spell that produces gold from lead at least not one that I can share! This

strategy does have a cost, something is given away in return for the

power. Before using the DELTA OPTION approach, you must understand

this cost. Return to Figure 2 and examine the profit lines again. Can you

figure out what is given away in return for the power of a DELTA OPTION

trade? Notice that between 465 and 495 the DELTA OPTION profit line is

below the futures profit line.In our example trade, if Gold prices make a

small move, say from 480 to 490, with the DELTA OPTION trade we would

make a profit of $675. Had we purchased a Gold futures contract instead of

a DELTA OPTION position, we would have made $1,000 on this small move.

If prices stayed the same, that is, Gold continued to trade at $480 per

ounce, our futures position would be a break-even venture. We would

neither make nor lose money (excluding the broker's commission). Our

DELTA figure 2 option position would, however, lose money. As every day

passes, our options with a 500 STRIKE PRICE are losing TIME PREMIUM.

Remember, time is money! Indeed, if we held our position all the way until

EXPIRATION of the options, and prices did not move at all from 480, we

would lose our entire investment of $1,800. This is, of course, because our

500 strike options are out-of-the-money and will expire worthless.

The cost of a DELTA option position is this: If prices fail to move much one

way or the other, one makes slightly less or loses slightly more than he or

she would with a futures position. There are two clear advantages of a

DELTA option trade: If prices move dramatically in our favor, we make far

more than we would on an outright futures contract; and if prices move

strongly against us, we lose far less. Understanding these costs, we can

design a trading strategy that will use option DELTAS efficiently and

profitably. This is not the approach to take every time we trade. As with all

tools, it must be used properly to work properly.

Back to our example. Gold is trading at $480, and the April CALL options

with a 500 STRIKE PRICE have a PREMIUM of $4.50 an ounce, or $450 per

option ($4.50 per ounce x 100 ounces = $450). We examine the last two

days' prices on The Wall Street Journal, and calculate that the DELTA of

this April 500 Gold CALL option is 0.25 (its PREMIUM has been changing 25

cents for every dollar change in Gold prices). With our $2,000 we buy four

options, at a total cost of $1,800, and save the $200 change. The total

DELTA of our position is 1. We will initially make one dollar for every dollar

change in the price of Gold. (For the technically advanced student only:

These following calculations are made with a market VOLATILITY of 15%,

interest rates at 6%, and 60 days until EXPIRATION but don't worry about

these technical comments.)

The price of Gold begins to move up, as we hoped. It quickly reaches $490

an ounce let's say this happens in the next two weeks and our options now

have 45 days until EXPIRATION. As the price moves up, remember the

DELTA of our options is also increasing. At $490, the DELTA on each of our

options has increased to 0.35. We own four options, so the total DELTA of

our position is 1.40 (4 x 0.35 = 1.40).Now for every dollar increase in the

price of Gold, we will be making $1.40 on our option position!! And what

happens when the price hits $500 an ounce, the STRIKE PRICE of our

options? The DELTA on each option is now 0.5, and the total DELTA of our

position is 2 (4 x 0.5 = 2.0). We are now making $2 for every $1 increase

in the price of Gold, or twice as much as we would make had we bought a

futures contract!

As the price of Gold continues to rise, we make more and more for each

dollar move as the DELTA of our options increases. If the price reaches

$540, the DELTA of each option will be over 0.90, and our total position

DELTA will be 3.6. We will be making $3.60 for every $1 increase in the

price of Gold now we own the profit power of four-hundred ounces of Gold,

instead of the single one-hundred ounce futures contract we might have

been able to purchase using our original $2,000 as margin!

FUTURES VS DELTA OPTIONS POSITION

EVERY PICTURE TELLS A STORY

Figure 2, above, shows the profit curve for this DELTA OPTIONS trade. The

line marked with the "+" indicates the profit/loss potential of a single

futures contract. Notice it is a straight line, for every dollar change in the

price of Gold, up or down, there is a $100 profit or loss. When the price

rises from $480 to $540, we make $6,000, or $60 per ounce on 100

ounces. When the price falls to $420, we lose $6,000.

Now notice the profit line of the DELTA OPTIONS trade. It is a curved line,

and a line curved in a very favorable way. As the price goes in the

direction of our trade, we make more and more. When the price moves

against the trade, downward, we lose incrementally less, until our

maximum loss of $1,800 the amount of our original investment is reached.

If the price of Gold moves up to $540, we will make over $14,000, well

over twice as much as with a single futures contract. When the market

drops suddenly, and against our expected projections, we lose a maximum

of $1,800, the amount of capital we chose to risk, and far less than we

might lose on a futures contract. There is never a chance of a margin

CALL. Our risk is defined and totally limited, and our profit potential,

depending on how far Gold prices move up, is doubled, tripled, or

ultimately, nearly quadrupled! A wizard once said that magic is simply

power discovered unexpectedly. Here resides the magic of DELTA:

Unexpected and unlimited power to pro fit, amazingly allied with total and

predictable control of risk. Used in the right way at the right time, this is a

magic that can make futures-trading "wizards" rich!

THE COST OF MAGIC

As you must see, this is a most powerful tool. Unfortunately, there is no

spell that produces gold from lead at least not one that I can share! This

strategy does have a cost, something is given away in return for the

power. Before using the DELTA OPTION approach, you must understand

this cost. Return to Figure 2 and examine the profit lines again. Can you

figure out what is given away in return for the power of a DELTA OPTION

trade? Notice that between 465 and 495 the DELTA OPTION profit line is

below the futures profit line.In our example trade, if Gold prices make a

small move, say from 480 to 490, with the DELTA OPTION trade we would

make a profit of $675. Had we purchased a Gold futures contract instead of

a DELTA OPTION position, we would have made $1,000 on this small move.

If prices stayed the same, that is, Gold continued to trade at $480 per

ounce, our futures position would be a break-even venture. We would

neither make nor lose money (excluding the broker's commission). Our

DELTA figure 2 option position would, however, lose money. As every day

passes, our options with a 500 STRIKE PRICE are losing TIME PREMIUM.

Remember, time is money! Indeed, if we held our position all the way until

EXPIRATION of the options, and prices did not move at all from 480, we

would lose our entire investment of $1,800. This is, of course, because our

500 strike options are out-of-the-money and will expire worthless.

The cost of a DELTA option position is this: If prices fail to move much one

way or the other, one makes slightly less or loses slightly more than he or

she would with a futures position. There are two clear advantages of a

DELTA option trade: If prices move dramatically in our favor, we make far

more than we would on an outright futures contract; and if prices move

strongly against us, we lose far less. Understanding these costs, we can

design a trading strategy that will use option DELTAS efficiently and

profitably. This is not the approach to take every time we trade. As with all

tools, it must be used properly to work properly.

Life is just a journey

- PebbleTrader
- rank: 1000+ posts
**Posts:**1633**Joined:**Fri Nov 12, 2010 2:15 am**Reputation:**1**Gender:**

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