Options on Major Hayden

Install ThinkOrSwim on Fedora Linux

major@mhtx.net (Major Hayden) — Thu, 31 Mar 2022 00:00:00 +0000

Over the past two years, I picked up stock trading and general finance knowledge as a hobby. There are plenty of things I enjoy here: complex math, understanding trends, and making educated guesses on what happens next. Getting the right tools makes this job a little bit easier.

I use TD Ameritrade for the majority of my trading and learning. They offer a desktop application with a great name: ThinkOrSwim. Using it feels a bit like flying the Space Shuttle at first, but it delivers tons of information and analysis in a small package.

This post isn’t about stock trading – it’s about how to wrestle ThinkOrSwim onto a Fedora Linux machine and get everything working as it should. 🐧

Getting (the right) Java

ThinkOrSwim’s download page mentions installing Zulu OpenJDK 11 first. This is a special certified release of the JDK that is well-tested with ThinkOrSwim.

Visit the RPM-based Linux page for Azul’s OpenJDK and follow the steps they provide:

$ sudo dnf install -y https://cdn.azul.com/zulu/bin/zulu-repo-1.0.0-1.noarch.rpm
$ sudo dnf install zulu11-jdk

If you already have a JDK installed, you’ll need to switch to the Azul JDK as the primary one. I have some other Java applications on my desktop and they seem to work just fine with this JDK. We will use the alternatives script to manage the symlinks for our default JDK:

$ sudo alternatives --config java

There are 2 programs which provide 'java'.

 Selection Command
-----------------------------------------------
*+ 1 java-17-openjdk.x86_64 (/usr/lib/jvm/java-17-openjdk-17.0.2.0.8-7.fc36.x86_64/bin/java)
 2 /usr/lib/jvm/zulu11/bin/java

Enter to keep the current selection[+], or type selection number:

Press 2 here and then press ENTER. Double check that the Azul JDK is the primary:

$ java --version
openjdk 11.0.14.1 2022-02-08 LTS
OpenJDK Runtime Environment Zulu11.54+25-CA (build 11.0.14.1+1-LTS)
OpenJDK 64-Bit Server VM Zulu11.54+25-CA (build 11.0.14.1+1-LTS, mixed mode)

Adding ALSA support

Yes, we are going back in time and getting ThinkOrSwim talking with ALSA. We will need libasound_module_pcm_pulse.so on the system:

$ sudo dnf whatprovides '*/libasound_module_pcm_pulse.so'
Last metadata expiration check: 3:09:00 ago on Thu 31 Mar 2022 11:14:57 AM CDT.
alsa-plugins-pulseaudio-1.2.6-2.fc36.i686 : Alsa to PulseAudio backend
Repo : fedora
Matched from:
Filename : /usr/lib/alsa-lib/libasound_module_pcm_pulse.so

alsa-plugins-pulseaudio-1.2.6-2.fc36.x86_64 : Alsa to PulseAudio backend
Repo : @System
Matched from:
Filename : /usr/lib64/alsa-lib/libasound_module_pcm_pulse.so

alsa-plugins-pulseaudio-1.2.6-2.fc36.x86_64 : Alsa to PulseAudio backend
Repo : fedora
Matched from:
Filename : /usr/lib64/alsa-lib/libasound_module_pcm_pulse.so

$ sudo dnf install alsa-plugins-pulseaudio

Now that we have ALSA support, let’s move on to configuring the JDK to use it properly. Keith Packard ran into sound problems in Ubuntu and fixed it with a small change to his sound.properties file:

#javax.sound.sampled.Clip=org.classpath.icedtea.pulseaudio.PulseAudioMixerProvider
#javax.sound.sampled.Port=org.classpath.icedtea.pulseaudio.PulseAudioMixerProvider
#javax.sound.sampled.SourceDataLine=org.classpath.icedtea.pulseaudio.PulseAudioMixerProvider
#javax.sound.sampled.TargetDataLine=org.classpath.icedtea.pulseaudio.PulseAudioMixerProvider

javax.sound.sampled.Clip=com.sun.media.sound.DirectAudioDeviceProvider
javax.sound.sampled.Port=com.sun.media.sound.PortMixerProvider
javax.sound.sampled.SourceDataLine=com.sun.media.sound.DirectAudioDeviceProvider
javax.sound.sampled.TargetDataLine=com.sun.media.sound.DirectAudioDeviceProvider

Let’s double check that this will work for the Azul JDK. We need to see if these com.sun.media.sound import paths exists for us:

$ find /usr/lib/j* |grep -i sound
/usr/lib/jvm/java-17-openjdk-17.0.2.0.8-7.fc36.x86_64/lib/libjsound.so
/usr/lib/jvm/zulu11-ca/conf/sound.properties
/usr/lib/jvm/zulu11-ca/lib/libjsound.so

$ strings /usr/lib/jvm/zulu11-ca/lib/libjsound.so | grep DirectAudioDeviceProvider
Java_com_sun_media_sound_DirectAudioDeviceProvider_nNewDirectAudioDeviceInfo
Java_com_sun_media_sound_DirectAudioDeviceProvider_nGetNumDevices
?com/sun/media/sound/DirectAudioDeviceProvider$DirectAudioDeviceInfo
Java_com_sun_media_sound_DirectAudioDeviceProvider_nNewDirectAudioDeviceInfo
Java_com_sun_media_sound_DirectAudioDeviceProvider_nGetNumDevices

Awesome! Those paths match up exactly! 🎉

Let’s find our sound.properties file and make the same modifications:

$ find /usr/lib/jvm -name sound.properties
/usr/lib/jvm/zulu11-ca/conf/sound.properties

Open /usr/lib/jvm/zulu11-ca/conf/sound.properties in your favorite editor and add on Keith’s four lines at the end:

# /usr/lib/jvm/zulu11-ca/conf/sound.properties
javax.sound.sampled.Clip=com.sun.media.sound.DirectAudioDeviceProvider
javax.sound.sampled.Port=com.sun.media.sound.PortMixerProvider
javax.sound.sampled.SourceDataLine=com.sun.media.sound.DirectAudioDeviceProvider
javax.sound.sampled.TargetDataLine=com.sun.media.sound.DirectAudioDeviceProvider

Installing ThinkOrSwim

Head over to ThinkOrSwim’s download page to download the installer. It’s a big installer bundled up inside a shell script (ugly, I know). Run the script with /bin/bash thinkorswim_installer.sh and follow the prompts. I choose to install it only for my user so that it installs in my home directory.

I use i3wm and the installer doesn’t put a desktop file in the right place for me. Here’s what I drop into ~/.local/share/applications/thinkorswim.desktop:

# ~/.local/share/applications/thinkorswim.desktop
[Desktop Entry]
Name=ThinkOrSwim
Comment=ThinkOrSwim Desktop
Exec=/home/major/thinkorswim/thinkorswim
Type=Application
Categories=Finance

Of course, if you aren’t running as the user major or if you installed ThinkOrSwim in a different location, be sure to change the Exec= line above. 😉

Start up ThinkOrSwim using your desktop launcher and enjoy trading on Linux! 🎉

Free resources for the stock market

major@mhtx.net (Major Hayden) — Thu, 22 Apr 2021 00:00:00 +0000

Every new trader in the stock market must wade through a myriad of tools, platforms, and websites that claim to have the best stock market research around. Some are free, some are not, and some cost so much that they eat into plenty of your profits.

This post rounds up all of the best research options out there that you can have for free (or almost free). I’m sure I missed a few, but these are the ones I rely on most often.

Charting

It’s difficult to beat the charting features on Yahoo Finance. Load up a particular stock, fund, or index and click on Full screen above the small chart. Take a look at the chart for SPY and click Indicators at the top left. You get tons of options for the basics, such as moving averages and relative strength index (RSI), and you get plenty of more advanced indicators as well. You can share the charts directly from the site.

My runner-ups in charting include:

StockCharts: The basic charts from StockCharts are great and the new ACP platform is useful, too. (ACP has limitations without a paid account.)
TradingView: Charts on TradingView are gorgeous, but there are limitations on the number of indicators on a free account.
Finviz: The automated technical analysis charts are helpful when you’re in a hurry.

Research

My favorite research choice may be surprising, but it’s Fidelity. They have tons of research, guidance, screeners, analyst reports, and more. Finding all of the information can be challenging at times because the interface changes depending on the information you are viewing. It feels like some of the pages are left over from an old system, but the information is still very useful.

Fidelity will require you to have an account before you can use the research tools, but this is probably as simple as setting up a brokerage account and making a small deposit. I already have a couple of accounts there for work-related investments and this gives me full access to their research tools.

There’s no API access and some of the data is a little sluggish to be updated, but the information is useful even for shorter term investors and traders.

As for the research runner-ups:

Barchart: Stock research, earnings information, charting, technical analysis, and more are available on Barchart. You can access plenty of data for free, but they have paid accounts that give you more access to screeners. If you aren’t able to get a Fidelity account where you live, Barchart will give you almost the same amount of information.
Finviz: There’s plenty of data per page on Finviz and the screeners are extremely fast and useful.
Stockrow: It feels like a copy of Finviz in quite a few places, but it presents data in some different ways. They offer paid accounts, but the free account has plenty of data.
Tradytics: It delivers a modern view of the overall market, the options flow, and plenty of other data. This one has paid accounts, too, but there are lots of free features that can help you make better decisions.
fintel.io: This site gives you insight into what big hedge funds are doing in the market. Just keep in mind that the data is delayed (based on reports submitted from the funds themselves), and it’s difficult to tell which side of the trade the hedge funds are on when they submit their forms. I like it better than HedgeFollow and HedgeMind, but those can be useful as well.

APIs

Most APIs for stock market data are so expensive that they’re not worth considering. However, if you don’t need up-to-the-second data, there are some free options with great data.

Yahoo! Finance has a great API for stock quotes, company information, and options quotes. The API also has historical data that normally costs hundreds or more from other APIs. If you use Python, the yfinance module is great. You can pull it into pandas so you can slice and dice the data all you want.

Although Finviz doesn’t have an official API, the finvizfinance Python module allows you to retrieve plenty of corporate data, quotes, and charts from Finviz.

iexcloud has one of the best APIs around. You can get a free account with a decent amount of credit (if you use it wisely) and their paid plans start at $9 per month.

News

Almost all of the previously mentioned sites have some sort of news flow available on their site. However, Benzinga has a feature where you can load up your watchlist and get near real-time data in your email inbox. You can select the stocks you care about and the types of news and filings for each. Their paid plan has more access to news that you won’t see elsewhere, but it’s expensive.

The SEC Edgar Filing Tracker is a great way to track SEC filings for the stocks you care about. You can search through filings via a simple interface and you can set up email alerts for certain stocks.

If you are a TD Ameritrade customer, the ThinkOrSwim platform has tons of real-time news that you can filter from within the application itself.

Why is all of this important?

You should trade stocks for companies you love and the companies that make products you love. However, it’s critical to understand if these companies are generating positive cash flow, making products that build a wider moat, and drawing the interest of institutional investors. These are just a few factors to consider when choosing to invest or trade.

Fortunately for you, almost all of the data you need to make these decisions can be acquired for free or at a very low cost. Good luck!

Disclaimer: Keep in mind that I am not an investment professional and you should make your own decisions around stock research and trades. Investing comes with plenty of risk and I’m the last person who should be giving anyone investment advice. 😜

Selling options made simpler

major@mhtx.net (Major Hayden) — Wed, 17 Mar 2021 00:00:00 +0000

🤔 This is another post in a set of posts on options trading. If you are new to options trading, you may want to start with some of my earlier posts.

After writing my original blog post about selling options contracts in the stock market, I received some feedback saying that the post jumped over too many steps and used too much terminology. I went back, re-read the post, and found lots of room for improvement.

If you understood the original post, then this post probably won’t give you much additional insight. However, if the original post left you perplexed, I hope this post helps.

Starting out with an asset

Let’s say you love classic cars. Many older cars that are one of a kind or very well maintained can keep their value for a long time. Sometimes they even go up in value over time due to demand!

You find a great deal on a gorgeous car for $15,000. It’s perfect! Also, demand has gone up for the car recently because it was featured in a popular movie, so it might be worth more after a while.

So you invested $15,000 in the car. But wait, what if the car is stolen or involved in a collision. Would it be worth $15,000 then? Likely not. Let’s assume that the car would lose half its value if it was involved in a collision.

How do you protect it? Insurance.

You call your insurance company and ask how much it costs for a six month auto policy on the car valued at $15,000. They offer you a deal of $500 for six months. You give them $500 and they insure your car.

Let’s convert this to options terminology:

You bought the car (which is like buying stock).
You’re worried about the value of the car going down, so you bought insurance (which is like buying a put option contract).
The insurance company sold you the policy (like selling a put).

The movie is a hit!

The movie that featured the same kind of car as yours was a huge success and now the demand for your classic car is way up. You can easily sell the car for $30,000 now!

But what about that insurance policy when the car was worth $15,000? It’s worth less now because the value of the car has increased so much. If you got in a wreck now and the price of the car was cut in half to $15,000, your insurance policy would still be there, but the value of the car is insured at $15,000.

So you call your insurance company and ask for a new policy. They agree to make a new policy for six months for $1,250. But wait, the car doubled in value and the insurance policy went up by 2.5x. Why is that?

The increase in price of the insurance policy is due to the value going up, but now the value is volatile. It’s more difficult for the insurance company to gauge the value of the car, how much the parts cost, and how much the labor would be to fix it.

You decide to sell your original $500 policy and buy the new one for $1,250 that protects your car valued at $30,000.

Back to options terminology:

The value of the car (stock) went up.
When you needed insurance for the higher value (a put with a higher strike price), the insurance company wanted more money to cover the cost and the volatility of the value of the car (similar to implied volatility for put options).
The insurance company bought back your old insurance plan (like buying a sold put).
You bought the new insurance plan (like buying a new put).

Too fast, too furious

You’re on the freeway in your classic car and you weren’t paying attention to the speed limit. A police officer saw you, pulled you over, and issued you a big ticket which included reckless driving.

It’s time to renew your insurance policy again. But now, the insurance company wants $1,500 to insure your $30,000 car. Why are you paying more for the same amount of insurance coverage?

The insurance company was notified about your massive speeding ticket and they believe that increased the chances of your car being involved in an accident. They want more money from you because there’s a higher chance of the value of your car going down drastically (due to an collision).

This happens with options trades, too. When there’s a bigger chance of a swing in the price of a stock, the implied volatility goes up. That means it’s more expensive to buy options and that selling options pays out more premium (just like the car insurance company could charge extra). The insurance seller (put seller) is taking more risk by selling insurance (puts) and demands to be paid more for it.

It wasn’t my fault!

You learned from your speeding ticket, which is good, but you ran a red light in town and collided with another car! Luckily everyone was okay, but your car is in terrible shape. It will need a lot of repairs.

You call your insurance company to tell them about it and they send you to a repair shop. The estimate to repair the car is $10,000. The insurance company pays for the repairs, but they have lost money on your policy ($1,500 premium minus $10k in repairs).

Once the repairs are finished, your insurance company says if you want to get insured again, it’s going to be $3,000 for six months. Again, volatility is in play here. Your car went from $15k to $30k to $20k in the eyes of the insurance company and that’s plenty of volatility.

Conclusion

Selling puts in the stock market allows you to act like an insurance agent for traders and institutions that want to buy insurance for their stock. If you choose high-quality companies that have good fundamentals and desirable products, then the chances of that insurance getting a claim is relatively low.

Very risky stocks, including those that have not been trading long (think IPOs) and those that have wild swings in value, pay out much more premium for this insurance, but as a put seller, you are on the hook for that swing in valuation.

Striking the right balance between the amount of premium received and the amount of risk taken is a difficult one. Companies that have been around for a hundred years with steady growth are not likely going down any time soon, but there’s not much premium for puts there. On the other hand, brand new companies could swing up and down drastically and the premium is high for those stocks.

Photo credit: Linh Ha on Unsplash

Defending losing options trades

major@mhtx.net (Major Hayden) — Wed, 10 Feb 2021 00:00:00 +0000

🤔 This is another post in a set of posts on options trading. If you are new to options trading, you may want to start with some of my earlier posts.

You did your research. You waited for a good time to sell a put option. You received a decent premium for your option trade. Now your trade has turned into a loss. What can you do now?

There are good choices for these situations, but there’s something important to remember. If you made the trade with strong conviction, you know your maximum loss, and you like the stock, then sticking with your original plan might be the best option.

This post will cover some common options scenarios and what you can do to work through a losing trade.

Losses in the first hour after making the trade

It’s very common to sell an option, either puts or calls, and see the trade show up as a loss immediately. This is unsettling as you first get started with trading.

Often times, this happens when you sell near the bid side of the bid/ask spread. Remember that these spreads have a few properties:

Bid: What the buyers are offering to pay to buy an option.
Ask: Price at which sellers are willing to sell their option.
Mark: Halfway in between the bid and ask price.
Last: The price of the last trade that was made.

Almost all brokerage software shows the current price for a stock or option as the mark price. If the bid/ask spread is $1.00 and $1.10, then the mark is $1.05.

If you sell an option at the bid price of $1.00, your trading software knows the mark price is $1.05. You will see a $0.05 loss on your trade. That doesn’t mean that you lost money, but it does mean that you could have made an extra $5 in premium on the trade. To avoid this, make your next trade at the mark price or higher. Everything has a downside, and the downside of making a trade above the bid price is that your order fill may be delayed or may not occur at all.

Keep in mind that when you sell options, you make more money on volatile stocks. Volatile stocks have a high probability of larger price changes. After you sell your option, the underlying stock can move downwards a little, and this makes your sold put more valuable. Stick with the conviction you had when you originally made the trade and give it a little more time.

The underlying stock price moved down closer to the put strike price

Let’s say you’ve sold a $100 put on your favorite stock, and a few days later, the stock moves down to around $102. You will see a loss in your trading software. The put option gained value as the stock moved closer to the strike price.

At this point, you still have your premium in your pocket and the stock is still over the strike price. You are in a good position to exit the trade profitable and the best option here is to wait.

On the flip side, if you sell a covered call at $110 and the stock creeps up to $108, your best option could be to wait.

The stock price moved just under the put strike price

This was a spooky situation when I first started trading. Let’s say you sold a $100 put for $2.50 premium and the stock moved down to $98. Your put is now “in the money” and it’s a lot more valuable than it was when you first sold it. You will see a loss in your trading software.

Your breakeven on this trade is $97.50 since the strike is $100 and you received $2.50 in premium. If the stock is at $98, then you are still sitting on a $50 profit.

When my trades reach this point, I will usually hold and wait. Best case, the stock will go back over the strike price and I can buy back my put for a profit.

If it expires in the money, but I am above the breakeven, I get a little less profit (still a profit!) and I hold 100 shares. I can then sell covered calls to collect more premium.

The stock price moved well under the strike price

In our previous example, we sold a $100 put for $2.50 in premium. What if the stock price moves down to $90?

At this point, you have a loss on paper of $750 since your breakeven is $97.50. Your put is “in the money” and you will likely be assigned 100 shares. Buying back the put doesn’t make much sense here unless you have a very strong conviction that the stock is going to go down a significant amount.

The goal is to reduce your cost basis. Your cost basis is how much you spent to get the shares you have. In this example, your cost basis is $97.50 when the stock price falls to $90.

Buy shares. You can reduce the cost basis by buying shares at $90. Do your research and ensure that the stock has some clear indicators that it is bottoming out. Use indicators like the 14 day RSI under 50%, stock price touching 50 or 200 day moving averages, or positive news about the company. Be careful here because you don’t want to throw good money after bad.

If you know you’ll have 100 shares at a cost basis of $97.50, buy 100 more at $90. That lowers your cost basis down to $93.75. If the stock price begins moving up, you’ll collect those gains and be able to sell two covered calls instead of just one.

Sell more puts. Selling puts allows you to collect more premium or potentially get assigned at a lower price. These can help you reduce your cost basis further. As said before, be sure to do your research to ensure the stock is bottoming out. Taking a loss on a second put will be frustrating.

If you sell an $85 put for $3.00, the stock stays at $90, and you get assigned on your first put at a cost basis of $97.50, your cost basis drops to $94.50 with the collected premium from the put.

Closing deep thought: volatile stocks are volatile

The more volatile the stock, the higher the premium when you sell options. That’s because the options buyer is paying a premium to transfer some risk to you, the seller. There’s always a risk of getting assigned, and sometimes those assignments are done at a loss.

When your option trade turns red, keep in mind that the volatility that sent the stock price down could easily send the stock price back up. You entered the trade with a strong conviction and often the best action to take is no action at all.

Stay focused on your cost basis and think about what you can do to lower it. Buy shares when the stock falls and begins to bottom out or sell more options to collect premium.

Photo credit: Yuriy Bogdanov on Unsplash

Which stock broker should you use?

major@mhtx.net (Major Hayden) — Sun, 24 Jan 2021 00:00:00 +0000

🤔 This is another post in a set of posts on options trading. If you are new to options trading, you may want to start with some of my earlier posts.

One of my sports coaches in high school used to say: “It’s not the tool, it’s the fool.” This was his reminder that when something goes wrong in the game, it’s usually the fault of the person and not the equipment.

However, when it comes to investing, your choice of brokerage can be critical. There are many factors to consider. My focus in this post will be brokerages for US-based traders.

In the end, every broker gives you access to trade various things in the market, including options, equity, futures contracts, and more. They are often different in many areas.

Data and research

Start by looking at the data that a brokerage provides for your trades. I usually look for the following:

Stock calendars that include earnings dates, product events, and other stock events.
Information about company financials and SEC filings.
Real-time quotes for equities and options. (Extremely important.)
Charting with technical analysis, such as moving averages.
Watchlists for your favorite stocks.

Try to look for brokerages that put as much of this data in a place that is easy to access. For example, a brokerage that puts earnings event data in the watchlist or close to where you make a trade can help you avoid making mistakes around binary events.

Keep in mind that some brokerages charge extra for detailed research data or they may charge for real-time quotes (especially real-time options quotes). (Costs are coming up later in the post.)

Trading inferfaces

Be sure that the brokerage allows you to trade where you want to trade. If you can’t trade at work on a computer, be sure your brokerage has a good Android or iPhone application. If you can only use a web browser to trade, be sure that the broker has a first-class browser-based experience.

Some brokers have full desktop applications that provide the best experience. Be sure to try out their applications on your computer. Almost every broker with a desktop client works on Windows, most work on Mac, and a few work on Linux. Ensure you have a strong enough CPU with enough memory to run the application well.

For trading, ensure that the broker allows a variety of order types, such as day, good til canceled (GTC), trailing stop, and order cancels other (OCO). Day and GTC orders are what I use about 99% of the time, but trailing stops can be handy for swing trades. If you can do a simultaneous cancel/replace (similar to being able to edit an active order), that’s also a plus.

I enjoy brokers that provide a full confirmation step of the order that allows me to read my potential order in plain English along with potential risks and profits. Everyone has made mistakes on an order from time to time, but you certainly don’t want to get caught selling a call when you meant to sell a put. 😬

Contact options

Most traders won’t need to use the customer service team at most brokerages since these platforms are built for traders to do as many things as possible on their own. After all, it is expensive to staff a large customer service team to do things that traders should be able to do by themselves.

Sometimes things do go wrong and that’s when things get complicated. Early assignments on sold options have caught me by surprise in the past and I’ve used customer service agents to ensure I handled the exercise process carefully.

When you get into a difficult situation and lots of your money is on the line, do you want someone you can call immediately? Is an email ticketing system enough for you? How about live chat as an in between option? Decide what is important to you and choose a broker with the right customer service options.

Live chat is acceptable for me but I prefer a toll-free number to call.

Moving money

Look for brokers that make it easy to connect a bank account for deposits and withdrawals. Some brokers will give you a portion of your deposit to use while the remainder clears. Some may give you all of your deposit to trade immediately, but you can only buy stock with it until it clears.

Read the fine print for your broker to ensure you know how long it takes for deposits and withdrawals to clear. Be sure to read about any potential fees for moving money. If you have more than one account with the broker, find out what is involved with moving money (and stocks) between your accounts.

Trade execution

Find out if the broker sends orders directly to the exchange or through a third party. Third parties can reduce cost, but they can sometimes add delays to trades or cause them to be executed at prices which are not the best.

When you are buying and selling stocks with limit orders, the difference here could be a few pennies or less. However, if you’re buying stocks in groups of 100 or more, those pennies add up quickly. For options, a $0.05 price difference is $5 worth of profit (or loss)!

Poor trade execution can cost a whole lot more than the fees from a brokerage with better execution. 💸

Cost

I saved the discussion of cost for last because there are a lot of factors involved here. Many low cost (or no cost) brokers are a great deal for certain trades. Others can be terrible. Lower cost doesn’t always make sense.

When I analyze a brokerage’s costs, I ask questions like these:

Can I get detailed company research for free?
How much does it cost to get real-time quotes for stocks and options?
What is the cost per equity or option trade?
If I get assigned stock on a sold option, what fees are involved?
What fees to I pay to exercise an option?
Will my costs go down as I make more trades?

Some brokerages have special fee structures where you can avoid certain fees based on how you trade. As example, Fidelity does not charge me an options fee if I buy back a sold option for $0.65 or less. If I sell an option for $1.50, I enter a buy order for $0.75 most of the time (to collect 50% profit). However, I can save about $0.70 per trade if I bump that buy order down to $0.65. Read all of the fine print! 🤓

My experience with brokerages

I’ve tried quite a few brokerages as I’ve learned to trade options and here are my thoughts for each with my most preferred brokerages at the top of the list. I currently use TD for almost all of my trades and I use Fidelity to trade options in my HSA.

TD Ameritrade / ThinkOrSwim

TD checks a lot of boxes for me. The full ThinkOrSwim desktop client works solidly on Linux, their Android applications are easy to use, and their web interfaces are straightforward. Options trades are $0.65 each, but the direct trade execution is totally worth it. There’s no fee for being assigned.

The desktop application is full of data and it is completely and utterly overwhelming at first. It takes time to learn the system and where you can find all of the things you need. Over time, it becomes much easier to find information and make trades. The charting is incredibly detailed and quick to render.

The trade confirmation process at TD is really good and I’ve caught some mistakes in the confirmation process. Real-time quotes are included for free and the updates are fast. You can configure the update rate to make it less dramatic.

TD and ThinkOrSwim give you a one-stop shop. You can do all of your trading, screening, and research all in one place. Their customer service is a toll-free phone call away or you can use the live chat that’s built into the ThinkOrSwim application.

Tastyworks

If your goal is to purely trade options, Tastyworks is a great platform. You can buy stocks, too, but that’s not their top priority. Their order entry process for options (buying and selling) is superb and I’ve never found one that I liked better.

Once you place your trade, you can put in a 50% profit order with a couple of clicks. Tracking your trade’s process is done with a handy progress bar.

Trade execution is really fast and the pricing structure is interesting. You pay $1 per option trade to open with a $10 maximum fee. Closing the trade is free. If you get assigned, there’s a $5 fee.

The real downside about Tastyworks is the mobile experience. The Android application is really difficult to use and everything oddly abbreviated. One could argue that you shouldn’t do much of your trading from a mobile device, but I do like to adjust trades on the go from my phone.

Another complaint I have is that transferring money or equities between multiple accounts must be done with signed paper documents. It’s not possible to do the process online. With other brokers, such as TD or Fidelity, you can do this instantly via self-service processes on their websites.

You will need to do your research somewhere else. Tastyworks has charting and tracking of earnings dates, but that’s about it.

Fidelity

Fidelity has full desktop client, but it does not run on Linux, so I haven’t used it yet. Their website works well, although it is pretty basic.

Their trade execution is quite fast and I often find that they improve my limit order price by $1-3 on each option contract. The fees per option trade are around $0.69 and that’s fairly close to the industry standard $0.65.

There are some research and charting tools on Fidelity’s website, but I prefer to do my research elsewhere.

Robinhood

Say what you will about Robinhood, but it’s an all around decent brokerage. You can get extra research data, real-time quotes, and margin for just $5 per month. Stock trades and options trades are free (but there are some small $0.01-$0.02 clearing fees for some trades). Even OTC trades, such as NTDOY, are free.

My main complaint about Robinhood is around trade execution. I usually set my limit orders on options trades near the mark price (halfway between bid and ask). I often have a difficult time getting an option trade to fill unless I adjust the price close to the bid. This isn’t a problem on TD or Fidelity. Spending $0.65 for TD’s better execution makes sense when I’m losing $1-2 per trade on Robinhood due to bad fills.

Robinhood’s customer service has always been superb, but it’s only available via email. I was sweating through an assignment on a put credit spread one Saturday morning and I was able to get a reply in a few hours with the right advice.

Their Android and website interfaces are superb and fast. When trading gets really busy, the website often lags and it can be difficult to enter trades. I’ve found it difficult to get trades done during the first 15-30 minutes of the day. In some situations, my trade has already executed but the website doesn’t show it.

Webull

Webull is another low/no-cost brokerage. Their Android and website interfaces provide some great ways to get research donw fast. They present a ton of information in a small amount of space that would normally require a lot of legwork at other brokerages. I often use my Android Webull app for quick research and charting.

As with Robinhood, trade execution is a challenge. Also, I got into a few situations where I couldn’t enter a GTC order for options trades.

You can’t queue orders outside of certain hours either. Sometimes I would want to adjust an order right before going to sleep but I wasn’t allowed to change my queued order until the next morning just before the market’s open.

Photo credit: Edan Cohen on Unsplash

Choosing options to sell

major@mhtx.net (Major Hayden) — Sat, 23 Jan 2021 00:00:00 +0000

🤔 This is another post in a set of posts on options trading. If you are new to options trading, you may want to start with some of my earlier posts.

You know your terminology, you know your max loss, and you are ready to start. Now you’re faced with the difficult question all new options traders face:

How do I choose which option to sell?

At first, you learn to look for the trades that are right for you. This post explains some of the things I look for when I make a trade, and how I compare different trades to see which one is right for me.

Determine how much you want to risk

If you’re starting the wheel strategy, then you are selling a put contract on a stock at a particular strike price. Options contracts involve 100 shares of the underlying stock, so you can multiply the strike price by 100 to know how much money you are risking on the trade.

For example, if you sell a $90 put option on AMD, then you are risking $9,000 on the trade. The chances of AMD rocketing to $0 is extremely unlikely, but anything is possible.

Compare the size of your trade to the size of your account. Risking $9,000 in a $10,000 account may not be the best idea for new traders since you are putting 90% of your capital at risk. The goal is to avoid “blowing up” – when you lose so much that you don’t have enough capital left for good trades. 💣

If my conviction on a trade is very strong (I know the company, I know the stock’s personality, and I’ve done my homework), then risking 15-20% of my account on the trade seems reasonable. For companies I know less about, I won’t go past about 5-10% of my account on the trade.

Watch your stock’s calendar

There a certain events in the lifetime of a stock that can cause wild swings in price. Selling options around the time of these events creates increased risk because you really don’t know what happens during the event. Some of these events include:

Dividends. These are announced far in advance and stocks will often creep up just before the dividend date and then fall a bit after. If your option buyer wants the dividend badly, you may get assigned early.
Splits. Stock splits are usually safe for options selling since your contract is automatically adjusted without you doing anything. However, if a stock does a significant split, like a 5:1, then a new influx of buyers with a new buying style may get into the stock. The stock’s “personality” can change quickly.
Product events and announcements. Launch events, such as Apple or Google’s new phone launches, or Tesla’s battery days, can have a huge impact on the stock price. The stock can fall even if the launch looks spectacular.
Earnings. Definitely watch out for these. Stock prices do some idiotic things around earnings time. I avoid these in almost all conditions unless I have a lot of conviction about the stock.

I’ve written about earnings in previous options trading post, but it bears repeating: earnings are unpredictable. Even if the earnings report is stellar, you may see the price fall off drastically. Why? Perhaps investors want to take profit. Perhaps investors were expecting more on earnings and the expectations were already “priced in”.

Don’t sell options around earnings unless you know what you’re doing. Even if you think you know what you’re doing, you probably don’t. 😉

Choosing a strike price

Once you know the stocks that fit your trading style, it’s now time to choose your strike price. IThere’s a critical options calculation to know here: delta.

Delta runs from 0 to 1 and some software represents it as a percentage. It describes how much the option price moves as the underlying price moves. Here are some examples:

1.00 delta (or 100%): The option price moves at the same rate as the underlying price. If the stock price goes up $10, the option price goes up $10.
0.50 delta (or 50%): The option price moves at half the rate of the underlying stock. If the stock goes up $10, the option price goes up $5.
0.25 delta (or 25%): If the stock goes up $10, the option price goes up $2.50.

Most of my puts are sold near the 0.25 delta mark. This means that there is roughly a 75% chance that my put will finish out of the money (I keep the premium and there is no loss). There is a 25% chance that my put finishes in the money and I will be assigned stock (possibly at a loss).

We could spend all afternoon talking about delta and theta, but a good start is to sell your puts somewhere near 0.25 delta. I will sometimes move towards 0.30-0.35 delta if I feel very bullish about a stock or I will move towards 0.20 delta if my conviction is less strong.

Calculate your return

We wouldn’t sell options if we didn’t expect a return! It’s a good idea to know your potential return for any trade you make. Let’s take an example trade and calculate our maximum loss and potential return.

AMD is trading at $92.79.
You choose to sell a put at the $85 strike (.26 delta) that gives $2.42 premium and expires 2021-02-19.
Maximum loss is strike price - premium received. That’s 8500 - 242 = $8,258 in the absolute worst case the world is ending scenario.
Your breakeven point is $82.58. As long as AMD stays above that price, you make money.

You can calculate your return with: bid / (strike - bid) * 100. For our trade, that’s: 2.42 / (85 - 2.42) * 100 = 2.9%. If AMD stays over $85 through the life of the contract, you get a 2.9% return.

There’s another angle we can use to analyze the trade: an annualized return. Annualized returns consider how long you had to tie up your capital on a trade while you wait for your return. Would you rather make a 2.9% return in one week or one year? I’d much rather make it in a week.

The annualized return calculation extends the calculation we’ve already done above: (potential return / days held) * 365. We know we have a 2.9% potential return and 28 days to expiration, so we can calculate the annualized return: (2.9 / 28) * 365 = 37.8%

If you did this trade successfully over and over again all year long, you could possibly get a 37.8% return at the end of the year on these trades. Don’t take this as a given, though. I usually use this to compare different trades against each other to see which one is a better use of my money.

Comparing trades

Let’s say you like the AMD trade from the previous section, but you’re also looking at another stock that you really like. How do you choose which one to sell? I usually consider the annualized return. If I can make more money with the same amount of capital, I’ll go for that trade.

FUBO is another stock I follow and I have strong conviction on it as well. Here’s a trade there:

FUBO is trading at $37.72.
You choose to sell three puts at the $30 strike (.22 delta) that gives $2.13 premium each and expires 2021-02-19.
Maximum loss is strike price - premium received. That’s 3000 - 213 = $2,787 Since we are selling three contracts, max loss is $8,361.
Your breakeven point is $27.87. As long as FUBO stays above that price, you make money.
Return: 2.13 / (30 - 2.13) * 100 = 7.6%
Annualized return: (7.6 / 28) * 365 = 99%

The FUBO put has a much higher annualized return, which gets my attention. However, FUBO is riskier for me since the stock has a much shorter history and it is much more volatile. Sure, I can make more money with this trade, but the risk is substantially higher.

After checking the calendars, I found that AMD has earnings in the next week! That breaks my trading rules since I avoid earnings under almost all conditions!

Making the trade

Every stock and options trade has a bid/ask spread. Buyers say “I will pay $1.00 for this trade” and that’s the bid. Sellers say “I will only sell if someone pays me $2.00” and that’s the ask.

Under most situations, I sell at the midpoint of the bid/ask spread. This means that on a spread of 1.00-1.10, I will sell at 1.05. The trade executes within 30 seconds unless the stock price is moving quickly.

If the stock is moving fast or if you really want to be sure your trade gets in, sell at the bid price. That almost always guarantees that a buyer is waiting to buy your contract as soon as you write it.

You can sell at the ask or even higher if you really want to, but your execution could be delayed or it may never execute.

Congratulations! You sold your first option. What do you do now? (Keep reading.)

After the trade

Your trade may turn red immediately after it executes: don’t panic! Most brokers show the midpoint price (or “mark”) and if you sold at the bid price, your trade will be red at first. Also, if the stock price dipped a little, your trade will be red for a short while. Take a deep breath.

One of the first things I do (after logging my trades on thetagang.com), is to put in a buy order at a 50% gain. Consider our AMD trade earlier ($85 put with $2.42 premium). I would enter a buy order for $1.21 with “good til canceled” (GTC). There’s no more work to do! As soon as I can get a 50% gain, the trade executes and I keep my $121 profit!

Why stop at 50%? I have several reasons:

It reduces my chance of loss because my money is at risk for less time.
Emotion is removed from the trade. My trade is closed the moment 50% gains are reached.
I have work and kids. I don’t have time to hover over my broker interface all day long.
It almost always leads to a better annualized return.

A better return with a smaller profit? How can that be? 🤔

Let’s take an example from a PLTR trade I did last month. I sold two $25 puts for $2.04 premium each that had a 128% annualized return. However, the 50% trigger closed the trade in two days when PLTR rocketed upward unexpectedly.

If I held the trade from January 20 to February 12 and PLTR finished above $25, I would have made $408 (128% annualized return). Instead, I made $204 in two days (Jan 20-22). What’s our annualized return here?

Potential return: 2.04 / (25 - 2.04) * 100 = 8.9%
Annualized return: 8.9 / 2 * 365 = 1,624%

Wow! 🤯

That’s 1,624% versus our original 128% annualized return and my money was only at risk for two days. What if PLTR suddenly drops next week? I avoid that risk by collecting profit early and freeing up capital for another trade.

One big part of risk management in the market is to keep your capital at risk for the shortest amount of time possible to make the returns you want.

Good luck! 🍀

Photo credit: Tomas Sobek on Unsplash

Lessons learned from selling puts

major@mhtx.net (Major Hayden) — Mon, 04 Jan 2021 00:00:00 +0000

🤔 This is another post in a set of posts on options trading on the blog. If you are confused on terminology, go back and start with the first post and the series and work your way to this one.

My options trading journey started back in September 2020 and I learned a lot in a short amount of time. This post covers some of the lessons I’ve learned along the way.

Edwin Lefèvre says it best as Larry Livingston in Reminiscences of a Stock Operator:

Whenever I have lost money in the stock market I have always considered that I have learned something; that if I have lost money I have gained experience, so that the money really went for a tuition fee.

Make a set of rules and stick to them

This was one I learned early on from Joonie, the leader of the Theta Gang. His podcasts covered this topic frequently and the importance of this step cannot be understated. Everyone needs a strong set of rules when making trades so that emotion can be removed from trades.

Emotion easily sneaks in and clouds your judgement whether your investments are green or red. When emotion takes over full control, you become “tilted” (as Joonie says), and you make poor choices. You can quickly over-leverage yourself and ruin a winning position. You can also throw good money after bad and make your losing positions worse.

Start by building a set of rules that you can follow, or better yet, add to a screener (more on that next). Here is my rule list as of today for selling puts:

The underlying stock must be a stock I would enjoy holding for an extended period (potentially weeks or months).
The underlying stock must be priced higher than $10.
Choose a trade between -.20 to -.30 delta on a monthly expiration date (no weeklies). This is roughly 70-80% chance of profit.
Make trades on an underlying that is moving sideways or has a long upward trend above the 50 day exponential moving average (EMA), but avoid any underlying stock with spikes or gaps up that aren’t explained by solid news. (This avoid pump and dumps or other manipulative patterns.)
The monthly expiration should be between 21-60 days away from the current date.
A trade should have an annualized return over 20%.
No earnings reports or other news should be scheduled before expiration. (Earnings are dangerous and unpredictable, even if you somehow get an advanced copy of the filing.)

By following your rules closely, you avoid making trades that you regret. However, market conditions could lead you to bend one of these rules. For example, if the market is fairly steady and the underlying has been moving sideways for a while, I may move closer to -.30 to -.40 delta (about 60-70% chance of profit).

Know exactly when you will exit the trade

This one is separate from the rules list above because it is important all by itself. When you enter any trade in the market, have an exact exit strategy in mind.

For my trades, I always exit when I have reached a 50% profit. If I sell a $90 put on AMD and get $2.50 in premium, I immediately enter an order to buy it back at $1.25. This takes all emotion out of the trade and it ensures that I won’t miss out on profits if I am away from the computer. It’s a great feeling to suddenly get a notification from your broker that you made money when you least expect it. 🤗

Always remember: profit is profit. I may make $1.25 on that trade while someone else makes $2.50, but my capital is freed up earlier for other trades and my profit is secured. I’d take a 50% gain over a loss of any size.

Wait on trade ideas to come to you

Sometimes the best trade is not to trade at all. My trading rules are fairly easy to pack into a scanner and that’s usually how I research my trades. I scan for options on Barchart and I will occasionally use finviz to find new stocks that should be on my radar.

I get an email from Barchart about an hour after the market opens with my list of options that meet my criteria. From there, I decide on which ones to trade and which ones to skip. If there’s something good in the list, I’ll make a trade. Otherwise I’ll wait for the conditions to line up with my investment goals and rules.

Trade outside the crazy market hours

I avoid trading during the first hour the market is open (9:30-10:30AM Eastern) and the last hour (3:00-4:00PM Eastern). The trading volume is really high around these times and it can be difficult to figure out what a stock is doing during those times. Day traders and swing traders are extremely active during this time.

Be patient with limit orders

Always use a limit order when selling options and be patient with them. For example, if the bid/ask spread is $1.00 to $1.10 and you decide to set your limit order to $1.05, be patient. Many people will rush to lower the limit when the trade does not execute immediately, but you should stick with your order.

Selling puts on volatile stocks allows you to collect premium, but volatile stocks have volatile options, too. I usually set my limit orders right in the middle of the bid/ask spread and wait. About 90% of the time, the order executes within a few minutes because the stock price is volatile.

Trade where other people are trading

Be sure to find out where the most active options are being traded in the market. Options volume helps you enter trades quickly at good prices. It also helps you exit when it’s time to take a profit. Stocks with low volume options trading can provide good premiums, but it can be challenging to exit the trade when you’re ready to capture profit or limit your loss.

Use care when you follow unusual options activity reports. It can be exciting to jump in on trades when you see lots of money pouring into puts and calls.

However, many of these big options trades are hedges from larger firms who want to avoid losses or capture extra gains for their clients. There’s also some market manipulations strategies here where people buy tons of calls on a stock in the hopes that market makers will buy lots of shares.

Scrutinize skyrocketing stocks

Sometimes you’ll see a stock that has traded sideways or posted small gains day after day and then it suddenly shoots straight up (often called “mooning”). These look like great targets for selling puts at first, but you should be cautious.

Stocks sometimes do this when big news comes out about a company. For example, if a small semiconductor company makes a deal with Apple to put chips in new laptops, there’s a good chance that the small semiconductor stock will moon wildly. The market does this because the company’s valuation is now in flux. Is this company’s valuation now 50% more? Double? Quadruple? Be careful until the market decides on the new valuation.

You may also see situations where stocks go through the roof and there is no news, no big insider trading, and no significant industry news. This is where you should be extremely cautious. Prices often do this when the stock is being manipulated or when activist investors are at work.

The worst case is that the stock is headed into a “pump and dump” scheme where shares are rapidly being bought in the hopes that other investors will buy it up thinking that some news is about to come out (the “pump”). Once a lot of new investors pile on, the group buying the shares stops and sells all their shares (the “dump”).

The dump side often involves investors called “shorts” who short the stock and cause the price to go down further. This is a dangerous move for shorts if the buyers keep buying as this could lead the price to skyrocket again and force shorts out of their shares.

Avoid trading around earnings

Earnings are some of the wildest times in the market and they’re incredibly hard to predict. I’ve seen companies post excellent earnings reports with glowing numbers, great sales, and excellent predictions. As soon as the earnings come out, the stock falls 20%. 🤯

Keep in mind that valuation is a tricky thing and that many investors won’t agree on a valuation for a particular stock. A great example is that one of the analysts following Tesla raised the price target from $90 to $105. Tesla is trading at over $700 today. Again, valuation is in the eye of the beholder.

I’ve also seen companies post terrible earnings reports and their stock remains flat or goes up. There’s a chance that investors already predicted the bad results and they’re priced in already.

Something that may look good at the moment may turn out awful later. For example, if a company releases earnings after the market close, they may only release a PDF after the market closes that includes their SEC filing data. That data may look fantastic and the stock moons immediately. Later, when the company has their conference call, they announce they’re acquiring another company and they are revising future estimates down by 20%. The stock prices falls through the floor.

Even if you had an advanced copy of a company’s earnings filing, it would still be incredibly difficult for you to make a trade that will make a profit once the market is closed.

Track your trades

Keep yourself honest by tracking your trades. I track mine on thetagang.com and it’s a free way to analyze your trading strategy. You can find other people trading the same stocks and ask them questions. There is also a list of trending stocks that is updated frequently and this can help you build your own watchlist.

You can learn a lot from reading notes from other traders about their trades. I encourage you to leave good notes as well since this tests your conviction on the trade. If you’re not confident enough to explain to other people why you made the trade, then why make it in the first place?

There are a litany of spreadsheets out there for tracking trades as well, but the best one I found is the Options Tracker Spreadsheet from 2 Investing. It pulls stock quotes directly from Google Finance and it calculates helpful metrics, including annual return metrics.

Like water off a duck’s back

When you win, take time to understand what worked in your favor so you can repeat it.

When you lose, take time to understand what went wrong and what concrete things you plan to change.

I was up almost $3,300 at the end of 2020 and I chased a skyrocketing stock, FUBO, much longer than I should have. It mooned without much news and I kept chasing it. That led to a loss of over $5,000 and my end of year finish was negative.

My mistake was that I had so many winning trades back to back that I got “tilted” and violated my rules. Initially, everything looked good, but once it turned after hours, there was nothing I could do. I continued to hold and hoped that the conditions would change, but nothing changed. The loss stopped the bleeding and I would have easily lost $2,000 more if I had not exited when I did.

After this failure, I went back to my list of rules and made them more strict. I’m also working on a script that allows me to maintain a watchlist and let quality trades filter through that match all of my rules. I plan to put the script on GitHub soon once it works. I also shared my failure with other people and told them what I thought I did wrong.

The loss still hurts, but I’m trading again to make up the loss. My goal is still to donate a percentage of my gains to charity, so I keep that goal in mind. The key is to stay in the game.

Photo credit: Artem Kniaz on Unsplash

Know your max loss

major@mhtx.net (Major Hayden) — Wed, 09 Dec 2020 00:00:00 +0000

This is the third post in a series of posts on options trading. You can read this one out of order since it applies to almost everything you do in the stock market, including buying shares of stock.

What is “max loss”

The maximum loss on a trade is the worst outcome possible. Knowing this number helps you protect your account from huge losses and avoids terrible situations such as margin calls. (This is when your broker is forced to arbitrarily sell off things in your account or demand money from you to get your account above a zero balance.)

When I first started learning about options trading, many people told me it was too dangerous. They told me “just buy shares since it’s safer.” If you begin analyzing maximum loss, you quickly realize that buying shares can be more risky than certain types of options.

Maximum loss when buying shares

As an example, let’s say you own 100 shares of Wal-Mart (WMT). It’s trading around $148 today, so that means you have $14,800 in total equity. Your maximum loss would occur if the stock fell to zero and your total loss would be $14,800.

A major retailer losing 100% of its value in a very short period of time is highly unlikely, but it’s possible. There’s nothing that prevents it from happening (other than the stock being halted in the market), and there is a chance that you could lose your entire investment.

It took Enron about a year to drop to nearly zero, but some other drops have been much more abrupt. According to Investopedia, some stocks have had some rough days:

Facebook lost $119B (2018-07-26)
Intel lost $90B (2000-09-22)
MSFT lost $80B (2000-04-03)
AAPL lost $60B (2013-01-24)

Buying shares is a great way to start in investing for your future, but it’s important to know your maximum amount of loss and ensure you’re prepared to hold the stock through the down times.

Maximum loss when buying options

When you buy options, your maximum loss is the amount of premium you paid for the option. If you pay $200 for a call on a stock, your max loss is $200. The same goes for puts.

The maximum loss scenario for bought options is when the option expires out of the money. For a call, this means the stock price was under your strike price at the expiration time. For a put, the stock price would need to be above your strike price.

Maximum loss when selling a put

There are two types of puts:

cash secured puts - You sell a put when you have cash to to cover the strike price.
naked puts - You sell a put without having cash to cover the strike price.

Some of this was covered in the The Dark Side: Selling Options post, but it’s worth talking about it here again. When you sell a put, you are obligated to purchase the stock at the strike price.

The max loss scenario here happens when the stock price falls to zero. Sure, that is unlikely, but it is possible. You will keep your premium from selling the put, however.

An important thing to remember is that your options are capped. If you sell a put at a $100 strike price and collect $200 in premium, your losses are capped at $9,800. The stock can’t go below zero (thankfully).

With a cash secured put, you have cash on hand to deal with the loss and purchase the stock. However, with a naked put, you don’t have cash to cover the loss. Your broker will issue a margin call and begin selling off other equities in your account to cover the loss. If that fails, they will demand that you deposit money to cover the loss.

💣 Never sell naked puts. Ever. Seriously.

Maximum loss when selling a call

Here’s where things can become horrifying. When you sell a call, there are two main types:

covered call - You own 100 shares of the stock and use them as collateral to sell a call option.
naked call - You sell a call for a stock but you don’t own any shares.

Let’s work with the covered call example first. Let’s say you own 100 shares of XYZ and that stock is trading at $100 per share. You think the stock might go up a little but not a lot, so you sell a call at the $105 strike price.

The best outcome would be for the stock to stay between $100-$105 so you don’t lose money on the shares you own and your call is not exercised. There’s no losses there.

What if the stock flew to $125? You get to keep the premium for selling your call option, but you have to sell those shares for $105 (since that was your strike price). Sure, you did lose $20 per share of profit ($2,000 total), but you still made money. You received the premium and your stock gained $5 per share ($500). You just missed out on some of the gains.

What if the stock falls to $50? You still keep your premium, but your $10,000 of equity (100 shares x $100) is now $5,000 of equity. You took a $5,000 loss. It’s the same loss you would have had if you bought shares and didn’t sell any options. However, you are getting the small benefit of the premium you received when you sold the call option.

In all of these scenarios, your losses are capped. You know what you can possibly lose, but you know the limit of the loss.

Never sell naked calls

This loss is potentially so bad that it needs its own section. Covered calls are nice because your collateral appreciates in value to cap your upside losses. What if you didn’t own the stock?

Let’s say you sold a call on XYZ for $105 again and it was trading at $100 per share. However, you don’t own any shares this time.

If the stock climbs to $104.99, your option expires out of the money and you keep your premium. Nice!

If the stock falls to $50, your option expires out of the money and you keep your premium. Nice!

If the stock climbs to $125, you have a problem. You agreed to sell 100 shares to the buyer for $105 per share. You now have to buy 100 shares at $125 each (since that’s the current stock price) and you have to sell them for $105 each. That’s a $2,000 loss right there.

However, let’s say that XYZ is a biotechnology firm and they report that they have a treatment for almost any cancer in the human body with a 14 day home treatment with almost no side effects. This is a life-altering change for people suffering from cancer. The stock climbs to $450 and investors say it will go higher. By the time the option expiration hits, the stock is worth $600.

What now? You sold a call option for $105. That means you have to buy 100 shares of the stock at its current price ($600 each) and sell that stock for $105 each. The math start to hurt:

You purchase 100 shares at $600 each = $60,000.
You sell 100 shares at $105 each = $10,500.
You lose $49,500. 🤯

💣 Never sell naked calls. Ever. Seriously.

Know your max loss

Before you enter a trade, know what the worst case scenario will bring and ensure your account is prepared for it.

I entered a trade earlier this year where I had a 85% percent chance of profit and the trade looked fantastic in my account. I had money to cover the loss but I doubted I would need it.

The company suddenly dropped news within 48 hours of entering the trade. The news said that one of their acquisitions was a little slower and more expensive than they thought and their Q3 number would be revised down. The numbers were revised down a lot. My nice gain turned into a $660 loss that I was forced to look at every day for a month until the expiration. It was a daily reminder of two things:

Anything can happen in the market.
I was fully prepared for maximum loss.

💸

Photo credit: Andre Benz on Unsplash

The Dark Side: Selling Options

major@mhtx.net (Major Hayden) — Mon, 07 Dec 2020 00:00:00 +0000

I’ve started a series of posts on options trading and if you haven’t read yesterdays post, Options trading introduction, you should start there first.

Recap: Buying calls and puts

Just to recap the introductory post:

Buying a call gives you the right to buy a stock at a certain strike price
Buying a put gives you the right to sell a stock at a certain strike price

Buying calls is a great way to capture gains from a stock that is trending upwards an buying puts provides an insurance policy in case your stock drops.

You can make money in multiple ways:

Exercising a call option to buy stock at a reduced price (without owning the stock first)
Exercising a put option to sell your stock at a higher price (and reduce losses on your owned stock)
The stock moves towards (and hopefully, past) your strike price and you can sell the option to someone else for a profit

But there’s an entirely other world out there and it involves selling options.

Rights versus Obligations

So far, we’ve only talked about rights. When you buy an options contract, you have the right to do nothing, exercise the option, or sell it away to someone else.

Selling options means you must fulfill an obligation. We aren’t talking about selling an option you purchased – that’s simply called selling to close. What we’re talking about here is a different concept: selling to open. This is sometimes called writing a put or writing a call.

When you sell a contract, you are paid a sum of money called a premium. The buyer is the one paying the premium to you. Let’s dig into what’s happening here:

You are going out into the market and saying “I’d like to get $200 to sell this put that expires on December 31”
A buyer can choose to take you up on your offer, give you $200, and the contract is written
The contract is written in stone until the expiration date

It’s key to remember here that there are only two ways out of an options contract that you sell:

You buy it back (hopefully at a profit). This is called buying to close.
The option expires.

There are three warnings we must cover before we go any further:

💣 Never sell an options contract that you do not intend to fulfill. Sure, it may sound amazing to receive $4,000 in an instant to sell an option, but eventually that option expires and that can sometimes be a disaster.

💣 Never assume that you will be able to buy to close your sold contract before expiration. The market does weird things and you may be stuck with holding your option through expiration or taking a loss before expiration.

💣 Never sell options contracts if you don’t have stock or cash to cover them. Getting stuck in a margin call (or worse) with your broker is not a good place to be.

With that said, about 95% of my current trades involve selling options. More on that later.

Selling puts

We should talk about selling puts first because that concept is a little easier. When you sell a put, you specify a few things:

Underlying stock ticket (such as AMD, WMT, or TM)
Expiration date
How much premium you want (this is the ask portion of the bid/ask spread)
The strike price

Selling puts can make money in a few different ways. The stock can go up, go sideways (where it hovers around a certain price), or go down a little.

Let’s go through an example. You think AMD is likely going to keep its same price or go up over the next few weeks. If AMD is trading at $100 now, you decide to sell a put for $90 and collect $200 in premium.

🛑 Before entering this trade, ensure you have at least $9,000 of cash in your account. 100 shares of AMD could potentially cost you $9,000 if you are assigned – more on that below.

Now what?

AMD skyrockets up to $125
- Your put loses value rapidly and you can buy it back for only $25 after a few days. You just made $175 in profit since you originally received $200 for selling the contract and paid $25 to close it.
- You can let your put expire and keep the $200 premium. (Risky!)
AMD gets stuck at $100
- Over time, your put loses value and you can buy it back at a cheaper rate before it expires (optional).
- You can let your put expire and keep the $200 premium. (Risky!)
AMD falls to $85
- You’re now in the money and that’s not great for a sold option.
- The buyer will likely exercise the option they bought from you and you will be assigned at a loss. (Keep reading)

Assignment on puts

Some traders hear about assignment and they run off to hide. Assignment means that the buyer of your contract wants to use their right to exercise.

Let’s go back to the very last example above where we sold a put for $90 and AMD fell to $85. This situation feels scary until you break it down:

You keep your $200 no matter what. You sold the contract and that’s yours.
You must buy 100 shares of AMD at $90 each.

But wait, you have to buy AMD at $90 even though AMD fell to $85! That’s your obligation for selling the contract. That means you will lose $500 on the stock purchase. (You bought $8,500 of AMD stock but had to pay $9,000 for it.)

All together, you lost $300. You paid $500 extra for the AMD shares but you kept your $200 premium for selling the contract. But, now you have 100 AMD shares worth $8,500 in your account!

What do you do with those?

Selling calls

Now you have 100 shares of AMD in your account worth $8,500 and you’re still down $300. It’s time to talk about selling calls. Selling calls and puts involve the same concepts of specifying a strike price, how much premium you want, and an expiration date.

You take a look at the options chain and you see that you can sell an AMD call for the $90 strike price for $250 and it expires in a few weeks. This is called a covered call since you own 100 shares as collateral for the contract.

You sell the call and now there are some potential outcomes:

AMD falls to $80
- Your call loses value rapidly and you can buy it back for a tiny amount. If you buy your call back at $25, then you made $225. ($250 premium originally received minus $25 you paid to close it)
- Go back and sell another call, collect more premium, and increase your profit.
- Allow the call to expire worthless and keep your full $250 premium. (Risky!)
AMD gets stuck at $85
- Your call gradually loses value and you can buy it back for a tiny amount.
- Go back and sell another call, collect more premium, and increase your profit.
AMD climbs to $95
- You’re now in the money here.
- When the option expires, the buyer of your contract will likely want to exercise and they will buy your shares at $90 each (your strike price).
- Your shares are gone. (But keep reading.)

Assignment on calls

Getting assigned on puts means you have to buy the stock at your stike price. Getting assigned on calls is a little different. You sell your stock at the strike price to the person who bought your call option contract.

Let’s go back to the previous example where you sold a $90 call option for $250 and AMD went to $95 per share:

You keep your $250 premium since you sold the contract.
You sell your 100 AMD shares at $90 each (your strike price) even though AMD is trading at $95.

Technically, you lost out on $500 of profit that you could have received if you had not sold the call. However, you keep the $250 of premium and you can begin selling puts again.

Why not just buy stock and hold it?

I have accounts where I buy stock and hold it for a long time. However, selling options allows you to collect premium and get profits even in a market that isn’t moving much.

If a stock gets stuck in a sideways pattern where it doesn’t move much for weeks, buying and holding the stock might give you a very small gain. During that time, you may have been able to get a better return selling options on that stock and collecting the premium.

What’s the worst that can happen?

It’s always important to know what your max loss is for any trade. Losses begin when the stock price breaches your breakeven price:

Put breakeven = strike price - premium received
Call breakeven = strike price + premium received

If you sell a $90 put for $200 and the stock falls to $89, you are still up $100. If you sell a $90 call for $200 and the stock goes up to $91.50, you are still up $50.

However, if you are selling puts or calls, there is a chance that the stock could completely crater and go to zero. The chances of that happening to a well-known company that has been on the market for years is very low, but it’s important to know max loss.

Let’s say you sold a put on company XYZ at the $100 strike and received $500 in premium. The stock somehow falls to $1 per share. Your max loss here is ((100 x $100) - (100 * x $1)) - $500 = $9,400. The buyer of your options contract will surely want to exercise so they can sell their XYZ stock at $100 instead of $1.

On the call side, let’s say you sold a $110 call on XYZ for $500 and the stock fell to $1. The 100 shares of XYZ you own would now be worth $1 per share, but you do keep your $500 premium. If you had owned the shares without selling that call at that time, you would have suffered the same fate (without getting $500 in premium).

The Wheel

The strategy shown here is called the wheel strategy. It involves these steps:

Sell puts and collect premium
If unassigned, go back to step 1
If assigned, sell calls and collect premium
If unassigned, go back to step 3
If assigned, go back to step 1

This strategy will be covered in the next post!

Photo credit: Ricardo Gomez Angel on Unsplash

Options trading introduction

major@mhtx.net (Major Hayden) — Sun, 06 Dec 2020 00:00:00 +0000

I’m always on the hunt for new things to learn and one of my newer interests is around trading options on the stock market. Much like technology, it becomes much easier to understand when you peel back the layers of archaic terminology, snake oil salespeople, and debunked data.

Stay tuned for additional posts that go into greater detail. This post covers the basics about what an option is (and is not) and how you can compare it to other investment vehicles, like stocks.

Investing in stocks

Most of us are likely familiar with how investing in stocks works to some extent. The process goes something like this:

Deposit money into a brokerage account
Find a company that has good qualities for value and growth
Buy shares
Wait

If the company performs well and other investors also see value in the company, your investment should gain value. For example, If you buy 10 shares of a company for $100 each ($1,000 total investment), and the stock value goes up by 10%, you will have 10 shares at $110 each ($1,100 total investment).

Stocks go up very often, but they go down, too. If the stock lost 10% of its value, you would own 10 shares of a $90 stock and your total investment would fall to $900.

Sometimes the stock market does downright silly things and companies with great fundamentals go down, while others with horrible numbers keep going up.

A. Gary Shilling once said:

Markets can remain irrational a lot longer than you and I can remain solvent.

Nothing could be more true.

How are stocks traded?

This could be an entire post in itself, but I’ll keep things simple. When you buy a stock, you’re buying it from someone else. That could be another investor, a hedge fund,a mutual fund maintainer, or a massive company.

The other entity will set the price they are willing to sell some stock. This is called the ask. Buyers in the market set the price at which they want to buy, called the bid. When you look at the highest bid and the lowest ask for a stock at one time, that’s called the bid/ask spread or often just the spread.

If nobody sets a bid at or equal to anyone’s ask price, no stock changes hands. Either the buyer needs to raise the price that they are willing to pay or the sellers need to come down on their asking price.

Look for stocks with a narrow bid/ask spread under $0.05-$0.10. This means the stock is liquid (easily bought and sold) and you’ll avoid a weird situation called slippage, where the bid/ask spread is really wide and your trade may not execute as a good price. (Limit orders help here. More on that later.)

What is similar about options?

Options have bid/ask spreads, just like stock. Options are called derivatives because they are derived from a certain stock. That stock is called the underlying, since the options depend heavily on the stock’s performance. (Not every stock on the market has options, though.)

What is different about options?

Options are contracts. Every options contract has rights, obligations, and an expiration date.

Buyers of options contracts have rights (things they can choose to do) and sellers have obligations (things they must do). Everything starts with a buyer or seller who wants to open a contract. Once it’s open, it can be closed via different methods.

It revolves around two main types of contracts: calls and puts.

Buying calls

If you buy a call option contract, you have the right to buy shares at the price you specify, which is called the strike price. (You can sell calls, too, but let’s keep this simple for now.)

AMD is a popular stock for options traders and we can use it as an example. Let’s say that AMD is trading at $100 per share and you think their next chip launch will be really successful. A call could help you catch some of the potential upswing in the stock.

Let’s say you buy a call at a strike price of $105 for $200 and the contract expires December 13. What have you done here and what are your rights?

You made a buy to open order for a call contract that cost you $200.
You cannot trade this option after the market close on December 13.

What are the potential outcomes before expiration? Let’s analyze what AMD could do during that time:

Best outcome: AMD rises to $110
- You are in the money
- Your options contract will increase in value and you can sell it before expiration.
- You can choose to exercise the option, which means you are using your right to buy 100 shares of AMD at $105 each, even though the stock is trading at $110! Your profit would be (100 * $110) - (100 * $105) = $500
Good outcome: AMD rises to $104.99
- You are at the money
- During this time, your call option goes up in value since the stock price has moved really close to your strike price of $105.
- You can sell your option contract for a profit before expiration.
Worst outcome: AMD falls below $100
- You are out of the money
- Your options contract will be worth a lot less since the stock price has moved away from your strike price.
- If your options contract still has some value left, you could sell it to get back some of your losses.
- If AMD falls really far below $100, you may find that your option has no value. This is called max loss and it hurts.

💣 Just in case you missed it: you can easily lose all of your investment with options.

With stocks, a company can take a heavy loss, but you still have some value left. With options, that same scenario means your original $200 investment is completely gone.

Buying puts

Buying a put, called a long put, is a different thing entirely. You are choosing a price where you are willing to sell 100 shares of stock you own. It’s a great insurance policy for stock that you own.

Going back to the AMD example, let’s say you own 100 shares of AMD at $100 each. If you buy a put at $90, you have the right to sell your stock at $90 even if AMD is trading lower than $90.

Let’s go back to our $100 per share AMD example and you buy a $90 put for AMD that costs $200 and expires December 13. There are some possible outcomes:

AMD rises to $110
- Your put option will lose lots of value, but it was your insurance policy anyway.
- You can sell your put as the expiration gets closer, or you can let it expire on December 13th. It’s worthless at that point, so nothing happens.
AMD drops to $90.01
- Your put will increase in value since the stock price has moved close to your strike price. You can choose to sell it before it expires to get a profit. (Keep in mind that the stock you own has lost value, too.)
AMD drops to $80
- You can exercise your put contract and sell your 100 shares of AMD for $90 each, even though the current price is $80 per share! This will net you $10 per share, or $1,000 total. Your losses from the stock’s fall are limited.

You might be asking: What happens if I think a stock will go down, I buy a put, but I don’t own the underlying stock?

If the stock drops, you can sell the put for a profit as the value goes up. However, if you choose to exercise it, you will have a short position in your brokerage account. This means you’ve borrowed stock from your broker and they will likely charge fees and/or interest for this.

If AMD’s price quickly rises afterwards, you will owe your brokerage the difference. This is painful! Just imagine borrowing 100 shares at $80 each from your broker only to see the stock fly up to $120 per share. You will owe your broker that $4,000 difference. 🥵

Exercising

In your personal life, I usually recommend exercising regularly. When it comes to options, exercising may not be your best bet. There are plenty of situations where exercising an options contract is the worst idea.

Let’s go back to our original example about buying a call on AMD for $105 when the stock is at $100. As an example, the stock price climbs to $110 before expiration and stays there on Friday afternoon. You are excited about your profits and you tell your broker to exercise your contract.

Your broker submits the exercise request to CBOE, the options clearinghouse. The CBOE has some detailed rules about exercising that I highly recommend reading.

Let’s say that something happens after hours at AMD that turns out to be really bad. Maybe there’s a delay on new chips, an accounting irregularity, or something else. The stock crashes after hours after you have asked for the exercise. The stock could be down to $80 by that point.

Since you asked for the exercise, the stock you expected to get (100 shares at $105 each) will actually be 100 shares at $80 each by the time your exercise is finished. This is an extreme example, but always consider what can happen during the exercise process.

For a detailed explanation of potential outcomes here, and how to avoid them, I highly recommend the Options Expire Saturday episode of the Theta Gang Podcast. (The podcast is excellent overall.)

What’s next?

👶🏻 This introduction barely scratches the surface of options contracts, so don’t start trading yet.

I’m planning future posts about selling options contracts, how to choose the options to sell and buy, as well as many other ways you can gain (and lose) money with options contracts.

Photo credit: Dave Hoefler on Unsplash