Options Level 2's targeted audience, and most of our user community, are investors, like you. It can be your only tool, or a much needed addition to an existing trading tool box. From newbies to mavens, Level 2 sharpens the edge and adds value. Option service providers are shops that sell investment advice, brokerage services, trading software and market data. You, and many of us, are what retail service providers categorize as a "retail trader".
In some cases, providers have shared business interests. In some cases, those shared business interests can be in conflict with the interests of their customers, the trading community. The more complex options are made to appear to the trading community, the better the prospects that traders will engage in complex trades and strategies that may benefit their providers bottom line more than theirs.
The more a trader believes that complex strategies are the only path to success, the more likely it is that he will purchase subscription data feeds and require full time brokerage services to trade. The question always is: Whose bottom line does the notion of complex investment strategies benefit more, the trader, or the providers selling the data and brokerage services required to support the notion of a complex strategy?.
Let's review some basic options terms before we discuss where Options Level 2 offers value and advantage.
Options trading, in simplest terms, is just a meat and potatoes "buy strategy". A "bet" on the future market performance of the stock underlying the option. One advantage to betting an option over a stock is that when a stock looses, the shares' owner looses a proportionate piece of his stake. With options, when the underlying stock does not perform, the option might still offer a profit, or at least retain all or some of it's premium cost. Options are cheap. Options offer two liquidity outcomes, a close and an exercise.
Options are a derivative, or "side bet" placed on the underlying stock. Options are "written" by traders and can obligate the option's writer acquire or sell shares of the option's underlying stock. An option is a contract that grants the option's holder the right to demand the option's writer buy or sell 100 shares of the underlying stock when the option is exercised. Options offer three outcomes: Exercise, closing and expiration. The preferred trade is to close, or sell to close the option back to the options market.
EXERCISING THE OPTION: Options can be "exercised" before they expire. A call option is a bet that the option's underlying stock price will advance above the option's strike price. A put option is a bet that the stock price will trend below strike. Exercising an option obligates a stock transaction. Exercising is the least common form of liquidation.
EXERCISING A PUT OPTION: Exercising a put option obligates the option writer to buy the stock from the option holder at the option's strike price. Example, a 25$ put strike, when the market for the stock is 18$. In this case the option writer will have to pay 7$ more for the stock than it's market price, 18$. Since an option contract is for 100 shares, the gross profit from exercising the option would be 700$ (25$ - 18$) x 100. The net profit expenses the cost of the option. So, if the "bid" acquiring the 25$ put strike was, for example, 1.50$, the total cost (or premium) would be 150$ (100 x 1.50$). The net profit, excluding brokerage fees, for our 25$ put strike is 700$-150$, or 550$.
EXERCISING A CALL OPTION: Exercising a call option is almost the opposite of a put exercise. The main difference is that option "writer" is required to sell the stock to the option holder at the call strike. The call holder profits from the difference of the current high market for the underlying stock and the option's lower strike. Example, a 10$ call strike is exercised when the market for it's underlying stock is 15$. The writer is obliged to sell the stock to the option holder at the strike price of 10$. The option holder can then sell the stock at it's current market of 15$ and realize a profit 15$ x 100 - 10$ x 100, or 500$ gross profit. The net, again, would be less the premium that acquired the option.
TO PROFIT FROM AN EXERCISE, the stock price has to breach the BEP, or "break even price", BEP is the strike, plus or minus (call or put) the option's premium. Exercise realizes a profit for a call when the stock price exceeds the BEP. Exercise realizes a profit for a put when the stock price falls below the BEP.
WRITERS AND HOLDERS: The option writer is offering a side bet that the stock will not cross his strike. To take the bet, the option buyer pays the option writer a premium to own, or hold the option and right to transact the stock at the option's strike. The risk to the option holder is the premium cost. The writer is obligated to an unknown risk, the difference between the stock price and strike should the option be exercised. The writer has reasons for offering. A story. It could be the market for the stock is "stagnant" and he is interested the liquidity he could get from the option's premium. Much of the demand for options comes from writers who would rather buy their contract back than risk the exercise.
MOST TRANSACTIONS are "sell to close" trades where an option holder "asks" a price for other traders to "bid" to hold, or own, the option.
CLOSE TO SELL: The sell to close, or closing sell, is a trade the option holder executes to sell his option back to the market before it expires. A closing sell, hopefully, realizes a profit. A closing sell can act as a stop loss to protect the premium, or unwind the option at a partial loss. A closing sell can be more profitable than exercising the option. A closing sell does not require a stock transaction. A closing sell can realize a profit even when the stock price is short of the strike.
THE PROFIT FROM CLOSING THE OPTION is the difference of the price the option was purchased and the bid the option was sold. Unless the option has departed significantly from break even, it may still be able to close above the premium. Don't use overly optimistic hedge ratios. Don't get emotional. Don't get greedy. A minimal profit is better than a loss. A slight loss is better than a big loss. Don't set the limit price too high. Don't set the stop loss to low. And don't wait until the last minute to let it go. Give the market, and yourself, plenty of room. Think or swim. It's your money.
EXPIRATION: Most options expire worthless. With Options Level 2's CBOE Viewer they are easy to spot. For example a 150$ call strike expiring in 180 days is offered for a stock currently trading at 15$. It's a sure bet the stock price will never get near the offered strike before the option expires. Options Level 2's CBOE Viewer also shows the trading volume for each option in the chain. If there is little to no trading activity associated with an option, then there's probably a pretty good reason it's collecting nothing but dust. As mentioned, future demand for the option is a factor in the probable closing value it may offer.
Options Level 2's Price Analyzer will forward spot models to a charted a "term" of the option, from current market, through expiration, using 3 Dimensional Black Scholes Pricing Surfaces. In most cases, traders will, instead, send liver market straddles using the CBOE Viewer to Options Level 2's Forward Price Matrix Models.
PREDICTING CLOSE TO SELL OUTCOMES IS ALL ABOUT IMPLIED PRICING. LEVEL 2 ALSO PROVIDES AN ALTERNATIVE METHODOLOGY THAT USES RATIO OF THE OPTION'S MARKET VALUE TO IT'S HISTORICAL VOLATILITY FAIR VALUE (sometimes referred to as a hedge ratio).
And that's where our program, Options Level 2, offers traders an advantage.
Many pricing tools render only a spot price for the date it was priced (or acquired). "Market Geeks" refer to Fair Value Spot Prices as the option's "intrinsic" value. The market value of an option is the price what traders "bid" to buy, and "ask" to sell an option. Options Level 2 forecasts in the market up to 3 weeks out using American or European models. Level 2 also features a Convergence Model that forecasts in the market at 3 weeks out from a prospective open. After 3 weeks, beginning around the 4th week traders relay on Level 2's decay model usinf so called sticky delta and theta decay of the options current trading range.
Historical Volatility Fair Value is used, along with Put Call Parity, to determine the relative bargain of an option to be purchased. If the spread of fair value to the market ask is too high, or the market is above Level 2's implied price, rhe trader can adjust the bid, or choose not bid at all.
The basic theme of Options Level 2 is to allow a bunch of options to be shopped with the intent of determining the redemption points and the value of the redemptions. Options closed to protect market gains would be redeemed at the underlying's stop limit price. Options closed to protect the investment would be redeemed at the underlying's stop loss price. Ideally, the closing order would allow the trader set the trigger price of the stock to execute the close.
Depending on brokers and trading systems, the trader may [also] be allowed to specify the initial closing ask. To do this, the trader would forward options in the CBOE View to Level 2 Implied Pricing Model to determine approximate stock price pegs based on his assumptions When a useful match is located. The total return matrix in the pricing model will show the expected value ot margin (total return or gain/loss) to help determine a reasonable exit strategy.
One of Options Level 2's user community forwarded this helpful link from Interactive Brokers as an example of one method to peg a closing sell order to the price of the stock. Anything to avoid chasing the ticker! Usually, our first limit is the most reasonable. Ticker intimacy is sometimes overrated. The tick is either at the money, or it's not at the money. It cannot be controlled. The potentential liquidity and the required liquidity has been what it is since day one - and nothing the tick does will change that.
Options Level 2 is not about complicated strategies or tick chasing. Options Level 2 is all about a smart buy strategy based on the trader's researched assumptions of the underlying stock's future market performance. Options Level 2 is about predetermining the sell of the option before the option is acquired.
Implied forward spot prices are a function of implied volatility, interest rate, divivend or carrying costs, stock price and time. If the stock were to stay in a very tight range, or constant, through to expiration, the option's forward spot prospects will change. Options Level 2's European and American Pricing Surfaces make fair value trends obvious. Fair value, depending on the market, has a probability, or trend characteristic. A change in stock price, or market day, and the passing of time towards expiration affects fair value.
Alternatively, Options Level 2 also offers a hedge ratio multiplier allowing HV fair value conversions to approximate market values to assess the redemption potential for future sell to close opportunities. Options Level 2's CBOE Viewer presents the hedge ratio, or market to fair value ratio for each leg of the straddle. A leg is the call and the put. The straddle is both legs of the strike and expiration (aka option pair). Options Level 2's pricing surfaces "price the straddle" and will mark the closing profit margins to the traders hedge ratio assumption.
The CBOE data is free. Options Level 2 will open the CBOE chain download page. The stock symbol is entered and the option chain, or all the options currently trading for that stock are downloaded and then read and priced (fair value, BEP, market to fair ratio, closing margin and exercise margin) and presented in the view. Once in the view, the straddle can be forwarded to the price analyzer.
Once in the Price Analyzer various charts for the option can be called up to determine future liquidity or profit features. Stop limit: the price of the stock at which the option would be closed to realize a profit and the initail ask. Stop loss: the price of the stock and the ask for the option to be sold to protect the premium from catastrophic loss.
Level 2 is perfect for new traders because it allows option legs in the CBOE View to sent to Options Level 2's Portfolio and held as test options to assess the righteousness of a trade. The ask for the test trade can be set. Then from day to day, the CBOE Chain can be downloaded and used to markup the closing and exercise positions of the "experimental" options.
Bottom line is Options are fair value animals. Fair value is today, and any day before the option expires. Fair value can determine the buying bid or the selling ask for the option for a range of stock assumptions and time assumptions before it expires. Options Level 2 is about determining when to fold and how many chips you need to keep, or when to call, and capping the chips you get to walk away with.
Options Level 2 is about learning and value based buying strategies. There is a learning curve. There are questions you will need to put to the search engines. Options Level 2 is about your success, your adventure, and not the numbers your data or brokerage services hit.
Options Level 2 is an 800$ pricing tool selling at a great introductory price with all the advantages of our upgrade polcy for lass than 100$! Some of our esteemed competitors sell solutions that, in some cases, are older, more expensive and less revealing and seem to place more priority in benefitting e-brokerage and data providers than adding value to the trading communities bottom line.
Get a copy and start using it! If you have questions, you can email me. Fattail is a great blog full of energetic, agenda free, knowledge. Never forget: Options are about your assumptions on the future performance of the underlying stock. That's all they are.
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