ESSENTIAL OPTIONS STRATEGIES FOR ANY MARKET · ESSENTIAL OPTIONS STRATEGIES FOR ANY MARKET Explore Put your knowledge into action. ... Learn what this indicator is and how you can

All Rights Reserved BigTrends.com

Let’s Get Started!

PRICE HEADLEY, CFA, CMT

ESSENTIAL OPTIONS

STRATEGIES

FOR ANY MARKET

ExplorePut your knowledge into action.

Practice and start using your new

trading tools to find and trade

opportunities

EducateUnderstand the tools you have for

trading. Learn what this indicator is

and how you can profit from it with

our unique tactics.

ExecuteNever trade alone. Join us in our

trading workshops to maximize your

new found expertise. We’ll trade

with you.

BIGTRENDS.COM


BIGTRENDS.COM






opportunities




our unique tactics.




with you.

COVERED CALLS


What is a Covered Call

Covered Calls

Sometimes referred to as a buy-write

strategy

Considered one of the fundamental

options trading strategies

A directional strategy, seeking a

bullish or sideways trend

Involves buying a stock, then selling

a call of the same stock

Typically, the call that is sold will be

Out of the Money (OTM), in order for

it to expire more likely.

Critical Trading Strategy


Covered Calls

Trading Strategy

Many stock investors will sell

covered calls to protect gains rather

than having to exit the position

Because selling covered calls limits

your maximum gain, traders often

sell OTM calls to have a higher

ceiling on their trade

Income focused traders often sell

covered calls with the goal of having

them expire worthless every month

Covered calls can also be used to

lower the cost basis for a stock trader

When to Use Them


Covered Calls

To properly execute a covered call strategy,

you need to master each of the steps below.

Stick with an appropriate time frame

Weekly or Daily Charts

Don’t use intra-day charts

Have an indicator that can consistently point out strong trends

Have a systematic approach to choosing the strike price for your option

Understand Max Gain, Breakeven & Stop Loss Levels

Execute your exits appropriately

Key Strategy Points


Time Frame

Trading Guidelines

When implementing an options

strategy, it must align with the type of

trader that you want to be

Day Trader

Swing Trader

Position Trader

For the Covered Call strategy, you

are placing a longer term trade

Position Trading is the best time

frame when trading Covered Calls

Covered Calls


Long Stock Trade

Trading Tool

Buying a stock is a common strategy

that most traders have experienced

Using profit and loss charts to

visualize the potential outcomes for a

strategy is often very helpful

When buying a stock, the gain/loss is

in direct correlation to the gain/loss

on the stock itself

The line remains at a constant slope,

with a defined loss of the stock hitting

zero, and an infinite maximum gain

Profit/Loss Charts


Profit/Loss Graph

Covered Call

The covered call graph is

similar to the long stock until

you reach the strike price

The maximum profit at

expiration is at the strike price

Once the stock reaches the

stock price, many traders will

roll the short call to a different

month and/or strike

When volatility is higher, the

premiums are higher, making

covered calls more attractive


Options Execution

Trading Strategy

Once you understand the

fundamentals of an options strategy,

you need to learn how to apply it

This execution step is where most

traders fall short and make mistakes

Your technical indicators must

provide a signal before you consider

entering into an option trade

Once you have a confirmed signal,

you must analyze the available

options to find the correct play

Building a Strong Foundation


Sample Trading Scenario

General Electria Company – (GE)


Covered Call – Bullish Scenario

Trade

Stock – 100 Shares @ $16.78 each = $1678

Call – Sell 1 $17.5 Call (100 shares) @ $0.30 each = $30

$1,678

- $30

$1,648

If stock goes to $17.62 (5% gain) at expiration

Stock worth $1,762

Option worth $12

Net Profit $84 on stock

+$18 on option decay ($30-$12 = $18)

+$102 gain on trade or +6.1% gain on $1,648 cost

General Electric Company – (GE) @ $16.78


Covered Call Bearish Scenario

Trade



$1,678

- $30

$1,648

If stock goes to $15.94 (5% loss) at expiration

Stock worth $1,594

Option worth $0

Net Profit -$84 on stock

+$30 on option decay ($30-$0 = $30)

-$54 loss on trade or -3.2% loss on $1,648 cost



Covered Call Neutral Scenario

Trade



$1,678

- $30

$1,648

If stock stays at $16.78 (Zero Change) at expiration

Stock worth $1,678

Option worth $0


+$30 on option decay ($30-$0 = $30)




Covered Call Actual Results

Trade



$1,678

- $30

$1,648

If stock goes to $20.37 (+21.3% Gain) at expiration

Stock worth $2,037

Option worth $287

Net Profit +$359 on stock

-$257 on option decay ($30-$287 = -$257)


Not managing the short call cuts your profits by $257






Covered Call Bullish Scenario

Trade


Call – Sell 1 $29 Call (100 shares) @ $0.55 each = $55

$2,719

- $55

$2,664


Stock worth $2,855

Option worth $0


+$55 on option decay ($55-$0 = $55)


Microsoft Corporation – (MSFT) @ $27.19



Trade



$2,719

- $55

$2,664


Stock worth $2,583

Option worth $0


+$55 on option decay ($55-$0 = $55)





Trade



$2,719

- $55

$2,664


Stock worth $2,719

Option worth $0


+$55 on option decay ($55-$0 = $55)





Trade



$2,719

- $55

$2,664


Stock worth $2,802

Option worth $0


+$55 on option decay ($55-$0 = $55)


The stock stayed below the short call, bringing in the full $55 premium







Trade


Call – Sell 1 $105 LEAP Call (100 shares) @ $4.20 each = $420

$9,468

- $420

$9,048

If SPY goes to $104.14 (10% gain) at expiration

Stock worth $10,414

Option worth $0


+$420 on option decay ($420 - $0 = $420)


S&P 500 ETF – (SPY) @ $94.68



Trade



$9,468

- $420

$9,048

If SPY goes to $85.21 (10% loss) at expiration

Stock worth $8,521

Option worth $0


+$420 on option decay ($420 - $0 = $420)


S&P 500 ETF – (SPY) @ $94.68



Trade



$9,468

- $420

$9,048

If SPY stays at $94.68 (Zero Change) at expiration

Stock worth $9,468

Option worth $0


+$420 on option decay ($420 - $0 = $420)


S&P 500 ETF – (SPY) @ $94.68



Trade



$9,468

- $420

$9,048

If stock goes to $107.39 (13.4% gain) at expiration

Stock worth $10,739

Option worth $239


-$239 on option decay ($420 - $0 = $420)


Not managing the short call cuts your profits by $239

S&P 500 ETF – (SPY) @ $94.68






Trade

Stock – 100 Shares @ $62.32 each = $6,232


$6,232

- $142

$6,090


Stock worth $6,855

Option worth $0


+$142 on option decay ($142 - $0 = $142)


Exxon Mobil Corporation – (XOM) @ $62.32



Trade



$6,232

- $142

$6,090


Stock worth $5,608

Option worth $0


+$142 on option decay ($142 - $0 = $142)





Trade



$6,232

- $142

$6,090


Stock worth $6,232

Option worth $0


+$142 on option decay ($142 - $0 = $142)





Trade



$6,232

- $142

$6,090

If stock goes to $84.80 (36.0% gain) at expiration

Stock worth $8,480

Option worth $980


-$838 on option decay ($142 - $0 = $142)


On the BigTrends you must manage the short call to increase your profits



Covered Calls

Trading Strategy

A trader using covered calls must

always be aware of volatility levels

Covered calls work best when IV is

decreasing because it also

decreases the option’s value

When the IV of a stock is high, it is

likely for a reason

Be aware of earnings or major news

announcements that might cause IV

to be higher than normal

These can cause unnecessary risk

Implied Volatility (IV)


Important Final Points

Covered Calls

When selling a covered call, you want the

stock to increase in value.

The call serves as protection.

You must buy both the underlying stock and

then sell the call option.

Pros

Lower Cost for the trade

Potential Losses lessened

Cons

Potential Gains lessened







opportunities




our unique tactics.




with you.

STOCK SUBSTITUTE

STRATEGY

BIGTRENDS.COM


What is the Stock Substitute Strategy

Options

Standard Options represent 100

shares of stock, or a round lot

There are a few distinct

disadvantages to buying stocks as

your investment strategy.

Buying round lots of stock can get

expensive for stocks over $100

Making money on bearish trends with

stocks is complex and challenging,

having to find stock and short it

That is why BigTrends teaches using

options in place of stocks for trading

Critical Trading Vehicle


Substitute

sub·sti·tute - [suhb-sti-toot] –noun,

1. a person or thing acting or serving in place of another.

2. (formerly) a person who, for payment, served in an army or navy in the place of

a conscript.

3. Grammar . a word that functions as a replacement for any member of a class

of words or constructions, as do in He doesn't know but I do.

4. to put (a person or thing) in the place of another.

5. to take the place of; replace.

Definition


Buying Calls

Options

Many traders start by trading stocks, often

buying ones that appear to be in bullish trends

While this is a viable strategy, it requires a very

large amount of capital to succeed.

Fund managers pool capital together to

accomplish this goal, but the individual investor

simply can’t trade that way

Instead of buying large quantities of stock,

create a Stock Substitute by buying ITM calls

Because they have intrinsic value, ITM calls will

often perform better on the same bull trend

Critical Options Principle


Stock Trade Option Trade

Buy 100 KO shares @ $66.50

Cost = $6,650

KO goes to $70.00 in 5 Days

Long Shares gain $350, or 5.2%

ROI

Buy 1 KO 65 CALL @ 1.90

Cost = $190

KO goes to $70.00 in 5 Days

ITMs reach $5.40

gain $350, or 184.2% ROI

Stocks vs. Options

Bull Trades


Buying Puts

Options

Many traders are used to the “buy low and sell

high” method of investing

You can also make money in stocks by doing

the opposite, “selling high and buying low”

Strategy options for a bearish trend:

Borrow the shares from your broker and

sell the stock (short-selling)

Buy a put, anticipating that it will increase

in value as the stock declines

Opening up your trading to bearish trends

allows you to trade all market conditions




Sell 100 CAT shares @ $104.50

Cost = $10,450

CAT goes to $100.00 in 5 Days

Short Shares gain $450, or 4.3%

ROI

Buy 1 CAT 110 PUT @ 7.00

Cost = $700

CAT goes to $100.00 in 5 Days

ITMs reach $13.40

gain $640, or 91.4% ROI

Stocks vs. Options

Bear Trades


Stock Substitute Rules

Options

Underlying Volume

500K+

Open Interest

100+

Volume Traded

50+

Bid/Ask Spread

Target 10%

No More than 25%

Liquidity


Stock Substitute Rules

Trading Strategy

Buy options with 2/3 (66%) or more

intrinsic value.

For trades, less than 5 days, buy

front month options

Otherwise, bypass the front month

and buy contracts 2-6 months out.

Intrinsic / Current Price = % Intrinsic

Example: VZ Jan 30 Call is trading

at 5.00, while VZ is trading at $34.10

4.10/5.00 = 82% Intrinsic Value

18% Time Premium

Time Premium


Buying Puts

Trading Strategy

The put buying strategy can be used

on many different types of securities:

Stocks

ETFs

Indexes

Futures

Currencies

Traders who were not prepared with

bearish strategy in 2001 & 2008 lost

a tremendous amount of money

You need to have a strategy that can

make money in bull & bear markets

A Broader Universe


Option Terms Refresher

Out-Of-The-Money

No intrinsic value and low Delta.

Delta will increase rapidly when stock moves in your direction.

Options are cheap; Most bang for your buck; Most risk.

In-The-Money

Greater intrinsic value and higher Delta.

Options are more expensive.

Less bang for your buck; Lowest risk.

Little to no intrinsic value and medium Delta.

Options are moderately priced.

Decent bang for your buck; Medium risk.

At-The-Money

Characteristics…


Case Study – KO Bullish

KO 37.5 call

5.40 bid by 5.70 ask

Delta - .87

Intrinsic – 5.34

Extrinsic – 0.21

$1500 buys 2 contracts

2 week profit/loss:

($1,065.00)

ITM

KO 42.5 call


Delta - .52

Intrinsic – 0.34

Extrinsic – 1.31


2 week profit/loss:

($1,372.50)

ATM

KO 45 call


Delta – 0.26

Intrinsic – 0.00

Extrinsic – 0.55


2 week profit/loss:

($1,470.00)

OTM

$1500 (5% of 30k) – Stock falls $3.74


Case Study – KO Bearish

KO 50 put


Delta – (.97)

Intrinsic – 7.16

Extrinsic – 0.39

$1500 buys 1 contract

2 week profit/loss:

$790.00

ITM

KO 45 put


Delta – (.74)

Intrinsic – 2.16

Extrinsic – 0.89


2 week profit/loss:

$1,600.00

ATM

KO 40 put


Delta – (.26)

Intrinsic – 0.00

Extrinsic – 0.725


2 week profit/loss:

$2,250.00

OTM

$1500 (5% of 30k) – Stock falls $3.74


Definitions

If you have an option with a high

intrinsic value & a low time premium,

what does that mean?

How does implied volatility affect an in

the money option position?

When I find a trade right now, should I

trade front month contracts or buy

more time for my contracts?

How important is underlying volume for

an option?

What is the most important Greek for

the Stock Substitute strategy?

Common Stock Substitute Questions


Knowing the Risks

Stock Substitute

The profit/loss chart for the Stock

Substitute strategy is similar to that

of the protective put.

Why?

Since you are only buying options,

your maximum loss is only what you

paid to purchase the option

Your maximum gain is limitless

Your break-even point is determined

by the difference between the strike

price and the cost of the option



Managing Risks

Trading Strategy

When buying options, time decay is

always working against you (Theta)

Increases in Implied Volatility (IV) are

positive for option buyers, because it

increases the value of the option

Since options are leveraged, you

need to properly size your positions

The BigTrends method for position

sizing is to trade according to the

amount of capital in your account

If you stick to this method, you will

risk the same amount each trade

Strategy


Position Sizing

Invest a fixed percentage of your capital on each trade (eg. 10%)

In a $25,000 account, buy as many contracts that $2,500 will allow

This method works, regardless of account size, because it is based

upon percentages and not raw dollars


Obstacles

Peak to Trough

Options buyers need to be

disciplined enough to manage their

Maximum Drawdown.

For the Stock Substitute Strategy,

this is usually a 30% - 50% loss

Preventing your losing trades from

damaging your account will keep you

ahead of most options traders

You must be able to handle TWICE

the Max Drawdown both:

Emotionally &

Financially

Big Draw-Downs


Big Drawdowns

As Drawdowns increase in size, the gain

required to recoup the losses increases

Percentage Loss Gain Required to Breakeven

-10% 11%

-20% 25%

-33% 50%

-50% 100%

-75% 300%

-90% 900%

Hard to Recover


Staying With Winning Trades

Trading Strategy

Give yourself a chance to stay with a

Big Trend by taking HALF of your

position profits at 100% or more

This allows you to release the fear of

giving up profits, as you recoup your

initial investment and guarantee at

least a breakeven

Ride the other half position until it

gives back half its gains, or exit half

again if it later doubles once more

Trade Management


The Closing Stop

Stops

To prevent being stopped out by

intraday noise, Use the concept of a

stop only at the end of a given bar.

This “Closing Stop” concept can

prevent numerous whipsaws

Note: It requires a more effort to

implement correctly.

For a daily closing stop, use the price

15 minutes before the end of the day.

If the stop is violated, place a Market

Order to exit the position.



Exploring Stock Substitutes

Trading Strategy

Now that you know the ins and outs

of the Stock Substitutes, you need to

master proper options selection

We will use Percent R as our

indicator to identify strong trends

Once a trend is confirmed, you need

to choose the correct option to buy

You should be able to quickly

determine what option to buy

Focus on Execution






Buy 100 BA shares @ $37.48

Cost = $3,748

Stock goes to $48.83

Long Shares gain $1135, or

30.2% ROI

Buy 1 BA 35 CALL @ 5.50

(BA has 1 point strikes)

Delta of 0.69

Cost = $550


ITMs reach $14.50

gain $900, or 163.6% ROI

Stocks Substitute

Bull Trades





LEAPS

Instead of buying 100 shares of a

stock for a year or longer, buy

LEAPS

While these options are more

expensive because you are

buying more time, they are still a

great stock substitute

100 Shares on MON @ $68.01

would cost $6,801

Compare that to buying an ITM

LEAP with the same rules

Option Trade

MON 60 LEAP CALL @ 17.50

-> Delta of 0.69

Cost = $1750

Stock goes to a high of $129.28

At the exit, stock is at $101.00

Option worth $42.00

gain $2,450, or 140% ROI

Stock gain $3,299, or 48.5% ROI

Stocks Substitute

Longer-Term Trades






Short 100 PG shares @ $57.38

Cost = $5,738


Short Shares gain $956, or

16.6% ROI

Buy 1 PG 60 PUT @ 8.60

(PG has 5 point strikes)

Delta of 0.76

Cost = $860


ITMs reach $18.90

gain $1030, or 119.7% ROI

Stock Substitute

Bear Trades


LEAPS

Instead of shorting 100 shares of

a stock for a long period of time,

you can buy LEAP puts

While these options are more

expensive because you are

buying more time, they are still a

great stock substitute

Buying LEAP puts also allows

you to make money on bearish

trends without needing to use a

margin account

Option Trade

COP 85 LEAP PUT @ 18.50

-> Delta of 0.68

Cost = $1850

Stock goes to a low of $34.12

At the exit, stock is at $45.94

Option worth $41.25

gain $2,275, or 122.9% ROI

Short gains $3,083, or 43.5% ROI

Stocks Substitute

Longer-Term Trades


Important Final Points

Stock Substitutes

Instead of tying large amounts of capital up

on stock only trades, buy ITM options as a

substitute for the stock.

These ITM options are more expensive, but

they have Intrinsic Value that is important

Remember: With options, you often get

what you pay for

Buying enough Intrinsic Value (2/3 or more)

will allow the option to properly follow the

trend, and you can profit accordingly

LEAPS can be used for longer-term trends

Documents

ESSENTIAL OPTIONS STRATEGIES FOR ANY MARKET · ESSENTIAL OPTIONS STRATEGIES FOR ANY MARKET Explore Put your knowledge into action. ... Learn what this indicator is and how you can