Index Options – Option Trading Strategies Video 33 part 4

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What we want to do is take a look at the stock price, in terms of historical volatility. We’ll go over to our profit chart here, and we’ll enter the symbol. This is where we really need to make a judgment call. If we take a look at the historical basis of the volatility of Disney, you can see that the last is $23.44.

Is that in the lower end of the range, the higher end of the range, or in the middle? I would say it’s probably close to the middle of the range. It’s not exactly on the high end. It’s not on the low one, that’s for sure.

What I’m going to do, is I’m going to come back here, and just put in “MID”. I’ll tell you exactly how we use that as we go along.

In order to determine the range index, the cost index, and the profit index, all we have to do is highlight these cells, and then bring them down and highlight them all. Go to “Edit,” “Fill,” “Down.” That automatically includes the formulas that we had previously on our issues, and brings them down and fills them in automatically for us.

Let’s not take a look at these, just for a second, to do our analysis. Let’s do another issue. We’ll go to CCU. We’ll take a look at the historical volatility. The historical volatility for Clear Channel Communications looks like it’s on the lower end of the range. It’s extremely low, actually, for this issue.

We’ll fill that in first, since we’re already at that chart. We’ll just say “LOW.” Now, let’s go back and get our straddle price. The last trade was $35.88, so more than likely, the at the money straddle is going to be the $35. We’re buying 10 contracts.

Just for the sake of analysis, let’s go to the $37.50, and see if it’s a different price. This is a dollar. That’s $1.70. It looks like the $35 is going to be the cheapest.

Let’s analyze that as a duplicate trade. If we take a look here, we have a range here – 20 days to expiration, between $34.24, and $37.67. Let’s go ahead and subtract those numbers. That gives us a range of $3.47.

We’ll bring up our worksheet here. The straddle price was $1. The range probability was $3.47. The current stock price is $35.88. The implied volatility is at 14.6%. If we calculate that in terms of decimal places, it’s 0.1466.

Then, all we have to do is highlight these cells, bring them down, and we can fill down to fill in our values.

Let’s do one more issue here. This time, it’s BroadCom. We’ll go directly to our Trade tab, and enter the symbol. The stock closed at $23.37, so the $25 straddle will probably be the closest to the money.

Let’s go ahead and buy that straddle. We’re going to do 10 contracts. Just for the sake of being as thorough as possible, let’s take a look at another strike price. This is the $25 strike price. Let’s bring up the $27.50. That’s a little bit more expensive.

We can go down to the $22.50. That’s $2.35. It looks like the $22.50 is the cheapest straddle, at $2.35. If you go down to the $20, it’s a little bit more expensive. Let’s go with the $22.50, at $2.35. Let’s go ahead and analyze that as a duplicate trade.

We’ll stretch this out, so that we get the most recent August expiration, so we can determine our range. We’re going to use the $22.50 straddle, for $2.35. Let’s bring up our spreadsheet. Our at the money straddle is $2.35. That’s the cheapest that we could find.

Our range of probability here is between $27.76, minus $19.47. That gives us a range of $8.29. The current stock price is $23.37. Our volatility is 53.92%, which we need to translate into a decimal. It’s 0.5392.

Let’s take a look at the chart, and see if the historical volatility is considered low or high at this particular time. It looks like there is certainly a lot of volatility in this issue. It seems to be to the mid to the high range. It looks like it’s going higher.

It’s not on the low end of the range. It’s certainly not in the middle end of the range. It’s in the high end of the range. Just give that a judgment call. Then all we have to do is copy these over. I’m just clicking with my right mouse, and dragging it over the cells I want to fill in. Then I go to “Fill,” and “Down.”

Now, let’s take a look at this, a little bit closer. Now that we’ve done our analysis, we can kind of determine – this helps us objectify the stock that we should be using for our Gamma Scalping activities. Let’s take a look at each one, based on its profit index.

Netflix, based on the profit index… Remember, we want the range to be as great as possible. In other words, we want this range, compared to the stock price, to be as large as possible. We want a large range, with a stock price that is relatively small, because we want that stock to move as much as possible.

When the stock moves, we make more money, when we day-trade using this particular technique. The cost index – basically, what we want to do is measure the cost of the at the money straddle, to the price of the stock, divided by its implied volatility.

If that volatility is actually high, and we have a relatively low strike price, and low at the money straddle, the at the money straddle is relatively cheap, compared to the stock price. That’s relatively low. That’s how we determine which of these issues we’re going to be using for Gamma trading.

The profit index itself is simply a measurement of the ratio between the range and the cost. We want the range as high as possible. We want the cost as low as possible. That gives us a profit index.

Now, if we take a look at our profit index, after all of the issues that we’ve put into our spreadsheet here – we notice that Netflix has the highest profit index, followed by American Express, followed by BRCM.

On the low end of the scale, we have the QQQs, which only has a 0.99 profit index. At the very lowest end is our Clear Channel Communications profit index, as 0.51. It looks like the reason for that extremely low profit index is because of the range. The range here is extremely low. Even though the at the money straddle is only a dollar, the range in which the Think or Swim platform is predicting its movement, is also extremely low.

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