Welcome to the strategy and optimization section. The first thing we're going to do in this lecture is 1
look at what a short call and a short put looks like we've seen two long trades. 2
We did a long call on Chipotle Mexican Grill. 3
We got an easy hit of our profit target. 4
And we were able to exit that trade very easily. 5
And then on FXE it was even better. 6
Even though the trade went on for a month. 7
But the trade went through a lot of different things and we even put conditional orders and we absolutely 8
milked that trade. 9
So now the opposite side of these long call in long puts are the short call and the short positions. 10
Now if you recall from from the first course itself. 11
Whenever you're short options that means you're selling those options. 12
And in this case if you put in a short put or a short call then you're going in for naked sells. 13
So if you sell an option naked first of all your margins and your risk factors go up tremendously 14
. 15
Think of yourself as the insurance company because whenever you sell any options you're absolutely acting 16
like the insurance company. 17
So just to take a quick example let's go to the march series of Apple and let's say we Apple is currently 18
trading at 460. 19
The advantage of selling options is that you can put probability on your side and you can go out of 20
the money and all of that. 21
That's great. 22
But if you're going to sell a naked option then you know you're going to find that first of all let 23
me take off some of these things here 24
and you're going to find that the broker is going to demand a huge margin. 25
So here we are selling 10 contracts of the march 425 put . 26
In this case we are doing a short put and we'll pick up a credit of $2 and 48 cents. 27
So for 10 contracts thousand shares will pick up two thousand four hundred eighty. 28
But look at the margin First of all then the brokers going to hold from you it's $57000. 29
And let's go take a look at the risk and reward profile of this particular short put. 30
The first thing that should jump out at you is the fact that you have unlimited losses. 31
If Apple continues to go down you have you're looking at an unlimited loss profile. 32
And the other issue that I want to make you aware of make it short positions is let's say Apple started 33
going down Apple's today and 460. 34
But if it starts to go down let's say it comes over here. 35
You know this is five percent below where Apple is currently trading at. 36
So if Apple came here at 437 we know exactly what those parameters are going to look like so that 37
is this minus 5 percent simulation line. 38
So first of all you can see you're going to be facing a loss of five thousand six hundred sixty dollars 39
on this particular option. 40
Secondly look at your margin your margins now gone up from fifty seven thousand to 81000. 41
And why did it go up. 42
That's because you are approaching your risk points on this position. 43
So when you started out here Apple was at 460. 44
So at that particular point in time your broker felt that holding a margin of fifty seven thousand dollars 45
was reasonable protection for him. 46
But after Apple moves 5 percent down. 47
Now he doesn't consider your $57000 as adequate protection anymore because you're right here and you're 48
about to fall off the cliff. 49
Just another ten, twenty dollars and you'll be down this very precipitous path 50
And so now the brokers are going to demand more margin. 51
You can see that your white line is going is showing you about fifty seven hundred dollar loss and you're 52
very close to your breakeven point. 53
So if you go down this path then you're facing very steep losses and all of and all of this is for what 54
you wanted to make two thousand four hundred eighty dollars because that's your max profit on this trade 55
. 56
So for a very small reward you're taking a lot of risk. 57
And this is exactly what the insurance company model is when we pay insurance premium and the insurance 58
company covers us for our car or a house. 59
This is exactly what they're doing. 60
But of course they've got large numbers and statistical advantage going for them. 61
And that's why they're their model is a proven one. 62
However when we're trading options you can you can very easily have a disastrous trade and you can very 63
easily go down this path. 64
So this is a short put. 65
And go to tell you the truth the short call is no is no different. 66
Let's say we wanted to change this into a call. 67
And of course we're not going to 425 because Apple is at 460 So let's say we put 68
a 490 call on a 500 call and let's look at the risk and reward profile again. 69
It's very similar. 70
You're going to pick up a credit of two dollars and sixty two cents. 71
The brokers are going to hold a margin of 52. 72
However and this is what your risk profile looks like. 73
There's so little reward. 74
And then your risk is literally going down this line here and here again if Apple goes up 5 percent 75
because now you're short a call so you're basically bearish. 76
So if this stock continues to move up that's when your position is going to get into trouble if you 77
add 5 percent to that. 78
We are at 483. 79
You're looking at a loss of about fifty six hundred exactly like the short put position and you can 80
even look at the margin. 81
That's exactly what it is. 82
So in general you would never sell a naked call or a naked put. 83
And that's the reason I have not shown these trades as live trades in this particular course because 84
there's no point in showing you that because you don't want to do that. 85
The only reason or the only time you would execute these trades is for the two examples that we showed 86
you in the first course in the introductory course on options call options and put options. 87
We showed you in the final part of that course that there are two specific instances where you would 88
do a naked put sell and a naked call sell the naked put sell is when you want to pick up stocks. 89
Let me show you that again in case you've forgotten that. 90
Let's go back to the put side and go to our 430 let's say 430. 91
So this is your naked put sell and why would you want to put this kind of a trade because when you're selling 92
this option you're taking the obligation to buy this stock at 430. 93
So the opposite side your counter party is the put buyer. 94
So the put buyer has the right to sell you this stock at a price of 430 . 95
So he has the right to sell it to you at 430 and therefore you have the obligation to buy it from him 96
at 430. 97
So the only reason you would put this kind of a trade is if you decided that $430 minus the premium 98
three dollars, four hundred and twenty seven dollars was an excellent price for you to pick up Apple 99
stock for the long term. 100
That is the only reason why you would put this trade on because if apple falls all the way down and 101
it could go below that also what you don't have to worry about is unlimited loss because your loss is 102
going to get stopped right here. 103
It's not even a loss because you're picking up Apple. 104
And if Apple goes further down your your Apple shares might show a paper loss in your account. 105
However you don't care because that is not your trade rationale your trade rationale was to pick up 106
Apple stock at a great price of 427 because you wanted to keep Apple stock for the next six months 107
next 12 months or perhaps next 24 months. 108
That is the only time you would do a naked sell of a put option. 109
So that's the one time where you will do what naked sell off a put. 110
Now what about the call . 111
Let's go take a look. 112
The on the call side we're going to go above Apple's price so we'll go to about a 500 call option. 113
And here we can see that Apple's trading here your call option is here. 114
And the only time you would do a naked call sell is because you already own the stock and you're willing 115
to give it away. 116
At this price of 500. 117
And if Apple doesn't touch that strike price well you get to keep the premium. 118
So this is the covered call strategy and we covered this also in the same course in course one . 119
So these are the only two instances where you would do naked cells and no others because frankly it 120
doesn't make sense and all the brokers are going to hold a huge amount of margin and for a small amount 121
of premium it just is not worth the risk. 122
So that's why we have not shown any of the short call positions as life trades because it really doesn't 123
make sense to do that. 124
However if you do want to get into a short sellers position because we've kept saying you know being 125
a short seller is actually a very viable strategy. 126
But you have to put it as a spread. 127
And that's coming in the next course. 128
So both on the call side as well as the put side. 129
If you put it as a spread then this is called a bear call. 130
So you know you're using call options and you're doing a bearish strategy and in the other case when 131
we had a short put which was going down here we would limit the loss of the short put and that 132
is called a bull put because you're using puts over there. 133
And it it is a bullish strategy. 134
So those two strategies are covered in the spread course which is coming up next. 135
Now that is really in the sweet spot of options trading so the next course on spreads is really where 136
you need to be and you need to be very comfortable with it. 137
You need to be an expert at that level. 138
Choose your spreads properly choose your strategies properly choose your strike prices properly and 139
learn to adjust spreads and then you are in a really good position as far as options trading is concerned 140
. 141
That's as far as this lecture. 142
If you have any questions please send us an e-mail in the next lecture. 143
We're going to get back to the strategy and optimization for single options. 144
Thank you.