Guide to Expert Options Trading - Cabot Wealth Network

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Guide to Expert Options Trading Advanced Strategies that will Put You in the Money Fast

By Jacob Mintz, Chief Analyst, Cabot Options Trader Pro

As a subscriber to Cabot Options Trader Pro, I hope you will benefit from my advice and experience in many ways. It will be my goal to enrich your investing knowledge base, and at the same time, your brokerage account. I believe all investors should use options in some form in their investing. Options can be used to hedge a portfolio, create yield or gain significant market exposure and returns with little capital risk. For the advanced options trader, I hope that you will also learn from my experience. The trading industry is always changing and there isn’t a day that goes by that I don’t learn something. With all the various strikes and expirations, there are countless ways to trade options, and we will occasionally use more sophisticated strategies to gain an edge. If you have any questions, please don’t hesitate to email me. I enjoy sharing my knowledge, and your questions and input will help me shape my advice. Your guide to successful options trading,

Jacob Mintz Chief Analyst, Cabot Options Trader Pro

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Philosophy My fundamental philosophy of options trading is to understand the risk and reward of every trade. When buying or selling options, I break down the best and worst case scenarios, and determine if the odds are in our favor, and if the trade fits our objectives. What makes options so potentially lucrative is that you can make tremendous profits with little capital at risk. When I buy options, I risk pennies to make dollars. When I recommend selling options, I will always do so in a way that has defined risk, often by using spreads. This way, we're never exposed to catastrophic risk. In the options world, there are many ways to take advantage of opportunities. There will be times when I recommend strategies to hit singles, and other times when I will go for the home run. If a trade I recommended is making money faster than I had anticipated, I will often recommend taking off half of the trade. As the old trading saying goes, “bulls make money, bears make money, and pigs get slaughtered.” That said, each subscriber to Cabot Options Trader Pro has a unique mix of investment style, objectives, risk profile and assets. It is up to you to decide which trades fit your objectives and risk profile. My recommendations are meant to be informative, but you must decide for yourself in each case whether you will implement them and what size positions you will take.

Trade Alerts When I feel that an opportunity for a trade has presented itself, I will send a detailed Cabot Options Trader Pro Alert to you via your email or text message. You can always check up on recent Alerts by logging onto the Cabot website (www.cabotwealth.com). When the trade is executed in my trading account, the website will be updated to reflect the new open position, and I will continue to keep you updated in weekly email and website Updates. When I feel that the trade should be closed, you will once again receive an email or text message Alert. All Closed Positions are also logged on the Cabot website.

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Cabot Options Trader Pro Playbook As I make a trade recommendation, I will reference this “playbook” so that you will understand my rationale in recommending the trade—and thus be better able to decide if my proposed trade meets your trading and investing objectives.    High Risk/High Reward Plays These are trades with lower probability of success but potential for enormous profits. Think of hitting a home run instead of hitting singles, with the risk of striking out. We will gain this type of exposure through outright call and put purchases or through call and put spreads. Often, there will be limited time for success, but the price will provide great risk/reward opportunity. Income Generation As soon as an option is created, it begins to lose value. This is referred to in the options trading world as option decay. One way to take advantage of this decay is by selling call spreads and put spreads. With these trades, we are basically selling insurance, getting paid to take the risk that the market will not make a big move. These trades have defined risk/reward, which will be explained in great detail when I recommend them.     Earnings Plays These trades are put on shortly before earnings announcements and taken off afterwards. We take advantage of possible elevated option volatility or potential stock movement based on historical price movement and risk/reward.    Volatility Plays Using proprietary scans, I find volatility trading opportunities to buy and sell volatility using straddles, strangles and time spreads.   Order Flow Reading   One way to get exposure to the smartest traders and hedge funds in the world is to watch what they are trading. By using market scans, we can follow large institutions or hedge funds into their trades. For example, if I see an extraordinary buyer of calls or puts, we will look to put on the same trade, or one similar, to gain similar market exposure.    Momentum Trades   These are strategies to chase the momentum in the market or individual stocks. If the market or a specific stock is consistently trending up or down, I will design a trade to take advantage of the trend.       

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Contrarian Plays   If I believe the market has gone too far in one direction, I will find option trades to take a contrarian position to the momentum in case there’s a sentiment change.    Portfolio Protection   These trades are designed to protect your portfolio if I’m fearful of a market turn to the downside. I will use the purchase of put spreads and the sale of calls to “hedge” our portfolios.   Trades tied to other Cabot Analysts’ Picks These trades will use options on stocks that other Cabot analysts are recommending, to either benefit from the same trends, or to insure against downside movement in those stocks.   

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Options Terminology What is an Option? An option is a contract that conveys to its holder the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) shares of the underlying security at a specified price (the strike price) on or before a given date (expiration day). After this given date, the option ceases to exist. Equity option contracts usually represent 100 shares of the underlying stock. Call Option A call option gives its holder the right to buy 100 shares of the underlying security at the strike price, anytime prior to the options expiration date. The seller of the option has the obligation to sell the shares Put Option A put option gives its holder the right to sell 100 shares of the underlying security at the strike price, at any time prior to the options expiration date. The seller of the option has the obligation to buy the shares. Strike Prices Strike Prices (or exercise prices) are the stated price per share for which the underlying security may be purchased (in the case of a call) or sold (in the case of a put) by the option holder upon exercise of the option contract. Exercise Exercise is the process by which an option holder invokes the terms of the option contract. If exercising a call the holder will buy the underlying stock, while the put owner will sell the stock under the terms set by the option contract. All option contracts that are in-the-money by at least one cent at expiration will be automatically exercised. Expiration Date The expiration date is the last day an option exists. Monthly options cease trading on the third Friday of each month and expire the next day. Weekly options cease trading on the Friday of the week they are due to expire. The Options Premium An options price is called the “premium.” The potential loss for the holder of an option is limited to the initial premium paid for the contract. On the other hand, the seller of the option has unlimited potential loss that is somewhat offset by the initial premium received for the contract.

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Time Decay All options are a wasting asset whose time value erodes to zero by expiration. This erosion is known as time decay. Generally, the longer the time remaining until an option’s expiration, the higher the premium will be. This is because the longer an option’s lifetime, the greater the possibility that the underlying share price might move so as to make the option in-the-money. This time decay increases rapidly in the last several weeks of an option’s life as the likelihood of it finishing in the money declines. Hedging Hedging is a conservative strategy used to reduce investment risk by implementing a transaction that offsets an existing position. The VIX VIX is the ticker symbol for the Chicago Board of Options Exchange Market Volatility Index, a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Often referred to as the fear index, the VIX represents the market’s expectation of stock market volatility over the next 30 days. Historical Volatility Historical volatility is the realized stock volatility over a given period of time. Often times expressed in time periods of 10 days, 30 days and 60 days. Implied Volatility Implied volatility is an important input in pricing options. If the market becomes volatile, or is expecting more volatility, implied volatility will rise thereby increasing the price of options. On the other hand, if the market expects lower volatility, the implied volatility will fall, thereby lowering the price of options. Traders often use historical volatility to price implied volatility.

Sources: Chicago Board Options Exchange (CBOE), International Securities Exchange (ISE).

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Cabot Option Trading Pro Strategies Call Purchase A call purchase is used when a rise in the price of the underlying asset is expected. This strategy is the purchase of a call at a specific strike price with unlimited potential for profits. The maximum loss on this trade is the amount of premium paid. Call Purchase

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For example, the purchase of the XYZ 100 strike call for $1 would only risk the $1 paid. If the stock were to close at $100 or below at expiration, that call purchase would be worthless. If the stock were to go above $101, the holder of this call would make $100 per contract purchased per point above $101.

Call Sale A call sale is used when a decline in the price of the underlying asset is expected. This strategy is the sale of a call at a specific strike price with unlimited potential for loss. The maximum gained on this trade is the amount of premium received. Call Sale 2 1 0

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For example, the sale of the XYZ 100 strike call for $1 would collect a maximum of $1 if the stock were to close below $100 at expiration. If the stock were to go above $101, the seller of this call would lose $100 per contract sold per point above $101.

Put Purchase A put purchase is used when a decline in the price of the underlying asset is expected. This strategy is the purchase of a put at a specific strike price with unlimited potential for profits. The maximum loss on this trade is the amount of premium paid. Put Purchase 10 9 8

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For example, the purchase of the XYZ 100 put for $1 would only risk the $1 paid. If the stock were to close at $100 or above at expiration, the put would expire worthless. If the stock were to go below $99, the holder of this put would make $100 per contract purchased per point below $99.

Put-Write A put-write is used when a rise in the price of the underlying asset is expected. This strategy is the sale of a put at a specific strike price with the potential for loss till the stock hits zero. The maximum gained on this trade is the amount of premium received. Put Sale 2 1 0

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For example, the sale of the XYZ 100 strike put for $1 would collect a maximum of $1 if the stock were to close above $100 at expiration. If the stock were to go below $99, the seller of the put would lose $100 per contract sold until the stock hit zero.

Buy-Write (Covered Call) The term buy-write is used to describe an options strategy in which the investor buys stocks and writes or sells call options against the stock position. The writing of the call option provides extra income for an investor who is willing to forgo some upside potential. My example shows the purchase of 100 shares of stock XYZ, which is trading at 100, and the sale of the XYZ 105 strike call for $5. If the stock were to close at 100 on expiration, the trader will collect $5 on the expiring call. If the stock were to close at 105, the trader would make $500 on his stock appreciation and $500 on his call. If the stock were to fall to 95, the trader would lose $500 on his stock, but make $500 on the call, which would leave him at breakeven. Buy-Write

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Bull Call Spread A bull call spread is used when a rise in the price of the underlying asset is expected. This is a strategy that involves purchasing a call at a specific strike price while simultaneously selling a call at a higher strike price. The maximum profit on this strategy is the difference between the strike price of the long and short option, minus the premium paid. Bull Call Spread 10 9 8 7

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For example, the purchase of the XYZ 100/110 bull call spread would entail buying the XYZ 100 calls and selling the XYZ 110 calls. If you paid $1 for this spread, the most you can lose is the $1 paid. The most you can make is $9 if the stock were to go to $110 or above.

Bear Call Spread A bear call spread is used when a decline in the price of the underlying is expected. This strategy involves the selling of a call at a specific strike price while simultaneously buying a call at a higher strike price. The maximum profit on this strategy is the premium collected. The maximum loss is the difference between the strikes minus what you received. Bear Call Spread

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For example, the sale of the XYZ 100/110 bear call spread would entail selling the XYZ 100 calls and the buying of the XYZ 110 calls. If you collect $1 for this spread, the most you can make is $1. The most you can lose is $9 if the stock were to go to $110 or above.

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Bear Put Spread A bear put spread is used when a decline in the price of the underlying is expected. This strategy involves the buying of a put at a specific strike price while simultaneously selling a put at a lower strike price. The maximum profit on this strategy is the difference between the strike price of the long and short option, minus the premium paid. The maximum loss is the premium paid for the put spread. Bear Put Spread

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For example, the purchase of the XYZ 100/90 bear put spread would entail the buying of the XYZ 100 put and selling of the XYZ 90 puts. If you paid $1 for this spread, the most you can lose is the $1 paid. The most you can make is $9 if the stock were to go to $90 or below.

Bull Put Spread A bull put spread is used when a rise in the price of the underlying is expected. This strategy involves the selling of a put at a specific strike price while simultaneously buying a put at a lower price. The maximum profit on this strategy is the premium collected. The maximum loss is the difference between the strikes minus the premium that was received. Bull Put Spread 2 1 0

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For example, the sale of the XYZ 100/90 bull put spread would entail the selling of the XYZ 100 puts and the purchase of the XYZ 90 puts. If you collect $1 for this spread the most you can make is $1. The most you can lose is $9 if the stock were to go to $90 or below.

Long Straddle A long straddle is a good options strategy to pursue if a trader believes that a stock’s price will move significantly, but is unsure of which direction. A long straddle is also a good strategy if a trader believes that option volatility is priced below a stock’s potential movement. The gain is unlimited to the upside and limited to the downside if the stock were to go to zero. The maximum loss is the premium paid. Long Straddle 7 6 5 4

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For example, the purchase of the XYZ June 40 Straddle would entail buying the XYZ June 40 Call and buying of the XYZ June 40 Put. If you paid $4 for this straddle, the most you can lose is the $4 paid. Your profits are limited to $36 if the stock went to zero, and unlimited to the upside.

Long Strangle A strangle is a good options strategy to pursue if a trader believes that a stock’s price will move significantly, but is unsure of which direction. A strangle is also a good strategy if a trader believes that volatility is priced below a stock’s potential movement. To purchase a strangle, a trader buys a long position in both a call and a put with different strike prices, often out of the money, but with the same expiration date. Long Strangle 8 7 6 5

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For example, the purchase of the XYZ June 35/45 strangle would entail buying the XYZ June 35 Put and the XYZ June 45 Call. If you paid $2 for this strangle, the most you can lose is the $2 paid. The most you can make is $33 if the stock were to go to zero and your profits are limitless to the upside.

Long Iron Condor A long iron condor is a directionally neutral spread used when a stock’s price is expected to stay within a range. This is a strategy used when volatility is believed to be too high. The strategy involves the selling of an out-of-the-money put spread and an out-of-the-money call spread. The maximum profit on this strategy is the premium received. The maximum loss is the difference between the strike’s sold price minus the premium received. Long Iron Condor 3 2

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For example, the long iron condor would entail the sale of the 85/80 put spread and the sale of the 100/105 call spread for a $2 credit. If you collected $2 for the iron condor, the most you can make is $2 if the stock stays between 85 and 100. The most you can lose is $3 if the stock were to go to 80 or below, or 105 or above.

Long Butterfly Spread Long butterfly spreads can be used to enter either a bullish or bearish trade. Butterfly spreads use four option contracts (puts or calls depending on directional opinion) with the same expiration but three different strike prices to create a range of prices the strategy can profit from. The trader sells two options at the middle strike price and buys one option contract at a lower strike price and buys another option contract at a higher strike price. The most you can lose is the premium spent if the stock were to close below the lower strike price or above the higher strike price. Your maximum return is achieved when the price of the stock closes near the middle strike price at expiration. Long Butterfly 9 8 7 6

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For example, the purchase of the XYZ January 80/90/100 Long Butterfly for $2 would entail buying one 80 call, selling two times the 90 calls, and buying one of the 100 calls. The most you can lose on this spread is the $2 paid. The most you can make on the trade is $8 if the stock closes at $90 on expiration.

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Risk Reversal A risk reversal is typically used when a rise in the price of the underlying asset is expected. This strategy is typically the sale of an out of the money put and the purchase of an out of the money call. This trade has unlimited profit potential to the upside and extreme loss potential to the downside. Risk Reversal 7 6 5 4

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For example, a January 20/25 risk reversal for a $1 credit would be the sale of the January 20 Put and the purchase of the January 25 Call. If the stock stays between $20 and $25, the trader collects the $1 credit. If the stock goes to $20 or below, the trader will be forced to buy the stock. If the stock goes to $25 or above, the trader will exercise his right to buy the stock, or simply sell out his call for a profit.

Long Time Spreads A time spread is used when a stock or index is believed to be range-bound and when volatility is believed to be too low. The strategy involves the selling of an option in a near-term expiration cycle and the purchase of an option in a longerterm expiration cycle. This spread looks to take advantage of time decay of the option closer to expiration. The maximum loss is the premium paid. For example, the purchase of the XYZ January/February 100 Call spread would entail the sale of the January 100 Call and the purchase of the February 100 Call. The goal of the trade is for the January call to expire worthless while the February call appreciates in value.

Diagonal Spreads A diagonal spread is a bullish position that reduces capital outlay. The strategy involves the selling of an out-of-the-money near-term option and buying a longerterm option closer to at-the-money. This spread looks to take advantage of the time decay of the option closer to expiration. The maximum loss is the premium paid. For example, one could sell the October 25 call (expiration 10/19/2014) and buy the January 20 call (expiration 1/19/2015) for a net debit. The goal of the trade is for the October call to expire worthless while the January call appreciates in value.

Collar A collar is a protective options strategy that is implemented with a long stock position. It’s created by purchasing an out-of-the-money put and selling an outof-the-money call. The put protects against downside movement in the stock, and the call, while limiting the upside of the position, helps reduce the cost of the put protection. Collar 5 4

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For example, if you purchased 100 shares of stock XYZ, to collar this trade you would buy one XYZ January 23 Put and sell one XYZ January 30 Call for $1 debit. If the stock went to 23 or lower at expiration, you would exercise the put, which would take you out of the stock position. If the stock went to 30 or above at expiration, you would be forced to sell your stock position.

Resources Option Volatility & Pricing by Sheldon Natenberg If I were to recommend one book to learn about options and options trading, it would be Option Volatility & Pricing. This book does an outstanding job of breaking down the fundamentals of options, slowly building up to more complex concepts. Unlike many other authors, Natenberg uses very little exotic math, and illustrates many important concepts in an easy to understand manner. Many traders consider this book to be the “bible” on options trading and is mandatory reading for most proprietary firms and derivatives training programs.  Chicago Board of Options Exchange (CBOE) website Another trading resource is the Chicago Board of Options Exchange (CBOE) website (www.cboe.com), which has many functions for all levels of traders including seminars, online courses as well as the opportunity to trade with “paper money.” Livevol Stock Options Trading Software The trading tool that I use to find many of my trade ideas is from a company named Livevol, Inc. (www.livevol.com). Their software was designed by traders for traders, and is an outstanding way to scan the options world for trading opportunities without a degree in computer science. Livevol excels in volatility comparisons, order flow recognition and historical pricing.

176 North Street • Salem, Massachusetts 01970 • 978-745-5532 • www.cabotwealth.com Cabot Options Trader is published by Cabot Wealth Network, which is neither a registered investment advisor nor a registered broker/dealer. Neither Cabot Wealth Network nor our employees are compensated in any way by the investments we recommend. Information is obtained from sources believed to be reliable, but is in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that readers acting on the information assume all risks involved. Options and other investments are subject to risk and are not suitable for all investors. Please read “Characteristics and Risks of Standardized Options” prior to trading options. There is no guarantee that any of the strategies or services promoted will result in the desired outcome. This content provided is for general education and information purposes only. No statement contained herein should be construed as a recommendation to buy or sell a security or to provide investment advice. All readers should consult with an independent financial advisor with respect to any investment in the securities mentioned. In no event should the content of this report be construed as an express or implied promise or guarantee from Cabot Wealth Network or that you will profit or that losses will be limited in any manner whatsoever. Any opinions, projections and predictions expressed are statements as of the date of this publication and are subject to change without further notice. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of past recommendations.

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