My Option Strategy

 Options are a great way to reduce investment risk. Since this is not a option basics post so that's the only introduction that I am going to give. You can always read more here - Options details. Some of the important terms though :

Call options - Option to buy 100 shares of the underlying equity withing given time frame defined by "time to expiry" (1 call contract = 100 shares)

For example , 

Buy to open 1 contract PSTH Sep 17 2021 20 Call @ $8

Buy to open - You are buying a option

1 contract - 100 shares

PSTH - Stock Symbol

Sep 17 2021-  Expiry for the option . It needs to be exercised or sold before that date, if it's "in the money" (ITM based on the strike price). All out of money (OTM) options expire worthless  

20 - Strike price. This will determine if the option is ITM or OTM. For call options, strike price + is ITM , strike price - is OTM. In above  example, anything above $20 is ITM so either it needs to be sold off or excised (bought 100 shares) before / 4 pm EST at the expiration date.

@ $8 - Cost of single option share so total cost of 1 contract would be $800

Let's get into some important option technical details, Below is the example of PSTH call option at 5.16.2021 (at 3 pm EST)


 

 










Open Interest : It tells about the option liquidity. Basically open interest tells the total number of contracts (call contracts in this case). If it's low, Bid/ask spread are wider . For This one - $ 7.90 (bid) - $8.30 (ask). In this example, 2,427 contracts are open.

Implied Volatility : Implied Volatility is the determined by the market price of the option rather than underlying stock , so it basically gives the indication of future price movement. If it's high then it means a higher option premium. For example, If it's high and underlying moves $1, option won't $1 (considering everything else constant). That's why it's more profitable to sell the call option (more on this later) rather than buying the call if it's really high (compared to historical standards of the same option). " High " simply means that option price has more premium inbuilt , making it expansive . This could be because of the upcoming earning/ major market event, etc.

Time Value : It refers to the premium paid of the option based on the "Days to expiration" . It would be more for the OTM options as compared to ITM. 

   So current price PSTH stock - $27.34

        PSTH Apr 16 2021 20 Call - 0.06 ( $6 per contract - Time value)

        PSTH Sep 17 2021 20 Call - 0.96 ( $96 per contract - Time Value)

         PSTH Sep 17 2021 40 Call - 3.50 ( 350 per contract - Time Value)

 Delta :  Basically delta correspond to rate of change option price for one-unit change in the price of underlying stock. In a way , you can say that if the delta is 0.50 , it correspond to 50 shares equivalent ( considering all the other - gamma, theta , etc being constant). So if the price of the stock changes $1, option price will change $0.50 cent per share ( $50 per contract, everything else being constant) . In the market though, everything else - implied volatility, etc varies so you won't get the 1-1 relation. For ITM , it's more closely related and as the option gets close to ITM, it increase more than the underlying stock price.

Call option Buy & Sell case

Let's say you are buying the call option -  PSTH Mar 19 2021 20 Call @ 7.30 ( $730 per contract), someone needs to sell it. They can either sell you a covered call ( meaning they own 100 shares of the underlying stock) or it could be a naked call (they don't own the security but if you decide to exercise  your option then they are obligated to buy the stock from open market or should have a call option to cover the ask).  

Vertical Call spread 

Call spread is a option strategy where you simultaneously buy & sell the call option for the same time expiry but different strike price. You are using the proceed that you got from selling a call to buy the call. Goal is to have limited upside and downside for a bull case . Below is the example :

         Buy 16 APR 21 20 C  - $740 ( delta - 0.95)

          Sell 16 APR 21 40 C - $120  (delta -  0.22)

Total cost of the trade - $740 - $120 = $620 ( instead of $740)

Max profit                                          = $1380 ( instead of infinity - theoretically )

Max Loss                                            = $ 620 ( instead of $740 ) 

Breakeven                                           = $ 26.20 (loss 0 ,price > $26.20 instead of current $27.30)   

THE STRATEGY 

Now the best part - My option strategy. It's basically based on two objectives :

1) Risk / Reward ratio should be as close to 0 as possible 

2) Premium should be least for the -  call that you buying while maximum for the call that you selling

In order to achieve this, my strategy is a mixture of vertical call & calendar spread while choosing the strike price of both calls ( one buying & one selling) based on volatility , fundamentals & market conditions.

  

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