Re: A trading question

Thank you Luke.



Awaken21 wrote: 
newhand wrote:

A trader said that"...there is a way to short TZOO at 50 and have everything
well protected all the way to 100..."

How this could be done? Let's say you buy and own a stock, if you short it,
would it automatically sell your long position, at least it is the case with
Ameritrade?

Is this done with stock + option combinations?

Thanks in advance! 


Playing the same stock in both directions is known as a straddle.
Here's a basic explaination of the three main straddle techniques as
they relate to stock options.

-Luke
Exit / Entry Strategy Study
http://tinyurl.com/aaxav

Long Straddles
Have you ever had the feeling that a stock was about to make a big
move, but you weren't sure which way? For stockholders, this is exactly
the kind of scenario that creates ulcers. For option traders, these
feelings in the stomach are the butterflies of opportunity. By
simultaneously buying the same number of puts and calls at the current
stock price, option traders can capitalize on large moves in either
direction.

Here's how this works. Let's imagine a stock is trading around $80 per
share. To prepare for a big move in either direction, you would buy
both the 80 calls and the 80 puts. If the stock drops to $50 by
expiration, the puts will be worth $30 and the calls will be worth $0.
If the stock gaps up to $110, the calls will be worth $30 and the puts
will be worth $0.

The greatest risk in this case is that the stock remains at $80 where
both options expire worthless.

Here's what the trade might look like:

Long Straddle
Buy 1 80 Call @ $7.50 $750
Buy 1 80 Put @ $7.00 $700

At these prices, every straddle will cost about 14.50. Since you are
buying two options, a call and a put, you might get a slightly better
price than the offer for each individual option. But, to keep it
simple, we'll assume the prices listed above are the best available for
the straddle. The 14.50 or $1,450 you pay for the straddle will also be
the most you can lose if the price remains close to $80. Since the
position profits from big moves in either direction, it has both an up-
and a downside breakeven point calculated as follows:

Upside breakeven: Straddle Strike + Cost of Straddle

80 + 14.5 = 94.5

Downside breakeven: Straddle Strike - Cost of Straddle

80 - 14.5 = 65.5

Given this, the position will show a profit as long as the stock moves
above 94.5 or below 65.5. Between those prices, the position will show
a range of losses with the maximum lost right at the strike price where
neither option has any value.

Short Straddle
The short straddle, as the name implies, is the opposite of the long
straddle. By establishing this position, you would have to be fairly
certain the stock wasn't going to move in either direction because the
risk on either side if you're wrong is unlimited. Fortunately, there is
another position known as the long butterfly that meets the same
objectives with much less risk.

Regardless, let's assess the profitability and risks of the short
straddle by adapting the same basic example as the long straddle. As
you will see, the graphs showing the profitability of this position are
mirror images of each other. Here's what the trade might look like in
the same market selling the options at the bid.

Short Straddle
Sell 1 80 Call @ $7.25 ($725)
Sell 1 80 Put @ $6.75 ($675)


At these prices, you can sell the straddle for 14. Since you are
selling two options, a call and a put, you might get a slightly better
price than the bid for each individual option. But, to keep it simple,
we'll assume that the prices listed above are the best bids for the
straddle.

Value at Expiration
Stock Price Profit (Loss)
$50 ($1,600)
$60 ($600)
$66 0
$70 $400
$80 $1,400
$90 $400
$94 0
$100 ($600)
$110 ($1,600)


The $1,400 you sell the straddle for will be your maximum profit. As
before, the position is sensitive to large moves in either direction.
Like the long straddle, the position has an up- and a downside
breakeven point calculated as follows:

Upside breakeven: Straddle Strike + Sale Price Straddle

80 + 14 = 94

Downside breakeven: Straddle Strike - Sale Price of Straddle

80 - 14 = 66

Given this, the position will show a profit as long as the stock
remains between 66 and 94. Above or below those prices, the position
will begin to show unlimited losses in either direction.

The Long Butterfly
The long butterfly spread is a three-leg strategy that is appropriate
for a neutral forecast - when you expect the underlying stock price (or
index level) to change very little over the life of the options. A
butterfly can be implemented using either call or put options. For
simplicity, the following explanation discusses the strategy using call
options.

A long call butterfly spread consists of three legs with a total of
four options: long one call with a lower strike, short two calls with a
middle strike and long one call of a higher strike. All the calls have
the same expiration, and the middle strike is halfway between the lower
and the higher strikes. The position is considered "long" because it
requires a net cash outlay to initiate.

When a butterfly spread is implemented properly, the potential gain is
higher than the potential loss, but both the potential gain and loss
will be limited.

The total cost of a long butterfly spread is calculated by multiplying
the net debit (cost) of the strategy by the number of shares each
contract represents. A butterfly will break-even at expiration if the
price of the underlying is equal to one of two values. The first
break-even value is calculated by adding the net debit to the lowest
strike price. The second break-even value is calculated by subtracting
the net debit from the highest strike price. The maximum profit
potential of a long butterfly is calculated by subtracting the net
debit from the difference between the middle and lower strike prices.
The maximum risk is limited to the net debit paid for the position.

Butterfly spreads achieve their maxim profit potential at expiration if
the price of the underlying is equal to the middle strike price. The
maximum loss is realized when the price of the underlying is below the
lowest strike or above the highest strike at expiration.

As with all advanced option strategies, butterfly spreads can be broken
down into less complex components. The long call butterfly spread has
two parts, a bull call spread and a bear call spread. The following
example, which uses options on the Dow Jones Industrial Average (DJX),
illustrates this point.

Long Butterfly - DJX = $75.28
Buy 1 DJX 72 Call @ $6.10 x 100 $610 (wing)
Sell 2 DJX 75 Call @ $4.10 x 100 ($820) (butterfly body)
Buy 1 DJX 78 Call @ $2.60 x 100 $260 (wing)
Net Debit from Trade $50 ($870 - $820)


In this example the total cost of the butterfly is the net debit ($.50)
x the number of shares per contract (100). This equals $50, not
including commissions. Please note that this is a three-legged trade,
and there will be a commission charged for each leg of the trade.

<Profit/Loss Graph not included here>

This profit and loss graph allows us to easily see the break-even
points, maximum profit and loss potential at expiration in dollar
terms. The calculations are presented below.

The two break-even points occur when the underlying equals 72.50 and
77.50. On the graph these two points turn out to be where the profit
and loss line crosses the x-axis.

First Break-even Point = Lowest Strike (72) + Net Debit (.50) = 72.50
Second Break-even Point = Highest Strike (78) - Net Debit (.50) = 77.50


The maximum profit can only be reached if the DJX is equal to the
middle strike (75) on expiration. If the underlying equals 75 on
expiration, the profit will be $250 less the commissions paid.

Maximum Profit = Middle Strike (75) - Lower Strike (72) - Net Debit
(.50) = 2.50
$2.50 x Number of Shares per Contract (100) = $250 less commissions

The maximum loss, in this example, results if the DJX is below the
lower strike (72) or above the higher strike (78) on expiration. If the
underlying is less than 72 or greater than 78 the loss will be $50 plus
the commissions paid.

Maximum Loss = Net Debit (.50)
$.50 x Number of Shares per Contract (100) = $50 plus commissions

By looking at the components of the total position, it is easy to see
the two spreads that make up the butterfly.

Bull call spread: Long 1 of the November 72 calls & Short one of the
November 75 calls

Bear call spread: Short one of the November 75 calls & Long 1 on the
November 78 calls

Summary
A long butterfly spread is used by investors who forecast a narrow
trading range for the underlying security, and who are not comfortable
with the unlimited risk that is involved with being short a straddle.
The long butterfly is a strategy that takes advantage of the time
premium erosion of an option contract, but still allows the investor to
have a limited and known risk.


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