For example if a trader is bullish ANZ, they could buy a call (limited risk vs unlimited return) or sell a put (unlimited risk vs limited return) and the list goes on.

Also different strategies work differently on different stocks depending on volatility levels. Basic debit spreads can work well on the banks, while ratio spreads can work well on the resources stocks. Debit spreads basically have the potential to return 100-200% if the direction on the stock is correct. On the resource stocks ratio spreads can not only profit from the direction if correct, but not lose anything if the stock actually went in the wrong direction. These are all strategies I trade depending on my view on the particular share.

Debit Bear Put Spread

Buy ANZ Aug 23.00 Put @ 100

Sell ANZ Aug 21.50 Put @ 50

Net cost $500 per contract

Max return $1000 per contract (200%)

The reason for this trade is that if the stock goes the wrong way, the loss is small and capped. If the stock does actually fall towards $21.50 as suggested the trade could return up to 200%.

Also with a strategy like this, trade trader doesnt have to worry about been stopped out prematurely as you can build the stop into the price you pay for the spread.

This is one of the more basic strategies, however as I mentioned the simpler trades often work best on the lower volatile stocks. For more information on more advanced strategies send me an email on the contact page.

Woolworths shares (WOW)

Woolworths (WOW)  is a retail company with primary activities in supermarkts, liquor stores and co branded service stations. WOW shares are listed on the ASX  with approximately 1.2 billion quoted shares on issue.

Woolworths (WOW) head office

The Woolworths (WOW) head office is located at:

1 Woolworths Way

Bella Vista NSW 2153

Woolworths (Wow) share registry

Computershare Investor Services Pty Ltd

Level 3 – 60 Carrington Street Sydney

NSW 2000

Ph: 1300 787 272

An example for BSL would be a BSLKZK mini warrant.

This is traded on the ASX, like you would buy and sell a share.

The good thing about these mini warrants, is that they have a delta of one, so they move cent for cent with the share price, all while having a built in stop loss.

For example this warrant at time of writing would cost 50 cents. They always trade at extrinsic value, so the strike price on this warrant is $2.00 The stop is at $2.31

If the stock was to fall and hit $2.31 it would be stopped out and the trader will receive back the remaining value between the strike price and the stop price so in this case would receive back 31 cents, which means the risk on this mini warrant is 19 cents. The terms and conditions for all warrants are are not standardised so before trading them it is recommended you contact your adviser. They are limited recourse which means that the stop is in place, however slippage may occur but the most the trade can lose is the cost of the mini warrant.

Knowing that it has this built in stop, the trader could buy the mini warrant in anticipation of the share price going up, and it will behave just like the share or CFD except you have less risk having the built in stop.

The trader can then sell calls against the mini warrant, and in this example they could sell a call for the first month for 18 cents, which would reduce your risk to 7 cents if this trade expired safe. Then they could continually keep selling calls each month, and have no risk. The mini warrant never expires. If the stock rises and it happens to be exercised, you can also exercise the warrant to deliver the stock so there is no issue there either.

Because the mini warrant is a leveraged product, the trader is only paying 50 cents for exposure to the share, instead of $2.50 if you bought the share outright. With less capital outlay you can increase returns, all while having the stop loss in place. Because it means the trader has effectively borrowed the $2.00 (where the strike price is) interest is charged on this loan. Its just like how interest would be charged on a CFD, however with the warrant the holder doesnt pay the interest, the strike price just adjusts upwards. The interest rates charged are about 8% pa so a lot cheaper than holding a short term call. That way the warrant can be purchased with the intention of selling the short term call and aiming for a monthly income.

This post only provides a basic example on warrants trading, all the terms and conditions for each warrant can be different and a licenced adviser can provide more information.

How do I decide on a strike price? (in or out the money).

How to decide on a strike price when selling covered calls depends what your intentions are. Basically you sell a call where you would be happy to sell the stock if it went above that level. If you were pretty keen to sell the stock, you could sell an in the money or at the money option. If you think the market will rise, you would sell a call option a little higher.

How do I decide the options expiry date?

How to decide the options expiry date can be influenced by one by the premium you receive at the strike you have chosen and how long you feel you need to be hedged for. If the market is in a long term uptrend, you probably wouldn’t want to sell too many months away, however the more time until expiry, the larger the premium you will receive.

What happens if the stock price goes down and I want to sell the stock but the call is still open?

If the stock price has gone down and you want to sell the stock but the call is still open you just need to buy back the call option, so that you do not expose your self to unlimited risk. If the stock has fallen, then the value of the call option should have decreased to offset the lower value in the stock. Depending on your broker you may be allowed to simply sell the stock and leave the option to expire, but it does open up to having unlimited risk.

What happens if at expiry the call still has some intrinsic value?

At expiry if the call option still has some intrinsic value, it means that it is in the money and if nothing is done you will be exercised and have to sell the stock. You can avoid this by simply purchasing back the sold call. Depending on your view, you might want to buy the option back, and sell another one to pick up for time value for a later expiry.

Credit spread roll

Let’s assume several weeks ago the following trade was placed:

Bear Call Spread

Sell NAB 28.50 CALL @ 29

Buy NAB 29.00 CALL @ 22

The net credit was 7 cents, and the risk 43 cents.

If the stock stays below $28.50 by the options expiry, then the maximum profit will be retained.

If at expiry the stock is trading above the protection then the maximum loss will be realised if the trade is closed out. Depending on the new view on the stock, this might be the best option, however if the view is that the stock is now overpriced, and likely to fall back there is a rolling strategy which can help reduce your breakeven on the credit spread.

Lets assume the stock at expiry was trading at $33.00 and the view is that the stock would now fall. If the options trade was simply rolled, you would not start making back money on the trade unless the stock then fell a few dollars again and expired below the $29.00 protection

To increase your chances of returning a profit, or reducing the loss, the breakeven can be reduced by rolling the sold option to the same strike, and rolling the bought option to a higher strike around where the market is trading.

Credit spread roll

Example:

Sell NAB 28.50 Call

Buy NAB 32.50 Call

This would increase the credit spread to $400 from the 0.50 cent spread, so to keep the risk approximately the same you would need to reduce the contracts by the equivalent amount. In this example the spread has been increased by 8 times, so you would need to divide the amount of contracts you traded by 8. If you traded 40 contracts, then the new position size would be 5 contracts.

By purchasing the $32.50 protection or bought put, and reducing the contracts the risk will be approximately the same, allowing for a some extra cost in time value in the bought option. (there is more time value in options closer to the money) … Now although the risk is fairly close to the original trade, instead of needing the stock to fall below $29.00, it will only need to fall below $32.50 for it to start reducing your loss.

I believe this is an excellent opportunity to gain exposure in the industry and I am also already holding shares.

The particular biotech stock I am interested in is an anti-cancer biotechnology company which uses naturally occurring viruses to fight cancer. Their technology is administered by injection and could mean less down time for patients. What I like about this stock is that they have just completed Phase 1 intra-tumoural melanoma trials and on release to the market the stock rose about 200% on a significant increase in volume. The share price has since re-treated back to levels where it was trading before the announcement as there is still a long road ahead to get through phase 2 and 3 trials, however it does show the potential that the stock has to move once it starts entering phase 2 and 3 trials. I also like this stock recommendation because they are the only company in Australia specialising in this area, and they are already starting to receive media attention. There are several competitors in the US who are already approaching phase 2 and 3 trials which means that the technology they are researching is likely to reach phase 2 and 3, and is not an unrealistic study. If this becomes big, it will be the only company in Australia to buy to gain exposure! They also have 20 patents granted worldwide with at least another 20 pending. They have also recently raised capital, and have options due to expire which should net the company $2.67m. Combined with other funds including cash at bank, and capital raisings, it is likely the company has enough funds to get through to phase 3 trials.

Biotech Stock Trades

Biotech stock trades cab be speculative in nature, however what is attractive to them is the potential gains that are possible. The most that can be lost is 100% of the investment if the share price went to zero, however the potential returns are unlimited and 10 times returns have happened in the biotechnology industry. Owning a portfolio of these speculative bitoech shares, can also lead to good returns, if just one of the stocks has a significant re-rating for the share price. It can also take sometime for these shares to move, and often considered best for the bottom draw. Some trading opportunities exist though for the short term trader.

Biotech stock Chart

Below are two charts, the first showing the short term price action. Notice the spike in volume after the Phase 1 announcement and the increase in the share price. The stock has retreated on profit taking since, as there is a long road ahead to phase 2 and 3 trials, however this price action is promising, showing the potential for the stock to move on an early positive announcement. Since then they have also raised more cash and have the options due to expire which will net the company $2.67m. Combined with this positive news, if the stock was trading at around 4-5 cents before the Phase 1 announcement then I believe the current price of about 5.2 – 5.5 cents represents good value.

The second chart below shows the long term trend.

If you are interested in receiving more detailed information on this biotech stock or other biotech recommendations, and copies of recent press releases please send back an email with your interest. I already personally own this stock.

Biotech Stock Chart

Biotech Share Chart

Put ratio back spread – Option Strategy

Another option strategy that I rarely see used by retail clients for stock insurance and protection is a put ratio back spread. This strategy is more complex, however can have many benefits over just purchasing a put. The reason for using a put ratio back spread is 1. The protection could cost you nothing, if managed properly and 2. it gives unlimited protection on the stock to a share price of Zero.

The put ratio back spread strategy works buy selling a put at the money that expires in several months, and using the premium received to buy 2 out of the money options. This way if the market runs up, the protection costs nothing (as apposed to just buying the put) however if the market falls, you will have twice as many puts to gain in value than there are sold.

There  are more to the mechanics on how this trade works. It needs to be propertly managed to avoid potential losses at expiry, and it may need to be exited to lock in profits depending on share price movements. Other strategies can be implemented to generate income, all while having the protection in place.

For more information on  how this strategy works, don’t hesitate to send me an email.

• Learn to trade and invest in biotech stocks and shares
• Receive biotech recommendations
• Why could the biotech industry be the next craze?
• Biotech analysis and research

For more information on Biotech analysis and recommendations, please send an email on the contact page.

XYZ current price 24.61

Buy 1 XYZ Mar 24.50 Put @ 18 cents

The delta on the option is 0.41 – The delta measures how fast the option will increase or decrease if it is in the money or out of the money. It accelerates as it is in the money (the value of the trade increases faster) and slows down (the position loses value slower)

So lets assume in two days the stock has fallen 50 cents (it moved 46 cents today so that movement is realistic) You profit would be 50 cents x 0.41 = 20.5 cents. Remember this is approximate because the option delta will actually increase. To get a good idea of how much it will change, check the price of the option strike 50 cents higher. Its trading 29 cents higher. You could estimate then that your profit after a little bit of time decay would be somewhere between 20 + 29 cents. Taking the middle if you exited with a profit of 25 cents, your return would be 138% in two days.

This particular example demonstrates the potential returns on a long put trading the front month option. Because front month options cost less, the percentage movements in the option vs the share price are higher than longer dated options. This means that trades can be setup with the potential of high returns, however has the risk that the trade can also lose value quickly, and time decay is greater than the longer dated options.

For more information register for a one month free trial to receive long put strategy trades, and other options trading strategies.