Moneyness is a common term which is very important when looking at an option chain. Moneyness in an option chain refers to the relationship of where the price of the underlying is currently trading and the strike price of the option within the option chain.

If this is the first time you have heard the term Moneyness, the term may sound funny to you. But, it is one of the basic concepts of option valuation. Knowing and understanding Moneyness will help you to interpret the information within an option chain.

**What is an Option Chain…**

An option chain is a display or listing of all the call and put option prices, along with their corresponding premiums, for each expiration period. Each option chain can supply the bid-ask quotes of each strike price of the option in each expiration period. Using the bid-ask quotes allows a trader to estimate the premium of the option at each strike price and expiration period in the option chain. A trader can usually get a fill on an option order somewhere between the bid and ask price in the option chain.

**Figure A. NKE Option Chain**

Figure A shows an option chain of NKE. The underlying price is 86.42 as shown at the top left of the option chain. The strike prices, and the bid-ask spread for both the calls and puts, are shown below using the 29 March 19 expiration cycle.

**Understanding the Language of
Moneyness…**

Traders will often refer to an option as being In-The- Money (ITM), At-The-Money (ATM), or Out-Of-The Money (OTM). Other terms traders use are Near-The -Money, or Close-To-The-Money. This terminology is very important in reference to an option chain. Moneyness helps a trader to understand what the information in the option chain is showing.

**What is an In-The-Money Option (ITM)…**

When the strike price of a call option is below the current trading price of the underlying equity, it would be referred to as In-The-Money (ITM). As an example, a 86.00 call strike option contract would be ITM if the underlying equity price is 86.01 or greater. The equity must be trading above the strike price of the call option in order for the call option to be In-The-Money.

In Figure A, the price of NKE is trading at 86.42. The 86.00 strike call option is currently ITM. To determine how much the 86.00 strike call is ITM, take the current price of NKE (86.42), and subtract the 86.00 call strike of the option, which equals 0.42.

A put option would be ITM when the strike price of the option is above the current trading price of the underlying equity. In Figure A, let’s use as an example the 87.00 put option. The put option strike would be ITM if the current price of the underlying is below the strike price of the put option. Since the current price of NKE is trading at 86.42, and the put option strike price is 87.00, the put option is 0.58 ITM. This is calculated by taking the strike price of the put option (87.00) and subtracting the current price of NKE (86.42), which equal 0.58.

**What is an Out-Of-The-Money Option (OTM)…**

When the strike price of a call option is above the current trading price of the underlying equity, it would be referred to as Out-Of-The-Money (OTM). As an example, a 87.00 call strike option contract would be OTM if the underlying equity price is 87.01 or greater. The equity must be trading below the strike price of the call option to be Out-Of-The-Money.

In Figure A, the price of NKE is trading at 86.42. The 87.00 strike call option is currently OTM. To determine how much the 87.00 strike call is OTM, take the call option strike price 87.00 and subtract the current price of NKE (86.42), which equals 0.58.

A put option would be OTM when the strike price of the option is below the current trading price of the underlying equity. In Figure A, let’s use as an example the 86.00 strike put option. The put option strike is OTM if the current price of the underlying is above the strike price of the put option. Since the current price of NKE is trading at 86.42, and the put option strike price is 86.00, the put option is 0.42 OTM. This is calculated by taking the current price of NKE (86.42) and subtracting the 86.00 put option strike, which equals .42 OTM.

**What is an At-The-Money Option (ATM)…**

When option strike price is the same as the current price of the underlying, it is At-The-Money (ATM). An ATM call or put strike option is equal to the current price of the underlying.

**What is a Near-The-Money Option …**

When the price of the underlying is in close proximity, but not exactly equal to the strike price of the option, it is many times referred to as being near-the-money or close-to-the-money.

**What Determines the Value of an
Option at Expiration?**

In-The-Money options have value because of their premium. If the option is In-The-Money, it can be exercised. If the option strike is ITM by only one cent, it will have value at expiration.

As an example to illustrate the value of an option at expiration, a trader bought a 86.00 strike price long call option which expires 29 MAR 19. The option expired, and NKE closed at 87.00. The trader who bought the 86 strike price long call option which expired on 29 MAR 18 realized a profit of 1.00. The option expired 1.00 In-The-Money, which created the 1.00 profit.

OTM options will only have value because of their premium. Since they are Out-Of-The-Money, they cannot be exercised. If an option strike expires just one cent out of the money it will be worthless.

**In Summary … **

Moneyness is a term which you as a trader will often hear mentioned. Now that you have more of an understanding as to what In-The-Money, Out-Of-The-Money, At-The-Money and Near-The-Money means, it should be easier for you to know what fellow traders are talking about. If an option strike expires In-The-Money at expiration, it will have value. An ITM option can be exercised. If an option strike expires Out-Of-The-Money at expiration it will have no value. An option that is Out-Of-The-Money cannot be exercised.

If you are looking for a trading community that has a wide variety of programs including one-on-one mentoring, educational classes, and interactive trading groups, look no more. Join today!

Please leave a comment below if you would like to add to the conversation.

]]>I have the greatest respect for Adam Grimes and have known Adam for several years. I am happy to re-publish Adam's article that was originally published at Adam Grimes's blog.

Most of Adam Grimes's readers know about the Art and Science of Trading course, but, if you don’t, it’s just about the best education in technical analysis that’s available, and it really is completely free. (If you haven’t seen it, you should go check it out.) For at least a few years, Adam had plans to create an options course, and he's excited to tell you The Art & Science of Options launches this week!

One of the reasons this course has taken so long to create is that Adam was looking for the sweet spot in terms of depth and complexity. With options, it’s easy to get deeply involved in specialized concepts and mathematical detours that just don’t matter. (Until they do, and here’s part of the problem!) The other big mistake in options trading is to oversimplify, and there are many people who have built a career, for instance teaching investors at retirement age to write options, on misunderstandings and oversimplifications.

Adam's goal was to create a course that would go in depth enough to understand what you really need to know, but also to be something you could apply pretty quickly. It’s no good if you have to take a college-level math class to think about buying a call! On the other hand, you should understand the risk and potential in any position, and understand how the position will change as the stock moves, volatility changes, and time marches forward.

These things tend to evolve over time, but **ten modules are currently planned**:

**Intro to options**: The very basics, from what an option is to how to read options quotes to some issues you might face when trading. Adam will look at both directional and non-directional strategies, and finish up with an overview of major topic areas in the course.**Option pricing**: Starting with an intuitive approach to “what are these things worth?” Adam will look at the factors that could make an option more or less valuable, and end up looking at some of the standard price models. This is the most conceptual module planned, but it’s important. In fact, it ends with a section called “Why this matters” and it does matter a lot!**Volatility**: When we trade options, we’re really trading volatility. After this module, you’ll understand what volatility is, how it’s measured, and why you should care. Most options education falls flat here, simply telling you, for instance, to sell options that are ranked high on some scanner. We will also take the lessons of cutting-edge quant models and put them into practical lessons any trader can use to understand how volatility is likely to change.**Basic directional strategies**: How to understand the P&L of an options position, trade offs between different strikes and months, and how to execute swing trades with simple options positions.**What you really need to know about the Greeks**: Adam has seen many profound mistakes in this area. It’s easy to get into very complex math that will never matter for most traders, and it’s also very easy to ignore these measures completely—many people running options services will tell you “Greeks don’t matter.” They are wrong; there are things you can only understand if you understand a few key concepts. Adam will show you what you really need to know.**Basic Greeks, applied**: Adam will revisit the basic swing trading ideas, but look at them through the position of Greeks, this time. You’ll see how these measures can simplify your risk management task, and how you can use Greeks to help you pick which specific options to trade. Adam will sneak in the concept of trading option spreads in this module**Spreads**: Most options traders trade spreads, and even those who don’t should understand them! Adam look at the most common and useful spreads and see what markets favor certain structures over others.**Selling options**: Adam will have touched on selling earlier, but this is a module that dives deeply into writing options—why you might want to do it, how to understand the risk, and why it’s not the holy grail it’s often presented as being.**Other strategies**: Adam will have gotten to this point in the course with a heavy focus on just a handful of strategies and structures, and that’s not a mistake—Adam is going to focus on a few trades you can make that offer the flexibility to make trades in a wide range of market conditions. But there are also a few more complex strategies to consider. Even if you’d never actually trade them, exploring trades like calendar spreads and back spreads will cement your understanding of the concepts in the course. (Oh, and someday you’ll find a perfect setup for some of these trades and will be glad you know them well!)**Practical examples**: An in-depth look at what can go right and wrong with examples drawn from recent market action.

The first module of the course will be presented in a live webinar on Thursday February 21 at 17:30 Eastern.

Subsequent modules will be presented as available, but with no more than a week between modules. (In other words, some may be presented back-to-back weeks, and some may have a week in between.) **The full course will only be available to MarketLife Premium or Plus subscribers,** in contrast to the big, free Technical Analysis course, which is, and will always remain, free.

Have you ever been assigned in options trading? Many traders have gone through assignment at some point in their trading life, and it can be an uncomfortable feeling. Today's blog will be a refresher on the “ins and outs” of option assignment. Before I get into the specifics about assignment in options trading, it's worth re-visiting the basics about buying and selling options as it relates to assignment :

**A call option**gives the buyer the right, but not the obligation, to buy a specific underlying at a specific price by a specific date. As the call buyer, you control 100 shares of stock and have the choice whether or not you want to exercise the option. If you exercise, your right is to purchase shares of the stock (100 shares for each option contract). When you buy a call option, you cannot be assigned stock unless you choose to exercise your option. Remember, it is your right, but not your obligation, to exercise that call option.

The seller of the call option will automatically have 100 shares called away from his account if the call buyer exercises his/her option.

**A put option**gives the buyer the right, but not the obligation, to sell a specific underlying at a specific price by a specific date. This means that if the put option expires in the money, the put seller has the obligation to purchase the stock at the same strike price.

As the put buyer, if you exercise your right to sell stock, then the seller will automatically be sold 100 shares of stock per option contract. If the new stock is something the seller wants to keep, he certainly can if he has the available funds in his account. If he chooses to do so, he will now own 100 shares of stock at the strike price per share.

The specific date as defined above is the option's
expiration date. On or prior to the
expiration date, the buyer of the option has the right to exercise the option.
The term “exercise” stands for the process by which the buyer of an
option converts the option into a long stock position in the case of a call, or
a short stock position in the case of a put. ** Buyers of options can exercise. **

**Now, let's talk about the term
“assignment”.**

The term “assignment” refers to the process by
which the seller of an option is notified of the buyer's intention to exercise
that option. The exercise price (strike
price) is the price at which the holder of the option has the right, but not
the obligation, to buy (in the case of a call) or sell (in the case of a put),
the underlying security. **Sellers of options can be assigned.**

**Here is an example of two traders engaging in buying and selling an option:**

**You:**

- You purchased an AAPL (Apple) put option from Joe, at a strike price of $165, for the January 2019 expiration cycle.
- AAPL closed at 156.82 on January 18, which was the option's expiration date. Because AAPL closed below the strike price of $165, the option is expiring in-the-money and you decide to exercise the option.
- You sell 100 shares of AAPL to Joe for $165 per share (the strike price).

**Joe:**

- Joe sold an AAPL put option to you at a strike price of $165.
- The option expired in-the-money and the buyer (you) chose to exercise his option.
- Joe must purchase 100 shares of AAPL stock from you at $165 per share (even if there is not adequate capital in his account).

**What happens next?**

If Joe does not have sufficient funds in his account to purchase the stock, he will still own it, but for a short time. Joe will be required to close the position immediately (usually because Joe receives a margin call from his broker). Joe will also be charged an assignment fee, which varies depending on his broker, as well as commissions.

**The 3 most common questions related
to trading options and being assigned stock are:**

*What situations would cause me to get assigned stock?*

When **you’re the option buyer, you have the power to assign**. If
you are the option seller, that is a different story…

When you** sell an option** (a call or a put), **you will be assigned stock if your option
is in-the-money at expiration**. As the option seller, you have no
control over assignment, and it is impossible to know exactly when this could
happen. Generally, assignment risk becomes greater closer to
expiration. Having said that, however, assignment
can still happen at any time.

An important note to remember is there is additional assignment risk when the underlying's company has upcoming dividends (dividends are when a company distributes cash to their shareholders). Essentially, if the extrinsic value on an ITM short call is LESS than the dividend amount, the ITM call owner will have good reason to exercise their option so that they can realize the dividend associated with owning the stock. If you would like to read more about the intrinsic and extrinsic value of options, I published an article on August 17, 2018 titled “What are Intrinsic & Extrinsic Option Values”? That article can be found here: https://aeromir.com/00182/what-are-intrinsic-and-extrinsic-option-values

s* 2. What can I do to help prevent being assigned stock? There are two ways:*

- You can close the trade before it expires and take any profit or loss on the trade.
- You can roll the trade to another expiration cycle to extend the days to expiration. This will give you more time to be right on your original entry premise.

* 3. And…If I am assigned, what should I do?*

Assignment can happen pretty easily if you are not monitoring your positions on a regular basis (and can also happen even if you are). There are two things that can happen if you sold an option that has expired in the money…

- If you were assigned stock and had the money to cover the shares in your account, then you can choose to hold the long (or short) stock, or buy/sell the shares back for a profit or loss. Some traders assigned stock, and have the sufficient funds, may choose to retain the stock and write covered calls against it. This may be a strategy if you feel the stock will rebound over time; writing covered calls in the meantime can be a way to recover some of the realized loss as a result of being assigned.
- If you were assigned shares and don't have the money to cover the shares you were assigned (the term for this is a margin call), you will need to buy/sell back the shares ASAP. If you do not, the broker will do it for you before the end of the trading day.

**Doesn't the use of vertical spreads versus long options
minimize the risk of assignment?**

When you sell a put spread or call spread, the assignment risk comes from your short strike expiring in- the-money . If both strikes expire in the money, they will essentially cancel each other out and you will not be assigned.

If you sell a call spread and the short strike is in the money at expiration, you will be forced to sell 100 shares per option contract to the buyer. If you sell a put spread and just the short strike is in the money at expiration, you will be assigned 100 shares of stock per contract.

**In summary, here are a
few things to keep in mind regarding assignment:**

- Assignment can happen at any time – it is more likely to occur at expiration; but remember it is controlled by the option buyer.
- If you do not have funds in your account to cover long or short stock, you will be required to close the position immediately.
- Vertical spreads give more protection against being assigned, but they do not protect you unless BOTH legs are in the money.
- If you have a short call position, there is additional assignment risk if that call is in the money at the time of the dividend.

Whether you are new to trading or a veteran looking to share your trade experiences with others, Aeromir is the place. We offer mentoring, educational trade alert services, and trading groups that meet on a regular basis.

I hope this article reduces any uncertainties you may have on assignment in options trading. If you have an experience on being assigned that you would like to share with others, feel free to comment below.

]]>Charles Cottle and Ali Pashaei presented “Surviving and Thriving in Volatile Markets” on Friday. They showed how they navigated the large move down and did well protecting their portfolios.

Charles and Ali teach group mentoring classes at Aeromir.com. They are offering 15% to 30% discounts to their recorded classes but you have to act before midnight Eastern on Friday January 25, 2019.

To see what Charles and Ali have been teaching, please visit these pages:

To order discounted recorded classes, please click on this button:

Enjoy the replay!

]]>Charles Cottle and Ali Pashaei are presenting a free webinar of how to survive and thrive in volatile markets

The webinar will be Friday, 18 January 2019 at 11:00am Eastern.

>>> Register for the webinar <<<

The webinar should be approximately 60-minutes but may go over if there are enough questions.

The webinar will be recorded and posted on our YouTube channel. Consider subscribing to our YouTube channel to be notified when the recording is ready.

]]>Volatility levels are widely used by traders when making a decision to enter or exit a position. Understanding the differences between the various metrics of volatility can help gauge option pricing, and can be essential in your efforts to be more consistently profitable in your trading.

Implied Volatility Percentile (IVP) or Implied Volatility Rank (IVR) are two tools which can be used to track historical volatility. Using these tools will show you where the current IV number is in relationship to what volatility has been in the past.

When you learn to use the relationship of the current implied volatility and compare it to historical volatility by using either IV percentile (IVP) or IV rank (IVR), you will have an edge in your trading for many strategies. When you compare IV to IVP or IVR, it is important to use IVP consistently or IVR consistently. Comparing the current IV to both IVP and IVR can lead to confusion. It is important to either use IVP or IVR. Using IVP one time and IVR the next time is not recommended. Stay consistent.

When you look at the implied volatility (IV) of an option, it is reflecting the current IV. It is important to understand the relationship of the current volatility to the past historical volatility. This will help to determine what type of trading strategy to use when you enter a trade.

The can give your trading an edge.

To start, let's review the basics of Historical and Implied Volatility

**What is the definition of Volatility?**

**Historical Volatility**is a measure of past performance. Because it allows for a more long-term assessment of risk, historical volatility is widely used by traders and market analysts in the creation of investing strategies. Historical volatility is also referred to as realized or statistical volatility. For the purpose of this article, I am using current IV percentile as historical/statistical IV. IV Rank is another method to determine historical IV which you will also learn about in this article.**Implied Volatility (IV)**is the estimated volatility of a particular stock/index. IV is a calculation which reflects the current volatility. In general, implied volatility increases when the market is bearish, when investors believe that the underlying price will decline over time. Generally, implied volatility decreases in a bullish market, when investors believe the underlying price will rise over time. If there is a sharp move upward in price, there are instances when short term volatility may increase.

**How can Implied Volatility affect Options Traders?**

**Implied volatility is one of the key factors in the pricing of options.**Options give you the opportunity to purchase or sell an underlying at a specific price during a pre-determined period of time. The higher the implied volatility, the more premium the option will have. The less the implied volatility, the less the option's premium.**Knowing the relationship between implied volatility (IV) and current IV percentile**can allow you to determine if an option is more inexpensive or expensive…**Implied volatility has the biggest effect on the amount of extrinsic value in the price of an option.**When IV increases, the extrinsic value of both calls and puts increases. This makes the call and put option prices more expensive. When IV decreases, the extrinsic value of both calls and puts decreases. This makes the option prices less expensive. If you would like to read more about the intrinsic and extrinsic value of options, here is an article published on August 17, 2018: Intrinsic and Extrinsic Value of Options

**An option's value is determined by the following components:**

- Stock Price
- Strike Price
- Time to Expiration
- Volatility
- Interest Rates
- Dividends

Five of these components are easy to determine. They are basically fixed. The one which is unknown is volatility. As volatility goes up or down, it can reflect significant changes in the price of an option. Two of the most important components of an option's price are volatility and time to expiration. These two components can greatly affect your overall profit and loss. When you purchase an option, it is not enough to be right on market direction. You also have to be aware of time decay, volatility, and the relationship of current IV to its historical IV.

** What is IV Percentile?**

Implied Volatility Percentile (IVP) can provide traders with an additional metric to help gauge the pricing of options. IVP will tell you the percentage of days over the past year that implied volatility traded below the current level.

To explain IVP, let's start by looking at the current implied volatility using the S & P 500 Index as an example.

The one year chart of SPX is shown below, showing the current implied volatility of 21.67%.

Figure A. One Year SPX Chart indicating current Implied Volatility

Below is a screenshot taken from the Think or Swim option chain.

Figure B. Today's Options Statistics from Think or Swim

One way to find Current IV and IV percentile on the Think or Swim platform is to scroll down to the bottom of the option chain and look for Today's Options Statistics. It shows the Implied Volatility of 21.67%, as well as the Current IV percentile at 34%**. **

The current IV Percentile is calculated by taking the number of trading days the IV of SPX was below its current level and dividing it by 252 (the number of trading days in a year). The current IV Percentile in this example is 34%.

Using this example with IVP at 34%, the understanding can be that implied volatility of SPX traded below the current implied volatility of 21.67% for 34% of the past year, or about one-third of the year. This indicates that SPX IV was below 21.67% for about one third of the year. For two-thirds of the year, the implied volatility was above the current level of 21.67%.

This means that the current IV of SPX in relationship to its historical past is in the lower one third region. Therefore, option prices will be less expensive or “rich” than if the current implied volatility was at higher percentage.

**How do you know if the IV of an option is high or low in relationship to itself?**

**Here is an example:**

Stock ABC ‘s current price is currently trading at 50. The implied volatility of the stock is 20.0%, and the IV percentile is at 80%. Looking at an implied volatility of 20.0% you, would probably think the current IV was on the lower side.

Look at the Implied Volatilty Percentile. It is at 80%. What does this mean to you? It means over the past year 80% of the time ABC’s current IV was below 20.0%. This indicates ABC options are probably costly due to the current implied volatility of 20.0% relationship to the implied volatility percentile of 80.0%.

Remember, the current IV of 20.0% was lower 80% of the time over the last year. This shows the current IV to be high. This will make options more expensive or “rich”.

**Implied Volatility Rank is yet another volatility metric that many traders take into account when making their trading decisions…**

Implied Volatility Rank (IVR) can tell you whether the current implied volatility is high or low based on the IV over the past year. It is an average of the highest high and lowest low volatility for the past 52 weeks. Other time periods can be used such as 30 days with some trading platforms.

Let's use the same SPX example for one year to calculate IVR. The 52 week IV high was .468, and the 52 week IV low was .088. The formula used for a one-year IV rank is as follows:

Figure D. IV Rank Formula (photo courtesy of www.projectoption.com)

To calculate the one year IVR, look at the options statistics in Figure 2.

With SPX IV currently at 21.67%, the IV Rank would be calculated as follows:

Current IV (.2167) minus 1-Year IV Low (.088) = .1287

1-Year IV High (.468) minus 1-Year IV Low (.088) = .38

.1287 divided by .38 = IV Rank of .338 or 33.8%.

This IV Rank of 33.8% indicates that the current IV and the low IV is only 33.8% of the entire IV range over the past year. This means the current IV is closer to the low end of historical levels of implied volatility.

At the extreme levels, an IV rank of 0% means that the current IV is at the lowest point of the one-year range, and an IV rank of 100% means the current IV is at the highest point of the one-year range.

**How can you take advantage of the relationship between current Implied Volatility and IV Percentile or IV Rank?**

You can base the type of trade you place using Implied Volatility, IV Percentile and IV Rank. As you know, there are risks and rewards with every type of trade. A few strategies for consideration using high and low volatility levels are:

**High Volatility Could Indicate Opportunities to Sell**

You expect volatility to decrease, thus the option you sell could decrease in price, making it profitable.

**Credit spreads.**When you sell a credit spread, you will receive a higher credit when volatility is high.**Iron Condor.**When you sell an Iron Condor, you will also receive a higher credit when volatility is high.- When you buy a
**Butterfly**in a high volatility environment, your position will benefit as volatility drifts down, as long as the underlying price stays close to your short strike.

**Low Volatility Could Indicate Opportunities to Buy**

You expect volatility to rise, therefore, the option you buy could become worth more.

**Long put or put debit spread.**This trade can allow you to lower your cost and benefit from a spike in volatility.**Long Calendar spread.**This trade could benefit from the back month volatility increasing while the front month options decay.**Iron Condor.**The Iron Condor tends to perform better in higher volatility markets, but can still do well in lower volatility markets.

When you base your trade strategy on the relationships between Implied Volatility, and IV Percentile, and IV Rank, it does not guarantee that your trade will be profitable. However, it does give you a tool to use for your trade entries and exits so volatility can have a chance to work in your favor.

Do you have a trading method using volatility you would like to share? Please feel free to comment below.

]]>A calendar spread is a strategy often referred to as a time spread. A calendar is a method which could benefit from the time decay of an option and changes in implied volatility.

For the most part a calendar concentrates on the movement of time and volatility more than the movement of the underlying asset. For this reason a calendar spread can be used for either stagnant or large movements in the underlying.

Like any strategy the calendar has advantages as well as disadvantages. The risk can be quite limited for the buyer; the seller can have a larger risk. To contain some of the risk, a seller can act on the position at the expiration of the near term option. There are also strategies which can be used to lessen the seller’s risk.

One of the advantages of the calendar strategy is the position can be entered with less of an investment than purchasing the underlying asset.

**How is a Calendar Spread created?**

A Calendar spread is constructed by purchasing one option and the sale of another option in different expiration cycles in a one to one ratio. Both options will have the same strike price. The calendar can be created by using either two puts or two calls. The longer out in time option has more time value and will cost more than the closer in time option.

**How to construct a long Calendar…**

If you think the volatility is at a low level, you can buy a long calendar. To create a long calendar, you would purchase one option with an expiration further out in time and sell one option with expiration closer in time. As an example, you would buy a February 50 Call option and Sell a January 50 Call option. Another example, would be to buy February 50 Put option and sell a January 50 put option.

Figure A. Long Calendar Risk Graph from Think or Swim

As you can see in Figure A, the strike price of 50 is at the center of the risk graph. The highest profit potential is at the strike price.

**How you could profit from the long calendar spread…**

You can profit from a long calendar spread as time progresses and the price of the underlying stays favorable. The shorter term expiration will decay at a faster rate than the longer term position.

If the volatility increases the further out in time option will increase faster than the closer in time option. This will tend to increase the value of the calendar spread.

If you enter the calendar spread either in-the-money or out-of-the money and the price of the underlying moves towards the strike price, the position will gain in value.

**How you could lose from a long calendar spread… **

A decrease in implied volatility will decrease with the farther out in time option more quickly than it will decrease the value of the closer in time option. This will cause the position to lose value.

If the price of the underlying asset moves away from the calendar spread strike price, the calendar spread will decrease in value.

**How to construct a short Calendar Spread…**

If you have the assumption volatility is at high levels, you can create a short calendar. To create a short calendar, you would sell the farther out in time option and buy the nearer term option. For instance you would sell a February 50 Call option and buy a January 50 Call option.

Figure B. Short Calendar Risk Graph from Think or Swim

As shown in Figure B, the short calendar profits more as the underlying moves away from the center strike of 50.

*A word of caution concerning short calendar spreads. Shorting the longer dated option and buying the shorter dated option can be risky. The shorter dated option will expire before the longer dated option. This could lead to the seller of the longer dated option being naked that longer dated option. Therefore, the brokerage will most probably margin your account as though you are short the naked option. *

**How you could profit from a short calendar spread …**

If implied volatility decreases, the further out in time option which was sold will tend to lose money more quickly than the closer in time option which was bought. This is due to the higher Vega in the further out in time option. This will tend to create an increase in value to the seller of the calendar spread.

If the underlying asset moves up or down, away from the strike price of the calendar spread which was sold in either direction, it will tend to increase in value for the seller of the calendar spread, as long as the time decay of the option does not outdo the movement of the price of the underlying.

**How you could lose from a short calendar spread …**

As time passes it will usually negatively affect the seller of a calendar spread. This is due to the nearer term option, which is the long option for the seller, decaying at a more rapid pace than the farther out in time option, which the seller of the calendar spread is short.

If implied volatility increases it will also affect the seller of the calendar spread negatively. When the volatility increases the longer term option which was sold increases in value more quickly than nearer term option which the seller is long due to the longer term options higher vega.

**At-the-Money vs. Out-of-the-money and In-the-money options… **

Many times calendar spreads are entered at-the-money due to at-the-money options having the greatest amount of extrinsic value. The extrinsic value of an option will decay as the option gets closer and closer to expiration. This can be beneficial for a calendar spread because the strategy is looking for time decay.

There are other calendar strategies which can be constructed using out-of-the-money and in-the-money options. It is your choice.

The decay rate of the option with the same strike price, which has a longer expiration date will be slower to erode than the decay rate of the option which is closer to expiration. This applies to an in-the-money option, out-of-the money option or at-the-money option.

**Gamma’s Effect on the Calendar Spread…**

Gamma can be defined as the rate of change of the option’s delta as it relates to the movement in the price of the underlying. It can be thought of as the delta of the delta.

Gamma tends to be highest with at-the-money options in the nearer term expiration. Gamma will tend to decrease the further the price of the underlying moves away from the at-the-money strike and as the expiration date moves further out in time.

The nearer term option expiration will move more quickly due to its’ gamma being higher.

**How Does Volatility Influence a Calendar Spread?**

It is important to monitor the change in volatility when using the calendar spread strategy.

The volatility of an option is measured by vega. Vega is an approximate measurement of how much an options price will tend to change with a one point move in implied volatility.

Vega is shown in dollars for a one tick move or change in volatility. Let's say an option is valued at $2.00 and has 45 implied volatility with a vega of .05. Then the volatility moves up one tick to 46. The option would now have an approximate value of $2.10.

This is calculated by multiplying .05 times 2.00 which equals .10 or 10 cents. Adding the .10 to the original value of the option which was $2.00 equals $2.10.

**Key points about vega …**

- The price of an option will change as volatility increases or decreases
**Vega will tend to decrease with shorter dated expiration options**- Vega will tend to increase with longer dated expiration options
**Vega tends to be greatest with at-the-money options**- Vega applies to the strike price both calls and puts
**Vega will tend to increase when volatility increases**- Vega will tend to decrease as volatility decreases

**Wrapping up the Calendar Spread…. **

- Use two call options or two put options
**Use the identical strike price for both of the options**- Select different expiration periods for each option
**Create a one-to-one ratio**- Any two expiration periods can be used to create the calendar spread.

Usually, the calendar spread benefits when the price of the underlying is not moving too much and stays within a range.

If you have limited capital, the long calendar spread offers limited risk when entered as a debit. The risk is defined to the debit paid for the calendar.

You can use the calendar spread when volatility changes are expected.

As a seller of a calendar spread, you can take on potentially greater risk.

When the underlying price moves away from the calendar strike price, the buyer of a calendar will tend to lose money.

When the underlying price moves away from the calendar strike price, the seller of a calendar could increase profits as long as time decay does not surpass the movement of the underlying’s price.

If you have experience trading calendars, either long or short, and would like to share with the community, feel free to comment below.

Are you new to trading looking for mentoring, or an educational trade alert service? Or, are you a veteran seeking a trading group where you can interact with like-minded traders who share their experiences? Look no more. Join Aeromir today!

]]>Marko, from OptionSlam.com, is presenting the Double Eagle Trade on the Aeromir Round Table on Wednesday, 10 October 2018 at 11:00am Eastern.

The Double Eagle Trade is a pre-earnings trading discipline with an excellent track record. We know you'll enjoy the presentation.

Marko is teaching a workshop on the Double Eagle next weekend.

We look forward to seeing you on the webinar!

]]>Gamma, one of the options “Greeks”, is often referred to as the Delta of the Delta. Gamma is the rate of change in the delta of an option per a one-point move in the underlying instrument. It is important for traders to understand the effect Gamma can have on their positions. As Gamma increases, it can dramatically affect a position in terms of its profitability.

To define and provide an understanding of Gamma, we will first touch on Delta. Delta measures the price movement of an option with a $1.00 movement in the underlying. If an option has a .38 Delta and the underlying instrument moves $1.00, the option price theoretically would move $.38 in value. Thus, the new option price would theoretically be $1.38.

**What is long Gamma?
**

When you purchase an option, either a call or put, it creates long Gamma. If you are long Gamma and the underlying instrument increases in value, the Delta of the option strike will theoretically increase by the amount of your Gamma for every $1.00 move in the underlying instrument. If the underlying's price decreases, the Delta of the option strike would theoretically decrease by the amount of the Gamma for every $1.00 movement in the underlying. So, if the underlying's price increases and you are long Gamma, your Delta would theoretically increase. The opposite occurs if the underlying price decreases and you are long Gamma – your Delta would theoretically decrease.

**What is short Gamma?**

When an option is sold, you are short Gamma. When a position is short Gamma and the price of the underlying increases, the position Delta would decrease. Conversely, if a position is short Gamma and the price of the underlying decreases, the Delta of the position would increase.

**How Gamma and time are related…**

Time affects Gamma.

The closer an option gets to its expiration, the higher the Gamma. An option's Gamma is highest in the nearest term expiration cycles. Gamma is also highest for options at-the-money or near-the-money. As with many aspects of trading, there are exceptions to this which I'll discuss later on. Gamma tends to decrease as the underlying's price moves away from the at-the-money strike. As the price moves further in-the-money or further out-of-the-money, the Gamma tends to decrease.

Let's use Figures A and B below with SPY as an example to illustrate the affect time has on Gamma. Below are two option chains for SPY; 7 September which is 2 days until expiration, and 19 October which is 44 days until expiration.

SPY is currently trading at 289.64, so the 290.00 strike is at-the-money for the October 19 cycle, and the 289.50 strike is at-the-money for the 7 September cycle.

Figure A. SPY Put Option Chain 44 Days to Expiration, SPY currently trading at 289.64.

Figure B. SPY Put Option Chain 2 Days to Expiration, SPY currently trading at 289.64.

Refer to the Gamma column in Figures A and B to see how Gamma is affected by time. Also notice the relationship of Gamma at-the-money, and further out-of-the-money. Do you see how it tends to be higher at-the-money? Do you see how Gamma tends to decrease as it moves away from the at-the-money strikes?

**As I said earlier, there are exceptions to the effect of Gamma over time …
**

What are the exceptions? At times, the back period expirations can have higher Gamma than the near-term expirations. This may occur because options that are very deep-in-the-money act like the stock itself, and stock itself has no Gamma.

**It's important to understand how Gamma can affect a position which is composed of multiple options…
**

As shown in the SPY option chains in Figures A and B above, each option strike has it's own Gamma. Most trading platforms combine the Gamma for each option, and calculate the long and short Gamma to determine the overall Gamma of a position composed of multiple options.

Many traders manage their positions according to Gamma, and feel that Gamma can be a measure of how often a position may need adjusting. They do this by looking at the T + 0 line (the black, curved line in Figures C and D below) You can get a visual of Gamma on most platforms when you view a risk graph. Is the T + 0 line relatively flat or is it curved? If your T + 0 line is flat or only slightly curved, your position will have less Gamma. If it is steeply curved, your position will have higher Gamma.

Using SPY again, see the two Iron Butterfly positions in Figure C and D. We will use the same expiration cycles as in the option chain example above … September 7, which is 2 days to expiration, and 19 October which is 44 days to expiration.

Figure C. SPY Iron Butterfly 2 Days to Expiration (sharply curved T + 0 line)

Figure D. SPY Iron Butterfly 44 Days to Expiration (flatter T + 0 line)

The two positions shown above in Figure C and D are for an at-the-money Iron Butterfly, which consist of: Short the 290 call strike, long the 295 call strike; short the 290 put strike, and long the 285 put strike.

In Figure C, with only 2 days until expiration, the Gamma is -27.42, whereas the position Gamma in Figure D which has 44 days until expiration is only -.1.10. See how steep the curve is on the T + 0 line (black, curved line) in Figure C versus Figure D?

Those who trade shorter term positions such as weeklys take on the potential of a higher profit, as well as the risk of a larger loss on their positions with even the smallest move in the underlying. This is mainly because of Gamma. More conservative traders who trade longer-term positions such as the one in Figure D have less potential risk of a major profit or loss, at least early in the trade, due to the lower Gamma.

**Summing it up…**

It can be confusing at times, particularly for those traders with less experience, to remember the characteristics and relationships of an option's Gamma and Delta. An easy way to remember them is:

• Positive Gamma makes Delta more and more positive as the underlying price increases.

• Negative Gamma makes Delta more and more negative as the underlying price increases.

Gamma, like the other option Greeks – Delta, Theta, Vega, and Rho, is a metric that can be used to measure the level of risk for a position or portfolio. While Delta is often used as the Greek that affects a position's profit and loss as the underlying price moves, Gamma is a metric that a trader can use to gauge how much the Delta may move.

If you have any additional insights to Gamma and how you use it to manage your positions and would like to share, feel free to comment below.

Whether you are new to trading, or an experienced trader looking to fine-tune your craft, the Aeromir community is here to help you. There are trading groups where you can share your trades, educational trade alert services, mentoring, and more. Don't hesitate, join today!

]]>Because trends are composed of a series of price swings, momentum can play a key role in determining the strength of the trend. It is important to know when a trend may be slowing down, as it may be indicative of a reversal. How can a trader assess the strength of a trend? Using momentum, along with rate of change and momentum divergence, can signal something may be changing. This could mean that the trend may consolidate, or even reverse.

Price movement refers to the direction and magnitude of price. By comparing price swings, a trader may gain insight into price momentum.

**How is momentum defined?**

The magnitude of price movement is measured by the length of the short-term price swings. The beginning and end of each swing is established by price pivot points, which form swing highs and swing lows. Strong momentum is indicated by a steep slope and long price swing. Conversely, weak momentum is exhibited by a shallow slope and short price swing.

There are several momentum indicators such as the Relative Strength Index (RSI), Stochastics, and Rate of Change (ROC). The examples we will be using are analyzed with the Rate of Change Indicator.

Below is a six month chart of SPX with the Rate of Change Indicator.

Figure A. SPX 6 month chart with Rate of Change Indicator

As you can see in Figure A, for each upswing in price, there is a similar upswing in the Rate of Change (ROC). When price swings down, ROC also tends to swing down.

**What is the calculation for Rate of Change?
**

The default settings for Rate of Change calculation on Think or Swim as shown in Figure A above are:

• Length – the number of bars used to calculate the Rate of Change. Think or Swim uses 14-days as the default.

• Color norm length – the number of bars used to calculate the color gradient. In Figure A above, this is also 14-days. You can see the gradual change from red to blue as the price changes.

• Price – This is the price used in the calculation of Rate of Change

In Figure A above, the default setting on Think or Swim is the closing price. Traders have a choice of other prices such as open, high/low divided by 2, high/low divided by 3, volume, etc.

In the case of Figure A above with the default settings as outlined, the rate of change divides today's closing price by the closing price days 14 days prior. If both values are equal, ROC is 1. If today's price is higher, then ROC is greater than 1. Conversely, if today's price is lower, then ROC is less than 1.

Many traders find oscillators such as ROC are most useful using narrow time frames, detecting potential short-term changes in the market, perhaps within the time frame of a week. Other indicators that are trend-following are most often better used for longer-term trends.

**What Rate of Change means for traders …
**

In general, when ROC is rising, it indicates a bullish market and prices are likely to continue higher. When ROC is falling, the outlook becomes bearish and lower prices could be likely.

When prices rise but momentum or ROC falls, this is called momentum divergence, which we will discuss next.

**What is divergence?
**

Divergence is usually associated with an oscillator indicator. For the purpose of this discussion, we will continue to use the Rate of Change indicator. Many traders use divergence to aid in their decisions for new trade entry, adjustments, or exit.

Divergence in technical analysis can occur when the price of an underlying and an indicator are moving in the opposite direction of each other on a price chart.

• Bullish divergence occurs when the underlying price is moving lower as the indicator moves higher.

• Bearish divergence occurs when the underlying price reaches a new high, as the indicator moves lower.

Either bullish or bearish divergence may be a signal of a shift in the direction of the price of the underlying.

You can see an example of both bullish and bearish divergence on the charts below:

Figure B. Bullish Divergence chart from Think or Swim

Figure C. Bearish Divergence chart from Think or Swim

**How can traders interpret divergence?**

Bullish, or positive, divergence can be a signal the downtrend may be weakening. Traders may interpret the lower lows in price while Rate of Change makes higher lows to be an indication a rally is forthcoming. This may be a signal to go long and enter a bullish position.

Bearish, or negative, divergence could be a signal the uptrend may be weakening. Traders may interpret the higher lows in price, while Rate of Change makes lower lows, to be an indication a downtrend may be forthcoming. This may be a signal to go short and enter a bearish position.

**In conclusion …
**

The momentum indicators can be powerful indicators that can guide the trader on not only the market's future direction, but also the speed of the direction. It is important to note that there must be price swings of sufficient strength to make momentum analysis valid. When the market is in a strong trend in either direction, oscillators tend to not function all that well.

Momentum divergence can indicate that something is changing, but it does not mean the trend will always reverse. It is a signal a trader could consider to make modifications to his/her strategy…trade entry, adjustment, and/or exit.

Those using the Rate of Change or other momentum indicators should do so in conjunction with other technical analysis such as price action, support and resistance, volume, etc. Also, any one indicator a trader chooses to incorporate into his/her technical analysis is not going to make you money unless you use it consistently.

If you have found the momentum indicators to be particularly helpful in your technical analysis and would like to share, please comment below.

Whether you are new to trading, or an experienced trader looking to fine-tune your craft, the Aeromir trading community is here to help you. Don't hesitate. Join today!

They have a wide variety of programs including mentoring, educational trade alert services, trading groups, and veteran traders willing to share their trade techniques. When you surround yourself with consistently profitable traders, your own trading can improve.

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