Options and CANSLIM InvestingACCUMULATING SHARES – BUYING STOCKS VS. USING OPTIONS

LAURENCE CHAN – FREMONT IBD MEETUP GROUP

(V0.9)

Disclaimer� I am not a professional trader!

� My presentation is for education purposes only.

� Options are NOT suitable for all investors.

� Using Options may expose you to potentially rapid losses!

� Any investment decisions you make in your self-directed account is solely your responsibility.

� BE CAREFUL – read, learn, paper trade, consult a professional advisor, understand the risks involve in the trades you do before investing using Options.

Accumulating Shares BUYING STOCK VS. BUYING CALL OPTIONS

Important Options Concepts

� See: https://www.dough.com/stock-options-explained

� And search on: www.tastytrades.com

MBLYBuying Stock� “MBLY making a move past a

downward trend line in the handle in +50% volume.”

� Good day to buy in?

� Take a full position 1000 shares at closing price = $48.02 (Pivot = 48.78).

� Capital used = $48020.00.

� Your maximum possible loss = $48020.00.

� If you adhere to CAN SLIM sell rules your possible loss is much less e.g. ~ 7% or ~ $3361.00

Buying Call Options

� Alternate to buying stock, buy Calls to acquire the rights to buy stock at future date.

� Benefits for buying Call Options vs. buying stock:

� Limit maximum loss.

� Less Capital commitment. A Call Option is a fraction of the cost of buying the stock. The 48 strike September expiration Call Option for MBLY on June 9th was ~$3.80. $380.00 gives you the right for 100 shares vs. paying $4800.00 for 100 shares.

� Can defer stock ownership but still benefit from stock appreciation.

� You can buy as far out a possible if you don’t mind a larger capital outlay. E.g. Jan 2016 47 Call Option Bid / Ask for MBLY was $5.50 / $6.40 on June 9th.

� Option value appreciates and depreciates as stock price goes up or down. You can trade Options just like you trade stocks. You can close the Option contract before expiration.

� Differences: 1) Option value becomes zero at expiration if the not exercised or closed. 2) Option price change is typically smaller than stock price movement.

Call Option purchase considerations� Expiration:

� How many weeks / months out should you buy? This depends on how long you want to keep the position, the Option cost and availability.

� You can buy an Option that is a week out, a month out or even multiple years out!!! Further out = more time value = more costly.

� Strike Price = price at which the Option contract can be exercised. For call options:

� The strike price is where the security can be bought up to the expiration date.

� “At The Money” = strike price at or near the current stock price. Most costly due to highest time value.

� “Out of the Money” = strike price that is higher than the current price = cheaper = lower probability of profit.

� “In The Money” = strike price that is lower than current stock price = has Intrinsic value.

� The more “In The Money” the more the Option value tracks the price of the stock. The measurement = “Delta”. Delta is also approximately the same as the Probability of Profit (POP).

� Contrary to intuition ATM Option is actually most expensive to own – it has the most Time Value which depreciates away. Deep ITM Options is actually least expensive and has a lower stock breakeven price.

� Cost of Option as it relates to above

Buy Call Option“Best” Choice?� At least a few months out, less time decay

impact.

� A strike that has good volume.

� Tighter bid / ask.

� As high a Delta as possible – better track stock price movement.

� Higher Delta = lower strike.

� A lower strike also has a lower stock breakeven point and lower time value giving you a higher probability of profit.

� Again: it depends on how long you want to keep the position and how much you want to pay.

MBLY – Call Option purchase 6/9� On 6/9 – decided to buy Calls vs. spending $$$ to buy the stock. I don’t want to

spend more than 8% of the current price of the stock, I want to keep the Option for a few months at least, I want to have an Option that is more readily available thus easier to have my order filled and less chance of paying too much.

� The September expiration At The Money 48 Call Option for MBLY has good volume, Bid / Ask = 3.60 / 3.90 – not really tight but not bad for a low Option volume stock.

� Rights to 1000 shares = 10 Contracts.

� The Delta of the 48 Call Option is .53 = for every dollar MBLY moves the Option price would move by ~0.53.

� Capital used = 3.80 * 100 * 10 = $3800.00 = maximum possible loss at expiration

Stock vs. Call Options @ 6/26

� On 6/26 MBLY has appreciated to 53.70 a 3% drop from day prior but still a nice appreciation from 48.20 purchase price on 6/9

� The September expiration 48 Call Options also appreciated. The Bid price of the Call Option is 6.90, a nice gain from 3.80, Delta improved to .76, Time value is reduced to 1.55, the Intrinsic value increased from 0.20 to 5.70.

Stock vs. Call Options P&L Compared 6/26

� $ wise buying stock has higher P&L: $5,680 vs. $3,100

� However $ at risk is higher with straight stock purchase.

� As MBLY appreciates, the Call Option would have higher Delta = behave more and more like the stock.

StraightStock Purchase

Capital Used

Stock Price 6/26

AccountValue

P&L P&L % $ at risk

1000 Shares $48,020.00 $53.70 $53,700.00 $5,680.00 11.8% $48,020.00

Far Month Option Purchase

Capital Used

OptionPrice 6/26

Account Value

P&L $ P&L % $ at risk

10 Contracts 48Call Expiring September18th

$3,800.00 $6.90 $6,900.00 $3,100.00 81.58% $3,800.00

Accumulating Shares BUYING CALL OPTIONS + SELLING PUTS

MBLY

� Buy Call Options

� In addition: Sell Put Options

Selling Options is fundamental in Cost Basis Reduction and higher Probability of Profit.

Note: when selling Puts your account needs to be cash secured to the maximum possible loss or you need to have a margin account with the appropriate balance.

MBLY - using Options Buy Calls a few months out + Selling Put Option� In addition to buying far month Calls, take on the obligation of owning MBLY at a

discount: Sell a near month Put Option and earn the premium associated with the Option as the Option value decays or depreciates if the stock price goes up.

� Which strike to sell?

� Out Of the Money (OTM) Put Option = less premium earned, higher probability of expiration OTM at expiration.

� At The Money Option (ATM) if you are convinced that the stock price will gap up or appreciate beyond the current price at expiration. Advantage: more time value, higher premium.

� 46 strike Put Option is $1.15 ~63% probability OTM @expiration. If you sell this Option $115 would be credited to your account per contract. 10x = $1150.00.

Buy Calls + Sell near ATM Put Option� You are convinced that MBLY will gap up. You don’t mind buying the stock at the

current stock price, but you don’t mind having a discount.

� Instead of selling an OTM 46 Put Option, sell At the Money 48 Put Option

� 2.00 credit *10 Contracts = $2000 credited to your account

� Obligation for 1000 shares of MBLY at $48.00. More aggressive = higher probability you will own the stock at expiration on top of the Call Options you bought.

� RISK: MUCH HIGHER than just buying a Call Option.

6/9 MBLY July 17th Put Options on 6/26� Because MBLY appreciated ~12%.

The Put options from 6/9 have more intrinsic value and less time value.

� If we had sold the 46 Put, the 46 Put Option expiring July 17th = 0.25 Ask. LastX = 0.15. Unrealized gain = (1.15 – 0.15) * 10 * 100 = $1000.

� If we had sold the 48 Put, the 48 Put Option Ask = 0.45, LastX = .40. Unrealized gain = (2.00 – 0.40) * 10 * 100 = $1600.

� Probability of both expiring worthless is very high: 91.84% and 85.41%!!!

Buy Call + Sell Put P&L Compared

� $ wise buying stock has higher P&L: $5,680 vs. $4700.00 ($3100 + 1600).

� $ at risk is slightly higher with Buy Call + Sell Put = $46,000 + 3800 = $49,800 vs. straight stock purchase $48,020 or less if you follow CAN SLIM rules to sell.

StraightStock Purchase

Capital Used

Stock Price 6/26

AccountValue

Un-realized P&L

P&L % $ at risk

1000 Shares $48,020.00 $53.70 $53,700.00 $5,680.00 11.8% $48,020.00

Far Month Option Purchase

Capital Used

OptionPrice 6/26

Account Value from Option

Un-realizedP&L $

$ at risk

Bought 10x 48Call Expiring September18th

$3,800.00 $6.90 $6,900.00 $3,100.00 $3,800.00

10x 48 Put Expiring July 17th

$0.00 $0.40 $1600.00 (+ $400 liquidity)

$1600.00 $48,000 -$2000 = $46,000

Accumulating Shares BUYING CALL OPTIONS + SELLING PUTS + ROLLING

Rolling for additional credit

� At any time you can “Roll” the Put Option by closing the Open Put Option – realizing profit (or loss) for the Put, and sell another ~66% probability of OTM Put Option to earn more credits.

� E.g. Roll to the 52 Put July expiration for $1.15 – gives you another $1150 credit in your account that would be realized if MBLY is > 52.00 on July 17th

� Disadvantage: you are increasing your risk since the new Put you are selling is at a higher base price. E.g. you will have the obligation to own MBLY at $52.00 should the stock drops.

Buy Call + Sell Put + Rolling P&L 6/26

� Possible P&L = 3100 + 1600 + 1150 = $5850.00 = higher than straight stock purchase

StraightStock Purchase

Capital Used

Stock Price 6/26

AccountValue

P&L P&L % Possible Loss, $ at risk

1000 Shares $48,020.00 $53.70 $53,700.00 $5,680.00 11.8% $48,020.00

Far Month Option Purchase

Capital Used

OptionPrice 6/26

Account Value from Option

P&L(* = realized,^ = potential)

Possible Loss, $ at risk

Bought 10x 48 Call Expiring September18th

$3,800.00 $6.90 $6,900.00 $3,100.00 $3,800.00

Closed 10x 48 Put Expiring July 17th

$0.00 $0.40 $1600.00 $1600.00*

Sell 10x 52 Put expiring July 17th

$0.00 $1.15 $1150.00 $1150.00^ $52,000 – ($1600 + $1150) = $49250

Accumulating Shares NOT HAPPY CASE + ADVICE FROM AN EXPERT

“Non Happy Case” gap down handling� Scenario 1: Buying Calls. On gap down, stock down by 7% or more. Close the Call

position. Your loss can be a substantial portion of the Call Option. However your maximum loss is still what you paid for the Call. In the first example = $3800.00.

� Scenario 2: Buying Calls + Selling Puts. Consider closing the Options if stock is down 7% or more. Your loss will be more than scenario 1 since you will need to close the losing Put position also. Your loss may still be less than buying straight stock due to premium earned. You can also defend your Put sold by Rolling to earn more premium.

� Scenario 3: Buying Calls + Selling then Rolling Put. Your loss on a down > 7% stock may be even less than the other scenarios due to additional premium earned.

� In all cases above your loss should be less than loss from owning straight stock!!

� Before a gap down you can further protect against loss with additional premium earned if you sell Calls against the number of long Call contracts you have (i.e. a Covered Call). The disadvantage is you may be limiting your upside gain.

Tips from an expert: Min @SVL Meetup� ATM options are most expensive: Buying ATM calls risks the largest amount of money

because you pay for purely time values and the time values are at their maximum. In comparison, ITM and OTM call premiums contain smaller amounts of time values.

� Stay out of excessive time decay: Don't wait until the last few weeks to exit a long call unless you are sure the stock will make a climax run in that last month.

� Follow CAN SLIM loss exit rules: Exit options positions when corresponding stocks are down 4% to 7%, or at most 10% a la Lee Tanner. Following these rules, the potential stock loss for the MBLY example should be $4,800 (Lee Tanner style) or at most 2x, $9,600, to be a fair comparison to the ATM call options.

� Stick to CAN SLIM quality: I'd only consider selling naked puts on quality CAN SLIM stocks. Selling naked puts on names suggested in other webinars / shows but not meeting CAN SLIM criteria should be avoided because some of them tend to be long-term downers. It is difficult if not impossible to recover from losses in those names with rolling. For example, see the 5-year charts of TBT, VXX, UNG, UCO or even USO. 3x and inverse types of stocks are more prone to making continued down moves due to construction, and commodity (e.g., oil) stocks can be affected by contango, which builds downward bias into such ETFs. Although you are not using any of these in your example and you are showing a happy case of up-rolling, I think it should be made very clear that selling naked puts should be limited to quality stocks that have fundamentals to recover from if they were hit.

Follow up questions?

� Please email me @ mwclccfin@gmail.com

� Let me know if you are interested in joining an email group on Options and CANSLIM.