Calculating Your Investment IQ (6)

26. It is important that you take your Tax Losses regularly, particularly if you have held the losing position for less than one year.



27. Annuities, particularly Variable Annuities, are perfect investments at retirement both for people of limited resources and for the wealthy.



28. Technical Analysts can predict the future movements of the economy, individual securities, and the stock market with a very high degree of accuracy.



29. Index funds will always beat the market, or market sector, that they are designed to track.



30. The keys to successful investing are Asset Allocation using only two investment buckets: Equity and Income, and the development of realistic expectations about their market value performance.



Investing is as fascinating as it is frantic, as scary as it is exciting, and as intimidating as it is satisfying.



But perhaps the most interesting thing about it is how educationally unprepared most individual investors are for the adventure!



Books have been written, graduate degrees awarded, and doctoral dissertations presented in most of the topical areas touched upon so glibly above.


Most of you will give your seal of approval to too many of the statements.

Calculating Your Investment IQ (5)

18. Zero Coupon Bonds are an important part of the fixed income portion of the investment portfolio, especially when retirement is contemplated within five years or so.



19. The second step in every stock purchase should be the establishment of a Stop Loss Order.



Such an order assures you that your losses will be limited to a specific percentage of your purchase price.




20. The IGVSI tracks the market value of a small but elite group of New York Stock Exchange equities.




21. The Four Most Important Investment Ideas include: buying only high quality securities, diversifying properly, using discount brokers exclusively, and establishing reasonable profit-taking targets.




22. Profit Takers and Traders hurt the average investor.



23. Investment Grade Value Stocks will be the next red-hot market sector.



24. "Sell your losers and let your profits run" is the essence of sound Investment Management thinking.




25. The November Syndrome is the partial result of the interaction of Wall Street institutional window dressing and the Infernal Revenue Code.

Calculating Your Investment IQ (4)

12. The Dow Jones Industrial Average is comprised solely of investment grade companies, and generally gives a clear indication of what is going on in the stock market.



13. Smart Cash is an integral part of any asset allocation formula because it allows investors to time the market successfully.


Professional market timers know precisely when to move into or out of cash in anticipation of the next major directional change in the market.



14. It is a well-known fact that there are certain Core Portfolio Securities that belong in all investment portfolios if long-term success is to be expected.



15. There is no such thing as a freebie on Wall Street.




16. Closed End Mutual Funds (CEFs) are not popular with Wall Street professionals because they are inherently more risky than normal mutual funds.




17. Packaged Investment Products are designed with a sincere concern for the financial well being of the average investor, and are good for everyone.

Calculating Your Investment IQ (3)

7. No Load Mutual Funds are particularly good for investors because the mutual fund company does not charge anything for its services.



8. In the long run, investing in the stock market will assure you of keeping up with Inflation.



9. The proper gauge of your total Investment Portfolio Performance is the change in market value over the course of a calendar year, compared with the change in one of the more respected stock market averages during the same period of time.




10. Quality, Diversification, and Income are considered by many investors to be the three basic principles of investing.




11. Mutual Funds have always been a safer route to long-term investment success than trying to create your own portfolio of individual securities.

Calculating Your Investment IQ (2)

3. Buy-and-Hold


continues to be the proper investment strategy for most individual investors, especially if automatic reinvestment of income is part of the package.



4. It's a better Investment-


Income Strategy to buy shorter duration corporate and municipal bonds (rather than higher yielding long-term debt) because the market value doesn't fluctuate as much with anticipated changes in the direction of interest rates, and that is the most important concern with income investing.




5. If an investor can learn to control his own Greed and Fear, he will have a much better chance of investing successfully.




6. Asset Allocation is a strategy used by investors to move assets from weak market sectors to strong ones in order to improve the growth of the Investment Portfolio's bottom line.

Calculating Your Investment IQ

Stocks, bonds, index funds; averages, recessions, market rallies and corrections; mutual funds, technical analysis, financial statements; commissions, taxes, and discount brokers.


Just how much do you know about investing, or perhaps a better question: is there any "know" in the investment vocabulary?


So many terms, ideas, and strategies; so little time and money!



Here's a list of thirty mostly-true or mostly-false comments for you to kick around with your friends and fellow investment bloggers:



1. Every Properly Diversified Portfolio will have up to 5% of its market value in each of these areas: miscellaneous speculative opportunities, gold or other commodities, small cap stocks, and global index funds.



2. Financial Professionals are well trained in all aspects of investing, investment portfolio design, and management.



Consequently, a significant portion of their compensation is tied directly to how well they help their clients develop high quality, properly diversified, and goal directed portfolios.

How to Avoid Investing Mistakes (2)

Be careful with what mindset you approach investing with.


Thinking you are going to get rich in a week or two from penny stocks is dangerous.



Youre definitely going to need more patience than that and realistic expectations.



Im not saying you should expect the worst but only be prepared for it, there is a difference.


You definitely want to diversify.



There is no sense in taking unnecessary risks by having so much trust in one stock that you bet all of your money on it.


You need a portfolio that will weather the storms of the stock market.



I mention diversification many times on this site because it is one of the best defenses against losses.



Be careful what stocks become your favorites or which ones you become loyal to.


Remember they are only as loyal to you as long as business is good.


Though it may sound cold it really is about the money and you are just another investor.


So you must look out for yourself because no one else will.


You cannot afford to play favorites when it comes to your money.



No one will care about your money more than you.


Of course there are those who care about getting it but we are talking about keeping it and making more off of it.


Would you be willing to give me all your money if I just simply asked for it?


I didnt think so.


So dont give it away to those asking for it in a more creative sales manner.


Trust not what you see but what you feel when it comes to important financial decisions.


This method will definitely pay off in the long run.

How to Avoid Investing Mistakes

It is inevitable that you will make mistakes throughout your investing years.

This is normal and you can certainly learn from mistakes.

There are some big mistakes that you can and should avoid.

First off it would be a mistake to let your fears keep you from investing.

All wealthy people have learned how to make their money work for them.

Even if you start off small it is better than nothing at all.

Make sure you are financially stable before jumping into the stock market.

You dont want to start investing when you have lose ends to tie up with bills or massive debt.

You dont have to be in the perfect financial situation but you definitely want to take care of priorities first.

Investor Financing in this Crazy Real Estate Market (5)

Paying Points:


Cash is king, so I don't recommend paying points to discount interest rates unless it's necessary to qualify for the loan or if you plan to hold the property more than 5 years.



Commercial Properties:


If you have 20-30% for a down payment, an average credit score and would like to consider a larger investment, multi-family apartment buildings and trailer parks are a great opportunity.


Stated income and stated asset loans are still available for investors with FICOs in the low 600s.


Lenders care more about whether the property cash-flows than the borrower's ability to repay the loan.


This is good for both the lender and the investor.


I hope you found this general information useful in guiding your investment decisions.

Investor Financing in this Crazy Real Estate Market (4)

Recommendations:

Short Sales:

If you are looking at a short-sale, don't automatically assume that conventional loans aren't an option.

I've closed several short sale loans in less than a week.

With preparation, a conventional loan can take only a few days more to close than a hard money loan.

Conforming Loan Sizes:

Stick with "Conforming" size loans and select properties that are smaller and will still sell or rent in a slower market.

A conforming loan is less than $417,000 and a "Jumbo" loan is greater than $417,000.

REO Properties:

For first time investors, REO (bank owned foreclosures) properties are a great way to buy wholesale.

You have time for due diligence, inspections and closing a conventional mortgage.

Investor Financing in this Crazy Real Estate Market (3)

3. Hard Money Loan:


These loans became popular during the bull market for fix and flip investors.


In slower times, these are expensive loans and upfront costs and pre-payment penalties make them unfavorable for buy and hold strategies.


Rates are in the 11-14% range and typically cost 3-5% in loan fees.


Investors still look to these loans for quick transactions that have large short-term upside.


Limited documentation is required and they can be closed in a few days. 35-45% is required for down payment.



4. Foreign Nationals:


This is hot category because of the weak US dollar.


Foreign investors can buy property at an immediate discount when they use Euros or the Canadian Dollar. 20% down payment and income documentation is required.


Rates are in the 8% range.



Note: As a general rule, interest only loans are no longer available for investment properties so calculate cash-flow assuming fully amortizing loan terms.

Investor Financing in this Crazy Real Estate Market (2)

1. Stated Income and Stated Assets (SISA) Loan:

This loan does not require documentation (bank statements or tax returns) to support income and asset numbers.

With a credit score above 720, you may still qualify for this type of loan as an investor with as little as 10% down.

The loan amount must be below $417,000.

Rates for a 30 year fixed loan are going to be in the low 7% range without paying points.

ARM rates are in the low 6% range, however, most lenders are requiring discount and origination points to purchase these loans.

2. Full Documentation Loan:

These loans provide the most favorable rates, terms and allow a lower credit score.

The minimum down payment is still 10%.

You must show tax records, liquid asset records and income statements (P&L if business owner) to qualify.

Investor Financing in this Crazy Real Estate Market

Here is an overview of the general guidelines and recommendations for investors buying residential and commercial property during this volatile market.


General Guidelines:


With 25% of the foreclosures coming investor-owned properties, it's understandable why investor loans are one of the most hated on Wall Street.



However, Wall Street is still buying these loans for the right borrowers and the rates on available programs are still reasonable for the smaller real estate investor.


Here are some of categories of loans that are still available for residential purchases and refinance.

Buy, Sell, or Hold? (6)

The market downturn, in my opinion, has also created some attractive opportunities in growth-oriented companies.

In particular, I like companies that are part of longer-term global trends.

For instance, global growth and the need for alternative energy have spurred tremendous demand in several industries.

Those stocks are now very attractive.

The key is to not run with the herd.

When everyone is rushing for the exits, those brave enough to stay behind can pick up some real bargains.

I believe that now is one of those times.

Buy, Sell, or Hold? (5)

With the 10-year U.S. Treasury now yielding less than 4%, these are very attractive yields.


As market fears subside, investors looking for a higher level of income will once again recognize these securities and move money back into them.


That should bring a recovery in their share prices.



In the meantime, we continue to earn over double the 10-year Treasury note.



In short, if we just look at the headline numbers of the major stock market averages, it's easy to come to the conclusion that we should get fearful, sell off stocks and move a large part of the portfolio to cash.


When you dig below the headlines and do some research you see that there are high-quality, defensive companies that make sense to continue to hold and to buy more.

Buy, Sell, or Hold? (4)

Another group of securities that haven't been fairing well lately is the closed-end bond funds.

Typically, bond funds do well when the stock market is falling and interest rates are going down.

Credit-related panic selling, though, has driven the price some quality shares down 8-10%.

Will the credit crunch adversely affect these holdings?

I don't think it will.

There are closed-end funds with attractive portfolios of bonds that can be purchased for less than the underlying costs of the bonds themselves.

For instance, a sovereign government fund isn't going to be adversely affected by the sub-prime mortgage situation, yet these shares have been sold-off just like everything else.

But they continue to pay their dividends and have yields over 6%.

Buy, Sell, or Hold? (2)

Of course, that doesn't mean that other stocks are immune.

Investors (and traders) can panic when they see the decline of the averages and they sell everything.

And sell they have.

The decision to buy, sell or hold shouldn't be based on the overall market.

It shouldn't be based on fear or greed.

I believe we need to look at individual holdings to determine which action we should take.

I don't know of anyone who has stopped using their telephone or internet based on the recent decline in the market.

You'll continue to use it and you'll continue to pay your phone bill month after month.

That's money the telephone companies can use to grow their businesses and to pay dividends.

Rural telephone companies also receive subsidies from the U.S. Government.

This represents a very stable cash flow.

Buy, Sell, or Hold? (3)

To say that differently, a rural telephone company's ability to pay their dividend usually isn't affected by the economic cycle.


That's one reason I regularly use them in my clients' portfolios.


That hasn't prevented a sell-off of these rural telephone carriers of late.


Those buying these stable companies now are handsomely rewarded by higher dividend yield (many now in the 6-10% range).



The underlying businesses of these companies haven't changed.



Their ability to pay and increase their dividends hasn't changed.


So it's hard to justify selling them now.


It's quite easy to build the case for buying them.

Buy, Sell, or Hold?

The markets continue to be tumultuous and we're seeing the markets re-test the lows .







Even energy stocks are getting hit hard.





Should you be selling stocks, gritting your teeth and hanging on or be stepping up to the plate and buying?







To answer that question, you can't just look at the headlines or your account value and decide whether or not action should be taken.







The market headlines are based on averages.







Movements of the bigger companies in the averages can easily skew the performance.







The financials have been getting hammered lately and financials make up a large part of the S&P 500.

Clean Up Your Finances Before You Invest (6)

Annuities are contracts sold by insurance companies to provide payments at specified intervals, usually after retirement.



You will be charged a penalty for withdrawing funds prior to a certain age, but you won't be taxed until you withdraw the funds.



Annuities are considered to be safe,low-yielding investments.



Additionally, annuities have death benefits that equal either the current value of the annuity or the amount that has been paid into it - whichever is has a higher value.



Once you are ready to start investing, you need a plan.



Start by making a list of your most important financial goals like buying a home, paying for a child's college education or living comfortably in retirement.



When you have the extra money, make a habit of paying yourself first by putting money into your savings and investments.



If you feel you don't know enough about investing on your own, you can always seek professional investment advice.



Investment professionals provide a variety of services at different prices.



Some are very expensive and others are very affordable; it pays to shop around.

Clean Up Your Finances Before You Invest (5)

A bond is a certificate of debt issued by the government or a company with a promise to pay a specified sum of money at a future date.


Bonds carry a fixed interest rate.



The term of a bond can range from a few months to 30 years.



Bonds can be traded and are considered to be safer than stocks because bondholders are paid before stockholders if a company goes bankrupt.



Mutual funds are professionally managed pools of money from a group of investors.



A mutual fund manager invests your funds in securities like stocks and bonds, money market instruments or a combination of all of them depending on the fund's investment objectives.



Investing in mutual funds allows you to diversify, which makes the investment less risky.



Keep in mind that mutual funds usually charge a fee for the service and you will have to pay taxes on any profits you earn.

Clean Up Your Finances Before You Invest (4)

A certificate of deposit or CD is an account that usually offers a higher rate of interest than a regular savings account.


CDs are also insured up to $100,000 and the longer the period of investment the higher the interest rate.



On the downside, there are usually penalties for early withdrawal.



A money market account generally earns a higher interest than a regular savings account.


They are also insured and work like a checking account.



However, there is a limit on the number of withdrawals or transfers you can make during a given period of time.



Investing in stocks gives you ownership of part of that company's assets.



When the company makes money, its stockholders usually receive dividends and have the opportunity to sell their stocks for a profit.



On the other hand, if the company does poorly, the stock price will probably fall and you could lose some or all of the money you invested.

Clean Up Your Finances Before You Invest (3)

If you're living from paycheck to paycheck like alot of people, it doesn't necessarily make sense to start investing funds right away.


If you're struggling to pay your bills and your bank balance is always next to nothing, investing any money you have saved up will most likely put you in a worse financial situation.


Your investment dollars would be better spent to rectify adverse financial issues that affect you on a daily basis.



Even if you are unable to invest money at the start, While you are in the process of clearing up your present financial situation you should make it a point to educate yourself about the various types of investments.



Read up on things like savings accounts, CDs, money market accounts, stocks, bonds, mutual funds and annuities and choose the type of investments that best suit your needs.



Savings accounts are considered to be a safe haven for your money as your deposits are usually insured, but on the downside they usually offer low interest rates so it takes longer to get a good return on your investment.

Clean Up Your Finances Before You Invest (2)

The next thing you should do is look at what you are paying out each month and get rid of any unnecessary expenses.



Although things like high interest credit cards are convenient and nice to have, they most certainly aren't necessary and can end up costing you thousands in the long run.



Pay them off and get rid of them.



Likewise, if you have high interest loans outstanding, you should pay them off as well.



If nothing else, you could do a balance transfer from one credit card to another, exchanging the high interest credit card for one with lower interest.



You could also look into refinancing high interest loans with lower interest loans.



You might end up having to use some of your investment funds to take care of these matters, but in the long run, you will see that this is the wisest course of action

Clean Up Your Finances Before You Invest

Before you consider investing in any type of market, you should really take a long hard look at your current situation.



Investing in the future is definitely a good thing, but clearing up bad or potentially bad situations in the present is more important.



The first thing you should do is get a copy of your credit report.



You should do this at least once a year.


It is important to know what's in your credit report and clear up any negative items as soon as you possibly can.


If you have $25,000 set aside to invest, but you have $25,000 worth of bad credit, your best bet is to clean up your credit before you start any type of investing.

Introducing The Amazing Stock Repair Strategy (4)

In some cases, you can even put on this trade for a credit, whereby you can sell the out of the money calls for more than you paid for the at the money calls.


This scenario is ideal, because then you also profit from this part of the trade - also known as a credit spread.


(Remember, you will be selling the out of the money calls in a 2:1 ratio to the at the money calls you purchase.)


The out of the money calls will invariably be cheaper than the calls you buy, but the 2:1 ratio makes up for the difference in pricing.


The easiest way to explain this is by example.


Again, we will go back to our XYZ example. You have purchased 500 shares of XYZ for $40.00.


The stock then trades down to $30.00 leaving you with a $5,000 loss.


At this point, at $30.00, you would construct the Stock Repair Strategy. (Option prices are for example purposes only.)


You would buy 5 February 30 calls for $1.50 and sell 10 February 35 calls for $.75 each.


This strategy is known as a 1 by 2 spread.


Now that the position is in place, you are long 500 shares of XYZ, long 5 February 30 calls and short 10 February 35 calls.


Just to clarify, if you were long 1000 shares of stock, then you would also be long 10 February 30 calls, and short 20 February 35 calls.


Remember, the ratio of stock, to purchased calls, to sold calls is 1:1:2.

Introducing The Amazing Stock Repair Strategy (3)

Here's why.

The 500 shares of stock you have, along with the 5 call options you just bought, will result in an even spread trade.

The reason this is important is because without owning the equivalent of 10 calls (or 1000 shares of the underlying stock), then the 10 out of the money calls you sell would be considered 'naked' and may require an additional margin requirement.

Selling naked calls is considered risky.

However, by owning 1000 shares of stock (or 10 call options) at a lower price, your risk is limited because your sold calls are considered 'covered.'

The chart below shows some examples of the correct Stock Repair Strategy ratios.

The total dollar value of the options' trade should be neutral or very close to neutral.

In this way, you can establish the position without putting out any more money or at least very little.

Introducing The Amazing Stock Repair Strategy (2)

Now that you have purchased the correct and exact amount of at-the-money calls, you then must sell exactly twice the amount of out-of-the-money calls.


Again, it is imperative that you sell exactly two times the amount of out-of-the-money calls as the amount of at-the-money calls you own.



Looking at the case in which you owned 500 shares and bought 5 at-the-money calls, you would then have to sell 10 out-of-the-money calls to properly construct the Stock Repair Strategy.


Likewise, in the case where you owned 3000 shares and bought 30 at-the-money calls, you would then have to sell 60 out-of-the-money calls for proper Stock Repair Strategy construction.

Introducing The Amazing Stock Repair Strategy

Introducing the Amazing Stock Repair Strategy.

This strategy involves buying one at-the-money call option while simultaneously selling two out-of-the-money call options on the same stock, in the same month.

The construction of this trade is critical.

First, you must make sure to purchase exactly the equivalent amount of at-the-money call options as shares of stock you own.

Remember, each option contract is worth 100 shares.

So if you own 500 shares, then you would purchase 5 at-the-money calls.

If you owned 3000 shares then you would purchase 30 at-the-money calls.

The Effects of Volatility on the Time Spread When Trading Options(5)

Notice the increasing pattern as you go out over time.

Also notice how the value decreases as you move away from the at-the-money strike.

Another important fact about vega is that it is a strike-based number.

That means that the vega number does not differentiate between put and call.

Vega tells the volatility sensitivity of the strike regardless of whether you are looking at puts or calls.

So, the vega number of a call and its corresponding put are identical.

The Effects of Volatility on the Time Spread When Trading Options (4)

Although increasing, they do not progress in a linear manner.


When you check the same strike price out over future months you will notice that vega values increase as you move out over future months.


The at-the-money strike in any month will have the highest vega.


As you move away from the at-the-money strike, in either direction, the vega values decrease and continue to decrease the further away you get from the at-the-money strike.


Remember, vega (an option's volatility component value) is highest in at-the-money, out-month options.


Vega decreases the closer you get to expiration and the further away you move from the at-the-money strike.

The Effects of Volatility on the Time Spread When Trading Options (3)

As we continue to discuss vega, keep these facts in mind


1. Vega measures how much an option price will change as volatility changes.


2. Vega increases as you look at future months and decreases as you approach expiration.


3. Vega is highest in the at the money options.


4. Vega is a strike-based number - it applies whether the strike is a call or a put.


5. Vega increases as volatility increases and decreases as volatility decreases.



It is important to note that an option's volatility sensitivity increases with more time to expiration.


That is, further out-month options have higher vegas than the vegas of the near term options.


The further out you go over time, the higher the vegas become.

The Effects of Volatility on the Time Spread When Trading Options (2)

An option's volatility component is measured by a term called vega.

Vega, one of the components of the pricing model, measures how much an option's price will change with a one point (or tick) change in implied volatility.

Based on present data, the pricing model assigns the vega for each option at different strikes, different months and different prices of the stock.

Vega is always given in dollars per one tick volatility change.

If an option is worth $1.00 at a 35 implied volatility and it has a .05 vega, then the option will be worth $1.05 if implied volatility were to increase to 36 (up one tick) and $.95 if the implied volatility were to decrease to 34 (down one tick).

Remember, vega is given in dollars per one tick volatility change.

The Effects of Volatility on the Time Spread When Trading Options

When purchasing a time spread, the investor should pay attention not only to the movement of the stock price but especially to the movement of volatility.

Volatility plays a very large roll in the price of a time spread and, as we have stated,

the time spread is an excellent way to take advantage of anticipated volatility movements in a hedged fashion.

Since the time spread is composed of two options, the investor should understand the role of volatility in options as well as in time spreads.

Let's start with option volatility.

Properly Calculating Accurate Volatility Levels(3)

In order to accurately calculate volatility levels for pricing and evaluating a time spread, the key is to get both months on an equal footing.

You need to have a base volatility that you can apply to both months.


For instance, say you are looking at the June / August 70 call spread.June's implied volatility is presently at 40 while August's implied volatility is at 36.


You can not calculate the spread's volatility using these two months as they are.


You must either bring June's implied volatility down to 36 or bring August's implied volatility up to 40.


You may wonder how you can do this.Actually, you have the tools right in front of you.


Use the June vega to decrease the June option's value to represent 36 volatility or use August's vega to increase the August option's value to represent 40 volatility.


Both ways work so it doesn't matter which way you choose.


Let's use some real numbers so that we may work through an example together.


Let's say the June 70 calls are trading for $2.00 and have a .05 vega at 40 volatility. The August 70 calls are trading for $3.00 and have a .08 vega at 36 volatility.


Thus the Aug/June 70 call spread will be worth $1

Properly Calculating Accurate Volatility Levels(2)

It is important to know how to calculate the actual and accurate volatility of the spread because the current volatility level of the spread is one of the best ways to determine whether the spread is expensive or cheap in relation to the average volatility of the stock.

There are several ways to calculate the average volatility of a stock.

There are also ways to determine the average difference between the volatility levels for each given expiration month.

Volatility cones and volatility tilts are very useful tools that aid in determining the mean, mode and standard deviations of a stock's implied volatility levels and the relationship between them.

The present volatility level of the spread can then be compared to those average values and a determination can then be made as to the worthiness of the spread.

If you now determine that the spread is trading at a high volatility, you can sell it.

If it is trading at a low volatility, you can buy it.

But first you must know the current trading volatility of the spread

Properly Calculating Accurate Volatility Levels

Understanding and properly calculating accurate volatility levels is imperative for spread traders.


In order to get accurate volatility levels, you must first determine a base volatility for the two options involved in the spread.


Getting a base volatility must be done because different volatilities in different months can not, and do not, get weighted evenly mathematically.

Since they are weighted differently, you can not simply take the average of the two months and call that the volatility of the spread; it is more complicated than that.


The problem is related to calculating the spread's volatility with two options in different months.


Those different months are usually trading at different implied volatility assumptions.


You can not compare apples with oranges nor can you compare two options with different volatility assumptions

How to Calculate the Volatility of the Spread in Options Trading(4)

We know the spread is worth $1.20 at 36 volatility with a vega of .03.


So, we can assume that the spread trading at $1.00 must be trading at a volatility lower than 36.


To find out how much lower we first take the difference between the two spread values which is $.20 ($1.20 at 36 volatility minus $1.00 at ? volatility).


Then we divide the $.20 by the spread's vega of .03 and we get 6.667 volatility ticks.


We then subtract 6.667 volatility ticks from 36 volatility and we get 29.33 volatility for the spread trading at $1.00.


We can also determine the volatility of the spread as the spread's price changes. Let's fix the spread price at $1.30.


To calculate this, we must first take the value of the spread ($1.20 at 36 volatility) and find the dollar difference between it and the new price of the spread ($1.30).


The difference is $.10.


This dollar difference must now be divided by the vega of the spread.


The $.10 difference divided by the .03 vega gives you a value of 3.33 volatility ticks.


Then add the 3.33 ticks to the 36 volatility and you get 39.33 as the volatility for the spread trading at $1.30.

How to Calculate the Volatility of the Spread in Options Trading(3)

Since we now have an equal base volatility, we can calculate the spread's vega by taking the difference between the two individual option's vegas.


In the example above, the spread's vega is .03 (.08 - .05).


The vega of the spread is calculated by finding the difference between the vega's of the two individual options because in the time spread, you will be long one option and short the other option.


As volatility moves one tick, you will gain the vega value of one of the options while simultaneously losing the vega value of the other.


Thus the spread's vega must be equal to the difference between the two options vega's.


So, our spread is worth $1.20 at 36 volatility with a .03 vega or $1.32 at 40 volatility with a .03 vega.


Going back to our original spread value of $1.00 with a vega of .03, we can now calculate the volatility of that spread.

How to Calculate the Volatility of the Spread in Options Trading(2)

If you wanted to move the August 70 calls instead, you would take the August 70 call vega of .08 and multiply it by the four tick implied volatility difference.


This gives you a value of $.32 that must be added to the August 70 call's present value in order to bring it up to an equal volatility (40) with the June 70 call.


Adding the $.32 to the August 70 call will give it a $3.32 value at the new volatility level of 40 which is the same volatility level as the June 40 calls.


Now, our spread is worth $1.32 at 40 volatility.


August 70 calls at $3.32 minus the June 70 calls at $2.00 gives the price of the spread at 40 volatility.


It does not make any difference which option you move.


The point is to establish the same volatility level for both options.


Then you are ready to compare apples to apples and options to options for an accurate spread value and volatility level.

How to Calculate the Volatility of the Spread in Options Trading

To be able to calculate the volatility of the spread, we must equalize the volatilities of the individual options.


First, let's move the June calls by moving June's implied volatility down from 40 to 36, a decrease of four volatility ticks.



Four volatility ticks multiplied by a vega of .05 per tick gives us a value of $.20.



Next we subtract $.20 from the June 70 option's present value of $2.00 and we get a value of $1.80 at 36 volatility.


Now the two options are valued at an equal volatility basis.Looking at this first adjustment where we moved the June 70's volatility down to 36 from 40, we have a value of $1.80 at 36 volatility.


The August 40 call has a value of $3.00 at 36 volatility.


So the spread will be worth $1.20 at 36 volatility.

Options Buyer Risk & Reward (3)

Third, the buyer can make money due to stock price movement.

As stated before, a time spread's value is at its maximum when the stock price and the spreads strike price are identical (at-the-money).

You could have an increase in value if you owned an out-of-the-money or in-the-money time spread, and the stock moved either up or down toward your strike.

As the stock moves closer to your strike, the spread will expand and increase in value creating a profit for you, the buyer.

The buyer's risks are obviously the opposite of the rewards.

You can not stop or reverse time so the buyer of the spread can never be hurt by time.Implied volatility, however, can decrease as easily as it can increase.

A decrease in implied volatility will decrease the value of the out-month option (which the buyer is long) faster than it will decrease the value of the nearer month option (which the buyer is short) due to the higher vega of the out-month option.

This will narrow the spread thereby creating a loss for the buyer.

In the same way that stock movement in the right direction can be profitable for the buyer of a time spread, stock movement in the wrong direction can be costly.

As the stock moves away from the spread's strike, the spread decreases in value.

That will create a loss for the buyer of the spread

Options Buyer Risk & Reward (2)

The buyer can profit in several ways.


First and foremost, being a time spread, the buyer can profit by the passage of time.


Options are wasting assets.


So as the nearer month option decays away more quickly than the outer-month option, the spread widens (increases in value) and the buyer sees a profit.



Second, implied volatility can increase.


As implied volatility increases, the out-month option, which the buyer is long, increases in value more quickly (due to its higher vega) than the nearer month option which the buyer is short.


This will force the spread to widen or increase in value, which again is profitable for the buyer.

Options Buyer Risk & Reward

Like most trades, time spreads have a maximum loss for the buyer.

As a buyer, you can only lose what you have spent.

If you paid $1.00 for the spread then your maximum potential loss is that $1.00.

If you bought the spread for $2.00, then $2.00 is the maximum potential loss.

The buyer of a time spread will be purchasing the out-month option while selling the nearer month option of the same strike in a one-to-one ratio.

Since the out-month option will have more time until expiration than the nearer month option, the out-month option will cost more.

This means the buyer will be putting out money (debit spread) which makes sense.

The buyer can only lose the amount of money they spent to purchase the spread.

Thus the buyer's maximum risk is the cost of the spread.

Options Seller Risk/Reward (4)

The second risk is that the option the seller is long is going to expire approximately 30 days prior to the option the seller is short.


If volatility does not decrease or the stock does not move away from the strike significantly before the seller's long option expires, he/she will be left short a naked or un-hedged option and a loss on the position.


If the seller can wait out the position, the lost extrinsic value of the short option can be recaptured.


As we know, this option too has a limited life and must shed its extrinsic value, no matter how much, by its expiration.



The problem facing the seller is that the position is no longer hedged and the seller now faces unlimited risk.


Once the long option expires and the seller is left short a now naked call, stock price movement in the wrong direction is a substantial risk and under the circumstances described above, a big problem.


While the seller can wait out an implied volatility movement that created an increase in extrinsic value, they probably will not be able to wait out a large, negative stock movement creating an increase in intrinsic value.


In that case the seller must take action to prevent substantial losses once the front month expires.


Attention to the implied volatility in the farther out option when the nearer month option expires can save the seller from a large loss.

Options Seller Risk/Reward (3)

Increases in implied volatility are also detrimental to the potential profits of the time- spread seller.


When implied volatility increases, the out month option (which the seller is short) increases in value faster than the near month option (which the seller is long) due to the out month option's higher vega.


This creates an expansion in the spread and increases its value resulting in a negative for the spread seller.


The seller, in theory, has an unlimited loss potential.


For the seller, the maximum loss potential is not so much determined by the stock price movement but by the movement in implied volatility.


As the seller, you will be long the front month call and short the out- month call.


As we know, the out month call will be more sensitive to movements in implied volatility due to a higher vega or volatility sensitivity component.


If implied volatility increases then the seller's short, out month option will increase more in value than will the seller's long, front month option.


This will cause the spread to widen or increase in value; that is negative for the seller.

Options Seller Risk/Reward (2)

Second, the stock can move.

As stated before, a time spread is at its widest, most expensive point when it is at-the-money.

A movement away from the strike in either direction decreases the value of the spread.

So, as long as the stock moves in either direction away from the strike, the seller's position could be profitable provided that time decay does not outperform the stock movement.

Time, unfortunately, never works in favor of the time-spread seller.

The passage of time hurts the seller because the nearer month option (which the seller is long) naturally decays at a faster rate than does the out-month option (which the seller is short).

These differing decay rates cause the spread to expand and increase in value.

That obviously produces a loss for the time spread seller.

Time can neither be stopped nor turned back.

It only moves forward which always hurts the time spread seller.

Options Seller Risk/Reward

The seller of a time spread buys the nearer month option and sells the outer-month option in a one to one ratio.

In order to profit from the sale of the time spread, the seller is looking basically for two things.

First is a decrease in implied volatility.

As volatility decreases, the out-month option (which the seller is short) loses money faster than the near month option (which the seller is long) because of the higher vega in the out month option.

This will cause the spread to contract or lose value.

That will be profitable for the time spread seller.

Options Trading Lesson: Spread Trading (2)

Spreads are strategies that do not involve the use of any security other than another option.

Their positives are that they are inexpensive, offer protection for both buyer and seller and are in effect automatically hedged trades.

Spreads can provide large percentage returns with low risk and can be entered into with small capital outlay.

A spread involves the purchase of one option in conjunction with the sale of another option.

There are many types of spreads.

Some take advantage of stock movements while others are set up to take advantage of movements in implied volatility and even time decay.

There are calendar or time spreads, diagonal spreads, ratio spreads and also vertical spreads, which we will discuss in depth here.

Spreads are more advanced and sophisticated than the strategies discussed in our beginner product 'OPTIONS 101.'

Where certain spreads, like 1 to 1 vertical spreads, can be less risky than a buy-write, there are more variables to consider and control which makes trading the spread more complicated.

When you trade a spread you are dealing with three elements:

the spread as a whole (which you can buy or sell) and its component parts - the option you buy and the option you sell.

Although the cost of most spreads is relatively inexpensive to initiate, they can provide a large percentage return and there is protection (limits) to both sides of the trade.

Therefore, even experienced investors can profit from learning about spreads and their investment potential.

Options Trading Lesson: Spread Trading

In options trading, there are some basic lessons that are the backbone of many other successful options trading strategies.

How to engage in spread trading in options trading to enhance potential gains is one of these lessons.

Spread trading is a foundational tool that you should have in your options trading toolkit.

It will allow you freedom and flexibility for enhanced profit and will give you defense against potential loss while reducing your overall risk.

Now, let us look at this fundamental of options trading, the spread trade.

We have demonstrated how well options function in unison with a stock position.

They enhance potential gains, provide profit protection and limit the risk of the entire investment.

They enable us to manage risk in a single stock as well as an entire portfolio.

But, as good as options are in conjunction with stocks, they can be even better when traded against each other.

Options Trading Lessons: Vertical Spreads (2)

To recap, if you feel a stock will be increasing in value, you may put on a bull spread by either buying a vertical call spread (bull call spread) or selling a vertical put spread (bull put spread)

A bear spread, however, is used when, you the investor, feels a stock is likely to trade down.

Remember, 'bearish' means that one's outlook on the future movement of the stock is negative.

To take advantage of this expected downward movement, the investor would put on a bear spread.

This can be done in either of two ways.

First, the investor can do it using puts.

The purchase of a vertical put spread (bear put spread) can be accomplished by purchasing a put with a higher priced strike and selling a put with a lower priced strike.

The second way an investor can construct a bear spread is by using calls, specifically, by selling a vertical call spread (bear call spread).

You do this by selling a call with a lower strike price and purchasing a call with a higher strike price.

So if you think that a stock is likely to decrease in value, you sell a vertical call spread (bear call spread) or purchase a vertical put spread (bear put spread).

Finally, there are two fundamentals that are universal to all vertical spreads.

These fundamentals are critical to understanding the foundation of the vertical spread strategy:

(1) you can determine a vertical spread's maximum value by taking note of the difference between the two strikes and

(2) vertical spreads have intrinsic value.

Options Trading Lessons: Vertical Spreads

There are two main types of vertical spreads.


There is the vertical call spread and the vertical put spread.


Each spread allows you to do two things.


First, you can buy it, making you long the vertical spread.



Second, you can sell it making you short the vertical spread.



Both can be employed to take advantage of directional stock plays.


When we use the term 'directional stock play,' we refer to using vertical spreads to capitalize on anticipated stock movements either up or down.


A bull spread is used when the investor feels that a stock is most likely to go up.


As we recall, 'bullish' means to have a positive outlook on a stock's future movement.


There are two ways to set up a bull spread.


The first is with the use of calls.


In this case, a bullish investor would buy a vertical call spread (bull call spread).


This is accomplished by buying a call with a lower strike price and selling a call with a higher strike price.


The second way to construct a bull spread is with the use of puts.


A bullish investor could sell a vertical put spread (bull put spread) hoping to profit from an increase in the stock's value.


The investor would sell a put with a higher strike price and buy a put with a lower strike price.

Debt Consolidation and Refinance Mortgages (3)

One of the most important tasks debtors must carry out to achieve in debt consolidation is keeping away from complications.

When debtors have bills that are behind merely because they didn't have the cash to repay the debts, then their stress will build.

Some people may go on binge, spending instead of paying their bills, and procrastinating instead of working to restore their credit.

These people may believe that after three, seven or ten years the problem will end, since the credit reports remove any pending debts after seven years and any bankruptcies after ten years.

The fact is, the problem doesn't go away the problems only get bigger.

Yes, it is true: after three years, if you manage to payoff a debt, then the debt is removed from your credit report.

In addition, yes, it is true if after seven years you failed to make payments the debt is removed in most instances from your credit report.

Furthermore, it is true that in many cases, after ten years, bankruptcy is removed from your credit report.

If you have the patience to wait this long, can tolerate the hassling phone calls and letters, and don't mind worrying about going to court for this long, then by all means procrastinate.

Bills and debt consolidation is optional, however bill and debt reduction is your best bet.

You can do this by start paying as much every month on your bills as possible to reduce your debts.