Demystifying Options Part 10

Wayneqq
2022-01-07

If you are not familiar with options, I would suggest reading my first 9 posts which can be found under my postings.

From Part 10 onwards, I will be discussing multi-leg options. As of this posting, the Tiger app does not allow easy deployment of multi-leg options. This may change in the future. For now, I will be discussing the theory of how we can utilise multi-leg option strategies to turbo-charge your investment / trading and not show the step by step instructions of how to deploy multi-leg options orders on Tiger.

What is multi-leg option order?

A multi-leg option order is basically buying and/or selling multiple options contract simultaneously with one or more strike price and/or expiration date in a single order. There are many such option strategies (e.g straddle, strangle, spreads, butterflies, and others). I will attempt to demystify them in subsequent posts.

When do we use multi-leg option?

Let me use an example to illustrate a situation where we can use multi-leg option.

Assuming you are interested in a company, but do not want to hold the shares. You are not sure if the price will go down or up in the short term, but you are sure the price will experience big swings. You can BUY PUT and BUY CALL simultaneously at ATM strike price with a certain duration to expiry. In this case, if the price goes up, your BUY CALL will be ITM and you can sell off the BUY CALL to profit from it. If the price goes down, your BUY PUT will be ITM and you can sell off the BUY PUT to profit from it. This is called straddle.

Notice a few things:

1) There is no interest in holding the company shares. We are purely trading options here. There is no requirement to hold shares.

2) Both are BUY option contracts. This means that if the share prices is flat during the entire option time, it is likely to suffer total loss. I will explain more in future posts.

3) Both contracts need to become valid within a short period of time. If the stock price moves, then the option premium will change and the strategy might no longer be valid.

4) If one contract fails to become valid, e.g the BUY PUT fail to find a seller, then you will lose that leg of the strategy, meaning if the stock price goes down, you cannot profit from that and vice versa. This means the strategy has failed since you will likely lose money.

How to execute multi-leg option order?

As mentioned earlier, Tiger app currently does not allow execution a multi-option strategy as a single order. In order to execute multi-leg option on Tiger app, we need to submit each individual option contract we want to buy/sell and hope for the best. This is not ideal because such strategies typically require all the individual contracts to become valid within a short period of time at the set premiums. If any of the contracts fail to become valid, the entire strategy could fail and there is a potential to lose money. However, some strategies are less sensitive to the time of entry of the individual options contract compared to others. I will point out which strategies are more sensitive to time of entry and which are less in subsequent posts.

As far as I am aware, TD Ameritrade (ThinkorSwim client) provides a very comprehensive platform to execute multi-leg option order, so if you want to practice multi-leg options and do not mind the complexity of using ThinkorSwim client, you can use that.

What do we need to take note when executing multi-leg option order?

Multi-leg option orders are essentially multiple single order option contracts that will "cover" each other in order to profit from certain movement of the stock price.

Note 1: Different strategies will have different number of single order options contracts. The more option contracts required for the strategy, the more commission will be paid to the broker. This has to be factored into the profit and loss statement.

Note 2: If SELL PUT or SELL CALL options are utilised, there is a possibility that they might be exercised by the buyer before expiry. This means that you will need to know how to close out the strategy when that happens.

Note 3: Always understand the purpose of each strategy before attempting to execute them. Every strategy will have pros and cons and I will attempt to highlight them, and point out the pitfalls, but I might miss out information or it might not become apparent until the strategy is in play, so always do your own diligence to study each strategy in detail.

Note 4: For multi-leg options, there is a need to pay attention to margins. For most strategies, there is no requirement to have a lot of cash or own shares of the company, but this is if the strategy is successfully executed. However, there are situations where the stock price might fall into an area where one leg of the option is exercised whereas the other is not. This may cause you to experience a margin call if you are not careful. I will try to point out this during the strategy posts, but it is important to pay attention to such details to prevent unnecessary loss of money.

In Demystifying Options part 11, I will be discussing Straddles and Strangles..

Always remember.. If you do not understand what is happening, do not blindly follow and execute the trade!

@TigerStars

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精彩评论

  • maroketo
    2022-01-07
    maroketo
    The risk of option is more than n times that of stock, and of course the potential return is also more than n times. Beginners should not be greedy. The consequence of heavy positions is to lose everything quickly. If you often make mistakes when placing orders, you can lose everything within a day or two at the earliest, so be sure to make sure there is no mistake before placing orders.
  • falleno
    2022-01-07
    falleno
    Options can make people go from hell to heaven, and can also make you go from heaven to region. Ordinary retail investors should be cautious.
  • RudolfKennedy
    2022-01-07
    RudolfKennedy
    I suggest opening a simulated account to play option for a few months, playing more simulations, and then playing real games with experience.
  • waipoin
    2022-01-07
    waipoin
    Is the commission of options higher than that of ordinary stock trading?
  • kiekie
    2022-01-07
    kiekie
    Thanks for sharing. Options is too difficult for me.
  • RubyPulitzer
    2022-01-07
    RubyPulitzer
    Great. I hope our retail investors can make money every day.
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