For about 3 years we have offered an Excel Program called OptionMizer® which evaluates the cost of an underlying stock's option and provides the best selection based on a price reward basis.
In our mechanical trading manuals, on the other hand, we suggest a simplified method which can provide a quick and dirty, although not optimum selection process which follows our rule of 3-6 months out and 5-10 dollars in the money. On very active stocks you can actually purchase much closer to "At-the-money" for better value because of increased volatility, but it takes additional analysis in order to do so.
After considerable research we have come up with a sensible screener for both Call and Put options that combines the best attributes of both systems in its evaluation. Even better, it is available as an online service, thus there is no requirement to own Microsoft Excel or run a separate program to get the results you are looking for.
With this new screen which runs in your browser, we evaluate Delta and Gamma to come up with the best option situated for growth, limited by our basic time constraint rules, always remembering that we will never hold an option closer than 30 days to expiration so as to eliminate the wasting asset loss of premium which goes exponential in the final weeks of trading.
The closer an option is to expiration the less you will pay in premium which means that to get the best price we want to be holding an option that is at least one more month away than the longest time we anticipate being in the position. Remember, we are not going to hold till expiration anyway. If we buy a long term leap as an example, we may well sell it after only 2 months with no appreciable loss of premium, but benefit from the gain of the stock as reflected in the price of the option.
We can generalize for our different systems as
LONG TERM: ProxyTrades and SectorTrades: At least 9 months away and preferably one year. These are long term plays that only switch 1-2 times per year.
MEDIUM TERM: Pitbull Long Selections fall into this category, where we are looking at holding a position perhaps 90 days on average. In this case we would look for an option at least 4 months out.
SHORT TERM: EarningsTrader and Momentum Trading Systems. Here, particularly with EarningsTrader we are looking at trades that average 90 days or less. We should therefore be looking at options that are at least 4 months away. Because the exit date has already been established for most of these trades you know how long you will be in this trade.
DELTA is the most important factor we analyze in our method of options selection. Delta is the return you can expect for a dollar of change in the underlying stock AT THE CURRENT PRICE RANGE FOR THE STOCK. As the stock increases in price its Delta will also increase. If we pick an option with a Delta of .6, we can expect that the option will go up about 60 cents for the next 1 dollar rise in price of the stock. After that price increase, the Delta of the option would be greater than .6 and if the stock continues to increase in price at some point the option will have a Delta of 1.0 which means it effectively increases on a dollar for dollar basis in parity with the stock.
How fast will it reach parity of 1:1? This is determined by the Gamma of the option.
GAMMA- Gamma comes into play forecasting the rate of acceleration of the option's Delta.. I know this sounds complicated, but it is really very simple in practice.
We want to pick a Delta to match the length of
time we believe the option will be in play to allow it to grow. Here are the
ranges we look at:
LONG TERM (180 to 360 days): Delta of 40 to 60
MEDIUM TERM (90 to 180 days): Delta of 50 to 70
SHORT TERM (30 to 90 days): 50 to 80
VERY SHORT TERM (less than 30 days): Delta of 80 to 90
So how do we use Gamma?
In any screen that we look at, once we find options which fall within the optimum range, we want to pick the option that has the HIGHEST Gamma so that the Delta will increase in value more rapidly than any other option in its time frame for selection.
THAT IS PRECISELY WHAT OPTIONMIZER-III® DOES!
We automatically screen for:
Optimum holding period
Best Delta from with those available
Best Gamma/Delta ratio
You will generally be presented with a couple
of possible options for the system you are using. Any one of them
is acceptable according to our screening technique, but generally we would choose the first one available.
Then we produce an output at the top of the options tables that looks like this.
As you can see, on the first two lines we have been presented with two options which are deemed suitable to use as
proxies for the stock we are looking at, in this case 'LLL' Both are 50 strike, but one is an April and one is a July. The
April is considered to be the better selection. By looking at the full options tables we can tell why.
The April 50 has a Delta of 52 and a Gamma of .07 while the July table shown below shows that the 50 strike has a
Delta of .53, (slightly higher), with Gamma of .053, but is almost a third cheaper because it is closer to expiration.
Either one is acceptable. The July will hold its premium longer and has the potential for a longer term play while
the April has a higher Gamma which means the Delta will accelerate faster if you expect a rapid change in price.
Notice that both of the Options are just
at-the-money, thus cheaper than our "Plug" option of $5-$10 in the
This is because the implied volatility of this stock
As an added bonus to the screener, you can click on the option symbol selected and get a historical listing of the
options price. By clicking on the stock symbol you can get a historical listing of the Stock price. This allows you
to track the option price vs the stock price between any two dates. We will be adding other features as time permits.
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