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Options Trading The Pristine WayOptions Trading The Pristine Way

With With

Oliver L. VelezOliver L. Velez

Founder of Pristine.com, and Author of the best selling book, Founder of Pristine.com, and Author of the best selling book, Tools and Tactics for the Master Day TraderTools and Tactics for the Master Day Trader

Copyright 2001, Pristine Capital Holdings, Inc.Copyright 2001, Pristine Capital Holdings, Inc.

Pristine.com PresentsPristine.com Presents

Table of ContentsTable of Contents

IntroductionIntroductionFour Styles of TradingFour Styles of Trading

Tools of the Options TraderTools of the Options Trader

Two Categories of Trading Two Categories of Trading

Options PricingOptions Pricing

Time Premium DecayTime Premium Decay

3 Determinants of Price3 Determinants of Price

The Greeks: Assessing RiskThe Greeks: Assessing Risk

Playing the NASDAQPlaying the NASDAQ

Pristine MethodPristine Method™™

When to be a BearWhen to be a Bear

Counting Your Way to ProfitsCounting Your Way to Profits

Determining Who is WinningDetermining Who is Winning

Pristine Trading CombinationsPristine Trading Combinations

When to be a BullWhen to be a Bull

Pristine OptionsPristine OptionsAdvantages & DisadvantagesAdvantages & Disadvantages

Buying/Selling CallsBuying/Selling Calls

Buying/Selling PutsBuying/Selling Puts

Combo StrategiesCombo Strategies

Options DisclaimerOptions DisclaimerIt should not be assumed that the methods, techniques, or indicators presented in this book will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples in this book are for educational purposes only. This is not a solicitation of any order to buy or sell.

“HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES IN THIS BOOK HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS WE STATE MAY HAVE UNDER OR OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.”

The authors and publisher assume no responsibilities for actions taken by readers. The authors and publisher are not providing investment advice. The authors and publisher do not make any claims, promises, or guarantees that any suggestions, systems, trading strategies, or information will result in a profit, loss, or any other desired result. All readers and seminar attendees assume all risk, including but not limited to the risk of trading losses. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (www.cboe.com).

Options Trading can result in large losses and may not be an actOptions Trading can result in large losses and may not be an activity suitable for everyone.ivity suitable for everyone.

Copyright © 2001 by Pristine Capital Holdings, Inc. All rights reserved. Printed in the U.S. of America. Except aspermitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without prior written permission of the publisher.

IntroductionIntroduction

Part IPart I

Four Styles of TradingFour Styles of Trading

Types of TradingTypes of Trading

Four Styles of Trading:Four Styles of Trading: CoreCore;; SwingSwing;; GuerrillaGuerrilla;; MicroMicro

Which fall into….Which fall into….

Two Broad Trading Categories:Two Broad Trading Categories: WealthWealth;; IncomeIncome

Two Broad Trading CategoriesTwo Broad Trading Categories

Wealth Trading StylesWealth Trading Styles Income Trading StylesIncome Trading Styles

Core TradingCore Trading

Swing TradingSwing Trading

Guerrilla TradingGuerrilla Trading™™

Micro TradingMicro Trading

- Weekly Charts

- Daily Charts

- 60 Min. & 30 Min.

- Hours to Days- Weeks to Months

- Days to Weeks

- 5 Min. & 15-Min.

- Minutes to Hours

The Pristine PhilosophyThe Pristine Philosophy

Pristine Tip:Pristine Tip:

The Pristine Trading Philosophy calls for a The Pristine Trading Philosophy calls for a trader to have trader to have 1)1) a a WealthWealth Building trade andBuilding trade and

2)2) an an IncomeIncome Producing trade on….Producing trade on….

At All Times!At All Times!

The Pristine The Pristine Options ToolsOptions Tools

Options ToolsOptions Tools

Options Trading ToolsOptions Trading Tools

Tools of the Options TradeTools of the Options TradeCharting Tools:Charting Tools: ColorColor--coded charts & Volume coded charts & Volume

displayed in Candlestick formdisplayed in Candlestick form

Technical Tools:Technical Tools: 2020--period ‘simple’ moving period ‘simple’ moving average; Bollinger Bands; CCI(5)average; Bollinger Bands; CCI(5)

Options Tools:Options Tools: DirectDirect--Access Executions; Options Access Executions; Options Pricing Screen; Options AnalyticsPricing Screen; Options Analytics

Chart Courtesy of Chart Courtesy of www.mastertrader.comwww.mastertrader.com

Candlestick Charts w/ VolumeCandlestick Charts w/ Volume

ColorColor--coded Volumecoded Volume

Candlestick BarsCandlestick Bars

Bollinger Bands w/ 20MABollinger Bands w/ 20MA


Upper Bollinger BandUpper Bollinger BandOverbought AreaOverbought Area

Lower Bollinger BandLower Bollinger BandOversold AreaOversold Area


20ma20ma

Commodity Channel Index (CCICommodity Channel Index (CCI--5)5)

+100+100

--100100

Pristine CCI(5) Buy SignalPristine CCI(5) Buy Signal

O/BO/B

O/SO/S

+100+100

--100100

Anticipatory CCI(5) Buy SignalAnticipatory CCI(5) Buy Signal

O/BO/B

O/SO/S

+100+100

--100100

Anticipatory CCI(5) Sell SignalAnticipatory CCI(5) Sell Signal

O/BO/B

O/SO/S

+100+100

--100100

Pristine CCI(5) Sell SignalPristine CCI(5) Sell Signal

O/BO/B

O/SO/S

Note:Note: Pristine looks for buy signals in Pristine looks for buy signals in uptrendsuptrends & sell signals in downtrends.& sell signals in downtrends.

Options Technical ToolsOptions Technical Tools



Candlestick BarsCandlestick Bars

CCI (5)CCI (5)

Bollinger BandsBollinger Bands

20MA20MAUpperUpper

LowerLower

Options Execution ToolsOptions Execution Tools

Options Execution Module Courtesy of Options Execution Module Courtesy of www.mastertrader.comwww.mastertrader.com

DirectDirect--Access Execution ModuleAccess Execution Module

Option TypeOption Type

SymbolsSymbols

Strike PricesStrike Prices

Level IILevel II4 pit exchanges4 pit exchangesand 1 electronicand 1 electronic

exchangeexchange

The Pristine The Pristine MethodMethod™™

Part IIPart II

An Introduction to:An Introduction to:

Pristine Capital Holdings, Inc.

The Ongoing Market BattleThe Ongoing Market Battle

Determining Who Won The BattleDetermining Who Won The Battle

Bears WinBears WinBulls WinBulls Win

HighHigh

LowLow

CloseClose

OpenOpen

OpenOpen

CloseClose

HighHigh

LowLow

Real BodyReal BodyReal BodyReal Body

An Important Statistical FactAn Important Statistical Fact

Pristine Tip:Pristine Tip:

Bulls and Bears cannot consistently win more Bulls and Bears cannot consistently win more than 5 battles in a row. Each side typically than 5 battles in a row. Each side typically

surrenders to the other after 3 to 5 battles won. surrenders to the other after 3 to 5 battles won.

If the Bulls or Bears win significantly more than If the Bulls or Bears win significantly more than 5 battles in a row, 5 battles in a row, a catastrophic loss will be the a catastrophic loss will be the

priceprice paid for such an abnormal winning streak. paid for such an abnormal winning streak.

However…However…


Pristine’s Key Buy ConceptsPristine’s Key Buy Concepts

When to be a BullWhen to be a Bull

3 Bars Down3 Bars Down 4 Bars Down4 Bars Down 5 Bars Down5 Bars Down

Think “Buy”Think “Buy” Think “Buy”Think “Buy” Think “Buy”Think “Buy”


Pristine’s Key Sell ConceptPristine’s Key Sell Concept

When to Be a BearWhen to Be a Bear

3 Bars Up3 Bars Up 4 Bars Up4 Bars Up 5 Bars Up5 Bars Up

Think “Sell”Think “Sell”

Think “Sell”Think “Sell”Think “Sell”Think “Sell”


Count Your Way to ProfitsCount Your Way to Profits


3 Green Bars3 Green Bars

5 Red Bars5 Red Bars

3 Green Bars3 Green Bars 3 Green Bars3 Green Bars



Count Your Way to ProfitsCount Your Way to Profits




3 Red Bars3 Red Bars33--5 Red Bars5 Red Bars

3 Green Bars3 Green Bars 5 Red Bars5 Red Bars

4 Green4 GreenBarsBars

The Pristine The Pristine CombinationsCombinations

Pristine Trading CombosPristine Trading Combos



Bull & Bear TailsBull & Bear Tails

Bottoming & Topping TailsBottoming & Topping Tails

Topping Tail (TT)Topping Tail (TT) Bottoming Tail (BT)Bottoming Tail (BT)

3 or more green Bars3 or more green Bars++

3 or more red bars3 or more red bars++


Bottoming & Topping TailsBottoming & Topping Tails

Chart Courtesy of MasterTrader.comChart Courtesy of MasterTrader.com

TailsTails

4 Up Bars4 Up Barsw/ Tailw/ Tail 3 Up Bars3 Up Bars

5 Down Bars5 Down Bars


3 Up Bars3 Up Bars

3 Down Bars3 Down Bars4 Up 4 Up BarsBars

3d3d


Bull & Bear COGBull & Bear COG

Changing of the Guard (COG)Changing of the Guard (COG)

Bear COGBear COG™™ Bull COGBull COG™™

3 or more green Bars3 or more green Bars++

3 or more red bars3 or more red bars++


Bull & Bear Changing of the GuardsBull & Bear Changing of the Guards

Chart Courtesy of MasterTrader.comChart Courtesy of MasterTrader.com

Bear COGBear COG™™

Bull COGBull COG™™Bull COGBull COG™™ Bull COGBull COG™™

TailsTails

4 Up Bars4 Up Barsw/ Tailw/ Tail 3 Up Bars3 Up Bars



3 Up Bars3 Up Bars


4 Up 4 Up BarsBars

3d3d

Pristine Trading SummaryPristine Trading Summary

Pristine Trading CombinationsPristine Trading Combinations3 to 5 Bar Buy/Sell Setups3 to 5 Bar Buy/Sell Setups

1) Topping/Bottoming Tails1) Topping/Bottoming Tails

2) Bull/Bear COG Setups2) Bull/Bear COG Setups

Can happen with:Can happen with:

and/orand/or

Powerful Powerful TradingTrading

CombinationsCombinations

These Combinations can happen:These Combinations can happen:

1) Outside the Upper/Lower Bollinger Band1) Outside the Upper/Lower Bollinger Band

2) Overbought/Oversold CCI(5) Readings 2) Overbought/Oversold CCI(5) Readings

withwith LocationLocation

Putting It All TogetherPutting It All Together




3 Green Bars w/ COG3 Green Bars w/ COG


3 Green Bars3 Green Barsw/ COGw/ COG

Pristine OptionsPristine Options

Part IIIPart III


What is an Option?What is an Option?

2001 Ferrari 360 Modena Spider2001 Ferrari 360 Modena Spider

You have just traded a You have just traded a commoditycommodity!!

Suppose you’re in the market for this wonderful 2001 Suppose you’re in the market for this wonderful 2001 Ferrari 360 Modena SpiderFerrari 360 Modena Spider

You find a dealer with one in stockYou find a dealer with one in stock

You wire transfer $275,000You wire transfer $275,000

The dealer delivers the car to youThe dealer delivers the car to you



You have just traded a You have just traded a futures contractfutures contract!!

Suppose you want this 2001 Ferrari 360 Modena Spider, Suppose you want this 2001 Ferrari 360 Modena Spider, but you prefer to purchase it four weeks from now, when but you prefer to purchase it four weeks from now, when you get your yearyou get your year--end bonusend bonus

You enter into an agreement with the dealer to purchase the You enter into an agreement with the dealer to purchase the car for $275,000 1 month from now car for $275,000 1 month from now



You have just traded an You have just traded an options contractoptions contract!!

You like the 360 this dealer has, You like the 360 this dealer has, butbut you ask the dealer to put the car on you ask the dealer to put the car on hold for two weeks in order to shop around. hold for two weeks in order to shop around.

This will deny the dealer the ability to sell the car for two weThis will deny the dealer the ability to sell the car for two weekseks

You and the dealer agree that for a nonYou and the dealer agree that for a non--refundable fee of $2,000 the car will refundable fee of $2,000 the car will be held for two weeks, and that any time during that period you be held for two weeks, and that any time during that period you may may purchase the car for $275,000.purchase the car for $275,000.

You are under no obligation to buy the car.You are under no obligation to buy the car.

Options AdvantagesOptions Advantages

Limited RiskLimited Risk

Calculable RiskCalculable Risk

Higher Levels of LeverageHigher Levels of Leverage

Higher Potential ROIHigher Potential ROI

TriTri--directional vs. Bidirectional vs. Bi--directionaldirectional

Versatile StrategiesVersatile Strategies

No UpNo Up--tick Rule Requiredtick Rule Required

Conservative or SpeculativeConservative or Speculative

Less Accuracy on Entries NeededLess Accuracy on Entries Needed

Guaranteed by Options Clearing CorporationGuaranteed by Options Clearing Corporation

Options DisadvantagesOptions Disadvantages

Less LiquidityLess Liquidity

Wide Bid/Ask SpreadsWide Bid/Ask Spreads

Slippage in Fast MarketsSlippage in Fast Markets

Not all brokers allow options tradingNot all brokers allow options trading

Delayed OpeningsDelayed Openings

Can lose despite being Can lose despite being rightright about direction of stockabout direction of stock

Time Depleting AssetTime Depleting Asset

Higher Levels of LeverageHigher Levels of Leverage

Relatively Higher CommissionsRelatively Higher Commissions

Two Types of Options ContractsTwo Types of Options Contracts

Call OptionsCall Options

Put OptionsPut Options

This type of contract gives the holder (This type of contract gives the holder (buyerbuyer) the) theright to buy (“right to buy (“call awaycall away”) the underlying stock”) the underlying stockfrom the seller (from the seller (writerwriter) at a specific price () at a specific price (strikestrike),),but only for a specified amount of time (but only for a specified amount of time (expiryexpiry))

This type of contract gives the holder (This type of contract gives the holder (buyerbuyer) the) theright to sell (“right to sell (“putput”) the underlying stock to the seller”) the underlying stock to the seller((writerwriter) at a specific price () at a specific price (strikestrike), but only for a ), but only for a specified amount of time (specified amount of time (expiryexpiry))

Buyers (Buyers (holdersholders) of calls are bullish) of calls are bullish

Sellers (Sellers (writerswriters) of calls are bearish) of calls are bearish

Sellers (Sellers (writerswriters) of puts are bullish) of puts are bullish

Buyers (Buyers (holdersholders) of puts are bearish) of puts are bearish

Calls in Everyday LifeCalls in Everyday Life

Suppose you want to buy this quaintSuppose you want to buy this quaint$25 million house, but don’t know if your$25 million house, but don’t know if yourtax advisors will approve of the purchase. tax advisors will approve of the purchase.

So, to secure the property, you enter intoSo, to secure the property, you enter intoan agreement (an agreement (call optioncall option) with the owner) with the ownerby paying $10,000 (by paying $10,000 (premiumpremium), which gives), which givesyou the right to buy the mansion for $25 you the right to buy the mansion for $25 million (strike price) anytime during themillion (strike price) anytime during thenext 45 days (next 45 days (expiryexpiry), minus your $10,000. ), minus your $10,000.

The $10,000 (The $10,000 (premiumpremium) locks in the $25 million price.) locks in the $25 million price.If you choose not to buy, the owner keeps the full $10,000.If you choose not to buy, the owner keeps the full $10,000.If someone subsequently offers the owner $27 million, you canIf someone subsequently offers the owner $27 million, you canbuy from the owner at $25 mil and immediately sell for $27 mil,buy from the owner at $25 mil and immediately sell for $27 mil,pocketing a quick $2 million for yourself. pocketing a quick $2 million for yourself.

Puts In Everyday LifePuts In Everyday Life

Buying a put is like buying an insurance policy.Buying a put is like buying an insurance policy.

The premium paid guarantees that if your car The premium paid guarantees that if your car is stolen, within the agreed upon time frame is stolen, within the agreed upon time frame (expiry),(expiry), you will get the full insured value you will get the full insured value (strike price).(strike price).

Insurance companies are like option sellers, receivingInsurance companies are like option sellers, receivingPremium for assuming obligations.Premium for assuming obligations.

Put buyers pay a fee Put buyers pay a fee (premium)(premium) to to transfer risktransfer risk to put sellers.to put sellers.

Common Characteristics of Puts & CallsCommon Characteristics of Puts & Calls

The buyer purchases a right from the seller.The buyer purchases a right from the seller.

The seller incurs an obligation.The seller incurs an obligation.

A fee or “premium” is exchanged.A fee or “premium” is exchanged.

The contract is for a limited time.The contract is for a limited time.

The buyer & seller have opposite profit/loss positions.The buyer & seller have opposite profit/loss positions.

The buyer & seller have opposite riskThe buyer & seller have opposite risk--return potentials.return potentials.

HedgeHedgevs.vs.

SpeculationSpeculation

Owning a CallOwning a Call

XYZXYZ is trading at $50.is trading at $50.

You have been given the right toYou have been given the right tobuy buy XYZXYZ at $50, free of charge,at $50, free of charge,for the next 30 days.for the next 30 days.

If If XYZXYZ stays at $50 or declines,stays at $50 or declines,you have no use for this right.you have no use for this right.

If If XYZXYZ rises to $55, you canrises to $55, you cando either of the following:do either of the following:

Buy Buy XYZXYZ for $50, then sell for a $5 profitfor $50, then sell for a $5 profit

Buy Buy XYZXYZ for $50 and holdfor $50 and holdoror

Tip:Tip: Your original right to buyYour original right to buy XYZXYZ is known as a is known as a Call OptionCall Option, or simply a ‘, or simply a ‘CallCall.’.’

+10+10

+5+5

XYZXYZ4545 5050 5555 6060

Profit/Loss GraphProfit/Loss GraphXYZXYZ Call OwnerCall Owner

Sell the right for a $5 profitSell the right for a $5 profitoror

Offering a CallOffering a Call

He has given you the right to buy He has given you the right to buy XYZXYZat $50, free of charge, for the next 30 days.at $50, free of charge, for the next 30 days.

If If XYZXYZ stays at $50 or declines,stays at $50 or declines,he wins and keeps he wins and keeps XYZ.XYZ.

If If XYZXYZ rises to $55, he loses (gives up)rises to $55, he loses (gives up)the $5 gain to you. the $5 gain to you.

He is obligated to sell He is obligated to sell XYZXYZ to youto youfor $50, even though for $50, even though XYZXYZ is at $55.is at $55.

If he doesn’t own If he doesn’t own XYZXYZ, he will have to, he will have tobuy buy XYZXYZ at $55 and deliver it to you at $50.at $55 and deliver it to you at $50.

Tip:Tip: As the owner of the call, your potential As the owner of the call, your potential gaingain is exactly his potential is exactly his potential lossloss..

By giving you the By giving you the rightright to buy, he assumesto buy, he assumesthe the obligationobligation to sell. to sell.

--55

--1010

XYZXYZ 4545 5050 5555 6060

Profit/Loss GraphProfit/Loss GraphXYZXYZ Call SellerCall Seller

Example of Call PurchaseExample of Call Purchase


Major IntermediateMajor Intermediate--term Price Supportterm Price Support

1) QCOM down 1) QCOM down 8 red bars8 red bars in a rowin a row

3) QCOM puts in a 3) QCOM puts in a Bull COGBull COG™™

2) QCOM punctures lower band2) QCOM punctures lower band

4) QCOM on prior price support4) QCOM on prior price support

TargetTarget

The Pristine Options Trader looks to buy QCOM Calls!!The Pristine Options Trader looks to buy QCOM Calls!!Action:Action:

Choosing Your StrikeChoosing Your Strike

ATAT--THETHE--MONEY (ATM)MONEY (ATM) options have a strike price at or options have a strike price at or near the current price of the stock near the current price of the stock (QCOM $50).(QCOM $50).

ININ--THETHE--MONEY (ITM)MONEY (ITM) options have Intrinsic Value. For Call options have Intrinsic Value. For Call options, ITM options have strike prices below the current price options, ITM options have strike prices below the current price of of the stock. For Put options, ITM options have strike prices abovthe stock. For Put options, ITM options have strike prices above e the current price of the stock the current price of the stock (QCOM $45 Call).(QCOM $45 Call).

OUTOUT--OFOF--THETHE--MONEY (OTM)MONEY (OTM) options have no Intrinsic Value. options have no Intrinsic Value. All the value of the option is time value. For All the value of the option is time value. For callcall options, OTM options, OTM options have strike prices above the current price of the stock.options have strike prices above the current price of the stock. For For PutPut options, OTM options have strike prices below the current options, OTM options have strike prices below the current price of the stock. price of the stock. (QCOM $55 Call).(QCOM $55 Call).

Note:Note: The strike you select depends on your risk tolerance and on howThe strike you select depends on your risk tolerance and on how bullish/bearish you are.bullish/bearish you are.

Buying a QCOM (ATM) CallBuying a QCOM (ATM) Call

--3.003.00

Break Even (BE) = $53Break Even (BE) = $53

00

11

22

33

44

--11

--22

--33

--44

5252515150504747 4848 4949 5353 5454 5555 5656 5757

--1.001.00••

--2.002.00••

+1.00+1.00••

+3.00+3.00••+2.00+2.00••

+4.00+4.00••

••

The The QCOM QCOM SeptSept 50 Call costs you a $3 premium.50 Call costs you a $3 premium.

To cover cost, To cover cost, QCOMQCOM must rise to $53.must rise to $53.

Your Your Maximum LossMaximum Loss is $3 cost of call.is $3 cost of call.

You profit above $53, which is You profit above $53, which is unlimited.unlimited.

You lose part of the $3 if You lose part of the $3 if QCOMQCOM remains remains between $50 (between $50 (strikestrike) and $53 () and $53 (BEBE).).

Assumes at ExpirationAssumes at ExpirationAssumes 20 days leftAssumes 20 days left

Selling a QCOM (ATM) CallSelling a QCOM (ATM) Call

+3.00+3.00

00

11

22

33

44

--11

--22

--33

--44

5252515150504747 4848 4949 5353 5454 5555 5656 5757--1.001.00••

--2.002.00••

+1.00+1.00••

+2.00+2.00••

••

The Seller ofThe Seller of thethe QCOM QCOM Sept 50 Call receives your $3 premium.Sept 50 Call receives your $3 premium.

Call SellerCall Seller profitsprofits if if QCOMQCOM staysstaysbelow $53 (below $53 (BEBE). ).

Seller loses if Seller loses if QCOMQCOM rises above $53,rises above $53,which is which is unlimited.unlimited.

Seller keeps Seller keeps Maximum GainMaximum Gain ($3) if ($3) if QCOMQCOM remains at $50 (strike) or below.remains at $50 (strike) or below.

Seller keeps part of the $3 if Seller keeps part of the $3 if QCOMQCOM remains remains between $50 (between $50 (strikestrike) and $53 () and $53 (BEBE).).


--3.003.00••--4.004.00••

Summarizing Call OptionsSummarizing Call Options

A call is used to capitalize on upside market movement w/ leveraA call is used to capitalize on upside market movement w/ leverage.ge.

A call serves as an alternative to buying the underlying stock tA call serves as an alternative to buying the underlying stock to o limit downside exposure. limit downside exposure.

The call seller receives The call seller receives premiumpremium and assumes the and assumes the obligationobligation to sell to sell the underlying (the underlying (stockstock) at the call buyer’s discretion.) at the call buyer’s discretion.

The call contract is for a limited time period.The call contract is for a limited time period.

The call buyer pays a The call buyer pays a premiumpremium for the for the rightright, but , but not the obligationnot the obligation, , to buy the underlying asset (to buy the underlying asset (stockstock).).

A call is the A call is the rightright to buy the underlying asset (to buy the underlying asset (stockstock) at a specified) at a specifiedprice (price (strikestrike) for a specified period of time () for a specified period of time (expiryexpiry).).

SummarySummary

Buyers have unlimited profit; sellers have maximum gain.Buyers have unlimited profit; sellers have maximum gain.

Example of Put PurchaseExample of Put Purchase


1) INTC up 1) INTC up 3 green bars3 green bars in a rowin a row

2) INTC punctures upper band2) INTC punctures upper band

3) INTC puts in a red bar 3) INTC puts in a red bar

4) CCI(5) is oversold 4) CCI(5) is oversold

The Pristine Options Trader looks to buy INTC PutsThe Pristine Options Trader looks to buy INTC PutsAction:Action:

TargetTarget

Buying an INTC (ATM) PutBuying an INTC (ATM) Put

00

11

22

33

44

--11

--22

--33

--44

3131303029292626 2727 2828 3232 3333 3434 3535

--1.501.50 ••--2.002.00 ••

+1.00+1.00••

+3.00+3.00••+2.00+2.00••

••

INTC INTC AugAug 32.50 Put costs you $2.50.32.50 Put costs you $2.50.

To cover cost, To cover cost, INTCINTC declines to $30 (declines to $30 (BEBE).).

Your Your Maximum LossMaximum Loss is the $2.75 cost of put.is the $2.75 cost of put.

You profit below $30, which is not You profit below $30, which is not unlimitedunlimited..

You lose part of the $2.75 if You lose part of the $2.75 if INTCINTC remains remains between $32.50 (between $32.50 (strikestrike) and $30 () and $30 (BEBE).).

--2.502.50Break Even (BE) = $30Break Even (BE) = $30

Selling an INTC (ATM) PutSelling an INTC (ATM) Put

00

11

22

33

44

--11

--22

--33

--44

3131303029292626 2727 2828 3232 3333 3434 3535

+1.50+1.50••+1.00+1.00••

--1.001.00••--2.002.00••

•• +2.50+2.50


--3.003.00••

The Seller ofThe Seller of thethe INTC INTC Aug 32.50 Put receives your $2.50 premium.Aug 32.50 Put receives your $2.50 premium.

Put SellerPut Seller profitsprofits if if INTCINTC stays above $30 (stays above $30 (BEBE). ).

Seller Seller losesloses if if INTCINTC declines below $30,declines below $30,which is not which is not unlimitedunlimited..

Seller keeps Seller keeps Maximum GainMaximum Gain ($2.50) if ($2.50) if INTCINTC remains at $32.50 or above.remains at $32.50 or above.

Seller keeps part of the $2.50 if Seller keeps part of the $2.50 if INTCINTC remains remains between $32.50 (between $32.50 (strikestrike) and $30 () and $30 (BEBE).).

Summarizing Put OptionsSummarizing Put Options

A put is used to capitalize on downside market movement.A put is used to capitalize on downside market movement.

A put serves as a safer alternative to selling (shorting) the A put serves as a safer alternative to selling (shorting) the underlying stock, as it limits the potential loss. underlying stock, as it limits the potential loss.

The put seller has the The put seller has the obligationobligation to buy the underlying (stock) at to buy the underlying (stock) at the put buyer’s discretion.the put buyer’s discretion.

The put contract is for a limited time period.The put contract is for a limited time period.

The put buyer has the The put buyer has the rightright, but , but not the obligationnot the obligation, to sell the, to sell theunderlying asset (underlying asset (stockstock).).

A put is the A put is the rightright to sell the underlying asset (to sell the underlying asset (stockstock) at a specified) at a specifiedprice (price (strikestrike) for a specified period of time () for a specified period of time (expiryexpiry).).

SummarySummary

Option MatrixOption MatrixCALLS

PUTS

Pay a premium for right to buy stock

Buy to open (long)

Owner/holder of asset

Max gain = unlimited

Max risk = premium paid

Buyers (Bullish) Sellers (Bearish/Neutral)

Receive premium for the obligation to sell stock

Sell to open (short)

Max gain = premium received

Max risk = unlimited unless covered

Buyers (Bearish)Pay a premium for right to sell stock

Buy to open (long)

Owner/holder of asset

Max gain = strike price – premium paid

Max risk = premium paid

Sellers (Bullish/Neutral)Receive premium for the obligation to buy

Sell to open (short)

Max gain = premium received

Max risk = strike price – premium received

Options PricingOptions Pricing

Part IVPart IV


3 Determinates of Price3 Determinates of Price

A Change in the A Change in the UnderlyingUnderlying

The Passage of The Passage of TimeTime

A Change in A Change in VolatilityVolatility

Options theoryOptions theory is able to is able to calculate the exposure to calculate the exposure to these three variables.these three variables.

The terms that apply to The terms that apply to the calculations are called the calculations are called the the GreeksGreeks..

The Four GreeksThe Four Greeks

DeltaDelta GammaGamma

ThetaTheta VegaVega

Time Premium DecayTime Premium Decay

1144 002233Number of Weeks to MaturityNumber of Weeks to Maturity

Opt

ion

Val

ueO

ptio

n V

alue

Time premium will decay as time passes.Time premium will decay as time passes.

Options are time depleting assets.Options are time depleting assets.

The closer the option is to maturity,The closer the option is to maturity,the more rapid the time premium decay.the more rapid the time premium decay.

Time premium is greatest forTime premium is greatest foratat--thethe--money options.money options.

Deep in(out)Deep in(out)--of the moneyof the moneyoptions have small premiums.options have small premiums.

Decay accelerates rapidly duringDecay accelerates rapidly duringthe last 15 days. the last 15 days.

The Greeks: DeltaThe Greeks: Delta

Delta:Delta: It is the amount that an option changes with respect to a small It is the amount that an option changes with respect to a small change change in the underlying.in the underlying.

Deep, inDeep, in--thethe--moneymoney options will often change one for one with the options will often change one for one with the underlying. In this case, the option’s underlying. In this case, the option’s deltadelta would be would be 1.001.00. .

AtAt--thethe--money options money options generallygenerally change price at half the rate, and change price at half the rate, and therefore have therefore have deltasdeltas of of .50.50..

Options so far Options so far outout--ofof--thethe--moneymoney are often considered worthless, and are often considered worthless, and therefore have deltas close to therefore have deltas close to 0.000.00. This means the option will not . This means the option will not move in price, no matter what the underlying does.move in price, no matter what the underlying does.

Pristine TipPristine Tip:: Think of delta as the probability of an option expiring Think of delta as the probability of an option expiring inin--thethe--money.money.

If an option has a delta of .10, it has a 10% chance of If an option has a delta of .10, it has a 10% chance of expiring inexpiring in--thethe--money.money.

2 strikes in the money = 2 strikes in the money = high Deltahigh Delta..

Greeks: Gamma, Theta & VegaGreeks: Gamma, Theta & Vega

Gamma:Gamma: Quantifies the rate of change of the delta with respect to a chQuantifies the rate of change of the delta with respect to a change in ange in the underlying. the underlying.

Measures how quickly or slowly delta responds to a change in theMeasures how quickly or slowly delta responds to a change in theunderlying.underlying.

It is the amount that the option decays in one (1) day.It is the amount that the option decays in one (1) day.

A writer (seller) receives income from time decay and therefore A writer (seller) receives income from time decay and therefore has has ‘‘positive theta.positive theta.’ A buyer incurs an expense from time decay and ’ A buyer incurs an expense from time decay and therefore has ‘therefore has ‘negative theta.negative theta.’’

Theta:Theta:

Vega:Vega: It is the amount that an option changes if the ‘It is the amount that an option changes if the ‘implied volatility’implied volatility’changes by one percentage (1%) point.changes by one percentage (1%) point.

A long options position profits from an A long options position profits from an increaseincrease in implied volatility, in implied volatility, and therefore has ‘and therefore has ‘positive vega.positive vega.’ A short options position profits from ’ A short options position profits from a decrease in implied volatility, and therefore has ‘a decrease in implied volatility, and therefore has ‘negative theta.negative theta.’’

Playing the NASDAQ w/ OptionsPlaying the NASDAQ w/ Options


r20mar20ma

r40mar40ma

Options Trader:Options Trader:Buys Puts; Sells Calls!Buys Puts; Sells Calls!

d20mad20ma

d40mad40ma

Puts; Calls!Puts; Calls!


Options Trader: Options Trader: Buys Calls; Sells Puts!Buys Calls; Sells Puts!


Calls; Puts!Calls; Puts!

Tools & Tactics Tools & Tactics –– A Must ReadA Must Read

A Japanese proverb says, “If you wish to know the road, inquire of those who have traveled it.” The authors of Tools and Tactics for the Master Trader clearly know the road. Their unique insights, trading tactics and powerful tools, so enjoyably presented, make this a book that belongs on every trader’s shelf.

Steve Nison, CMT - Author of Japanese Candlestick Charting Techniques

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Pristine SeminarsPristine Seminars

Pristine Video CollectionPristine Video Collection

For this and other Pristine videos, visit:

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Pristine’s Options ManualPristine’s Options Manual

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at:

www.pristine.com/options.htm

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