Today's Trades (As of 2017-10-20)
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Note that the above table, "sorted by value," is complicated by the fact that the program trades in a fixed number of shares, rather than a fixed dollar amount. For example, trading 1000 shares of an equity valued at $60 will give much bigger swings than trading 1000 shares of an equity worth $5. There's no easy way to "normalize" these numbers, given the fact that the stock price may change dramatically over the course of the analysis period. I'm open to suggestions.
Tutorial and example using the Bank of Nova Scotia
In this section, we'll use the Bank of Nova Scotia (BNS) as an example to illustrate some of the concepts employed by the OPTIONific program. There are two important characteristics to keep in mind about BNS:
We'll explain puts and calls shortly.
Firstly, the Bank of Nova Scotia (BNS on the Toronto Stock Exchange) currently pays a dividend of $0.55 per share. This means that every quarter year, we will receive $0.55 for every share that we own:
This is a nice way to either build up some cash, purchase more shares (BNS offers a dividend re-investment plan that automatically converts dividends into shares), or have a steady income stream (regular, quarterly payments). Our goal on this website is to achieve a steady income stream.
Using the most conservative strategy, we could increase the income stream by writing covered call options.
Let's see how this works in practice:
The above table shows two income streams; one from the dividends that are associated with the BNS shares, and another from the premiums generated by selling (or "writing") covered calls.
Just looking at the total, we have now generated $6.62 versus $2.65! This is 2.5 times more than just plain dividends (you can think of this as effectively boosting our dividend from around 4% to 10%!)
So how does this work? The assumption in the table above is that we own shares of BNS, and that we are writing covered calls. Let's look at one in detail:
In this case, on July 29th, 2011, we wrote a call that expires in October, 2011 with a strike price of $56.00, for a premium of $0.97.
Recall that this obligates us, as the writer, to sell shares of BNS at the strike price ($56) if the calls are exercised. Therefore, there are three scenarios to consider:
What's the catch?
The best part is, there is no catch! The absolute worst thing that can happen is that our call gets "assigned" (case #1, above), meaning that the stock gets sold at the strike price for the call. Looking back at the table above, at the October 2011 call that we wrote in July:
If the call got assigned, we would be paid $56 per share, on top of the option premium that we already received, effectively selling the stock for $56.00 + $0.97 = $56.97!
Obviously, if we paid more than $56.97 for the stock, then we would suffer a loss.
Can I still write calls even if I don't own the stock?
Technically, the answer is yes. This is a "naked call." But we don't recommend it, because your risk is unlimited! If BNS really did go to $80, and you wrote a $56 naked call, then you would be obligated to sell BNS for $56. Since you don't own the stock (the "naked" part of "naked call"), you would have to go out and buy it on the open market for $80, resulting in a $24/share loss.
Optional risky strategy
If we don't yet own stock, or our shares get assigned, we can still make money! There is a higher element of risk involved (explained below) but we can use this technique to generate income even when we don't have the stock. This strategy uses something called "writing naked puts."
Practically speaking, naked puts mean that we are prepared to buy the stock for a certain price at a certain time in the future. Let's revisit the example of BNS above, except this time we start out not owning the stock.
In the "dividend only" case, we would get $0.00 — we don't own any stock, therefore we don't get any dividends. However, by writing naked puts, we can either get a constant revenue stream, or own the stock at a discount. Let's see how this works in practice:
The above table shows a new income stream, based on writing naked puts. Just looking at the totals, we once again have pure magic — $5.42 out of "thin air"! (Yes, it's legal). This is 82% of the $6.62 we would have made by writing covered calls.
So how does this work? We're assuming that we want to (eventually) own BNS no matter what (here's where the element of risk comes in). By writing a naked put, we've agreed to buy the stock at the strike price. So, looking back at the table above, let's take a look at the October 2011 put that we wrote (in July):
This transaction commits us to buy the stock for $52 in October. Just like with the covered calls, there are three scenarios to consider:
In the case of scenario #2, above, you should only use this riskier strategy in case you are comfortable owning the stock "no matter what" — effectively, if you are a long term investor in that stock. The upside is that the option premium that we received for the stock offsets our costs. In the table given above, even if we were forced to buy the stock for $52 in October, we would still have the $1.25 premium from July, effectively making the stock cost only $50.75.
Combining the two strategies
Of course, it's only a matter of time until our covered call options are assigned. This would happen when the stock price is higher than the strike price. When that happens, we can switch to naked puts until we get assigned (and own stock again), and then switch back to covered call writing. We can do this as many times as we like.
If you write a covered call and the stock price drops dramatically, you can repurchase your covered call (for significantly less money than what you sold it for) and write another one, effectively collecting your premiums twice! Same with the naked put -- if the price of the equity goes up, the premium of the naked put goes down, and you can repurchase your naked put (for less money that what you got for it) and write another one. (This is scenario #3 in both the call and put scenarios above). Over and over again!
In our examples above, we've shown the time horizon as three months. The available time horizons will depend on the underlying stock itself. OPTIONific allows you to choose between different time horizons, with full analysis.
About this website
A description of the algorithm is given in How to build an AI for trading stocks with some other interesting discussions in A C++ Library for Stock Analysis. Interested in security? The read about a way to make your devices secure, especially in the Internet of Things (IoT) world!
|(C) Copyright 2012 Robert Krten, all rights reserved.|
This is not an offer to sell securities, nor should it be considered investment advice under any circumstances. Trading in options can result in significant financial loss. You are viewing this website at your own risk. The opinions expressed herein are for educational purposes only. The information presented here may contain errors and is not guaranteed.