Picking the Magic Strike Price

1. Picking the Magic Strike Price Ernie Zerenner President Power Financial Group, Inc. PowerOptions – www.poweropt.com Copyright Power Financial Group http://www.poweropt.com/oxp2/

2. Introduction • Option investing has several degrees of freedom more than equity investing: • Strike price • Time decay • Month selection • This talk will concentrate on the choice of the strike price for both buying and selling strategies. Copyright Power Financial Group http://www.poweropt.com/oxp2/

3. Basic Covered Call Calculations Using the option premium for each strike price, our option chain calculates: • % Downside Protection • % if Unchanged • % if Assigned • % Probability the Stock Price will be above the Strike Price Copyright Power Financial Group http://www.poweropt.com/oxp2/

4. Copyright Power Financial Group http://www.poweropt.com/oxp2/

5. Observations on Option Chain • Observe the general trend in pricing as the strike price increases: • Option premium declines • % Downside protection declines • % if Unchanged is highest ATM • % If Assigned increases • % Probability Above declines Copyright Power Financial Group http://www.poweropt.com/oxp2/

6. XYZ ($81) with 44 days left Copyright Power Financial Group http://www.poweropt.com/oxp2/

7. How to interpret the data • High returns comes with a “risk” • Highest return (if unchg) is ATM • Greatest safety is ITM • Greatest potential gain is OTM • The more the potential gain then the lower the possibility of success based on probability Copyright Power Financial Group http://www.poweropt.com/oxp2/

8. Back to the point in Question: What strike? • It all depends on your own risk reward profile: • Looking at the last 2 columns of % if Assigned and % Prob. Above as a pair • The lowest return of 1% has a 90% chance of happening (highest % Probability Above) • The highest return of 6% has only an 18% chance of happening (lowest % Probability Above) Copyright Power Financial Group http://www.poweropt.com/oxp2/

9. What Strike based on Risk Looking at the % Downside Protection and the % If Assigned columns as a pair: • The highest downside protection has the lowest return, but the stock price can fall and still win • The highest return is possible at the highest strike price, but it has the lowest downside protection • To achieve the highest returns requires the stock to rise in price. If it does not rise the return is lowest of all. • The highest strike price is a play on stock appreciation not covered call income Copyright Power Financial Group http://www.poweropt.com/oxp2/

10. Real Life Example • Retired and looking for income • Preservation of capital is more important than speculative gains • Want a better return than a CD or a Bond • Want to reduce the volatility of my holdings Copyright Power Financial Group http://www.poweropt.com/oxp2/

11. Some of My choices • Case 1 – Already own stock and want to earn income. • Case 2 – Have cash and want to do a buy / write to generate income Copyright Power Financial Group http://www.poweropt.com/oxp2/

12. Case 1 – Already own • Use strikes ATM or slightly OTM • Want to avoid being assigned therefore must roll up and out if ITM. • Must watch dividend exposure to avoid early assignment. • Actively manage by buying back the option if it declines and rolling down Copyright Power Financial Group http://www.poweropt.com/oxp2/

13. Case 2 – Buy / Write • Always go ITM • Sacrifice large returns for safety • As a rule of thumb limit annual gains to 20 to 30% Max. • Reduce the excess gain by going further ITM. • Actively manage the position by liquidating once 70 to 80% achieved. Copyright Power Financial Group http://www.poweropt.com/oxp2/

14. Summary on CC Strikes • It’s all about risk / reward • Each situation is different, but each strike has a set of characteristics, which can be tailored to your circumstances • Be sure you have the tools and calculations available to make the smart choices Copyright Power Financial Group http://www.poweropt.com/oxp2/

15. That was selling options • Now we discuss buying options • Investors tend to pick the wrong strike price! • Choices based on number of contracts? • Go deep OTM for cheap options • Go ITM for high delta and low time premium Copyright Power Financial Group http://www.poweropt.com/oxp2/

16. Picking a Strike when Buying • We need to decide: Which month & strike. • How much time premium should we buy • The more ITM the more it costs • More time costs more money • This all effects the number of buy contracts • But, where is the best return? Copyright Power Financial Group http://www.poweropt.com/oxp2/

17. Tool to Maximize Returns • Assumptions in developing the tool • Forecast the stock price • Time frame for the move • How much will you invest • Will volatility change • Based on these inputs the best return can be calculated for every possible strike price Copyright Power Financial Group http://www.poweropt.com/oxp2/

18. Input Example: Copyright Power Financial Group http://www.poweropt.com/oxp2/

19. Output Example: Copyright Power Financial Group http://www.poweropt.com/oxp2/

20. Summary of Buying • Make a forecast for the stock • Determine the time the move will take • How much you want to invest • Then use a tool to calculate the best strike to use based on returns. Copyright Power Financial Group http://www.poweropt.com/oxp2/

21. http://www.poweropt.com/oxp2/ • Use the above URL for a 30 day FREE Trial • Toll free help using the site • Try these techniques by paper trading • One-click trading for optionsXpress clients • 877-992-7971 (toll-free) Copyright Power Financial Group http://www.poweropt.com/oxp2/

22. Tomorrow’s presentation Tools and Software • How to Find Option Trades with SmartSearchXL • 4PM Friday May 5th Copyright Power Financial Group http://www.poweropt.com/oxp2/