Options Expiration Set-up Explained

For non-option traders, options expire every 3rd Friday of each month. As expiration nears, premiums dry up until you're left with only the intrinsic value for the options. While some traders reduce their activity on options expiration week due to the volatility, I embrace it by placing more trades. As the premium dries up, I can use options to trade high-priced momentum stocks with absolutely minimal risk. Take the BAC trade detailed previously. If I have $100k and I normally risk 1%, or $1k (this is just an example, everyone should have his/her own risk parameters based on position-sizing of their capital) on each trade, I would have bought 1000 shares @ $21.50 with a stop at $20.50. Instead, taking that same $1000, I would buy Jul 22.5 Calls which were trading at $0.35 per call, yesterday. Now, I'm controlling 30 Call options, equivalent to 3000 shares, yet my risk is still $1000...now that's leverage! Yes, there is a risk that BAC trades at $21.50 through Friday and the options expire worthless. However, if you have the right set-up and can anticipate a big move, the reward MORE than justifies the risk. Given the BAC's closing price and increasing volume, the probability for a gap-open was high. When I place these trades, I never know if I will be to pick up $0.50, $2.00 or lose it all. However, occasionally, I've hit the homerun and have been able to catch a $5-10 move.



Summary:

1. Identify a momentum stock poised for an explosive move (industry break-out/break-down, earnings, news).

2. Buy calls/puts 1 strike away from the price of the underlying stock.

3. POSITION-SIZE based on your normal risk parameters. If you normally risk $1k, buy $1k worth of calls/puts.

4. Place the trade


I did NOT take the trade below but it illustrates the opportunites with options on expiration week. PCX has been on my radar but the volatility has been high as well as the price of the options. IF I could have forseen PCX's weakness today, the Jul 220 Puts were trading for below $1.00. Throughout the day, while I was fooling around with BS stocks like BIDU, I missed 4 low-risk set-ups to buy PCX puts. Yes, this is all 20/20 hindsight but if you look at today's trading range, someone bought/sold the Jul 220 puts for $0.65 and potentially made a killing as they traded up to $11.45 during the day!


Keep this set-up in mind for next month as it could be a profitable piece of your trading arsenal!