Open interest and volume have long been indicators that speculators have relied on for future stock movements. When rumors begin flying around the Street, institutions and retail investors alike try to capitalize by buying cheap out-of-the-money options at a specific strike and expiration. Most of you reading this right now are in the comfort of your own home and not lost in the trenches of Wall Street. You have very little knowledge of any potential takeovers or great earnings announcements being whispered about. However, learning how to spot this type of option action can help you take advantage of the potential movement as well.

On the thinkorswim software platform, there is an indicator called the "Sizzle Index." It allows you to search all optionable stocks and ETF's looking for unusual options activity. You can refine this search to your own watch lists or public watch lists. As an example, when searching the Russell 1000, Archer Daniels (ADM)appears as an illustration of something that is "sizzling." ADM has earnings approaching in a little over a week and some heavy option action is taking place.

Below you will see the sizzle index on the Stock Hacker tab of the thinkorswim software. ADM is highlighted and has a "call sizzle" of $5.978. What this means is that there is almost six times average volume on ADM calls right now. That's enough to cause some curiosity!

The next step would be to look at the options to see where this irregular options activity is taking place. Highlighted below you will see today's volume and the open interest. The August 30 and 35 calls along with the September 30 calls are showing very high volume in comparison to the open interest. The August 35 calls are currently trading at a bid ask of $0.25 - $0.35. This is a very cheap option that could be a speculative gamble based upon what earnings may do in the next week.

If you want to take it a step further, you can look at the order flow of the options utilizing thinkorswim charts. Below is a five minute chart of the Aug 35 call. You can see over the last couple days that the order flow has been pretty consistent and increasing.

If you make trade decisions based on this kind of information keep your trades small, recognizing the risk of losing the entire option premium exists. However, winning every once in a while utilizing the sizzle strategy can provide you with potential big returns.
Be patient, trade smart and trade happy!

thinkorswim, Inc. does not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

Copyright 2008 Investools Inc. All rights reserved. Terms of use apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law. Neither Investools nor its educational subsidiaries nor any of their respective officers, personnel, representatives, agents or independent contractors are, in such capacities, licensed financial advisers, registered investment advisers or registered broker-dealers. Neither Investools nor such educational subsidiaries provide investment or financial advice or make investment recommendations, nor are they in the business of transacting trades, nor do they direct client futures accounts or give futures trading advice tailored to any particular client's situation. Nothing contained in this communication constitutes a solicitation, recommendation, promotion, endorsement or offer by Investools, or others described above, of any particular security, transaction or investment.

Have you ever thought about trading long calendars but were perplexed as to how to put them on? In addition, how do you choose the strike price, or prices for double calendars? How do you choose how far out to trade them, or whether to give yourself a roll in the trade? Where do you start? In my opinion, the best place to start is with your own market bias. If that means utilizing charts to determine where the underlying might be headed, then so be it. If you think the underlying will fall, choose a put calendar strike below the current market price. If you think the underlying will rally, choose a call calendar strike above the current market price. If you have no directional bias, then an at-the-money calendar might be your best bet. Remember, a calendar is worth the most when the front month expires with the underlying sitting at your short front-month strike. Thus, directional bias does play a factor in the success of the calendar.

I speak volumes on calendars because I love the probability of return and the risk/reward characteristics they provide. For instance, the average ATM calendar has about a 44% probability of paying 2-to-1 on your investment. This is a long calendar play, so you are paying a debit for it. Try getting those odds in Vegas. If you don't believe me, take a look! As you can see, the $1.88 debit, or in terms of real dollars, $188.00, that we paid for the Aug./Sep 125 calendar pays out $180.00 for one calendar on August expiration if the underlying stays at the strike price. More importantly, this position makes money as long as the underlying settles between $121.20 and $129.10 at expiration.

Now let's dig a little deeper. We analyzed doing a one month Aug/Sep 125 calendar in the SPY. But how do we know whether a one-month or two-month calendar is more appropriate for our needs? First of all, you have to look at the cost of the calendar itself. In our first example, the one-month calendar traded for a $1.88 debit. That is pretty pricey relative to the two-month calendar with a possible roll embedded. Take a look at the same strike calendar 125 in the SPY but this time between August and October.

In this example the two-month calendar costs us $2.70. Is this calendar more expensive? Take a second to think about this. What does the two-month calendar offer us? It offers us the chance to roll our position forward into another calendar. This means that once August expires we can sell the September 125 strike against our already long October position. When we look at the $2.70 price with another roll embedded, the calendar actually costs $1.35 per month since we have a roll opportunity for September. By doing the two-month calendar, we have lowered the cost basis on our calendar from $1.88 for the one-month to $1.35 for the two-month. Now, as with any calendar, the position is a short Gamma position whether it is a one-month or two-month calendar, so the position provides the greatest profit if the underlying moves to our short strike and begins to lose money if the underlying moves too far away from our strike price. In order to determine how far the stock can move from the strike price, just use the Analyze Tab as shown above and set your slices to Break Even at Expiration +1 date. As always, happy trading, and stay profitable.

thinkorswim, Inc. and its registered employee, Joe Mazzola, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

Customers love calendar spreads! They understand that calendar spreads, AKA "time spreads," have broad profit ranges, defined risk, no margin, and use little capital. But what's the secret, or moreover, what are the rules for getting out and exiting calendar spreads?

I get email after email asking, "Bat, I did what thinkorswim said and bought a calendar spread when volatility was lower for the positive Theta (time decay) and the directional play. But now how do I get out of this trade? What's the secret? Are there rules for getting out of calendar spreads?"

Let's keep it simple. You should consider exiting a calendar spread when any of the following occur:

A.) It is 4-10 days before expiration.

B.) The short option of your calendar spread is trading for 1/10 of the strike price increment. For example: $5.00 wide strikes = $0.50, or $1.00 wide strikes = $0.10.

C.) Or when Nirvana shines upon you- Maximum profit occurs! The underlying stock price settles at or near the strike price of the short option at expiration. Consequently, the front-month short option expires worthless, and the back-month long option has its greatest value because it is ATM (at the money).

thinkorswim, Inc. and its employee, Tony Battista, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

Lately, the market has been fairly volatile and many investors are struggling to find long-term direction in the foreign exchange, or forex, market. The majority of consolidation and volatility is centered on the U.S. dollar. Today's proposed strategy is based on removing the U.S. dollar from the equation and using a broader view of the global economy to set up two spreads that create a synthetic cross (i.e., without the dollar in the base or quote).

The Swiss franc is considered a safe haven currency. Historically, during times of war and political unrest, money moves to the Swiss franc. In addition, the Swiss National Bank is recognized as the single-largest holder of bullion, and is also seen as a stable, safe haven bank. The Swiss franc's strength in price action has been noticeable because it has been the strongest currency over the past year in price percentage movement, compared to major world currencies.

In contrast, the Japanese yen has a history of being part of the carry trade, because banks and institutions sell it at a low rate (between zero and 0.5% over the past five years) and buy higher interest currencies to capitalize on interest rate differential in a leveraged market. Today's trade example is not focused on the interest rate that can be received from the trade, but rather, the shift in supply and demand that causes yen to trade in a bearish trend. The yen has been in a distinct bearish move against major currencies since March 2008. Many investors are speculating on the carry trade's return.

Using Philly Swiss Franc options (XDS) for half of the synthetic trade, notice the trend (see Figure 1). It is very bullish and has been for most of the past seven years. Buying the September 95 put and selling the September 97 put creates a bullish vertical spread or bull put spread near a support level. The bull put spread pays a credit of $102.00 per contract with a $96.00 break-even point, which is $0.33 below the current price. That is to say, excluding commissions and dividend risk, the bull put spread can profit if the XDS moves up, remains flat or even drops up to $0.33 by expiration.

Figure 1--PHLX Swiss Franc (XDS) Rising with Strong Trend Support

The Bullish Credit Vertical Spread (bull put spread):
Buy the September 95 put for $1.11
Sell the September 97 put for $2.13

This provides a credit of $1.02 per option, or $102.00 per contract.

Maximum gain potential in dollars: $1.02 per option, or $102.00 per contract.
Amount at risk: $0.98 per option, or $98 per contract (not including possible dividend risk or commissions).

Maximum gain as a percentage of amount at risk: 104%
Break-even price at expiration: $96.00

The yen is a little different than the franc's set up, which is trading a support bounce in an uptrend. The yen appears to have broken out to the downside of a wedge price pattern. For nontechnicians out there, a wedge breakout often runs the wedge's height in the breakout's direction. To be a little more conservative and use key support and resistance areas within the wedge, a $10.00 move could be expected, which would push the XDN back to one-year lows. Selling the September 94.5 call and buying the September 92 call for a bear call spread pays a credit of $100.00 per contract with a breakeven point at $93.05 (see Figure 2). That is to say, excluding commissions and dividend risk, the bull put spread can profit if the XDN moves down or remains flat by expiration.

Figure 2--PHLX Japanese Yen (XDN) Breaking Out of Wedge Pattern

The Bearish Credit Vertical Spread (bear call spread):
Buy the September 94.5 call for $1.02
Sell the September 92.00 call for $2.07

This gives us a credit of $1.05 per option, or $105.00 per contract.

Maximum gain potential in dollars: $1.05 per option, or $105.00 per contract.
Amount at risk: $1.45 per option, or $145.00 per contract (not including possible dividend risk or commissions).

Maximum gain as a percentage of amount at Risk: 72%
Break-even price at expiration: $93.05

The maximum risk on the XDN bear call spread is greater than the gain, which may seem to be against good money management. It can be argued that it is an equal or lesser risk, because probability and risk-to-reward ratios are often inversely correlated. Spot currency market prices are derived by dividing current exchange rates by each other. Analyzing breakeven points, maximum gain and maximum risk on the XDS and XDN at expiration, then deriving the synthetic value at time of expiration, the break-even point on the spot currency pair (CHF/JPY) would have to be 1.0317 or 25 pips below the current price. Maximum risk occurs when the pair price crosses 1.0056 or 294 pips below the current price. Maximum gain occurs at the 1.0544 spot price, up 200 pips from the current price (see Figure 3). The pair's probability of continuing 200 pips higher is greater than its probability of dropping 294 pips, based on historical price action trends.

Figure 3--CHF/JPY with Rising Trend and Max Gain Max Loss Points

Copyright 2008 Investools Inc. All rights reserved. Terms of use apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law. Neither Investools nor its educational subsidiaries nor any of their respective officers, personnel, representatives, agents or independent contractors are, in such capacities, licensed financial advisers, registered investment advisers or registered broker-dealers. Neither Investools nor such educational subsidiaries provide investment or financial advice or make investment recommendations, nor are they in the business of transacting trades, nor do they direct client futures accounts or give futures trading advice tailored to any particular client's situation. Nothing contained in this communication constitutes a solicitation, recommendation, promotion, endorsement or offer by Investools, or others described above, of any particular security, transaction or investment.
The security used in this example is used for illustrative purposes only. Investools is not recommending that you buy or sell this security. Past performance shown in examples may not be indicative of future performance.

Trading spot currency contracts can involve high risk and the significant loss of any funds invested. Spot currency contracts are highly leveraged. This means that significant losses can be created quickly and unexpectedly.

Options trading is generally more complex than stock trading and may not be suitable for some investors. Granting options and some other options strategies can result in the loss of more than the original amount invested. Before trading options a person should review the document Characteristics and Risks of Standardized Options, available from your broker or any exchange on which options are traded.

No, that's not a typo. For those of you looking to dip your toes into financial stocks at these levels, one strategy to consider is selling puts in order to get long the stock. Not only does this reduce your cost basis, it is also a good strategy for those of you trading within your retirement vehicles (IRA's, 401K's, 403b's, etc...). One key element to trading in this fashion that you must remember and adhere to is that you must want to own the stock in order for this strategy to be successful. This means that you should only implement this strategy in stocks that you want to own for a longer period of time. So why sell puts instead of just buying the stock outright? First of all, selling puts, as mentioned above, reduces your cost basis. Let's take a look at a recent example involving Citigroup, symbol C. As of the close of trading on July 28, 2008, the stock was trading $17.28. Let's say we wanted to purchase 1000 shares of C. There are two ways to transact this purchase. You could either purchase the shares here and pay $17.28 per share for a total debit of $17,280.00, or purchase the shares at a lower price by selling out-of-the-money puts on the stock. In the latter case, thinkorswim recommends selling premium 40-150 days out. So in our example, we would be looking to sell puts in September or October.

Currently, the September 15 puts are trading for $0.95. By selling 10 of the Sep 15 puts, the equivalent of 1000 C shares, we collect $950.00 premium from the sale in our account. In addition, we are now obligated to buy the 1000 shares of C at $15.00 if the underlying stock settles below the 15 strike at September expiration. However, if this is the case and the stock settles below $15 at expiration, we still keep our $950.00 premium from the sale of 10 puts and will be assigned the stock. Figuring out our stock basis is simple. You just take the strike price and subtract the credit you collected. Thus, our new cost basis for buying the Citigroup stock that we wanted to own becomes $14.05, or a debit of $14,050.00 for 1000 shares.

If, however, the stock never trades or settles below $15 at expiration, we simply keep our $950.00 credit, roll the same put sale into October, and so forth. Thus, we are buying by selling. As always, happy trading and stay profitable.

thinkorswim, Inc. and its registered employee, Joe Mazzola, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

The news on the tape and on most of the financial networks is bleak and unsettling. Housing Starts are at multi-decade lows, inflation is rearing its ugly head, and oil still languishes in the 120 range. And we have not even gotten to the Financials and the dreaded duo of Fannie and Freddie. So what gives with this market? How is it possibly holding up and not getting decimated? As an options trader, I am accustomed to watching the VIX, or Volatility Index, to give me clues as to what market bias the "fear gauge" may tell me. Looking at the charts below, I can see that in the Year-to-Date we have had three occasions when the VIX has poked its head above 30, and the broader market (SPX) has had significant moves downward on each occasion.

This correlation is not surprising to anyone; the market and options pricing reflect the trading environment. The market is also a forward-looking vehicle, and thereby the VIX generally reflects the expectations of the broader market. That being said, the VIX has been hovering around 20 throughout this latest round of "turmoil" and seems to be telling us that another steep drop in the market is not in the cards. I find the VIX to be a very useful tool in giving me an edge in predicting market movement. My take on the current VIX would lead me toward trading in a market-neutral to mildly Bullish trade. I would consider using this opportunity to place an Iron Condor with a slightly Bullish bias. For example, using the SPY in September Options, I could sell an Iron Condor and place the vertical put spread three points below the current trading price of 127 and sell a vertical call spread four points above 127. So in this case, it would be a 123-124 put spread and a 131-132 call spread. That will yield a premium of just over $50 on a $1.00-wide spread on both sides. It is more aggressive than we normally trade, but we are trying to capitalize on a channeling or indecisive market. The risk is roughly $50, as is the reward and our time frame is relatively short, giving us a shorter risk window. Good Luck, and Happy Trading!

thinkorswim, Inc. and its registered employee, Steve Quirk, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.