High Probability Option Trading:

Covered Calls and Credit Spreads

Steve Lentz

Director of Education and Research

OptionVue Research, Inc.

Disclaimer

Option trading can involve highly volatile returns and

unlimited risk. Option trading is not suitable for every

investor.

Overview

Introduction to Options and Graphical Analysis

Why Trade Option Spreads

The Role of Volatility

Advantages of Selling Premium

Covered Calls

Credit Spreads

Obtaining Candidate Stocks

Introduction to Options

and Graphical Analysis

Call Option – Right but not obligation to buy stock

at a certain price on a certain date

Put Option – Right but not obligation to sell stock

at a certain price on a certain date

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

IBM

2/18/03

Last Change Trade

Bid Ask MIV Trade Bid Ask MIV Trade

IBM

2/18/03

IBM

2/18/03

IBM

2/18/03

Last Change Trade

Bid Ask MIV Trade Bid Ask MIV Trade

IBM

2/18/03

Today’s Risk/Reward Line

IBM

2/18/03

Risk/Reward Line for 16 Days Away

IBM

2/18/03

1

st

Standard Deviation of

Possible Price Outcomes
Based on Last Month of Trading

IBM

2/18/03

Risk/Reward Line for Expiration in

32 Days

Why Trade Option Spreads ?

To Obtain Favorable Risk/Reward Ratios

IBM

2/18/03

IBM

2/18/03

IBM

2/18/03

Long 100 Shares of Stock

Long 1 Call Option
16 Days Out

IBM

2/18/03

Long Stock

1:1 Risk/Reward Ratio

IBM

2/18/03

Long Option

Negative Risk/Reward Ratio

On Normal Sized Moves

IBM

2/18/03

Long Option

Positive Risk/Reward Ratio

Only on Big Moves

Option Spreads

Help Create Positive Risk/Reward Ratios

On Normal Sized Moves

IBM

Option Spreads

Positive Risk/Reward Ratio

Only on Normal Moves

2/18/03

Advantages of Selling Premium:

Adopt the role of insurance company

Time is on your side

Through risk management, the long-term

odds can be in your favor

The Role of Volatility

SV

IV

IMPLIED VOLATILITY (IV)

Measures the volatility of the underlying asset
implied by current option prices

Higher IV Means More Time Premium to Sell

STATISTICAL VOLATILITY (SV)

Measures how much the price of the asset itself has
bounced around recently

Higher SV Means a Wider Standard Deviation of
Possible Price Outcomes

Percentile Rankings

Knowing a

Good Premium Selling Situation

Expensive vs. Inexpensive

Overvalued vs. Undervalued

Expensive = High IV Percentile

Inexpensive = Low IV Percentile

IV Percentile Rankings

0

30%

70%

100%

INEXPENSIVE

EXPENSIVE

Overvalued = High IV/SV Ratio

Undervalued = Low IV/SV Ratio

Knowing a

Good Premium Selling Situation

Sell Expensive and Overvalued Options

Purchase Inexpensive and Undervalued

Options

Covered Calls for the

Stock Investor

IBM

2/18/03

Last Change Trade

Bid Ask MIV Trade Bid Ask MIV Trade

IBM

2/18/03

Covered Call

Last Change Trade

IBM

2/18/03

Bid Ask T.Prem Trade Bid Ask T.Prem Trade

Covered Call

IBM

2/18/03

Today’s Risk/Reward Line

IBM

2/18/03

Risk/Reward Line for 16 Days Away

IBM

2/18/03

Risk/Reward Line for Expiration in 32 Days

IBM

2/18/03

73% Probability of Profit

IBM

2/18/03

Bid Ask T.Prem Trade Bid Ask T.Prem Trade

Last Change Trade

Covered Call

IBM

2/18/03

IBM

2/18/03

Vertical Credit Spreads for the

Option Trader

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

IBM

2/18/03

Vertical Credit Spread

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

IBM

2/18/03

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

IBM

2/18/03

Vertical Credit Spread

IBM

2/18/03

IBM

2/18/03

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

IBM

2/18/03

Vertical Credit Spread

IBM

2/18/03

81% Probability of Profit

IBM

2/18/03

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

IBM

2/18/03

Vertical Credit Spread

IBM

2/18/03

Position Requirements

Last Change Trade

IBM

2/18/03

Bid Ask T.Prem Trade Bid Ask T.Prem Trade

Covered Call

Stock Position:

100 shares

X $79.33 = $7,933

Margined Position:

$7,933 X 50% = $3,967

Minus $330 Credit for

The Sold Call

Total = $3,637

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

IBM

2/18/03

Vertical Credit Spread

Spread - Credit:

Spread = $10 X 100 shrs

= $1000

Credit = $390 Collected

- 115 Paid Out

$275

$1000 - $275 = $725

IBM

2/18/03

Covered Call:
$3,637

Vertical Credit Spread:
$725

IBM

2/18/03

Covered Call:
$3,637

Vertical Credit Spread:
$725

Obtaining Candidate Stocks

High Probability Option Trading:

Covered Calls and Credit Spreads

Steve Lentz

Director of Education and Research

OptionVue Research, Inc.