The Option-Graph Project

Basic Option Graph Step 12

Ways to use Basic Option Graph

  • Compare Simple Strategies

One way to make use of the multiple legs available to you in Basic Option Graph is to compare various strategies to each other. For instance, say you are bullish and are thinking of buying a long call. You can set up an In-the-Money long call in Leg1, an ATM long call in Leg2, and an OTM long call in Leg3. Then by just Including or not Including the various Legs, and updating the graph, you can see the advantages of each, such as the total investment required, and the reward to risk ratio.

If you are expecting a certain bullish move by the Check Date (which in Basic Option Graph is automatically set halfway between the last entry date and the first expiration date), you can see which strategy performs the best by that date, by looking at the gain on the green Check Date line, at the stock price you expect by that date.

Another way to compare a bullish strategy would be to set up a long call in Leg1, and a short call at a higher strike price in Leg2. Then by including Leg2 or not, you can compare the advantages and disadvantages of a long call and a bull call vertical. This can be especially important if the Implied Volatility is currently at very high or low levels.

If the volatility is currently at very high or low levels, set the IV to the current level, but change the Check IV to a more normal IV, and see how the strategies compare.

  • Compare Simple to exotic

Anytime you are considering a strategy with more than two legs, it can be educational to set up the strategy, and then Un-Include some legs. This will help show you where exactly the gains are coming from with the stock movement you expect, and if the additional legs are even necessary to make those gains. And of course remembering that any multiple-leg strategy has the built in disadvantage of requiring more commissions and slippage to enter, and if you need to exit early, even more commissions and slippage.

For instance, if you are considering a butterfly trade, set it up as a bear call in Legs 1 and 2, and a bull put in Legs 3 and 4. Include or Un-Include each part and look at various scenarios such as the stock rising or falling more than you think it will, or the Check Date IV being higher or lower than it is now. What do you stand to gain or lose by just entering a long call or a long put instead of the butterfly or either of the verticals? What are the risks of selling a straddle compared to the butterfly?

  • Roll Covered Calls

Basic Option Graph makes it easy to examine the theoretical possibilities for rolling options such as covered calls.

Set up the current stock price and the strike and expiration date of the short calls you now have in Leg1. Copy Leg1 to all the other Legs and Include all the option legs.

Since covered calls are often written against large dividend paying stocks, remember to enter the yearly dividend per share if there is one.

In Leg2, change the strike price to the next higher strike, and the expiration date one month further out. Do the same for Legs 3 and 4, increasing the strike price and moving the expiration date further out. Now use the "Find Price and Graph" button.

The graph itself will be meaningless, but the option prices shown on the Legs will show you the possibilities for rolling. Maybe you can roll for a credit to a higher strike at the next expiration, or maybe rolling for a credit can't be done even six months out. Maybe you can do a better roll if the stock price drops a bit over the next week, or maybe the stock price moving up strongly over the next week will make rolling much more difficult. All these things can be checked out - theoretically.

Always check the actual market, since factors such as earnings dates can affect the IV and therefore affect the actual option prices available.

  • Find how a Strategy is affected by changes in IV

You can see how any strategy might be affected by a change in the Implied Volatility just by setting up the strategy, and changing the Check IV to a higher or lower value than the current IV. If the green Check Date line moves to a higher gain at the stock price you are targeting, then the strategy benefits from the change in IV. If the green line moves to a lower gain at the stock price you are targeting, then the strategy is hurt by the change in IV.

Try setting up some strategies that look similar, and compare what happens to them with higher or lower IVs than when you enter the trade.

For instance, compare a Butterfly with a Calendar. Compare an Iron Condor with a Double Diagonal.

Make notes of your results. Then you will know which strategies to favor if Implied Volatilities are currently high or low and you expect a move back to normal.

  • Find if a Strategy benefits from time decay at a certain stock price

On any strategy you graph, the green "Check Date" line will normally be between the blue "Entry Date" line and the red "Expiration Date" line. Just by noting the relative position of the green line versus the blue line, you can tell if a strategy benefits from time decay, or is hurt by time decay, at a certain stock price.

If the green line is above the blue line, the strategy is helped by time decay at that stock price.

If the green line is below the blue line, the strategy is hurt by time decay at that stock price.

You can see both of these effects in action if you set up a bull call. Anywhere above the breakeven price, time decay helps the position - you will realize more of a gain by waiting, as long as the stock price stays at least at that level. Anywhere below the breakeven price, time decay hurts the position - your losses will increase if you keep holding and the stock stays at that level or goes down.

You can use this information as possible points to either "let your winners run", or "cut your losers short".

  • Find the earliest expiration that will enable a Stock Rescue at no additional cost

In the notes for the Option Calculator Project, we showed how you might find if a "stock rescue" strategy would work on a stock you own which is currently under water. Using the Calculator, the method involves a lot of steps and seems quite complicated. But using Basic Option Graph it becomes much simpler.

Say you bought 1000 shares of a stock at $30, and it is now $25. In Basic Option Graph, set up 10 long calls in Leg1 using strike price 25, and 20 short calls in Leg2 using strike price 27.50. Use the current stock price and IV. Now keep advancing the expiration date in both Legs, and clicking the "Find Price" until the Entry Value shows a credit for entering the trade.

The first expiration date that gives a credit represents the least amount of time you must wait in order to get out of your stock at breakeven overall, with no additional risk.

When the Entry Value is a credit, you can set up the Stock Leg with your 1000 shares bought at $30, and Include the Stock Leg.

The Graph should show that $27.50 (less any credit from entering) is now the new breakeven.

As a rule, the higher the current IV, the closer the expiration date is for a stock rescue. If the IV is low, a stock rescue might not be available for over a year, or at all.

If you cannot find any expiration that lets you enter for a credit, it means a risk-free stock rescue is not possible at the current stock price or IV.

You can read more about the "stock repair" strategy on at:

  • Graph option examples, notable trades, Guru trades, etc.

If you are studying options, try setting up some of the trades you read about in books or hear options Gurus talking about. This will help you understand things like an author saying "this is a good trade for when a stock has just fallen and the IV is very high". You can set up the trade, with a high current IV, and set the Check Date IV to a more normal value, and see how the trade benefits.

Many option trading sites also give information about notable trades for the day, such as "a large institutional investor entered the following trade on 10,000 contracts of XYZ". You can set up the trade in Basic Option Graph, and see what the large investor might be trying to achieve. If the number of contracts is more than Basic Option Graph can handle, just use half or 10% of the number - the graph of the trade will be the same. The max gain or loss on the actual trade will be twice as much or ten times as much as shown.

Never blindly follow any of these institutional trades with trades of your own unless you understand the risks involved. Many times the institutional investors are trying to hedge a stock portfolio with their trades, and there is no way to know how many shares of stock they are long or short.

If an institutional trade does not make sense to you, it is probably because of this type of hedging. Try adding Long or Short stock shares to the strategy and see if it makes sense.

  • How To Save a Picture and/or Print a Graph

Basic Option Graph does not have a built-in way of saving a graph or printing, but you can easily do that with standard Windows features and a graphics program such as "GIMP".

GIMP is a free open source graphics program - you can find it by doing a Google search. Other programs such as Adobe Photoshop will work as well, if you already have them.

To save an image of any graph, just press SHIFT-PRINTSCREEN when the graph is displayed in Windows. (The Printscreen key is normally just to the right of the F12 key on your keyboard). This will put an image of your entire Windows Screen on the Windows clipboard.

If you use GIMP, you can use "File - Create - From Clipboard" to get the image into the program. Then you can use the "Rectangle Select" tool to select whatever part of the image you want to save or print, and use "Image - Crop to Selection" to get rid of everything else.

Now you can save the image as a jpeg or any other format, or print the image to your printer.

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