Archive | European/American style RSS feed for this section

SPX Weeklys Options

No, it’s not a spelling error. The CBOE refers to these short-term options as ‘Weeklys.’

Last night, a simple question from a reader resulted in my first learning about something that has been going on since early December 2010. To me it’s gigantic news. However, when I googled, I found almost nothing.

My correspondent is short the SPX Feb 1290/1300 Put spread. Here’s the key line from that e-mail:
“I wonder whether it is a good idea to close the deal Thursday evening?”

Yes, it’s a good idea

I’ve cautioned traders (many times) that it’s foolish to take the risk of holding OTM index option positions overnight – when settlement is determined by the next day’s opening prices. Thus, I’m a big fan of closing Thursday.

I took a quick look at the (CBOE Micro site for Weeklys), just to be certain that I was not missing anything in my reply – when I discovered a few innocent looking lines:

NEW – SPX Weeklys Now PM Settled

On Thursday, December 2, 2010, CBOE commenced trading of PM-settled End-of-Week (“Week-Ends”) SPX Options for expiration on Friday, December 10, 2010. With the commencement of trading in PM-settled End-of-Week SPX options CBOE discontinued the listing of SPX AM-settled Short Term Options. For additional information please refer to the following circular

I’ve argued for a long time that A.M. settlement is a very unfair method for determining the ‘final closing price’ for any index. There is too much opportunity for market manipulation. Thus, this change is a good thing and makes it a more viable product for trading.
Continue Reading →

Read full story · Comments are closed

Trading Mistakes: Did You Make One? How can You Tell?


Sorry to be off topic a bit. But the only way I learn is by putting
money on the line, making mistakes and not doing THAT mistake again. Got
caught in a squeeze, extricated myself with considerable difficulty.
Licking my wounds right now.

A few days ago when you or somebody else said
"Waiting for expiration is so retail" is absolutely right. What
shenanigans they play, I gotta hand it to them. Had a sleepless night 2
days running yesterday & day before wondering if I would be
assigned. I should have taken the 70% of premium.

Chalking this to

Is this why you dabble in RUT only? I was thinking of dabbling in




Hey Amit,

You are never off topic.

I trade a single underlying for only one reason – a reason that may not be applicable for others.  If I get into trouble, if the market is going nuts, I want to have as few decisions to make as possible.

Even if planned advance, three underlying assets may be responding to the market situation differently.  I don't want to take too much time to put out fires.  I want to be efficient and quick.  Thus, one underlying asset.

Yes, it's a bonus that RUT is a European style option that settles in cash. SPY options are American style and settle in shares.

Per your opening paragraph: I want to play Devil's Advocate: 

Your plan is not efficient because:

a) How do you determine when a mistake was made?  Because you lost money or could have made more money with a different decision?  This is a terrible method for deciding if the action taken (or not taken) was a mistake.

Just because exiting at 70% of the maximum profit would have been a good idea this time does not make it a reasonable strategy.  I surely hope you agree with that statement.  The only thing you learned is this:  This time, this one time, exiting at 70% would have worked best.  

Now examine 99 similar occurrences, and when you have 100 examples, then you can decide on an exit strategy.  That means you must keep a trade journal and record each trade.  Keep tabs on what action would have achieved the maximum profit.  Keep track of your actual decisions.  Eventually you will have a clue about what to do.  Act accordingly when trading.  Just remember that no valid conclusions can be drawn until there are a significant number of data points. Be ready to modify your methods as you gain experience and have many more trades under your belt.

b) You can draw no valid conclusions from a single data point.  Doing so is dangerous.  In fact, it's a mistake.  If you want to avoid a mistake, here is an opportunity to avoid one.

Suppose riding the position to expiration would have worked this time.  Does that mean you would feel differently about waiting for expiration to be 'so retail' (nice phrase; not mine)?

c) It takes repetition and statistical evidence before you can draw valid conclusions.  This is even more true for inexperienced traders who don't have a background of many trades to use as a filter for the decisions being made.  Do not decide that something that resulted in a loss is a mistake.

d) You should recognize a mistake when you make one: You took too much risk.  You traded too much size.  You traded too little size because this situation was special and 10 to 20% more contracts would have been justified.  You got too greedy. You were far too cautious for no good reason. You ignored your trade plan for no valid reason.  You felt uncomfortable with position risk (more sleepless nights?) and did nothing to alleviate the risk.  Those are mistakes.  Even if the result is a huge profit, these are mistakes.

e) If you sell premium, you will get caught in squeezes.  Your job, as a risk manager, is to anticipate the squeeze and alleviate some of that pain in advance.  You may decide to reduce the effects of a squeeze by reducing position size.  You may exit the trade and eliminate the risk of a squeeze.  It locks in a loss?  Who cares?  You know some trades will lose money.  Minimizing those losses is NOT a mistake.

Your job is not to hold on to a bad trade stubbornly, hoping for the best.  Your job is manage risk well.  Succeed at that, and most of your 'mistakes' will disappear.

You will take losses.  The market will move in a manner that does not suit your hopes or expectations.  These are not mistakes unless you missed the obvious and refused to take appropriate action.

Sometimes, the market will behave in a manner that suits your positions.  That makes you neither a good trader nor a genius.

Recognize the facts:  You will win some and lose some. If you manage risk well, you are doing your job.  If you lose money despite taking good, appropriate action, you did the right thing and it is not a mistake.

One more point: Unless you are short OEX options, why are you afraid of being assigned an exercise notice?  Early assignment reduces risk and is often a gift.  If that assignment would result in a margin call that you cannot meet, then your positions are far too large. Assignment is nothing to fear.



Coming in the July 2010, to be published next Monday: July 19, 2010

Interview with Charles Cottle

Book review: Volatility Trading by Euan Sinclair

Bill Luby discusses the suggestion that volatile markets are coming

Guest article by Tyler Craig – Adjustment Trading

New Contest.  Win a year's subscription to Barron's

Lot's more

Read full story · Comments are closed

Short Course in Risk Management: Two Days. Part II

Part I

One risk management tool readily available to the individual investor is the risk graph supplied by your broker.  Those graphs provide a good overall snapshot of current risk.  Along with the profit/loss graph, specific risk parameters – as measured by 'the Greeks' are available.

The Greeks provide valuable information for measuring risk.  When the trader understand potential risk of a given position, it is easier to manage that risk.  However, the Greeks are not the focus of today's discussion.

Let's take a look at a hypothetical SPX (S&P 500 Index) position, assuming that it's Tuesday of expiration week.  As a reminder, SPX options are European style and stop trading when the market closes on Thursday (one day prior to the third Friday of the month).  The final, or settlement price for the index, is calculated, based on the Friday opening price for each individual stock in the index.

Ignoring how you came to hold this position, consider:

Position.  SPX price = 1205

Long 10 SPX May 1200 calls

Short 25 SPX May 1210 calls

Long 25 SPX May 1220 calls

 Let's assume that this is a single hedged position and that you have been managing risk on that basis. [It's always tempting to break a complex position into smaller parts and manage each separately. That's for each trader to decide.  For today, this is a single position]



This risk graph shows the P/L picture for the above SPX position.

The thin blue line represents risk as of today, with three trading days remaining before the options expire.  This graph looks pretty good.  If SPX declines, the loss is small, but if there's a rally, profits continuously increase as the index price moves higher.

The reason the position does so well on a rally is that the 10 extra calls (May 1200s) pick up value quickly.  The positive gamma translates into accelerating profits as SPX increases.

This position is not  all 'naked long.'  There's also the 25-lots of the short call spread (May 1210/1220) to consider.  These spreads lose value on a rally, but the gain from the 10 extra calls is enough to more than offset the loss from the 25 call spreads.

TWO days later

If you are still holding this position two days later, the risk picture has changed dramatically.  Thursday's risk graph is represented by the thick line (labeled 'think' line.  Although that's a typo, perhaps it shouldn't be).  At this point, both potential gains and potential losses are large.

Gains are essentially unlimited on the upside, but there is a barrier between you and those big gains.  If SPX settles (reminder, you will not know that settlement price until midway through the trading day on expiration Friday) in the vicinity of 1220, losses mount quickly.  The protection you owned on Tuesday has disappeared.

A rally places you in a big bind.  If the rally is BIG, you win.  If it stalls near 1220, you lose, BIG.  For most traders this is not a reasonable risk/reward scenario.  Everyone loves collecting theta as expiration nears, but that requires holding positions with negative gamma.  Thus, sometimes there's a big price to be paid to offset all those times when theta collection proves to be the winning choice.

This is too risky for me, but only you an decide whether it suits you and your comfort zone.   I urge you not to trade expiration week – at least not until you consider yourself to be experienced and able to handle risky positions with skill.  Closing your eyes and hoping they turn out well is not the skill set I have in mind.

The main point of this discussion is not taking today's risk graph at face value.  You must be aware of the effects of time an your overall risk.  A few days may seem insignificant – and it is when trading LEAPS options, but it plays a huge role when holding positions during expiration week.



"It is truly amazing how much I have
learned by reading your book.  I had shied away from trading options
because I thought they were too risky for a casual investor who did not have
formal training."


Read full story · Comments are closed

Options Expiration. Six Things to Know, Before you Play the Game. Part II

Over at the Options Zone, this post
(slightly edited) was published
on April 14, 2010.


Part I

3) Do not fear an assignment notice

If you are assigned an exercise
notice on an option you sold, that is nothing to fear, assuming you are
prepared.  By that I mean, as long as the assignment does not result in a
margin cal.

Many novices are truly fear receiving
an assignment notice.  It's as if they believe 'something bad has
happened.  I don't know what it is, nor do I know why it's bad.'

Being assigned prior to expiration is
usually beneficial from a risk-reduction perspective.  More on this
topic at another time.  

4) European options are different

Most options are American style
options and all the rules you already know apply to them.  However, some
options are European style (no, they do not trade only in Europe), and
it's very important to know the differences, if you trade these options.

Most index options are European
style:  SPX,
NDX, RUT (not OEX).  These are index options and not ETF (exchange
traded fund options).  Thus, SPY, QQQQ, IWM are all American style

a) These options
cease trading when the Market closes Thursday, one day prior to
'regular' options expiration day.

b) The final 'settlement' price – the
price that determines which
options are in the money, and by how much – is calculated early in the
trading day on Friday, but it's not made available until approximately
halfway through the trading day. 

The settlement price is NOT a real
world price.  Thus, when you observe an index price early Friday
morning, do not believe that the settlement price will be anywhere near
that price.  It may be near, and it may be very different.  
It is calculated as if each stock in the index were trading at its
opening price – all at the same time.  Be careful.  Often this price is
significantly higher or lower than traders suspect it will be – and that
results in cries of anguish from anyone still holding positions.  It's
safest to exit positions in Europeans options no later than Thursday

c) European options
settle in cash.  That
means no shares exchange hands.  If you are short an option whose
settlement price is in the money, the cash value of that option is
removed from your account.  If you own such options, the cash value is
transferred to your account.

5) Don't hold a position to the bitter end

It's not easy to let go.  You paid a
decent premium for those options and now they are down to half that
That's not the point.  You
bought those options for a reason.  The only question to answer is
this:  Does that reason still apply?  Do you still anticipate the stock
move you had hoped would happen?  Has the news been announced?

If there is no good reason to hold,
cut your losses and sell out those options before that fade to zero.

Is the shoe on the other foot?  Did
you sell that option, or spread, at a good price and then see the
premium erode and your account balance rise?  Is that short position
priced near zero?  What are you waiting for?  Is there enough remaining
reward to hold onto the position, and with it, the risk?  Let some other
hero have those last couple of nickels.  Don't take big risk unless
there's a big reward.  Holding out for expiration – especially when it's
weeks away is not a good plan.

6) Negative gamma is not your

When you are short options, you are
short gamma.  Most of the time that's not a problem.  You get paid a
nice rate of time decay to hold onto a short position – reducing risk
when necessary.  But show some respect.  Negative gamma is the big, bad
enemy. When the reward is small, respect this guy and get outta town. 
Cover those negative gamma shorts, take you good-sized profit and don't
bother with the crumbs.

Options expire monthly.  It's important to understand the risks and rewards associated with trading options as expiration day approaches.


Expiring Monthly: The Option Traders Journal


Vol 1 No 2 published today


Read full story · Comments are closed

Options Expiration. Six Things to Know, Before you Play the Game

Over at the Options Zone, this post (slightly edited) was published on April 14, 2010.


Options expiration.  When you sell options, it's an anticipated event.  When you own options, it's something to dread.

At least that's how most people view it.  There's much more to an options expiration, and if you are a newcomer to the options world, there are things you must know and steps you should take to avoid unpleasant surprises.  However, if you enjoy nightmares, feel free to disregard this entire post.

Many investors come to the options world with little investing background.  they consider the 'options game' to be simple:  You buy a mini-lottery ticket.  Then you win or you don't.  I have to admit – that's pretty simple.  It's also a quick path to losing your entire investment account.

It's important to have a fundamental understanding of how options work before venturing onto the field of play.  But not everyone cares.  It you are someone who prefers to keep his/her money, and perhaps earn more, then those option basics are a must for you.

No one takes a car onto the highway the
very first time they get behind the wheel, but there is something about
options, and investing in general, that makes people believe it's a
simple game.  They become eager to play despite lack of training.

Today's post provides some pointers for handling an options expiration.  Options have a limited lifetime and the expiration date is always known when options are bought and sold.  For our purposes assume that options expire shortly after the close of trading on the 3rd Friday of every month. (Expiration is the following morning, but that's just a technicality as far as we are concerned)


Please don't get caught in any of these expiration traps.

1) Avoid a margin call 

New traders, especially those with small accounts, like the idea of buying options.  The problem is that they often don't understand the rules of the game, and 'forget' to sell those options prior to expiration. If a trader owns 5 Apr 40 calls, makes no effort to sell them, and decides to allow the options to expire worthless, that's fine.  No problem.  However, if the investor is not paying attention and the stock closes at $40.02 on expiration Friday, that trader is going to own 500 shares of stock.  The options are automatically exercised (unless you specifically tell your broker not to exercise) whenever the option is in the money by one penny or more, when the market closes on that Friday.

In my opinion, this automatic exercise 'rule' is just another method that brokers use to trap their customers into paying unnecessary commissions and fees.

On Monday morning, along with those shares comes the margin call.  Those small account holders did not know they were going to be buying stock, don't have enough cash to pay for the stock – even with 50% margin – and are forced to sell the stock.  Rack up more costs for the investor and more profits for the broker.  Please don't forget to sell (at least enter an order to sell) any options you own. 

2) Don't exercise

If you own any options, don't even consider
exercising.  You may not have the margin call problem described above, but did you buy options to make a profit if the stock moved higher?  Or did you buy call options so that you could own stock at a later date?  Unless you are adopting a stock and option strategy (such as writing covered calls), when you buy options, it's generally most efficient to avoid stock ownership.  Here's why.

If you really want to own stock, when buying options you must plan in advance, or you will be throwing money into the trash.  For most individual investors – at least inexperienced investors – buying options is not the best way to attain ownership of the shares.

If the stock prices moves higher by enough to offset the premium you paid to own the option, you have a profit.  But, regardless of whether your investment has paid off, it seldom pays for anyone to buy options with the intention of owning shares at a later date.  Sure there are exceptions, but in general: Don't exercise options.  Sell those options when you no longer want to own them.

Example: Here's the fallacy.  The stock is 38, you buy 10 calls struck at 40, paying $0.50 apiece.  Sure enough you are right.  The stock rallies to 42 by the time expiration arrives.  You know a bargain when you see one, and exercise the calls, in effect paying $40.50 per share when the stock is worth $42.  This appears to be a good trade.  You earned $150 per option, or $1,500.

Before you congratulate yourself on making such a good trade, consider this: The truth is that you should have bought stock, paying $38.  If you are of the mindset that owning shares is what you want to do, then buying options is not for you.  And that's even more true when buying OTM options.

If you are an option trader, then trade options.  When expiration arrives (or sooner) sell those calls and take your profit (or loss).  There's nothing to be gained by exercising call options to buy stock.  Why pay cash for an option, then hope the stock rises so that you can pay a higher price for stock?  Just buy stock now.  If you lack the cash, but will have it later, that's the single exception to this rule.

If this exception applies to you and you are investor, not a trader, then buying the Apr 40 calls is still the wrong approach.   Buy in the money calls – perhaps the Apr 35s.  You might pay $3.60 for those calls.  If you do eventually take possession of the shares, the cost becomes $38.60 (the $35 strike price plus the $3.60 premium) and not $40.50.  Buying OTM options is not for the investor.

to be continued…


Read full story · Comments are closed

European vs. American Style Options. Part II

Last time I discussed the
difference between American and European style option. Today I’ll answer the questions: Why should you care and which style option is
advantageous to trade, assuming you adopt my recommended


  • European options
    may not be exercised prior to expiration. If the owner of a Europeans style option wants to remove the position
    from a portfolio, the option must be sold. Advantage: European.

you are assigned an exercise notice on an option you sold short, it’s not a significant
event when the settlement occurs in shares of stock. Why? Because the stock
position that results from the assignment leaves your portfolio essentially the
same as it was (measuring risk and reward) before the assignment. But when the option is cash-settled
receiving an assignment notice earlier than you expected can produce a big
problem with increased risk. Here’s why:

for example, you sold the OEX July 580/590 put spread (sold the 590s; bought
the 580s), you have a position that loses money when OEX drops and makes money
when OEX rallies. Assume that the market
is very bearish one afternoon, and OEX declines to 560. Also assume that bullish news is announced one
minute before the closing bell and the markets start to move higher. Responding to the news, OEX moves higher and closes
at 563.

what happens to you if you are assigned an exercise notice on the Jul 590

a. You first learn that
you have been assigned early next morning, before the market opens for
trading.  That means that you repurchased those options yesterday but were unaware of that until the assignment notice arrived.


b. Remember, these
options are cash-settled and no shares exchange hands.


c. When assigned an
exercise notice on a cash-settled option, you are obligated to buy the 590 put
at its intrinsic value as of the previous
day’s close.
In this example, that’s $27 (590 strike price minus 563 OEX
price = 27). That’s $2,700 per


d. Your position is
now naked long the 580 puts. Not a
problem? Remember the market turned very
bullish at the close of trading – and that’s the reason the owner of the put
options exercised them.


e. Sure enough, the
futures are significantly higher this morning, and when the market opens, your
580 puts are trading at 16. You have two


 i. Sell those puts
at 16. If you do that, you effectively
pay $1,100 for a spread that is never worth more than
$1,000. Not a happy situation.


 ii. Hold the puts and
hope the market falls. But, that’s a
risky play and you can lose all or most of the remaining value (currently
$1,600) of each option.

cannot happen to you when the options are European style.


  •  European options
    are all cash settled. Depending on the
    strategies you adopt, it’s usually more convenient when options settle in cash. Minor advantage: European.



  • Settlement price.
    American options settle at the closing
    price of the underlying asset at the close of business on the 3rd
    Friday of the month. That’s simple and
    straightforward. But, the settlement
    price of European options is determined by the price of each component of the
    index – when it opens for trading the morning of the 3rd
    Friday. As discussed,
    you never know where the market will open, and options that appeared to be
    safely out of the money and apparently were going to expire worthless suddenly
    become worth hundreds, even thousands, of dollars apiece. That’s a very large risk for option sellers,
    and in my opinion, if you are short any European style options, it’s better to cover
    them (buy them back) sometime before the market closes on Thursday, and not
    gamble by waiting for the market to open on Friday to learn your fate. Advantage: American.


you take the precaution of not allowing yourself to be exposed to a surprise
Friday opening by closing positions on
Thursday, then European options have significant advantages over American.

you understand that trading individual stocks is riskier (but the rewards tend
to be greater) than trading indexes, then you may prefer index trading – and that
comes with the added advantage of European style options.


Read full story · Comments are closed

European vs. American Style Options

Most options you are American style, but some European style options are very popular with investors. Too many don’t understand how these options differ. Today, we’ll list those differences. Next time I’ll explain why these differences are important.


Ability to Exercise

The owner of an American option has the right to exercise – any time before it expires. All options on individual stocks are American style.

Owners of European options can exercise only when expiration arrives. Options
on the major indexes (OEX is an exception) are European. Some examples of actively traded European style options:

  • SPX: Standard & Poor’s 500 Index
  • DJX: Dow Jones
    Industrial Average
  • NDX: NASDAQ 100 Index
  • RUT: Russell 2000 (small cap) Index


Settlement Price

American options are easy to understand. When the markets close for trading on the 3rd Friday of the expiration month, the final, or closing, price is the settlement price.  If the option is in the money (that means it has an intrinsic value), it is exercised. The call owner buys shares (and the call seller sells shares), the put
owner sells shares (and the put seller buys shares).

Under the current (recently revised) rules, all in the money options are automatically exercised (although an option owner has the right to notify his broker NOT to exercise such options). Thus:

· If JKLM closes at $49.99 or lower on the 3rd Friday of Nov, all JKLM Nov 50 puts are exercised. The put owner receives $5,000
cash and sells 100 shares of JKLM (for each option). All puts with higher strike prices are exercised.


· If JKLM closes at $50.01 or higher on the 3rd Friday of Nov, all JKLM Nov 50 calls are exercised and the call owner pays $5,000 cash and receives 100 shares of JKLM (for each option). All calls with lower strike prices are exercised.


European options are different.

Cash Settled

When a European option is exercised, no shares change hands. Instead, owners of options with an intrinsic value receive that intrinsic value in cash. That cash is automatically deposited into the option owner’s account. Similarly, cash is removed from the account of investors who are short (sold, but did not repurchase) the


The settlement price (see below) of the SPX Jul 1260 call is determined to be 1264.59. Thus, the intrinsic value is 4.59 (difference between strike price and settlement price).

Owners of the SPX Jul 1260 calls receive $459 for each option owned.

Owners of the SPX Jul 1250 calls receive $1459 for each option owned.

Those who are short the SPX Jul 1260 call must pay, and $459 is removed from their accounts.

As a result of cash settlement, owners lose their options (due to
expiration), but are compensated by collecting the intrinsic value of the option, in cash.  Option sellers must pay that intrinsic value to satisfy their obligations under the contract.

Cash settlement is far more convenient than buying and selling shares of stock, making expiration easier for most involved.


Calculating the Settlement Price

These indexes also have a final or closing price. But that price is NOT a real-world price determined at any specific time. Instead, the opening price of each component of the index is determined
on the morning of the 3rd Friday of the expiration month. These options do not trade on Friday. The last time they trade is the previous day (Thursday afternoon). Once all stocks in the index have opened for trading on Friday morning, the settlement
price is calculated – as if all stocks in the index were trading at that opening price at the same time. Because all stocks in the index never trade at their opening prices at the same time, the settlement price is not a real price. The official price is not published until hours after the opening (in some cases, not until the end of the day). 

Many times the official settlement price is higher than the day’s official high or lower than the day’s official low, resulting in confusion for traders who do not understand the process. This occurs because the index price is not a real world price. Suppose the market is bullish at the opening. Often, those buyers push stocks to the highest price of the day. When stocks open at different times, some stocks will have already begun to trade at lower prices, and the ‘current’ index price reflects those lower prices. But remember, the settlement price counts only those opening ‘high’ prices. Thus, the settlement price can easily exceed the highest price seen for the index during the day.

To be continued



Intrinsic value – the amount by which an option is in the money. In other words:

  •  The difference between the price of the stock and the strike price of a call option, when the stock price is higher than the strike price.
  •  The difference between the price of the stock and the strike price of a put option, when the stock price is lower than the strike price.
  •  Many options have zero intrinsic value, and are out of the money.
Read full story · Comments are closed

Q & A European vs. American Style Options

Hi Mark,

It might be interesting to post all euro style indexes and why euro style is

I was wondering if you might know of a European style index
of the coal and oil industries (separate indexes) on which options can be

Hope you're doing well.


Hello Don,

Good idea. The
comparison of European and American style options is on my short list of items
to discuss soon. Perhaps I’ll use your
suggestion to boost that topic to the top of the list.

I don’t know of any European style indexes in those


Read full story · Comments are closed