Nuggets of Options Wisdom: Jon Najarian

Compiled by John A. Sarkett, Developer, Option Wizard

Transcript of chat session with widely known CBOE options market maker and author Jon Najarian Feb. 2, 2000, host. While the stock references and prices are old, the nuggets of options wisdom here are timeless.

Thanks for joining us Dr J.. First, are the commissions are a factor in your strategy?

Commissions are always a factor. You need to be aware of both.

The effect of commissions and taxes for your trading.

Generally speaking taxes are no different with options than with stocks unless you hold your positions for twelve months

what do you feel is too volatile for options trading?

Why not give a short presentation first.

I have been an options trader for 19 years. I trade SUNW, MU, AOL, EBAY, CMGI, QCOM and JDSU to name a few. I think options make trading any of these stocks more tolerable from a risk standpoint and much more profitable as well. If you have any questions on option strategies or how to make an option position trade like stock with less risk ask away!

Hi! What is the best way to get out of a covered call where the common price is above the strike written and there's only two weeks to go? THX!

The best way out of a covered call is to either roll the position into the next month by buying back your short option and selling the next month option as a spread. Most traders will shave some of the bid ask spread because you are giving them both sides. If you are closing the position for good, you may just want to carry the in-the-money position into expiration and let the market close you out.

What is your favorite options strategy?

NAJARIAN My favorite options strategy tends to be a diagonal time spread. To do this a trader or investor buys an option with a greater time value and sells the shorter time value option against it. This is not just a time spread, but it works like one and I like setting this up with calls when I am bullish and puts when I am bearish.

Is it feasable to trade options simply by buying puts and calls?

Certainly it is feasable although I like spreads more because you can lessen the impact of time and volatility. These are two key components that many novice option players don't consider and they frequently come back to haunt them.

Would you buy a 2001 Jan. LEAPS call on DELL with a $70 STRIKE price?

No, that option is so far out of the money that if you are bullish on Dell I can think of many more strategies that offer greater success even though those Jan 70's look cheap. If you want an out of the money LEAP I would focus more on the 55's as a smaller move pushes these up quickly and gives you the opportunity to sell something (perhaps even the 70's) against it.

What o you feel is more important - stock action or finding undervalued options?

I think undervalued options are nearly impossible to find these People have analytics that make this opportunity virtually non-existant. However, you can buy options at a fair value with an outlook towards a certain stock action with a high degree of success and I favor investing in this way.

Do you trade mostly calls and puts or do you like spreads and stradles, etc.

Because I am a market maker I have to make two sided markets for all customers therefore I mainly trade calls and puts but I manuever them into spreads very quickly. I use options ahead of known events such as earnings and I think they are unusually well suited for earnings. I look at the industry group and see how it is performing. I search the news wires and chatrooms for tips and then if I believe the world is wrong in its estimates of what earnings impact will be I either buy the straddle or sell it.

For instance, today we were all watching Amazon who's earnings were due out today. The straddle in Amazon (the 70 calls and puts in Feb was 11 1/2. I didn't think AMZN earnings could move this stock more than that given its recent sell-off and other industry related events. The earnings are out now and they are better than expected. AMZN is trading up 1 1/2 to 2 dollars. Tomorrow that straddle will crush back from 100 volatility to more like 85 volatility. In other words, that straddle should be worth about 9 to 1/2 tomorrow and that is good for anybody who sold premium into this.

For AOL, I would buy the April 60 calls for $7 and I would sell the March 65's for 3 1/4. Less than $4 at risk and if AOL rallies my 60 calls will increase in value faster than my short 65's and I can always buy back the 65's and roll them up to the 70's depending on how bullish I get. Yes, the buyer of a call option can exercise this call and turn it into a long stock position at his or her discretion. This rarely happens until either the final days of expiration or if it is an option on a listed security the buyer might exercise the option to get long stock.

I rarely like delta neutral for customers as transactions eat up so much of their profits. For professionals we pay peNAJARIANies but for you the commissions can be significant and you need much better analytics to stay competitive with the pros so I don't think delta neutral can be employed easily by customers.

Can you make a call on a put?

Boy, you like to play with dynamite! I definitely like this more than playing the stock and when you consider that the Feb 160 calls are trading it is easy to see how even a small move in this volatile stock could cause these options to jump in value.

What would be a good strategy on AOL now that it went down so much.

I know it sounds like Monday morning quarterbacking but I loved AOL when it hit 55 this week so I still like it here although I think its merger ay cause it to slow from its rapid growth to a more manageable trading range.

With JDSU it seams like the stock extrinsic value is so high. What is a good ratio between extrinsix and intrinsic value on a call option?

Similar question to the QCOM moments ago. I like our odds buying out of the money options on high flyers like JDSU. I think you have lots of room for success and you're certainly taking less risk than owning a $207 stock.

When playing options do you prefer the current months expiration or the next months, and when you spread, do you use a 3 month or leaps?

I normally like to sell any of the front two months and buy one or two expirations further out.

Are you currently bullish or bearish and why?

think the market will continue to be volatile and I think we will see rotations from e-commerce to more bricks and mortar or picks and shovels. Having said that I think the market will trade higher and set new records but some of the leadership will come from new stocks.

If you buy @ the money call & sell @ the money put 6 months out & market goes up $5 will you get a $5 net return on your overall position?

Yes, but since we have time working for us even with the market moving higher the time decay in our short option is more rapid and if the stock makes steady rather than gap moves the near term option could decay to almost nothing. That is why I like these diagonal spreads so much. Time is your friend.

Do you use point & figure cht.(& or ) what do you think of it?

I think every ship at the bottom of the ocean is loaded with charts. But seriously, I like charts to confirm my opinions but I don't buy or sell based on them.

Is there a program that can provide fair values based on different time periods? Yes, we use several, some of which are proprietary. I like OptionVue a lot for its ease of use and volatility charts. I'm sure there are others but we all get a comfort with certain systems and this one is one I like.

Should most avg investors write only covered calls?

No, although I don't think you should do any strategy until you understand both upside and downside. Covered writing can be a great tool but if you're in high flying internet stocks don't think that this is reducing your risk. In fact, it could give you a false sense of well being.

Is there a rule of thumb for strike price and exp month when purchasing puts and calls I like to have at least 60 days in calls I am buying but there are times such as expiration week when buying calls or puts is more fun with much better odds than you can get in any casino. You just have to know the difference between investing and taking a shot.

Are there any disadvantages to trading options versus trading stocks, Tax, accounting complications?

There can be some disadvantages but I think the advantages outweigh them. The disadvantages would include early exercise and short term trading gains.

What tools do you use to check industry group strength?

I go to Clearstation, Track Data and SmartMoney to see which groups are moving and set up trades based on trends that I see developing.

Do you use Black-Scholes models for premium evaluations? 2. Are Butter-Fly spreads ridiculous? 3. Are you net short or net long on a daily basis? THX!

We use five different models including BS. I think butterflies are great but usually too expensive from a commission stand-point for customers and we are long or short massively during the trading day but we get hedged before we go home.

When you talk about volitility of 100 or 85- exactly what do you mean?

The more volatility the more the underlying stock is expected to move. For instance if I use a 100 volatility for AMZN 70 calls today I get a fair value of perhaps $7 for the 70 calls. If I drop the vol. to 80 that same 70 call would probably be worth only $5.

How about once you decide which stock you want to trade into earnings, when do you take the position? The day of the event, a few days prior..or last minute?

If I am buying a call or put I normally try to put this on two to three days ahead of the event. If I am selling I sell the day that earnings will come out after the close.

I'm new to this and wanted to learn more about PSIX

PSIX is a very volatile stock. The @ the money options are trading over 100 vol. so this is another high flyer like JDSU or CMGI.

Amazon just in at -.55 a share, How do you react to this news?

I like the news. AMZN is trading higher and I'm seeing trades come across at 75 after it closed at 69 1/2. Should be a good day tomorrow for AMZN.

Could you offer more specifics (ie strike, entry timing, hold through aNAJARIANouncement or sell before close, etc) regarding use of options to play earnings aNAJARIANouncements!

I tend to focus on the @ the money strike whether I am selling or buying ahead of earnings.

Do you still find the post split depression of the stocks now or is that becoming a thing of the past?

Since most of the stocks we trade are volatile internet stocks, we usually see follow through rather than stagnation after the split. SUNW, OL, QCOM are great examples of this. Thank you all for being part of this. I want to thank the folks at Track because that's the system that I use both on the trading floor and upstairs.

Designer of Option Wizard Online [free trial at] and Scan Wizard [] software, and author of Option Wizard Trading Method, John A. Sarkett writes on and is active in equity and options markets. Reach him via