The Optionetics Platinum web site has a powerful risk graph analysis tool for analyzing any option combination. Risk graph analysis such as long synthetic straddles, Condors and Iron Butterflies can be performed on option combinations not shown in the Optionetics Platinum strategy table. Any option combo trade can be saved online, and profit/loss characteristics can be followed as the market changes from day-to-day.

This discussion concentrates on forming a long synthetic straddle for the Eastman Kodak (EK) stock and performing a graphical analysis. A detailed explanation of the plots in the Optionetics Platinum graphical analyzer is provided. A long synthetic straddle is composed of owning the underlying instrument, which in this case is 100 shares of EK stock, and purchasing 2 long puts. Purchasing one long put, while owning the stock, is sometimes called a long synthetic call. The Optionetics Platinum strategy matrix refers to a long synthetic call as "buy stock, buy put".

A normal long straddle consists of buying a put and a call at the same strike price and expiration date. A long straddle is a delta-neutral trade that can make a profit if the stock price goes up or down. Opportunistic times to buy long straddles are when implied volatility is historically low and some future event may occur that could cause the stock price to become more volatile or make a sudden move. Such events include: a surprising earnings report, good or bad, or a hostile or friendly takeover attempt that may or may not transpire. In this particular case Eastman Kodak has historically low priced options and an unknown earnings report is coming for the second quarter.

The normal way to protect yourself against future uncertain events when you own the stock is to buy one put creating the before mentioned synthetic long call. Your losses are limited but still negative as the stock decreases. Buying two puts creates the possibility of making a profit when the stock declines without selling your underlying position.

• Enter EK in the stock input text box in the center of the Platinum Welcome page.
• Select the date of the trade in the date selector just above the text box. (This example uses the date 6-16-00.)
• Click the "Create An Option Trade" button.

The Create An Option trade button loads EK stock and plots the stock price for the last three months. There are two options for plotting stock price: Japanese Candlesticks or open / high / low / close (OHLC) bars.

Japanese Candlesticks draw boxes vertically centered on each date and with box height boundaries at the open and the close. Lines are drawn from the top of the box to the high and from the bottom of the box to the low. The box is red if the close is below the open and white otherwise.

The OHLC bar is a vertical bar from the high to the low. A left tick is drawn at the open and a right tick is drawn at the close. You can choose your display option of choice in My Personal Data.

There are two ways to load a new trade directly into the Risk Graph analyzer. We will show both approaches. If you go towards the middle of the web page, you will see the inputs shown below.

Select Oct 00 in the use selector.

This selection chooses the option expiration month.

Checkbox "buy stock, buy put" in the strategy matrix below the use selector.

As previously mentioned, this will load a synthetic long call as the option trade.

Click the "update option trade" button.

After the page reloads, we are ready to complete the trade. Under "add a new option or underlying" select:

Long 1 Oct00 EK 60 Put @ market price

You form the above trade by:

• Make the selections shown in the selector boxes.
• Click your mouse in the text boxes, backspacing out the text that is there and type in the text you desire.

Click the update option trade button again.

The center of the web page that reloads displays the components of our trade. The trade is shown below. We are long two puts and also own 100 shares of EK. The delta of the trade is 100-88 = 12. The open interest is high (3139), but the daily volume on 6/16/00 is low (2).

When you find a trade you like, you need to go out into the trading world and attempt to fill the option with the prices you found to be desirable. Your option trade purchase prices will usually be different from yesterday's closing prices. You must update the option trade on the web site with the option purchase price you paid your broker. Lets suppose you actually bought the EK shares at 50 sometime in the past, instead of the closing price of 59.375 on 6/16/00.

• Select the purchase price radio button for the 100 shares of EK.
• Click into the price text box, backspace out 59.375 and type in 50.
• Click the update option trade button.

You can do the same for the put purchase prices. If you select a trade with no quotes, you will get a NQ symbol next to bid and ask. The market and purchase price will both default to the "model price". The model price is the value of the option trade found using the implied volatility (IV) estimated from the quotes of the other options that had quotes. Using the estimated Implied Volatility, the Bjerksund Stensland American option model (the model) is solved to find the fair value of the option trade.

We will continue the EK trade with the market prices shown above.

At the top of Create An Option Trade are the Risk Graphs. The Risk Graphics are composed of two charts using the market prices. They are displayed below.

The top chart uses the stock price for the y-axis. The first time the trade is graphed, the web site finds the maximum and minimum stock values over the default three month time period being plotted and uses these minimum and maximum values to set the y-axis scale. These graph limit choices are sometimes not wide enough. You can change the limits in the control box below the chart.

• Change the chart plot "Upper" text box to 75 and the chart plot "Lower" text box to 45.
• Click into the text boxes, backspace out the default values and type in the new values.
• Click Update the Chart.

  You can also change the time period and the right x-axis independent variable (not discussed) and all of your changes will be used to redraw the plot.
  
  

The top stock chart left x-axis scale is time. The stock chart right x-axis scale defaults to option trade dollars. Four lines are drawn with the colors red, blue, green and black. Lets start with the red line. The red line shows the dollar value of the trade at today's prices with 126 days until the puts expire. As the stock price moves up and down the y-axis, the red line shows how the dollar value of the option combination will change with stock price movement.

You can use the red line to determine the current value of your trade. As the trade evolves in time, look at the stock's closing prices. The top plot has a black line that is parallel to the y-axis and passes through the stock closing price. Move along this black line until you intersect the red line. At the red line intersection move down until you hit the combo dollars y-axis. The y-axis dollars value is the latest profit/loss value of your option trade.

The blue line also moves with the stock price but represents conditions when there are 84 days left to expiration. There are 42 days between the red and blue line on the trade date shown. The date variation between lines changes as we approach expiration. The blue line is drawn assuming the implied volatility of the trade has not changed over these 42 days. If the stock price does not move much in 42 days, the puts loose time value. If we sold the puts with the stock still stuck near today's close, we would have a net loss of ~$140 42 days from now.

The green line shows what happens with no implied volatility changes and 42 days left to expiration. The black line shows performance at expiration. The other lines may change with implied volatility but not the black line. If the EK stock price closes at 60 at expiration, the puts expire worthless, and we lose the cost of buying the puts ($825). We do have a small profit on the stock of 60-59.375 for a total loss of $825-100*0.625 = $762. The maximum loss in the plot is $762.

The second chart is the volatility profit/loss graph. The y-axis charts volatility variations. The left x-axis is time and the right x-axis defaults to combo dollars. The four graphs above time are implied volatility for EK options that have different time expirations. Red is for options that expire between 7 and 30 days and have the most day-to-day variation. Blue is for 30-60 day options. Green is for 60-90 day options and black is for options that expire >90 days from now. Black includes Leap options if the stock has Leaps.

If we look at the EK implied volatilities, the IVs have decreased and are historically low. Stocks with low IVs make potentially good straddle candidates. We are buying the puts at historically low prices and the IV has a tendency to return back to the mean. The right side of the volatility chart shows what can happen if IV changes.

The red, blue, green and vertical black IV plots assume the stock price is constant at the current close, and the IV is allowed to vary. The solid black line in the plot parallel to the x-axis and just below 29 is the current IV of the option trade. Moving along this horizontal black line, it eventually hits the red line. Moving down from the red-line intersection, we reach the current dollar value of the trade on the x-axis. The red line shows possible volatility-price variations using today's data. If IV were to suddenly change from 29 to 35, our position would increase in value to $170 without a change in stock price. The volatility lines move toward the black line as time transpires. The vertical black line in the right volatility chart, on a day-to-day basis, shows the value of the option trade at expiration if that day's stock closing price is the stock value at option expiration.

The break-even points of the synthetic straddle are ~67 on the upside and ~53 on the downside. The trade is biased somewhat towards the upside. If the stock moves up quickly, it may be worthwhile to sell the puts to capture their remaining time value while still participating in upward stock movement, because you own the stock. If the stock price moves down far enough, you can close out your put positions at a profit.

On 6/16/00 EK was a StraddleFinder trade recommendation. StraddleFinder is a trading advisory service available from Optionetics.