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  • The risk-reward Ratio

    The risk-reward Ratio

    3 min read

     

    The risk-reward ratio is a formula used to measure the expected gains of a given investment against the risk of loss.

    It is typically shown as a figure for the assessed risk separated by a colon from the figure for the prospective reward. The adequate ratio can vary, but trade experts recommend a ratio between 2:1 and 3:1 to determine a worthy investment.  

    Typically, the ratio quantifies the relationship between the potential money lost, should the investment or action fail, versus the money realized if all goes as planned.

    In other words, the risk-reward ratio measures how much your potential reward is, for every coin you risk.

    For example:

    If you have a risk-reward ratio of 1:2, it means you’re risking $1 to potentially make $2.

    But, if you have a risk-reward ratio of 1:4, it means you’re risking $1 to potentially make $4.
    Investors use the risk-reward ratio to define the viability or worthiness of a given investment. You can limit risk by issuing stop-loss orders,  sometimes. That will trigger automatic sales of stock or other securities when they hit a particular price. If you don’t implement such a mechanism in place, the risk is likely endless.

    How to use the risk-reward ratio like a pro

    Let’s be clear: the win rate in trading it totally trivial on its own. Some traders put way too much importance on the win rate. At the same time, they don’t understand that a win rate will not tell you anything about the quality of a practice or a trader.

    The truth is that trader can lose money with a 70% or even with a 90% win rate if few losers are so big that they wipe out trader’s winners. But, the trader can have a successful system even with a win rate of 40% or only 30% if such a trader lets winners run and cut losses short.

    It all comes down to the reward-risk ratio.

    The reward to risk ratio (RRR, or reward risk ratio) is probably the most important metric in trading. A trader who understands the RRR can improve his chances of becoming profitable.

    But, however, there are some myths about risk-reward.

    Myth 1

    “You need a minimum of 1:2 risk reward ratio.”

    That is nonsense.

    Why?

    Because the risk-reward ratio is insignificant on its own.

    We will give you an example:

    Let’s say you have a risk-reward ratio of 1:2. This means, for every trade you win, you make $2.

    But, your winning rate is 30%.

    To have a clear picture, out of 10 trades, you have 7 losing trades and 3 winners.

    Let’s do the math…
    Total Loss = $1 * 7 = -$7
    Total Gain = $2 * 3 = $6
    Net loss = -$1

    You see, you are not the winner.

    And you understand the risk-reward ratio by itself is an insignificant metric.

    There is nothing like good or bad risk-reward ratios. It just comes down to how you use it. You can even trade profitably with a risk-reward ratio of 1:1 or less.

    So, you must combine your risk-reward ratio with your winning rate to know whether you’ll make money in the long run. That is known as your expectancy.

    Myth 2

    The risk-reward ratio is useless

    Some traders like to say the reward-risk ratio is useless. It cannot be further from the truth.

    When you use the RRR in combination with other trading metrics, such as win rate, for example, it instantly matures as one of the most important trading tools.

    Without knowing the risk-reward ratio of a single trade, it is literally impossible to trade profitably.

    The risk-reward ratio isn’t enough

    Do you want to know the secret code?

    Here it is.
    E= [1+ (W/L)] x P – 1

    Now let’s put this all together and let’s take a look at some performance statistics and how the RRR fits in.

    Below, we see a performance simulation based off a strategy with a win rate of 50% and a risk of 2.5% per trade. The RRR was first set to 2:1 on average per trade.

    The Risk - Reward Ratio 3

    You can see that out of those 20 simulated outcomes (the different graphs), all of them were positive after 500 trades.

    Remember, with a win rate of 50%, you just need a RRR greater than 1:1 to trade profitably. With a 2:1 RRR you can potentially trader very profitable with a win rate of 50%.

    Now let’s take a look when the only thing we change is the RRR. Everything else is the same.

    Assume that each trade has a RRR of 1:1.

    Out of the 20 simulated outcomes, only a few will generate a positive outcome and many show a negative outcome.

    To conclude, with a win rate of 50%, trading a RRR of 1:1 is very volatile and variance will be huge. You have to remember, with a win rate of 50%, you need a RRR greater than 1:1.

    Now let’s take a look when the only thing we change is the RRR. Everything else is the same.

    Assume that each trade has a RRR of 1:1.

    Out of the 20 simulated outcomes, only a few will generate a positive outcome and many show a negative outcome.

    The Risk - Reward Ratio 4

    To conclude, with a win rate of 50%, trading a RRR of 1:1 is very volatile and variance will be huge. You have to remember, with a win rate of 50%, you need a RRR greater than 1:1.

    The bottom line

    Portfolio with more unknown factors may have a higher probability of failure but at the same time offer a significantly higher return if they are successful. The ideal is the low risk-reward ratio – the little risk of failure and a high potential for reward. 

    risk disclosure

  • Investing in foreign markets – How to that

    Investing in foreign markets – How to that

    2 min read

    Investing in foreign markets - How to that

    Investing in foreign markets may sound intriguing or intimidating.

    Yes, international investing can be a difficult attempt. There are communication hurdles. Also, there are problems with money transfers to foreign exchanges. And regulations can be tricky. On the other hand, financial advisors suggest holding at least some foreign stocks in a diversified portfolio.

    Luckily, there are easy ways for Investing in foreign markets. That excludes picking up a new language or exchanging your local money for euros or dollars or something like that.

    One of the best ways to diversify your portfolio is to put some of your money in global investments. Foreign markets may react differently to economic conditions than, for example, U.S. markets. It is possible that strong performance abroad helps to compensate for weak performance at home.

    Foreign stocks can diversify your portfolio as we said, but they may open up chances for growth and success. In general, there are three ways you can use to make your portfolio more international in its exposure.

    Having an international stock appearance in your investments is a smart move that can improve your overall returns.

    International stocks add diversification

    You know the idiom: Don’t put all your eggs in one basket.

    This saying is particularly relevant when investing. Diversification or holding a mixture of stocks across different countries, industries, and areas of companies is a simple way to increase long-term investment returns while decreasing risk.

    An easy way to invest internationally is through a mutual fund that holds foreign securities. You get the privilege to choose from stock, bond or money market funds in several categories.

    The easiest way to invest in foreign markets is by buying exchange-traded funds (ETFs) or mutual funds that hold a basket of international stocks and bonds. The foreign holdings over multiple industries and countries, provide investors with the highly-diversified foreign component to their portfolio in just one easy purchase.

    In general, there are three ways you can invest internationally.

    Investing directly in foreign stocks.

    Using internationally focused exchange-traded funds to gain foreign exposure.

    Buying shares of multinational corporations that are based in the U.S. but do almost all of their business internationally.

    Let’s break down each of them.

    Buying foreign stocks directly

    The most reasonable way for Investing in foreign markets is to buy shares of foreign companies. You can find many foreign companies that list their stock on major U.S. exchanges. Moreover, investing in those companies is identical to buying shares of any U.S. company.

    For stocks that aren’t listed on major U.S. exchanges, investing gets complex. Some foreign companies trade on an over-the-counter basis. That makes them available with many brokerage accounts. But, at the same time, makes them subject to less liquid trading conditions.

    Still, other foreign stocks have no U.S. availability at all, so investors have to buy shares directly on foreign stock exchanges. There are limited numbers of brokers offer direct purchase and sale of foreign stocks on exchanges outside the U.S. This means, for example, you can count on finding the exact stock you’re looking for with a great deal of work.

    Try your hand at paper trading with foreign investments you find intriguing. This virtual-trading practice, offered by many online brokers, will allow you to learn to invest in new markets without risking any money.

    Buying international stocks through an ETF

    Many exchange-traded funds have a focus on foreign stocks. They offer a more diversified entrance at international investing. Also, they have a wide variety of different funds to choose from.

    Some international ETFs endeavor to offer stocks of the entire global market. Others focus in on particular regions, countries, industries, or other classifications of international stocks. One of the most common characteristics involves ETFs that focus on stocks in developed markets. That is versus those that concentrate on emerging market stocks. Many ETFs have limitation to one or the other of these groups.

    The benefit of international ETFs is that they’re listed on U.S. stock exchanges and are easy to trade. Fees can be higher than with domestic stock ETFs, so you have to look carefully at costs.

    Buying U.S. stocks that concentrate abroad

    Many U.S. companies have increased their presence to international markets.

    For example, Philip Morris International only sells cigarettes and other tobacco products outside the U.S. Some other companies keep a minimal U.S. presence. But they are available internationally.

    American companies win reputation abroad, especially in the consumer sector. So, the investors have to consider not only U.S. economic and industry conditions but also what companies face in their abroad markets.

    Risks of investing internationally

    Investing internationally carries the same risk associated with all investing. The market conditions can change, causing your investments to lose value.

    Political risk – Changes to government and political systems can cause devastation on a nation’s investment markets.

    Currency risk – Exchange-rate fluctuations can boost or limit investment returns.

    Market risk – Many abroad markets are characterized by wide price oscillations.

    The bottom line

    Investing in foreign markets are a great way to build international exposure in any portfolio. And you don’t have to worry about foreign stocks or regulations. Moreover, investors can achieve proper diversification for their portfolios by Investing in foreign markets.

    risk disclosure

  • Pound falls on Brexit stage fright and BoE Decision

    Pound falls on Brexit stage fright and BoE Decision

    2 min read

    Pound falls on Brexit stage fright and BoE Decision 1

    The Sterling pound yesterday dropped below 2-week lows in the early London session.

    The investors priced-in Brexit uncertainty ahead of a crucial meeting between Theresa May and the European Commission President.

    The GBP/USD currency pair dropped to new 2.5-week lows following the Bank of England‘s interest rate decision in the mid-European session.

    The GBP/USD currency pair yesterday dropped to a low of 1.2855 following the BoE rate decision before rallying to a high of 1.2997 on Mark Carney‘s balanced comments.

    Sterling is trading little changed at around mid 1.2900 before the UK Prime Minister Theresa May reaches Dublin to meet her Irish counterpart and discuss the problematical border plan.

    Cable (GBPUSD, often referred to as “The Cable”) tested fresh lows in the mid-1.2800s on Thursday. Although running to recover some ground later and close the day with small gains. It was a small drop in open interest and a decent raise in volume.

    There is a potential continuation of the bounce, which will leave at the same time occasional dips shallow.

    At the time of writing, the Pound was down 0.02% at $1.2932.

    Pound falls on Brexit stage fright and BoE Decision

    image Pound falls source Yahoo Finance

    The 4 hours chart shows that the pair quickly recovered above its 200 EMA, although it has already tested levels below it. A bearish 20 SMA keeps capping the upside, while technical indicators have recovered from oversold levels, now losing upward strength within negative levels, indicating that the risk of an upward extension remains limited. The pair would need to surpass the 1.3040 resistance to be able to extend its gains toward the 1.3100 price zone, yet as long as Brexit uncertainty prevails, the most likely scenario is sellers taking their chances on spikes above 1.3000.

    Support levels:  1.2925 1.2880 1.2835
    Resistance levels: 1.2995 1.3040 1.3090

    What about shares?

    UK shares were having a good day on Tuesday, with the FTSE 100 has gone from strength to strength as the morning has progressed.

    Shortly before midday, the UK’s benchmark share index was up 106.95 points, or 1.5%, at 7,141.08.

    The index was given a lift early on by BP’s better-than-expected results, which have pushed the oil giant’s shares up more than 5%.

    Shares were also boosted after the pound fell back in the wake of the disappointing survey of the UK services sector.
    Currently, rate is $1 = ÂŁ0.7728.

    Shares often rise when sterling falls. The weaker currency lifts the value of companies’ overseas earnings when they are brought back to the UK and converted back into pounds.

    Governor Carney’s said on Thursday, that further rate hikes should not be priced out of the Pound.

    Focus returns to Brexit and whether Theresa May can find more support for concessions to deliver a deal pleasant to Parliament.

    All options are still on the table

    With the UK government still working its way to the UK parliament with the Brexit agreement approval, the Brexit uncertainty is set for the next weeks. The 2019 GBP/USD forecast highly depend on the result of the Brexit deal going forward. All options are still on the table leaving different GBP/USD scenarios all applicable.

    Sterling could fall past 1.2000 level that historically frames the bottom and serves as a territory of rebound for GBP/USD in case of hard Brexit. The reasonable solution for all interested parties in the UK parliament, the UK government and in the EU should be to avoid the scenario of no-deal Brexit. That would throw the UK economy and Sterling into confusion with the Bank of England saying the bottom for Sterling would be some 25% lower.

    Also, no transition Brexit would realize an unfavorable scenario for Sterling with falling to the lowest level since 1985 of 1.0700. Such scenarios are still considered doubtful. Should such scenarios develop, it is almost a sure shot for traders while buying GBP/USD at historical or/and cyclical lows.

    The chance of the UK finally making some kind of Brexit deal with the European Union is still the mainstream scenario for the UK and for GBP/USD.

    A no-deal Brexit is still not the most probable scenario for the UK economy going into 2019. The UK parliament stands in deep opposition to the Brexit deal agreed by the government.

    The ruling Conservative party is divided profoundly.

    risk disclosure

  • Shorting Stock – Explanation

    Shorting Stock – Explanation

    Shorting Stock - Explanation 1Shorting a stock looks very simple. But, this isn’t a strategy for beginners.

    By Guy Avtalyon

    Shorting a stock is when a trader borrows stocks and quickly sells them. She or he does that in the hope that can buy them back later at a lower price and return them to the broker or lender. Of course, the trader pockets the difference in the stock price. Shorting is riskier than simply buying stocks. A trader that practice shorting is taking a short position, while investors that are buying and holding stocks have so-called a long position.

    In other words, when some trader starts short selling, he or she borrows stocks from an existing stockholder through the brokerage. Than sells borrowed shares at the current market price and takes the cash.

    What is shorting stocks? 

    Generally speaking, when you invest in stocks, you expect to profit from a company’s great times and increasing profits.

    But this is a whole different type of traders, called shorts. They do just the contrary. They search the Internet for news about car industry recalls, for example, and look for ways to cash when the stock of such a company is falling.

    It’s possible to make money when prices are going down. Of course, if you are willing to accept the risks which are big. One of the strategies to profit on a downward-trending stock is selling short. The hope behind shorting a stock is that its price will decrease or the company will go bankrupt. Of course, it can lead to total ruin for the stock owners. 

    Shorting a stock means you are profiting if the stock price drops inside the timeframe from your entering the deal and turning back the stock. But if stock price increases, you’ll take a loss. You can short almost every asset, stocks, ETFs, and REITs, but never mutual funds.

    What short-seller do?

    The short seller is a trader who is buying the stock back but at a much lower price. However, the short seller must promise to return the borrowed stock at some period in the future. Otherwise, the true owner or broker will never borrow the trader a stock.
    Borrowed shares have no dividends until the short seller turns them back. Even more, he has to compensate for missing payments to the lender from his own pocket. So, when short-selling it is very important to have accurate information.

    When you want to close your short position, you have the obligation to buy the same number of shares at the current price and return them to the lender. Your profit or your loss comes from the difference between the price you sold the stock and the price you bought them for.
    The stock for short selling can come from the broker’s inventory, a client of the firm, or from another brokerage company. When the shares are sold, the profits are added to your account.

    How to shorting a stock

    That involves some important steps. One of them is a short-term strategy.

    Selling short is essentially created for a quick profit in stocks that you expect to decrease in value.
    The main risk of shorting a stock is a possibility for the price to increase, and as a result, you’ll have a losing trade and losses. The possible stock price valuing is theoretically unlimited. Therefore, you are maybe exposed to great losses in a short position.
    Also, shorting stocks involves margin. Hence, a short-seller can be subject to a margin call if the stock price moves up. A margin call requires a short seller to deposit additional money into the account to fill the initial margin balance.
    Also, there are some restrictions on who can sell short, which stocks can be shorted, etc. You must be familiar with the regulation if want to short a stock. For example, some limitations are put on stocks wit low price.

    Who can short stocks?

    First of all, it isn’t for amateurs.

    Unlimited losses and a margin account can be exceptionally dangerous for an amateur trader. Especially you don’t completely understand the risk you’ll face whenever you enter a short position without protection.
    Due to the possible large losses that short selling generates, brokerages lower this strategy to margin accounts. In case you use a cash account without margin, you’ll not be allowed to short selling.
    If you’re not a short seller and don’t like your stocks to be borrowed, the best option is to open a cash account. That will hold away short-sellers to borrow your stocks without your personal permission.
    This is usually good practice, anyway.

    Is timing important for shorting a stock?

    In short, yes. The most important for shorting a stock is to know which one or more could be overvalued, also when it may drop, and when it may rise in value.
    Shorting a stock is possible because the stock can be overvalued. For example, the housing bubble in 2008. Firstly, we had an enormous increase in housing costs. So, when the bubble popped we had a correction in the stock market. Remember, stocks can be overvalued or undervalued. In shorting is important to know which one is overvalued.

    How long to stay in a short position?

    You can enter and exit a short position on the same day.  Or you may hold on the position for several days or weeks depending on the strategy and how the stock is performing. Timing is especially important to short selling.  But the possible influence of tax practice is important also. So, we have to say, this is a strategy that requires practice and study.

    Tools for shorting the stock

    Shorting a stock is a strategy that demands to identify winners and losers.
    For example, you may choose to go long a carmaker because you expect it’s possible to take market share. But, at the same time, you can go short to another carmaker that might sink.
    Shorting is useful to hedge the current long position. For example, you hold stocks of the company and you expect it to decline in the next few months. But you don’t want to sell that stock. So, you could hedge the long position by shorting that stock while expecting it to decrease. When the stock turn to grow again all you need is to close the short position.

    But you must be very careful.

    Shorting a stock appears as very simple. But, keep in mind, this isn’t a strategy for beginners. Only the advanced traders who recognize the potential problems should think about shorting.

    A valuable tool is the “short ratio”, you can see it specified for each individual stock. The short ratio commonly means how many days the stock needs to cover all the short positions. However, there is another benefit to that figure. It reveals the number of shares that are currently shorted by traders in comparison to the number of shares that are available overall.
    How to get this number?
    Multiply the current short ratio by the 30-day average daily volume of stocks.
    Just use it as a quick measure of investors’ sentiment towards a stock. For example, a high short ratio usually shows the belief that stock is falling. There are some exceptions, but understanding those exceptions is the key to victorious short selling.
    Stay tuned!

     

  • American option pricing and early exercise

    American option pricing and early exercise

    3 min read

    American option pricing and early exercise 3
    American option pricing is the binomial options pricing model that provides a generalizable numerical method for the valuation of options.

    American options are contracts that may be exercised early, prior to expiry.

    These options are contrasted with European options for which exercise is only permitted at expiry. Most traded stock and futures options are ‘American style’, while most index options are European.

    The exercise style of listed options is American by default. Except for options on equity market indexes such as the S&P 500 index.

    Options on futures are typically American as well.

    The Black-Scholes pricing formulas are not applicable to American option pricing.

    Being an algorithm, binomial option pricing models, nevertheless, can be modified to take care of the added complication in the American option.

    Let’s see the differences between these two styles: European vs American options

    European-style

    The seller sells the (call) option to allow the buyer to buy the underlying at the price of K on the expiration date only.

    American option pricing and early exercise

    American-style

    The seller sells the (call) option to allow the buyer to buy the underlying at the price of K and another option to buy at any time no later than the expiration date.

    American option pricing and early exercise 1

    In these graphs, you can see the main difference.

    The key difference between American and European options relates to when the options can be exercised: A European option may be exercised only at the expiration date of the option, i.e. at a single pre-defined point in time. An American option, on the other hand, may be exercised at any time before the expiration date.

    American options can be exercised early

    Unlike a European option, the holder of an American option can exercise the option before the expiry date. Because of this additional benefit, an American option is always more expensive than a European option.

    However, is this benefit of any real use? Is there a situation where the option holder will get a better payoff by exercising the option early?

    The answer is NO.

    You should never early exercise an American option, especially if it’s a non-dividend paying stock. Let’s look at the reasoning behind this.

    The option has intrinsic value and time value. The intrinsic value of the option is always greater than 0.
    Along with that, the cash has time value. So, you would rather delay paying the strike price by exercising it. As late as possible.
    You could use that money to earn interest.

    So, a positive intrinsic value plus time value implies that you are better off selling the option rather than exercising it early. This is true for a non-dividend paying stock.

    However, for a dividend paying stock, the only time it may pay to exercise a call option is the day before the stock goes ex-dividend. And only if the dividend minus the cost of carry is less than the corresponding Put.

    By exercising, the option holder may forego the time value.

    But don’t worry, it will make up from the dividend received.

    We use the word ‘may’ because the dividend may not be high enough to justify the early exercise.

    Here is the model for American options pricing. Here we take into account a put as an example.

    Let
    V = V (S, t)

    be the option value.

    At expiry, we still have
    V (S, T)=(X − S) +

    The early exercise feature gives the constraint
    V (S, t) ≥ X − S

    As before, we construct a portfolio of one long American option position and a short position in some quantity ∆, of the underlying.

    Π = V − ∆S
    With the choice ∆ = ∂V/∂S, the value of this portfolio changes by the amount

    American option pricing and early exercise 2

    The advantage of the American style

    The principal advantage of the American style of an option contract is the flexibility it offers to its holder as it can be exercised anytime before the expiration date T. Majority derivative contracts traded in financial markets are of the American style. In mathematical modeling of American options, unlike European style options, there is the possibility of early exercising the contract at some time t* ∈ [0, T) prior to the maturity time T.

    It is well-known that pricing an American call option on an underlying stock paying continuous dividend yield q > 0 leads to a free boundary problem. In addition to a function V (t, S), we need to find the early exercise boundary function Sf (t), t ∈ [0, T].

    The function Sf (t) has the following properties:

    If Sf (t) > S for t ∈ [0, T] then V (t, S) > (S − E)+
    If Sf (t) ≤ S for t ∈ [0, T] then V (t, S) = (S − E)+

    The free boundary problem for pricing an American call option consists in finding a function V (t, S) and the early exercise boundary function Sf such that V solves the Black-Scholes PDE on a time depending domain:

    {(t, S), 0 < S < Sf (t)} and V (t, Sf (t)) = Sf (t) − E, and ∂SV (t, Sf (t)) = 1

    In a stylized financial market, the price of a European style option can be computed from a solution to the well-known Black–Scholes linear parabolic equation derived by Black and Scholes.

    Recall that a European call option gives its owner the right but not the obligation to purchase an underlying asset at the expiration price E at the expiration time T.

    But, let’s make American option pricing simpler

    The value and pricing of stocks are fairly simple for most investors to understand. Basically, the value of a stock at any given time should reflect all known information about the company and the market.

    However, increased volatility in option value occurs when the expiration date draws close or when it is already “in-the-money.” A call option is “in-the-money” when the present price of the underlying stock is higher than the strike price. A put option is considered to be “in-the-money” when the market price is lower than the strike price. When options are “in-the-money” or close to their expiration date, their value will change at a different rate than the underlying stock. However, the Black Scholes formula is a mathematical equation that can be used to approximate the value of an option relative to its market price.

    Delta (Δ) in the Black Scholes formula is equal to the amount that the value of the option is expected to move for every 1 point of movement in the price of the underlying stock. Thus, if delta is 0.5 for stock A, then the value of the option for that stock will increase or decrease by 0.5 for every 1 point of fluctuation in the stock price.

    In addition to being affected by proximity to the expiration date and being “in” or “out” of the money, the value of delta may change due to the overall volatility of the underlying stock itself.

    There are times, however, when the Black Scholes formula fails to predict the value of the option. 

    The bottom line

    The overall value of an option is actually determined by six factors: strike price, the current market price of an underlying stock, dividend yield, prime interest rate, proximity to the expiration date, and the volatility of the stock prices over the course of the option. 

    Because these six variables combine in different ways to affect the value of an option, it is possible for the price of the underlying stock to increase while the value of the option falls. The Black Scholes formula may fail when other factors are affecting the value of the option more than the current stock price.

    American option pricing uses a “discrete-time” model of the varying price over time of the underlying financial instrument.

    risk disclosure

  • A European Call option – What is it?

    A European Call option – What is it?

    A European call option - What is it?There are many differences between European and American styles in trading call options. Here are all.

    By Guy Avtalyon

    A European call option means an option for the right to buy a stock or an index at a certain price on a certain date. Notice the expression “on a certain date.” This “European style call option” is different from the “American style call option” that can be exercised at any time “BY a certain date.”

    A European call option provides the investor with the right to purchase an asset, while a put option provides the investor with a right to sell it.

    In other words, unlike an American option, the European option has no flexibility in the timing of exercise.

    Formula

    In theory, a European option has a lower value than an otherwise equivalent American option. It is because a European option does not enjoy the convenience that arises from the flexibility in the timing of exercise.

    Value of a European Call Option = max (0, Asset Price − Exercise Price)
    Value of a European Put Option = max (0, Exercise Price − Asset Price)

    Asset price is the price of the underlying financial asset at the exercise date.

    The exercise price is the price at which the option entitles its holder to sell or purchase the underlying financial asset.
    Some examples

    European call option

    To differentiate between a European call option and an equivalent American call option we have to compare them here.
    Let’s say, a trader bought 100 American call options stock. The option has an exercise price of $42 and an expiry date of 27 July 2018. The trader believes that stock price on 24th, 25th, and 26th of July is expected to be $43.5, $44.5, and $43.

    Assuming a trader is very confident in owns projections, what is the maximum can gain on the options and when should exercise them?

    Since trader bought American options, he/she can exercise them at any time before 27th. Based on the projections:

    Value on 24th = max [0, $43.5 – $42] = $1.5
    Value on 25th = max [0, $44.5 – $42] = $2.5
    Value on 26th = max [0, $43 – $42] = $1

    The trader should exercise the options on 25th and gain $2.5 per option.

    But, the trader bought European options, and he/she would have been able to exercise them only on 26th July 2018 for a gain of $1 per option.

    Assume that traders used European options instead of American options.

    Solution

    Since trader purchased European options which she can exercise only on the exercise date i.e. 26th July 2018 and not before, trader’s gain per option will be only $1 (i.e. option value at the exercise date = price of underlying asset ($43) minus exercise price ($42).

    If the trader had bought American options, he/she could have exercised them on 25th July 2018 (the day it offered maximum gain) for per option gain of $2 (= $44.5 − $42).

    Like their American Option counterparts, a European option is traded on an exchange. The contract will specify at least four variables.

    • Underlying Asset:  stock indexes, foreign currencies, as well as derivatives.
    • Premium: the price paid when an option is purchased or sold.
    • Strike Price: identifies the price at which the holder of the contract has a right to sell (put option) or buy (call option) the underlying asset.
    • Maturity Date: also referred to as the expiry date; the option no longer has any value if not exercised on this date.

    As is the American Options, European-style options also come in two basic forms:

    Call Options: also named calls. This contract gives the holder the right to purchase the asset at the strike price on the maturity date.

    Put Option: also named puts. The contract gives the holder the right to sell the asset at the strike price on the maturity date.

    Most stock or equity options in the U.S. are American Styles, whereas most index options traded in the U.S. are European style. Since you can’t actually “exercise an index option” and by the index, index options are cash-settled. Cash-settled means that your broker simply deposits the “in the money” amount at expiration.

    What does the European style option mean for the trader?

    It means that you are concerned ONLY with the price of the stock or index at its expiration. European style options tend to be cheaper than American style options because if a stock spike prior to expiration. An American style call option trader can profit on that increase in value. The European style option trader has to hope the price increase holds until expiration.

    When to buy a European Call Option

    If you think a stock price or index is going to go up, then you should buy a call option. Unluckily, you don’t get to select if you want to buy a European style option or an American style option. That decision is already made by the exchange that the option trades on. Most index options in the U.S are European style. Take a look at the chart below:

    Example of a European Call Option

    If you bought an S&P500 Index option, it would be a European style option. That means that you can only exercise the option on the expiration date. Of course, it is still an option, which means that you have the right but not the obligation to exercise it.

    Obviously, if you have a call option and the Index closes below the strike price on the expiration date then you would not exercise it. And that option would just expire worthlessly. Likewise, if you have a put option on the Index and the Index closes above the strike price on the expiration date then you would not exercise it. And that option would just expire worthlessly, too.
    Notice in the chart above that the S&P500 Index (SPX) is a European style while the S&P100 (OEX) is American style.

    In the U.S., most equity and index options contracts expire on the 3rd Friday of the month. Also, note that in the U.S. most contracts allow you to exercise your option at any time prior to the expiration date. In contrast, most European options only allow you to exercise the option on the expiration date.

     

  • Stop loss hunting – What to do?

    Stop loss hunting – What to do?

    3 min read

    Stop loss hunting - What to do? 2
    The truth is, there are players in the market that are hunting your stop loss.

    Stop loss orders are designed to limit the amount of money that can be lost on a single trade, by exiting the trade when a specific price is reached.

    For example, a trader might buy a stock at $50 expecting it to rise. Trader place a stop loss order at $47. But the price goes against the trader’s expectations and reaches $47. In that case, the stop loss order will be executed, limiting the loss to $3 per share.

    All new traders should use a stop loss. The stop loss order is placed when the trader enters a position.

    Why is that so important?

    Markets are moving very quickly. A stop-loss is employed to limit the possibility of a loss. It also gives the possibility to trader having to get out of the trade if the price goes against him.

    Stop loss is a must.

    Stop loss position is very important and you should be able to distinguish where to set it. A too tight stop loss can be easily triggered even when you take the right position. And a too wide stop loss is like having no stop loss at all.

    Where is the best place to set the stop loss?

    You should place the stop loss at the level that will be triggered when your position is totally wrong.

    We are referring to stop orders going forward, plain vanilla stop order, opposed to a stop limit order.

    For example, the price is going up. You are waiting for some reversal signal. But, the price changes its direction and makes a reversal trade setup. And then starts going down. You take a short position. So the last high that the price has made before it goes down is a resistance level.

    But what if you realized that taking a short position has been a wrong decision and the price will keep on going up again?

    If the price goes up and breaks above the resistance level, it means you were wrong and the uptrend was not reversed. Therefore, you have to be out. That is why professional traders say: You are either right, or you should be out.
    So where should you place the stop loss in this example?

    Stop loss hunting - What to do?

    image source: tradingwithrayner.com

    A few pips above the last high (resistance level) plus the spread.

    When price moves to your preferred direction and you are making the profit, you can move the stop loss further to lock some part of the profit you have made. At least, you can move the stop loss to breakeven, entry price, when you are in a reasonable profit. So, if the market turns around, you will get out with zero loss.

    First of all, what is stop loss hunting?

    Do you know that forex brokers make money when you take a position? Yes. They charge you some pips when you buy a currency pair. This number of pips that brokers charge when you buy currency pairs is called spread. Brokers offer different spreads for different currency pairs.

    But, the spread is not the only way that forex brokers make money. It is one of the ways. They also make money through the swap. Market brokers make money through commission as well. However, the commission is the only legal way of making money for the true ECN/STP brokers. They can make money through other ways, but they are not allowed to.

    Short note: STP refers to Straight Through Processing and it is just a name given to dealing desk brokers that have automated the dealing process. Traditionally in the spot forex market, when you place a trade, you are being filled by your forex broker is also known as an RFED.

    ECN refers to Electronic Communication Network. ECN can best be described as a bridge linking smaller market participants with its liquidity providers through a FOREX ECN Broker.

    However, whatever you pay as the spread goes to the market maker broker pocket. Also, the money you lose is the market maker broker profit. Say that, when you trade Forex through a market maker broker, in fact, you are trading with the broker, not the real currency market.

    So it makes sense that the market maker brokers like you to lose.

    Your loss is their profit. Similar, it is expected they don’t want you to win because your profit is their loss. Market make brokers make a lot of money. The statistic shows that 99% of the trader lose on their own and nobody needs to push them to lose. However, some market maker brokers get greedier and want to make more money faster.

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    Stop loss hunting is one of the ways they use to do that. They have some special robots or train some employees who monitor the clients’ trades.

    How does it work?

    The trader takes a short position and sets a stop loss. The market goes against the position and becomes so close to the stop loss. And the robot or the stop loss hunter employee increases the spread manually to help the price hit the stop loss earlier.

    But, most regulated brokers are not hunting your stop loss because it’s not worth the risk.

    The word gets out that some broker hunts their client stops loss. What? It’s a matter of time before clients pull out of their account and join a new broker.

    Would you want to risk doing that over a few tiny pips?

    We guess not.

    Most brokers don’t hunt your stops as the risk is greater than the reward.

    But, your broker widens the spread and stops you out of your trade.

    There is a reason for this.

    A broker widens their spreads during major news release. The market has low liquidity during this period.

    YOU WOULD LIKE TO READ Stop Loss Order and How to Use It

    Take a look at the depth of the market. The bids and offers are low just before the major news release. The participants in the market are pulling out their orders ahead of the news release.

    The liquidity during such period is thin and that results in a wider spread.

    Because of this, the spreads in forex is widener. If it isn’t, there will be opportunities for arbitrage.

    So, you can see that widening is not there for fun their spread for fun. Your broker is doing it to protect themselves.
    Most brokers don’t hunt your stop loss because it’s bad for business.

    How to avoid stop loss hunting by setting a proper stop loss

    Let’s say, you find such broker.

    You can still protect yourself and beat the sharks who are hunting your stops.

    What can you do?

    Here are 3 techniques you can use:

    • Don’t place your stop loss just below Support (or above Resistance)

    Stop loss hunting - What to do? 1

    image source: bpcdn.co

    • Don’t place your stop loss at an arbitrary level
    • Set your stop loss at a level where it invalidates your trading setup

    The bottom line

    The one way to stay away from the stop loss hunting is trading through a bank account.

    Trading the longer time frames is another way of staying away from stop loss hunting. Well, nothing can 100% prevent a scam broker from cheating the clients. But trading the longer time frames is a good way to lower the risk. On that way, you will have wide stop loss orders that are harder to get hunt unless the broker increases the spread for hundreds of pips.

    In general, you will finally have to close your account and leave when you trade with a scam broker that hunts your stop losses and cheats because nothing that fully stops them from cheating you.

    Therefore, you’d better choose a good broker from the first day or trade through a bank account.

    risk disclosure

  • Twitter CEO Jack Dorsey thinks Bitcoin will be the Currency of the Internet

    Twitter CEO Jack Dorsey thinks Bitcoin will be the Currency of the Internet

    Twitter CEO Jack Dorsey thinks Bitcoin will be the Currency of the InternetTwitter’s Jack Dorsey believes that BTC will be the common currency of the Interner

    By Gorica Gligorijevic

    Twitter CEO, also CEO of Square says there will be a native currency for the internet. Jack Dorsey, CEO of Twitter and the mastermind behind the popular money transfer application “Cash App,” shared his confidence about Bitcoin.

    Appearing on the Joe Rogan Experience podcast, he stated that the Internet will eventually have a currency, which he thinks will likely be Bitcoin.

    Jack Dorsey explained that he still feels that BTC meets all the conditions to become the common currency of the internet in the future.

    For Twitter and Square chief, Bitcoin, the top-ranked cryptocurrency seems best-suited to that role.

    No plans, just personal view

    Jack Dorsey said that he has no plans for that at the moment, however, he expressed his personal view towards cryptocurrency and the internet.

    “I believe the Internet will have a native currency and I don’t know if it’s Bitcoin. I think it will be given all the tests it has been through and the principles behind it, how it was created. It was something that was born on the Internet, was developed on the Internet, was tested on the Internet, it is on the Internet.”

    Jack Dorsey believes that the internet will have its native currency one day, although he doesn’t know what that would be.

    Bitcoin could be the currency of the internet 

    But when he elaborates his opinion further, he says that it could be Bitcoin. His opinion is based on the tests Bitcoin has been through all this time, the principle behind its creation. And all of that happened on the internet.

    Twitter CEO has no plans to create his own currency, but he wants to participate in the growing technology, which he said to have done through the CashApp project.

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    Twitter CEO claimed that his company is the first publicly-traded company that offers crypto (Bitcoin) purchasing as a service.
    Dorsey has made similar observations, commenting in May 2018 that Bitcoin should be the native currency of the Internet.

    Thus, Dorsey says Square’s focus is solely on BTC with no present plans to offer support for other cryptocurrencies on the Square Cash App.

    Speaking about Square’s decision to offer support for the largest cryptocurrency, Dorsey said it gave the company the ability to serve more people across the world far better than was possible using mainstream channels.

    “We’d love to see something become the global currency. It enables more access, it allows us to serve more people and allows us to move faster around the world.”

    Twitter CEO: The Internet is like one nation 

    Dorsey compared the Internet to a single nation that exists digitally. Hence, it only makes sense that it would have its own universally accepted currency.

    Present-day fiat money is usually subject to nationalistic policies that might not appeal to different places across the globe. Bitcoin, however, is based purely on mathematical algorithms providing a certain sense of neutrality and universality devoid of any geographical or political bias.

    Jack Dorsey thinks the internet will eventually have its own currency and BTC is out in front in the race to be the chosen crypto. Twitter CEO doesn’t necessarily think mass adoption is near, but that worldwide cryptocurrency use will take hold soon.

    Banks don’t like Bitcoin’s disruption

    As the first and still biggest cryptocurrency, it’s not a bad bet. Bitcoin processed an incredible $9 billion in the past 24 hours, dwarfing any other blockchain by miles.

    Bitcoin, moreover, is the most integrated crypto. It remains still the only one to have regulated futures, its logo stands for the blockchain and it has a brand.

    Dorsey also mentioned the attitude of banks towards Bitcoin. Unsurprisingly, banks and many other financial institutions aren’t fans of Bitcoin’s disruptive tendencies, the Twitter CEO said.

    YOU WOULD LIKE TO READ: Two of the richest men in the world call Bitcoin “rat poison”

    JPMorgan analysts released, in January, a report claiming that BTC’s value could only exist in a dystopian economy. In 2018, Warren Buffet called Bitcoin “rat poison squared.”

    “People treating BTC like virtual gold,” said Twitter CEO

    “We notice that people are treating it (Bitcoin) as an asset, like virtual gold. We want to make it easy, just the simplest way to buy and sell Bitcoin. But we also knew that it had to come with a lot of educations, a lot of constraints,”  said Dorsey.

    Reminding what happened 3 years ago, when people had the “unhealthy way” of purchasing Bitcoin by using their life savings, Dorsey decided to put a very “simple” restriction and constraint on his app.

    “You can’t buy Bitcoin on CashApp with a credit card. It has to be the money you actually have in it. We look for day trading which we discouraged and shut down, that’s not what we’re trying to build, that’s not what we’re trying to optimize.”

    When the master of industry like Jack Dorsey speaks about the efficiency of cryptocurrency tends to lead to ecstatic investors. However, Dorsey has warned against wild speculation and hopes to push the public towards using digital currency rather than the narrow mentality of “hodl” and wait for riches.

     

  • QuadrigaCX CEO died – no one has access to cold storage

    QuadrigaCX CEO died – no one has access to cold storage

    QuadrigaCX CEO died - no one has access to cold storage 3
    Founder of QuadrigaCX, 30-year-old Gerald Cotten, unexpectedly had died in December while in India, from Crohn’s disease. He reportedly had sole access to the cold wallet. QuadrigaCX owes its customers $190 million and cannot access most of the funds.

    According to a Jan. 31 affidavits filed by his widow Jennifer Robertson and dug up by Coindesk, Cotten had sole access to most of the exchange’s $190 million worth of crypto held in cold storage.

    No one appears to be able to access QuadrigaCX

    Because when he died, Cotten took the keys with him.

    QuadrigaCX CEO died - no one has access to cold storage 1

    His death is a very sad moment for the family, big loss, of course. But customers are in sorrow, too.

    In a sworn affidavit filed Jan. 31 with the Nova Scotia Supreme Court, Jennifer Robertson, identified as the widow of QuadrigaCX founder Gerald Cotten, said the exchange owes its customers roughly $250 million CAD ($190 million) in both cryptocurrency and fiat.

    The customers of QuadrigaCX seem to be really worried as the Canadian crypto exchange can no longer access its cold storage and it owes its customers nearly $190 million, according to a report by CoinDesk.

    QuadrigaCX went offline a few days ago.

    Initially, it was thought that routine maintenance was the cause of the sudden malfunction. But now it seems that there is something bigger behind. Bigger than what was initially thought. Reddit users are saying it is just another ‘Exit Scam’.

    However, Quadriga users, are now concerned that the unannounced downtime for the QuadrigaCX website, is a sign that something might be very wrong with the crypto exchange.

    Users correspond

    Some Reddit users asked if QuadrigaCX shouldn’t have let their customers know before taking its site down. Another Reddit user speculated as to whether the exchange had gone bankrupt due to an inability to find a suitable bank to host an account and facilitate transfers.

    Reddit users are asking for proof of death, while one user claimed that the exchange, most likely, couldn’t access assets in cold storage, as the keys were only known to Cotten.
    QuadrigaCX CEO died - no one has access to cold storage
    According to the affidavit, the cryptocurrency exchange holds nearly 26,500 Bitcoin ($92.3 million USD), 11,000 Bitcoin Cash ($1.3 million), 11,000 Bitcoin Cash  SV ($707,000), 35,000 Bitcoin Gold ($352,000), nearly 200,000 Litecoin ($6.5 million) and about 430,000 Ether ($46 million), amounting to nearly $147 million.

    Speaking about the current difficult situation, Jennifer Robertson said, “The normal procedure was that QuadrigaCX founder and CEO Gerald Cotten would move the majority of the coins to cold storage as a way to protect the coins from hacking or other virtual theft.”

    She also added that the sole responsibility of handling the funds remained with Gerald Cotten and no one else has access to the exchange’s cold wallet.

    The board of the company encouraged its customers.

    They stated that the issue is being handled in the best possible way and an affidavit has been filed in the Nova Scotia Court requesting the authority to appoint a third party to help the exchange in finding a solution for the problem.

    If the application for creditor protection is accepted by the Courts, then the court might give QuadrigaCX at least 30 days of protection from its creditors.

    There is also a possibility that some of Quadriga funds are being stored on other exchanges, though this has not been confirmed.

    The Courts will rule on the request for creditor protection on February 5.

    Seems a bit suspicious that Gerald Cotten was the only one that had access to these coins. It is really hard to believe.

    But the whole enigma about crypto exchange QuadrigaCX become weirder because they claimed they used multi-sign wallets.

    It looks entirely as the result of poor governance and processes and that’s why we need regulated exchanges.