Thursday, March 11, 2010

Risk Graphs

The Risk Graph may be one of the most under-utilized tools available to the active trader.  Available in MachTrader, the risk graph, when understood, is a powerful compliment to the traders toolkit.

The Risk Graph solicits stock information as well as option information and then builds the corresponding risk graph.  The example risk graph shown is for a Bull Put Spread.  As the risk graph is produced, current stock price information is given within the black box and updates "real time" throughout the trading day.  The trader can watch the price of the stock move and the impact upon his/her position.

The blue dotted horizontal line in the middle of the risk graph is the 0.00 (zero) line. If the risk graph is above the zero line, then the position will yield a net profit, if it is below, then the net will be negative.  The black line is the risk graph of the position at expiration.

When the stock is in such a position that the stock price vertical line intersects the risk graph, then the corresponding net profit or loss is shown at the right.  The risk graph uses the black scholes formula to determine the net profit or loss.

The blue line comes on as a default whenever a risk graph is created.  The blue line (selected in the lower left) is the risk graph of the position now (in other words - today).  Notice that the number of calendar days that remain prior to expiration is listed.  The default colors of red, green and magenta and corresponding entry boxes are available to enter up to four different risk graph lines with four different time frames prior to expiration.

 If the trader wants to compare the current chart with the risk graph, he/she presses the "Show Chart" button on the lower right.  This is especially helpful to determine support and/or resistance levels as part of the criteria for spread trades.

As an options trader, the risk graph is a very valuable tool in assessing the current state of the options position and the stock.

Intermediate Trading Lab

Notes for the March 10, 2010 Intermediate Trading Lab are now posted on the Trading Lab Page.