Selling Options » Investment

Option Trading: Thinking “Outside the Box”

admin — Sat, 16 Jan 2010 00:13:45 +0000

Wouldn’t it be great if we could buy an option with five months left until expiration and sell an option with 2 months left until expiration for the same price? You couldn’t lose. Well we can’t. I love options spreads so much I realized something very important. We can buy a spread that has a lot of time value left at almost the same price as we can sell one with less time value left. The reason really opened my eyes and gave me new insight into options. Here is what I came to realize.
I started comparing how expensive options were in relation to the other strike prices in the same month and to the other months. I wanted to know based on th e price per day which options were more expensive.
The first 1 or 2 option months, as everyon e knows loses time value quickly. The at the money strike prices are very expensive compared to the out of the mon ey strike prices. Since there is not that much time left, how much can they charge for an out of the money option? Not much.
The next several months, the opposite is true. Compared to each other, the strikes that are closer to the money are cheaper in terms of price per day than the options further out of the money. Let me explain it another way using the S&P market.
6 days left at the money option cost 12 points
6 days left out of the money option cost 2 points
70 days left at the money option cost 43 points
70 days left out of the money option cost 29 points
There is more than 10X the time left but the 70 day at the money option (43 points) is only less than 4X the price than the 6 day at the money option (12 points).
The 70 day out of the money option (29 points) is almost 15X the cost of the 6 day out of the money option (2 points) but only has 10X the time value. We will buy the cheaper options and sell the more expensive ones.
Sell 6 day at the money and sell 70 day out of the money. Buy 6 day out of the money and buy 70 day at the money. This will be done for a 4 point debit. We are now buying a spread that has 10X more time value than the one we are selling and are only paying 4 points for it.
When the 6 day options expire we can sell the next month to take in more premium, still keeping the 70 day option spread.
What goes up, must come down! We have all heard this befo re in reference to the laws of Gravity. We have laws in the commodity markets as well. What comes down, must go up! The greatest traders of our time like War ren Buffet know this. He is perhaps the greatest Stock trader ever. He had never traded commodities until a few years ago. He bought silver in the futures market. When the market went even lower he bought more. The “smart money”, commercials will not be scared into selling when a market they have purchased drops even further. They know better than anyone that a commodity has real value and will always be worth something.
There is a famous book, “You Can’t Lose Trading Commodities”. The author buys commodities and then just waits for the market to go higher. He would purchase more as the market fell.
You need a big bankroll for this. Personally I know corn won’t go to $1.00 but what if it did? I want to minimize the risk in case I want to end the trade.
I started trading the Soy Complex this way several years ago. Not with options. Strictly futures. I bought what was similar to a crush spread. I increased the contracts as the market went against me until the spread rebounded a little. Since I increased the contracts I didn’t need the market to come back to where I started. It only had to rebound to the next level.
Black Jack players did this until Casinos caught on and put limits on bets. It is a known fact that futures traders make good gamblers and professional gamblers make good futures traders. I am against gambling but even gambling done with a system is not really gambling.
These card players would bet something like this: $5 lose, $10 lose, $20 lose, $40 lose, $80 win. The losses add up to $75. They would win $80, so the profit is $5. Not a lot, but they would do this all day. Black Jack is just under 50% probability for the player.
The problem is there is a slight chance that you could lose 40 times in a row. Now with Commodities we have a 50% probability and we won’t lose 50 times in a row because the market can’t go b elow zero.
Now before I go an y further, I need to tell you that I am not recommending you double down on your trades. What you can find are mark ets that are near their lows where you can do a small scale trade. Spreads offer even better opportunities. They have a closer range (high to low).
By now you can see we only use this to go long a market since we can never b e sure how much a market can go higher. First we need to find a market that is low already so we won’t have to wait that long and also so there will be less capital needed. I prefer to trade this using options. There are many ways to do this. You could buy an option in a market like soybeans and choose how many cents the market will drop before you buy more. The problem is, an option is a wasting asset. The Theta (time decay) would cause you to lose money.
I use spreads so I am not paying for time decay. I will probably sell more Theta than I buy, so if the market does nothing I will make money just on time decay.

Options Trading Strategy – An Economic Ecosystem

admin — Fri, 08 Jan 2010 14:25:58 +0000

There is much talk today about the earth’s ecosystem, how human activity has destroyed much of it and continues to do so at an alarming pace. Most of us know by now that human activity, as it is practiced today, is not sustainable in the long run. As a species we are loosing our home because the earth’s ecosystem is dangerously out of balance.

The financial markets are a similar system. It works best for the investor when trading practices are in balance, and Options Trading is the way to achieving balance for sustained, long-term returns.

If you have invested in the stock market for a while, you are probably pretty frustrated by wrongly guessing a stock’s move more often than not. Psychologically, most investors will bet on an upward move, and there certainly are a lot of researchers and advisors out there who will tell you things like “you can’t miss with this one – the fundamentals are just that good.” The problem is that there are so many things that can happen to a company that are simply not predictable: A product recall, an insider scandal, unexpected regulatory problems – the list goes on. Options trading takes this into account and hedges the bet.

Options trading is similar to a gambler hedging his bets on the roulette table by splitting his money between red and black, odd and even, certain series and other alternatives. Playing in this manner does not result in a sudden huge win, but rather in steady, sustained profits. That’s the difference between a novice and a professional.

The psychology of investing is similar to betting on a crap game. You can win by betting that you’ll win, or by betting that you’ll loose. There are only a few gamblers who bet on the latter, and that is similar to short-selling in the markets, i.e., betting on a stock’s downward move. If you are a more sophisticated investor, you may have tried that. How did that work out for you?

The point is, you are only betting in one direction, and that’s the problem. Options are an exciting alternative and the perfect way of hedging your bets and moving from guessing to safe investing. If you are a beginning investor when it comes to options trading, you would do well to subscribe to a reputable service that will do all the research and give you recommendations as to what moves to make and when.

Options research includes many different elements – not just “the stock will move either up or down”, but scenarios that take into consideration how long the stock may trade in a certain range, whether it will stay low for a few months but rise in the long term, whether it will trade cautiously until earnings are achieved, and then take off or fall dramatically. What’s more, with options you can always adjust your trade and change your strategy to fit the current market trend. What more can you ask for?

Options are like a balanced ecosystem that shield you from the wild up-and-down gyrations of financial markets that are so prevalent right now. If you are interested in more information, visit www.tradegreeks.com and opt in to the TradeGreeks Options Traders Newsletter. Then if you like what you see and want to participate, we invite you to become a member of TradeGreeks.

You are currently reading an article from our article series ‘Covert Life of Investment’.

Options Trading and Technical Analysis

admin — Sun, 27 Dec 2009 12:26:24 +0000

Recently, almost no options trading seminar is without some mention or introduction to technical analysis. In fact, almost all of the options trading blogs out there in the internet use technical analysis as their main basis of decision making. Why is that so? Why is options trading so closely related to technical analysis now?
In order to understand the important relationship between technical analysis and options trading, we need to first understand what technical analysis does in the first place.
There are two main methods of analysis; Fundamental Analysis and Technical Analysis.
Fundamental analysis is the reading of fundamental data of a company or economy in order to predict and invest in the future performance of the company or market. Such fundamental data includes profit and loss statements, earnings growth and earnings guidance. The problem with fundamental analysis is that great companies do not always make great stocks. Stocks of great companies also experience periods of downturn, often for extended periods of time. As such fundamental analysis helps an investor mostly in deciding what stocks to buy for the long term (5 to 10 years out), if nothing unpredictable happens to the company in the years down the road. In fact, fundamental analysis is a tool favorable by investors who buy stocks for their dividends and dividend growth.
Technical analysis is the studying of market data of a stock. Yes, while Fundamental Analysis is the study of a company, technical analysis studies its stock exclusively. Such market data includes the price across different time periods and volume transacted. From price and volume, options traders see how the price of a stock is doing no matter what the company data is doing. This helps traders and investors avoid those extended periods of downturn even though a company’s fundamental data looks great. Indeed, while fundamental analysis tells an investor which company is doing well, technical analysis tells an investor when it is time to buy or sell its stocks. Indeed, the strength of technical analysis is in its ability to guide the buying and selling decisions of investors across short time periods through price patterns and price trends.
So, why is technical analysis such a favorite in options trading?
Lets recall that fundamental analysis is favorable for long term investing and technical analysis is favorable for use even in short time periods. Stock traders can hold stocks forever but options expire after a fixed time! Yes, options typically last no more than a year and options traders frequently use options trading strategies that require extremely short outlooks in terms of months or weeks. This is exactly why technical analysis is so closely associated with options trading. Options traders simply do not have the luxury to hold a position for years like stock traders do. On top of that, options traders do not receive dividends like stock investors do. The only way to make money in options trading is for the expected outlook to play out within the expiration period of the options. This makes the fundamental strength of the company it is based on relatively unimportant. On top of that, options traders are able to profit when stocks drop as well. This also makes identifying good companies through fundamental analysis relatively unimportant.
Indeed, reading price trends and price patterns that might show the direction a stock is moving the next week or month has more value to options trading than reading a company profit and loss statement that does not tell you where its stock may be going for the short term at all.
I hope my short article explains why technical analysis and options trading are so closely related and that it will help you better understand the big lack of fundamental analysis whenever the subject of options trading is raised.
Visit http://www.optiontradingpedia.com to learn more about options trading for free.

Own Stocks at Zero Cost – Option Trading Secrets Revealed

admin — Thu, 24 Dec 2009 01:11:17 +0000

It’s true – you can own your favorite stocks at no cost or at deepest discounts! Learn the highly guarded, secret Option trading strategies professional investors use to make steady profits, year after year, no matter what the financial markets do. This article will show you the step-by-step process of using Options to get the stock you want at a deep discount, and sometimes at zero cost. Since trades don’t always go the way we planned, so we will also explore the worst case scenario.

Properly executed, these strategies have the advantage of minimal expenses – something everyone can appreciate during these troubled times. The following example will demonstrate how this is done.

Technical Tip: The seller of a Put Option is obligating himself to buy the stock at the striking price. For assuming this obligation, he receives the Put Option premium. For the more technical readers we have provided an in-depth article link at the bottom of this article.

On August 21, 2009, the day your August Put Option expires, two scenarios are possible: Either the stock price is greater than or equal to $50, or it is less than $50. Let’s evaluate both scenarios.

Scenario 1: The stock trades at $50 or above: in this case the Put Option will expire worthless and you get to keep the $400 that you received earlier. You can now repeat the strategy month after month. When carefully executed, you would have earned around $7,200 in 18 months without ever paying a dime and without even owning the stock.

Let’s assume the share price for the stock has gone up 41% to $72 over the course of those 18 months. If you now purchase the 100 shares of XYZ Corp., the cost of ownership to you is ZERO, as you would have offset the $7,200 required for that purchase by your strategy earnings. You are now the proud owner of 100 shares XYZ Corp. at no cost to you.

Scenario 2: The stock trades below $50, say at $48 (a drop of 11% from $54). In this case the August Put Options will be In-The-Money (ITM) and now you need to buy 100 shares of XYZ Corp. at the strike price of $50. But here is the best part: You get to keep the $400 that you earned earlier selling the Put Option. Your effective cost for this trade is $4,600 after adjusting for $400.

Compare this with someone who bought 100 shares at $54. Share traders ended up with a loss of $600 while you had a modest profit of $200 instead. Well not as good as Scenario 1, but not bad either!

The strategy acts like a low-cost replacement for actual stock ownership, BUT you must be prepared to take ownership of the shares under Scenario 2 circumstances. Keep in mind that this is a long-term strategy.

There are many different ways to construct these strategies – conservatively or aggressively. Just like regular investing, different people have different levels of risk tolerance. If you want higher profits, you’ll have to be willing to take higher risks.

At TradeGreeks we avoid high risks that MIGHT hit the big jackpot. Our focus is on conservative strategies with medium to long-term consistent, predictable returns. This will ensure great profits that beat anything else you might try in this market – sometimes well over 100% per annum. What’s even more important: Our strategies ensure peace of mind!

This is an article from the TradeGreeks’ “Tactical Series”

More in-depth explanations of this strategy can be found in our article “Uncovered Put Writing – Insider’s Guide”. We invite you to visit http://www.tradegreeks.com/ and register for free no obligation membership. This will allow you access to the article and many other educational resources regarding trading of Options.

The Many Benefits of Option Trading

admin — Sat, 12 Dec 2009 00:33:43 +0000

Option as a strategic investment is fast becoming the choice of many. The benefits that option trading offers are many and we shall discuss the same here. Option trading having many benefits it is actually a wonder as to why it was not a sought after means for investment for so long.
1. Option trading is not as risky as it seems if traded wisely. In case of option you do not require as much finance as you would do for stocks. As far as hedge is concerned, option trading seems to be the most reliable of them all. In case of option trading you have an insurance throughout he day, all seven days a week and not until the close of the market.
2. Option is very cost effective. You could be in a similar position as you would have stocks but by putting in much less as investment but the catch is that the investor needs to be careful and select the right call option so as to be in the same position as he would be with stocks. This stock replacement strategy is very cost effective.
3. Option as a strategic investment offers to its investors a high return on its investments. The return investors make on the right selection in option trading is far greater than any stock investment. Option can get you about 60-70% and even more on your investments and in the same scenario your stocks may give you a return of only about 10-15%. But there is a flipside to this. When option give you such high rate of return it is only when you have made the right choice but a wrong selection on the other hand can get you back by the entire 100%. So the returns are good but only when you take calculated risks.
4. Option as a strategic investment provides the investor with multiple options so as to attain their aim. Option offers the investors various alternatives if planned and executed well. An example to quote here would be how a margin would have to be paid if short selling is to be done. At times the margin quoted by the brokers is so high that the investor finds it difficult to go ahead with his plans. Then there are those who do not allow short selling by the investor thus again the investor going back to square one as far as his investment plans are concerned. This puts the investor in the back seat as he is unable to execute his plans and here is where the option trading comes into play. You wouldn’t find any broker who says that the investor cannot purchase puts when the market seems to be falling. This would give the option trader an advantage and he would be able to reap the benefits later.
An option trader can invest in the market not only when it moves up or down, when the prices are almost steady, a trader can also use the time factor where the prices are not moving significantly as a profit making opportunity. Thus it is only the option trader who gets a share in the pie in every kind of market.

Option Trading Strategies – a change from buy and hold

admin — Mon, 30 Nov 2009 13:19:32 +0000

A portfolio of stocks and shares is a standard investment strategy that exactly fits the bill in the search for a source of passive income, which is generated from the annual earnings payout from the shares. I am not a professional advisor, so this is just a personal opinion, but I do not think that a buy-and-hold portfolio is a safe strategy for your hard-earned cash right now.

If you are going to invest in the stock market, I believe you need a much more hands-on approach than buy-and-hold. Even so, a few hours portfolio management per week beats a full-time job. With a more active approach, investing in the stock market can be a wealth-building programme, not just a place to park your existing funds with a view to a slightly better return than the banks will produce.

There are many different approaches to managing your investments rather than buy-and-hold. One area worth looking at is options trading – when you buy options, you are not acquiring the stocks themselves, you are buying the right to make an agreed trade at some point in the future. This can be used when the stock values go up OR down, by buying the right kind of option. There are 2 basic kinds of options:

Call options – these give you the right, but not the obligation, to buy shares at an agreed price on or before an agreed expiry date. If the actual price of the shares rises above the price agreed in the option, then the holder of the option can make a profit by buying the shares at the option price, and immediately selling them at the higher market price. But there is no need to do this buy/sell transaction, since the option itself has an intrinsic value in this situation and can itself be traded.Put options – these give you the right, but not the obligation, to sell shares at an agreed price on or before an agreed expiry date. If the actual price of the shares falls below the price agreed in the option, then the holder of the option can make a profit by buying the shares at the market price and immediately selling them at the higher option price. Again, there is no need to do this buy/sell transaction, since the option itself has an intrinsic value in this situation and can itself be traded.

Because options values vary with the margin between the market price and the agreed option price, the option prices change by a much greater percentage than the prices of the shares themselves. It is not at all uncommon for options to change 50% in a week – 3 of my last 5 trades have gained over 50% in a week.

There’s a lot to learn about option trading, but for the small investor I recommend taking a look at this as an active investment strategy in preference to the passive buy-and-hold approach.

Stock Option Trading Millionaire Principles

admin — Sun, 29 Nov 2009 12:37:57 +0000

INTRODUCTION
Having been trading stocks and options in the capital markets professionally over the years, I have seen many ups and downs.
I have seen paupers become millionaires overnight…
And
I have seen millionaires become paupers overnight…
One story told to me by my mentor is still etched in my mind:
“Once, there were two Wall Street stock market multi-millionaires. Both were extremely successful and decided to share their insights with others by selling their stock market forecasts in newsletters. Each charged US$10,000 for their opinions. One trader was so curious to know their views that he spent all of his $20,000 savings to buy both their opinions. His friends were naturally excited about what the two masters had to say about the stock market’s direction. When they asked their friend, he was fuming mad. Confused, they asked their friend about his anger. He said, ‘One said BULLISH and the other said BEARISH!’”
The point of this illustration is that it was the trader who was wrong. In today’s stock and option market, people can have different opinions of future market direction and still profit. The differences lay in the stock picking or options strategy and in the mental attitude and discipline one uses in implementing that strategy.
I share here the basic stock and option trading principles I follow. By holding these principles firmly in your mind, they will guide you consistently to profitability. These principles will help you decrease your risk and allow you to assess both what you are doing right and what you may be doing wrong.
You may have read ideas similar to these before. I and others use them because they work. And if you memorize and reflect on these principles, your mind can use them to guide you in your stock and options trading.
PRINCIPLE 1
SIMPLICITY IS MASTERY
When you feel that the stock and options trading method that you are following is too complex even for simple understanding, it is probably not the best.
In all aspects of successful stock and options trading, the simplest approaches often emerge victorious. In the heat of a trade, it is easy for our brains to become emotionally overloaded. If we have a complex strategy, we cannot keep up with the action. Simpler is better.
PRINCIPLE 2
NOBODY IS OBJECTIVE ENOUGH
If you feel that you have absolute control over your emotions and can be objective in the heat of a stock or options trade, you are either a dangerous species or you are an inexperienced trader.
No trader can be absolutely objective, especially when market action is unusual or wildly erratic. Just like the perfect storm can still shake the nerves of the most seasoned sailors, the perfect stock market storm can still unnerve and sink a trader very quickly. Therefore, one must endeavor to automate as many critical aspects of your strategy as possible, especially your profit-taking and stop-loss points.
PRINCIPLE 3
HOLD ON TO YOUR GAINS AND CUT YOUR LOSSES
This is the most important principle.
Most stock and options traders do the opposite…
They hold on to their losses way too long and watch their equity sink and sink and sink, or they get out of their gains too soon only to see the price go up and up and up. Over time, their gains never cover their losses.
This principle takes time to master properly. Reflect upon this principle and review your past stock and options trades. If you have been undisciplined, you will see its truth.
PRINCIPLE 4
BE AFRAID TO LOSE MONEY
Are you like most beginners who can’t wait to jump right into the stock and options market with your money hoping to trade as soon as possible?
On this point, I have found that most unprincipled traders are more afraid of missing out on “the next big trade” than they are afraid of losing money! The key here is STICK TO YOUR STRATEGY! Take stock and options trades when your strategy signals to do so and avoid taking trades when the conditions are not met. Exit trades when your strategy says to do so and leave them alone when the exit conditions are not in place.
The point here is to be afraid to throw away your money because you traded needlessly and without following your stock and options strategy.
PRINCIPLE 5
YOUR NEXT TRADE COULD BE A LOSING TRADE
Do you absolutely believe that your next stock or options trade is going to be such a big winner that you break your own money management rules and put in everything you have? Do you remember what usually happens after that? It isn’t pretty, is it?
No matter how confident you may be when entering a trade, the stock and options market has a way of doing the unexpected. Therefore, always stick to your portfolio management system. Do not compound your anticipated wins because you may end up compounding your very real losses.
PRINCIPLE 6
GAUGE YOUR EMOTIONAL CAPACITY BEFORE INCREASING CAPITAL OUTLAY
You know by now how different paper trading and real stock and options trading is, don’t you?
In the very same way, after you get used to trading real money consistently, you find it extremely different when you increase your capital by ten fold, don’t you?
What, then, is the difference? The difference is in the emotional burden that comes with the possibility of losing more and more real money. This happens when you cross from paper trading to real trading and also when you increase your capital after some successes.
After a while, most traders realize their maximum capacity in both dollars and emotion. Are you comfortable trading up to a few thousand or tens of thousands or hundreds of thousands? Know your capacity before committing the funds.
PRINCIPLE 7
YOU ARE A NOVICE AT EVERY TRADE
Ever felt like an expert after a few wins and then lose a lot on the next stock or options trade?
Overconfidence and the false sense of invincibility based on past wins is a recipe for disaster. All professionals respect their next trade and go through all the proper steps of their stock or options strategy before entry. Treat every trade as the first trade you have ever made in your life. Never deviate from your stock or options strategy. Never.
PRINCIPLE 8
YOU ARE YOUR FORMULA TO SUCCESS OR FAILURE
Ever followed a successful stock or options strategy only to fail badly?
You are the one who determines whether a strategy succeeds or fails. Your personality and your discipline make or break the strategy that you use not vice versa. Like Robert Kiyosaki says, “The investor is the asset or the liability, not the investment.”
Understanding yourself first will lead to eventual success.
PRINCIPLE 9
CONSISTENCY
Have you ever changed your mind about how to implement a strategy? When you make changes day after day, you end up catching nothing but the wind.
Stock market fluctuations have more variables than can be mathematically formulated. By following a proven strategy, we are assured that someone successful has stacked the odds in our favour. When you review both winning and losing trades, determine whether the entry, management, and exit met every criteria in the strategy and whether you have followed it precisely before changing anything.
In conclusion…
I hope these simple guidelines that have led my ship out of the harshest of seas and into the best harvests of my life will guide you too. Good Luck.

Is Stock Option Trading A Profitable Investment Option?

admin — Sun, 29 Nov 2009 01:11:27 +0000

A lot of traders now favor option stock trading because of its many advantages. For one it can be highly profitable if used rightly, it offers the investor more flexibility and a larger option to diversify. This trading system offers more protection to the portfolio gives more control to the investor and offers a higher possibility to generate more returns on investment. They can be used under any market condition. They offer the investor the advantage of making returns on a change in stock price without actually owning the stock. Options stock trading can be used in combination with other option contracts and/or other financial tools to maximize returns.
Furthermore, a lot of trading is done on the floor of the stock exchange; one of such is referred to as stock option trade. Sometimes the trading could just be more of speculative activity. Speculative activity trading is done on stock exchanges through stock options trading. The term option in stock parlance means “a right”. There exists the right to sell as well as the right to buy. In a deal involving an option, the right to buy or sell a certain amount of securities, within a particular period at a given price can be bought off a dealer. If the purchased right was an option to buy securities it would be called a “call option”. If the right was the option to sell, it is called a “put option”. Instances where the two possible options are combined, to buy or sell a certain quantity of securities at a particular price up to a given future date, it is then referred to as “a double option”, or “a put and call option”
Speculative activity or stock option trade is carried out for anticipated profit. Here is how it works. If a speculator expects the price to go up, he buys a call option. This allows him in future when the price has arisen to buy at the old lesser price and sell at the higher prevailing price. When the reverse happens and a drop in price is anticipated he buys the put option.
When a speculator notices that his predicted or expected rise or fall in price did not occur he can chose not to exercise his right or stock trade option that he had purchased. The party that grants or sells the stock option trade to the speculator is paid a premium for granting it.
This premium is also called the option money. This is the fee that is earned by the trader who grants the speculator the stock option trade. When the speculator desires not to exercise his option he loses the option money or premium. But his loss is restricted to the option money alone. Stock option trade is useful for speculators who want to protect their capital and yet seize advantage of fluctuations in prices. He has the choice to decide whether to exercise his option or not.

Stock Option Trading – New Options Clearing Corporation Rule

admin — Sun, 15 Nov 2009 00:27:23 +0000

A few years ago on a Monday morning, I checked my brokerage account and to my surprise it showed that I had purchased 1,000 shares of AMD for a total cost of $15,000. The payment for this purchase was taken out of my brokerage money market account.
Why surprised you may ask. I had not put an order for this purchase nor did I really intend to buy AMD. I get to this in a little bit.
Had I wanted to sell the stock on that day, I would have received around $14,500, a loss of $500 in just a few hours. In the end it worked out and I sold that particular stock a few months later for a handsome profit.
But on that day I had a paper loss of $500 and if I didn’t have enough money to pay for the purchase, the $500 loss would have been the least of my worries.
So, how did I end up with a stock that I did not necessarily want or order?
Automatic exercise threshold for equity options is the reason.
Today, I received the following message from two of my brokerage firms that reminded me of that day.
“Beginning October 2006, the Options Clearing Corporation (OCC) will implement a change to reduce the automatic exercise threshold for equity options. The current threshold of $0.25 will be set at $0.05 for expiring options that are automatically exercised by the OCC. The threshold for index options will remain at $0.01.”
Who cares about a measly $0.20? You can’t even buy a stick of gum with that.
For options traders this could mean a huge potential loss, margin calls and a whole lot of trouble.
Let’s go over a few simple reminders about options trading. Options are contracts that allow a person to buy or sell securities, for example stocks, at a predetermined price called option exercise price and on/or before a predetermined date in the future called option expiration date.
Options represent a reserved right but not an obligation. In other words, the holder of this right, that is to say the buyer, can exercise this right or not.
For example if you own a Microsoft January 25 Call Option, it gives you the right to buy Microsoft for $25.00 on or before third Friday in January. It is obvious that you would not exercise your option if Microsoft is at $20.00. In that case, if you really like Microsoft, you just go to open market and buy it for $20.00.
However, if Microsoft soars to $40, then you want to exercise your right (option) and buy the stock at $25 and turn around and sell it at $40 or keep it for further potential increase.
To exercise your options you need enough money to pay for buying the stock. Each option contract represents 100 shares of stocks, so 10 contracts represent 1000 shares of stocks. In our Microsoft example, for you to exercise 10 options contracts at the price of $25.00 requires $25,000 to be in your account.
If you don’t have that money, well, you may face margin calls and some other not so pleasant consequence. This is where the new change can cause some serious damage.
Options are a right and not an obligation except that you have to deal with automatic exercise threshold. This is the threshold the Options Clearing Corporation (OCC) uses to determine if they should exercise your right on your behalf.
In the letter I received from my brokerage firm, they informed me that if the price of the stock is only a nickel ($.05) above the exercise price, that would mean they will automatically buy the stock for me according to this new rule.
So what can options traders do not to deal with unwanted stocks?
First, they can and should watch the stock price and be proactive in the process especially on the option expiration date. Option trading is not by any stretch of imagination a passive approach. They can also call their brokerage firm and find out what other alternatives are available to them.
Seasoned options traders know what they should do and the aim of this article is to bring some facts to the attention of those who are just getting started.
In investing and in life I remember what Robert Grant said, “Men and women everywhere must exercise deliberate selection to live wisely.”
* DISCLAIMER: Vishy Dadsetan, http:/www.MyPersonalFinance.com or My Favorite Shop, Inc. do not endorse any product or company. This article does not provide investment, legal, insurance, or other professional services. If investment or other expert assistance is required, the services of a competent professional should be sought. Although Vishy Dadsetan has made every effort to ensure the accuracy and completeness of the information contained in this site, it assumes no responsibility for errors, omissions, inaccuracies, or inconsistencies.
© Vishy Dadsetan

Demystifying Options Trading – Call Options Explained For Everyone

admin — Sat, 14 Nov 2009 12:08:03 +0000

When it comes to options trading, most people have been mystified by what seems like a lot of mumbo jumbo. This article will explain the investment terminology for Call Option in everyday terms that anyone can understand and appreciate.

To illustrate the concepts, let’s go on a shopping trip.

You’ve been thinking about buying a MacBook Air, Apple’s thinnest laptop, for a few days and you’ve done some research to find the best deal. You head for the mall on Saturday and spend most of the day trying to find the lowest price. This turns out to be $1799 for a 2.13 GHz MacBook Air.

Suddenly you realize that you have a dinner guest coming this evening and need to get groceries. Fortunately, the nearest store is right in the mall. Unfortunately, you discover that you forgot to bring your credit card and need to pay cash for the groceries. This leaves you with $150 plus some change.

On the way to your car you discover another electronics store, and to your amazement, the 2.13 GHz MacBook Air is advertised at $1499. Not believing your eyes, you go in and the store manager confirms the price but says that they have only one unit left. How are you going to nail down that price without sufficient cash and without a credit card?

You ask the store manager if he will hold the unit for you in return for $100, and that you will return in two hours to purchase at $1499. If you are not back in two hours, the store manager can sell it to someone else.

You make a written agreement, signed by both parties, that the unit cannot be sold to anyone else for next 2 hours but only to you at $1499 in exchange for $100, and that the $100 is forfeit if you do not return within 2 hours.

You have just engaged in “Options trading” The following options trading terminology should now make a lot more sense to you.

Options Contract – is what the note is called that you and the store manager just signed.

Underlying (underlying stock/share) – is the MacBook Air 2.13 GHz that you have agreed to pay ($1499).

Strike Price – is the agreed upon purchase price (in this example $1499).

Call Option – the type of contract in this example is a “Call Option.” It gives you the RIGHT but not the OBLIGATION to buy the MacBook Air. In order to exercise the “right to buy” you must return within 2 hours, and the store manager must sell it to you at $1499. If you change your mind, you do “not have an obligation” to buy. You simply don’t return and lose your $100 hold money.

Option Expiry – for this example the expiry is 2 hours, meaning that the option contract will cease to exist after 2 hours.

Option Premium – this is the $100 hold money you paid. It’s the cost to enter into this contract. This is not a deposit against the purchase price, but money the store will keep either way for providing you with the convenience. So, your effective purchase price will be $1599, which is still better than the $1799 “best deal” you had identified earlier, and it is the reason you entered into the contract.

Long Call and Short Call – for this example you have the “Long Call” since you are buying the contract for $100, and the store manager has the “Short Call” since he is selling the contract and gets to keep the $100.

Now let’s evaluate the risk exposure for both parties to the contract:

Your risk is limited to the $100 hold money you paid, i.e., a Long Call Option buyer’s risk exposure is limited to the premium paid. If, hypothetically, the price for the MacBook Air tumbles to $1000, then there is no way you would return and purchase it for $1499! If, hypothetically, the price shoots up to $2599 within the 2 hours, then your immediate profit would be $1000.

The store manager, on the other hand, has unlimited risk and limited profit potential. A Short Call Option seller’s risk exposure is unlimited while the profit potential is limited to the premium received. Yes, he gets to keep the $100 in case of a price drop where the buyer is not returning to purchase, but if the price for the MacBook Air shoots up to $2599 within the 2 hours, he stands to lose a lot of money because he cannot sell it to someone else for the revised price.

Hopefully, this will have taken some of the mystery out of options trading and its lingo. As illustrated by our example, we are engaged in these types of transactions in some form or other in our daily lives. We’re just not aware of it. As you gain knowledge and practice, it will come to you quite naturally.

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This was an article from our series ‘Covert Life of Investment’.