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Options Trading 101

admin — Tue, 26 Jan 2010 12:32:44 +0000

The individual investor will typically include some stocks in their investment portfolio. And whether they are a long term trader or in it for much quicker returns, many investors understand and feel somewhat comfortable with the concepts and techniques of trading stocks.
Options tend to be much less understood – and therefore avoided. But Options can form an extremely valuable part of your trading strategy as they can provide tremendous returns!
So here I will try and give you some of the fundamental concepts behind trading options.
Options are a contract conferring the right to buy (a call option) or sell (a put option) some underlying instrument, such as a stock or bond, at a predetermined price (the strike price) on or before a preset date (the expiration date). Options officially expire on the Saturday after the third Friday of the contract’s expiration month but because the markets are typically closed on Saturdays, the Friday is commonly used as the expiration date.
A key concept to grasp is that, when you buy an option, you don’t actually own the underlying security. You simply own the right to buy (or sell) at a specific point in time. But, of course, the price of the underlying instrument and the time remaing before expiration both affect the value of the option itself.
So in trading options you have two main ways to make money on them:
- You can hold to maturity and then exercise the option (with the expectation that the underlying instrument is then worth more than what you are entitled to buy it at – your “strike price”)
- You can sell the option itself prior to expiration (in the expectation that the value of the option itself has risen above what you paid for it)
A great many investors do in fact hold until maturity and then exercise the option to trade the underlying asset. Assume the buyer purchased a call option at $3 on a stock with a strike price of $30. (Typically, options contracts are on 100 share lots.) To purchase the stock the total investment is:
($3 + $30) x 100 = $3300 (Ignoring commissions.)
So if, at expiration, the stock is worth more than $33 you’ve made a profit (You can sell your 100 shares for more than $3300 right away).
Speculating on the actual value of the option itself is the second alternative.
Let’s use the same example above.
You bought your options for $3 with a strike price of $30.
If the price of the underlying stock goes above $33 at any time prior to expiration, then naturally more people will want to try and get a hold of that option you own, because they see a high likelihood of making a profit off the underlying security. With the increased demand for that option, the value of the option itself will likely go up. So you can sell the option to that higher bidder for a profit.
For example, if the price of the underlying stock rose to, say $35 then the option itself may become worth, say $4 on the open market. So you sell your options for $4 and make a nice 33% return. Without ever having owned the underlying stock itself.
Those are the kinds of returns that make options so attractive.
Many brokers offer trading accounts to individual investors that allow options trading and frequently at very competitive commision rates.
It really isn’t very difficult to get started.
Options trading is risky, so manage your risk and your assets wisely and only use a small percentage of your overall portfolio for trading options. But do consider them as an additional component of your investment strategy, as they can yield tremendous returns when traded correctly.

The 10 Keys to Successful Stock Options Trading Key #6

admin — Sun, 17 Jan 2010 00:11:36 +0000

Welcome again to the 10 keys of how to trade stock options successfully. Previously we have discussed the technicalities of options trading. This week I will start looking at the more esoteric aspects of trading beginning with how to formulate a trading plan.

It is imperative you trade with a plan. No trader has ever successfully prospered without a trading plan or with a plan that they didnt stick to. A sound trading plan includes, but is not limited to, the following items:

1. Money management rules, i.e. acceptable profits and losses per trade, how much capital you will commit to any one trade and to the market at any one time.

It is important you identify what your stop loss margin is (as discussed last week) and even more important you stick to it. Writing this sort of information into your trading plan will help cement it in your mind. More on money management will be covered in week eight.

2. Stock and option identification rules, i.e. how you will decide which stocks to trade options on and which options you will trade.

You should figure out if you like technical analysis, fundamental anlysis or a combination of both. How big will your watch list be? What price range of stocks will you trade? Do you like trading in the money or out of the money options? What Greeks will you consider?

3. Entry and exit rules, i.e. What will make you enter and exit a trade, what length of time will you stay in the trade and how often will you trade.

Entry and exit rules will depend largely on technical analysis, write down the patterns and indicators you will look for. Deciding how often to trade will be a big factor in your success. Most people over trade, if you have a fixed profit target then once you have met it you should stop trading. Attempting to go for that little bit extra can lead to a big loss, all the more difficult to take if you had already met your profit target!

4. Your own strategy rules, i.e. which trading strategies you will use primarily and which strategies suit your risk profile.

Know thyself as the ancient Greek saying goes is critical when formulating a stock options trading plan. You will tend to trade options and you do anything else in life, for example, if you are cautious by nature you will trade cautiously, if you are impatient in everyday life you will trade impatiently. Therefore consider your unique traits and formulate your plan around them.

Once you have practiced trading options you will discover your own style of trading, and from that you will develop a plan that suits you. Once you have your plan, and you know it works, stick to it through thick and thin. That doesnt mean that a plan cant be changed but you must ensure that you give your plan a chance to work and that you dont change it the first time you take a loss.

Once you formulate and implement a good trading plan you will be well on your to trading stock options successfully. Next week we will discuss trading with the overall market and index options.

US Government required disclaimer: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of the Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 (1-800-678-4667).

The 10 Keys to Successful Stock Options Trading ‘ Key #8

admin — Fri, 15 Jan 2010 12:09:01 +0000

Hello, this is week eight in my ten week series on how to trade options successfully. This week we are going to discuss saving.

Savigs is one of the most critical parts to any successfuly financial strategy; if you spend your gains as soon as you have them you will never reach true wealth. It is only by the miracle of compound interest that your gains will truly turn into a fortune.

Compound interest is the process whereby annual returns are added to the original investment and reinvested, rather than being spent or taken out, thereby creating a larger amount to invest again, as this process is repeated the compounding exponentially increases the returns over the lifetime of the investment. For example if you invest $10,000 a 20% return increases your portfolio to $12,000. A 20% return on that increases your portfolio to $14,400, 20% on that is $17,280, 20% on that is $20,736 and 20% on that is $24,883 which is a total return of $14,883.

Now assume as soon as you made the original 20% return you took it out and spent it, your next 20% return would only be the same $2000 on your $10,000 investment. If you kept doing this 5 times your total return would only be $10,000, $4,883 or almost 50% LESS than if you left your money in your account. The longer you leave your money in your account the more pronounced your returns will be and the greater the effects of compounding will be.

Einstein once said “Compound interest is the 8th wonder of the world”. When applied to options trading we can replace the word “interest” with “return on investment”. That means if you are winning and have a good return on your investment don’t take out the profits in your account to spend on a new boat, car or house. Re-invest your profits and if you are doing everything correctly the miracle of compounding returns will exponentially increase the size of your portfolio.

This is only a short article this week. Next week we have a lot to discuss when we talk about money management.

The 10 Keys to Successful Stock Options Trading ‘ Key #8

admin — Fri, 15 Jan 2010 00:30:51 +0000

Hello, this is week eight in my ten week series on how to trade options successfully. This week we are going to discuss saving.

This is only a short article this week. Next week we have a lot to discuss when we talk about money management.

How To Start A Home Business With Options Trading And Credit Spreads

admin — Thu, 14 Jan 2010 01:06:07 +0000

If you are like most people, in these times of economic uncertainty you are looking for a way to earn extra money, that doesn’t take a lot of time, preferably from home and that doesn’t require a lot of capital to get started. If you fall into this category then options trading might be just what you are looking for. Although trading is a simple business to get started in, it is far from easy and be wary of anybody who tells you differently. Also you may have heard that trading options is risky, and while nothing in life is risk free, there are ways to substantially reduce the risk.

How much money do I need to start?

One of the beautiful things about options trading is it’s one of the few businesses that you can take for a free test drive to see if you can be successful at it. By trading in a simulator you can start your business with no money. Obviously you won’t be earning anything either, but you will be gaining valuable knowledge. You can find a simulator at CBOE.com. After you’ve traded in the simulator for a few months and become consistently profitable you can start with as little as $2,000.

Finding a broker

The first step in getting started in an options business is finding a broker. There are many (excuse the pun) options available, a few of the good ones include, OptionsXpress, TradeStation and Interactive Brokers. These are all members of the Financial Industry Regulatory Authority (FINRA) and the Securities Investor Protection Corporation (SIPC), which are two organizations that protect you against fraud from financial brokers.

Putting the Odds in your favor

While this isn’t a comprehensive list there are a few things that you can do to stack the odds in your favor when dealing in stock options. First of all rather than buying puts and calls you can use credit spreads. This method of selling a higher priced option and purchasing a lower priced option alone will stack the odds enormously in your favor simply because this method can allow you to make money whether the markets go up, down or sideways. As a matter of fact using this method can allow you to win as much as 80-90% of the time, which is why professional traders use this type of trade to generate consistent income. The next thing you want to do is a bit of technical analysis and look at the S&P stock index. If the index is moving above it’s 200 day moving average you generally want to be purchasing stocks or using bull put credit spreads. If the index is moving below it’s 200 day moving average you should short sell stocks or use bear call spreads. How much can I earn? This can fluctuate depending on market conditions but by using credit spreads you can make anywhere from 5-20% a month. So with $10,000 you can generate anywhere from $500-$2000 in extra income a month.

Reducing Your Risk

1.Start off by trading in a simulator at CBOE.com

2.Always use a stop loss or have your positions hedged.

3.Never trade with money that you need to pay for you day to day expenses with such as rent and bills. Nervous money always loses.

If you’d like to find out more about options trading and credit spreads click on the link in the resource box below and sign up for a free 10 part course.

Options Trading Basics

admin — Wed, 13 Jan 2010 00:15:24 +0000

New to Options? Want to trade option? This is the first step for you.
You many know many wealthy individuals make lots of money using options and you can try too.
Stock and Bond trading strategies run the gamut from the simple ‘buy and hold forever’ to the most advanced use of technical analysis. Options trading has a similar spectrum.
Options are a contract conferring the right to buy (a call option) or sell (a put option) some underlying instrument, such as a stock or bond, at a predetermined price (the strike price) on or before a preset date (the expiration date).
So-called ‘American’ options can be exercised anytime before expiration, ‘European’ options are exercised on the expiration date. Though the history of the terms may lie in geography, the association has been lost over time. American-style options are written for stocks and bonds. The European are often written on indexes.
Options officially expire on the Saturday after the third Friday of the contract’s expiration month. Few brokers are available to the average investor on Saturday and the US exchanges are closed, making the effective expiration day the prior Friday.
With some basic terminology and mechanics out of the way, on to some basic strategies.
There are one of two choices made when selling any option. Since all have a set expiration date, the holder can keep the option until maturity or sell before then. (We’ll consider American-style only, and for simplicity focus on stocks.)
A great many investors do in fact hold until maturity and then exercise the option to trade the underlying asset. Assume the buyer purchased a call option at $2 on a stock with a strike price of $25. (Typically, options contracts are on 100 share lots.) To purchase the stock the total investment is:
($2 $25) x 100 = $2700 (Ignoring commissions.)
This strategy makes sense provided the market price is anything above $27.
But suppose the investor speculates that the price has peaked prior to the end of the life of the option. If the price has risen above $27 but looks to be on the way down without recovering, selling now is preferred.
Now suppose the market price is below the strike price, but the option is soon to expire or the price is likely to continue downward. Under these circumstances, it may be wise to sell before the price goes even lower in order to curtail further loss. The investor can, at least, minimize the loss by using it to offset capital gains taxes.
The final basic alternative is to simply let the contract expire. Unlike futures, there’s no obligation to buy or sell the asset – only the right to do so. Depending on the premium, strike price and current market price it may represent a smaller loss to just ‘eat the premium’.
Observe that options carry the usual uncertainties associated with stocks: prices can rise or fall by unknown amounts over unpredictable time frames. But, added to that is the fact that options have – like bonds – an expiration date.
One consequence of that fact is: as time passes, the price of the option itself can change (the contracts are traded just like stocks or bonds). How much they change is influenced by both the price of the underlying stock and the amount of time left on the option.
Selling the option, not the underlying asset, is one way to offset that premium loss or even profit.

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 Is a Opportunity For The Small Investor Too

admin — Sun, 03 Jan 2010 01:24:49 +0000

The stock market appeals to people for many reasons. Some see it as a quick way to make a nice nest egg to tuck away for their eventual retirement. Some see it as a way to live out their fantasies of being a powerful, corporate type. And some are actually more logical about it, seeing the stock market as a potential way to make money, if they play their cards right. They know that there are no sure things in life and nowhere is that more clear than in the stock market. But options trading is a opportunity for the small investor too.Options trading has grown in popularity, especially with the smaller investors over the course of the past ten years. Unlike other forms of trading that can require large amounts of venture capital, options trading can be accomplished with often a very small initial outlay. Of course, because they can be easily started, it can allow the uninitiated or poorly informed to get in well over their heads in a matter of a very short time. Not allowing yourself to understand the market before you make the first trade is financially foolhardy and personally dangerous. First of all, as the name implies, option trading is not buying actual stocks, but rather busying the right to own or sell them. The options trader can make the same profit with stock options that he would make as if the owned the outright stocks, but that also means that he would face the same risks if that stock did not do well on the market. As with other forms of trading, options trading will require that you learn some facts and make some decisions before hand. Know everything you possibly can about options trading, as well as trading in general. Know how to track stocks for movement and know how to watch for trends. Know what the basic types of options trading is- and understand how each works. And, as with any other type of trading, make sure you know and adhere to your personal limits, including your absolute loss cap. Do not overextend yourself, even if you just got a tip on a great stock. Options trading can focus on stocks that are heading in one of two directions, up or down. Call options will focus on rising stocks, while Put options focus on those on the decline. Both allow you the right to buy the option on a stock at a fixed price, but do not force you to do so. Knowing how to work this system to your best advantage is key.Invest in yourself, learn the basics and expand on that to become profitable in options trading.

Forex Options Trading – How Forex Options are Calculated (part 2 of 2)

admin — Sat, 02 Jan 2010 00:10:35 +0000

In the last article, you have learn about “delta” . Let us continue…

Gamma: Gamma is derived from Delta is the odds of a change in Delta. It also informs in advance if the Delta could be changing. Gammas are positive for both the call and put. When options are deep in the money of deep out of the money the Gammas will be near zero as the probability of a change in Delta are very low. Likewise at strike price the Gamma would likely to e the highest.

Theta: Time decay is reflected in the option position as Theta. Options bought have negative Theta, which means that each day you do not sell that option, the time value is declining because of the time decay. In this case, time decay is making it worse for the buyer of the option. When you sell options, Theta is positive, meaning that time decay is good for the option seller.

Vega: How volatility affects the option pricing is reflected in the in Vega. In other words, its sensitivity to volatility. Options tend to have price increases when the underlying asset’s volatility increases. In this case, volatility is good for the buyer of an option and bad for the seller of an option. Vega is positive for long option and negative for short option.

Rho: Rho is how interest rates affect the pricing of the the option. When interest rates are high and it is good for the position, Rho will be positive. If interest rates are high but bad for the option position, Rho will be negative.

Stocks for Options Trading: Low-Risk, Low-Stress Strategies for Selling Stock Options-Profitability (Hardcover)

admin — Fri, 01 Jan 2010 15:53:50 +0000

Review

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From basic option terms, to finding the best optionable stocks, to a winning investment plan creating and utilizing an option portfolio, Stocks for Options Trading: Low-Risk, Low-Stress Strategies for Selling Stock Options Profitably provides low stress tactics designed to make predictable profits when the stock market moves up, down, or sideways. Once learned these strategies allow you to accumulate assets steadily, and reach your investment goals. It clearly explains the features and risk/reward characteristics of basic options transactions, as well as hedging, tax benefits, correct use of margin and trading strategies. With this book you can create a portfolio that:Increases profitabilityProtects st (more…)