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? Many people think of options trading as very risky and suitable only for the "high rollers". In this article we will demonstrate one of the ways options can be used in conservative financial portfolios.
The basic definition of a put option is that it gives the owner the right, but not the obligation, to sell 100 shares of the underlying stock at the strike price anytime before expiration. If I buy 100 shares of Apple Computer (AAPL) at $136.50 or $13,650 and buy one contract of the Oct $135...
•Trading Options: Good or Evil?
? You have probably heard people refer to options as a risky enterprise, akin to gambling. And it is true that options trading can be very risky, especially when engaged in with minimal knowledge and preparation. The average stockbroker or financial planner does not have sufficient options knowledge to guide you in the use of options in your portfolio. But that doesn't mean options cannot play a role in a conservative portfolio of stocks.
The majority of today's options trading volume derives...
•The Psychology of Trading
Perhaps the most critical characteristic shared by successful investors and traders is their psychological approach to the market. All forms of financial investments have foundational knowledge that is essential to success in that market. I am not suggesting that you can simply think the right way and trade stocks, commodities or any other market successfully. But you could be the world's foremost expert on the commodities market and still not be able to translate that knowledge into monetary...
•Trade Options with a 90% Probability of Success
It is common to see web site banners or other advertisements similar to the title of this article, touting the benefits of options trades with probabilities of success of 85-90%. Technically, these trades indeed have a high probability of success, i.e., if you placed a trade with the same parameters every month of the year, you should see about 10 or 11 trades per year be successful and one or two be losers. And the longer you traded in this way, the more likely your results would conform to...
•Why Losing Trades Are Good For You
Many people enter trading, whether it be stocks, options, commodities or other markets, after having been very successful in their primary occupation. Many of these new traders are perfectionists by nature and driven to be successful.
This often leads to a couple of fatal flaws in trading: 1) The novice trader stays with a losing trade too long because of a reluctance to admit the original analysis was incorrect. His or her ego and sense of success are intertwined with the trade. 2) The...
•Equity Option Cycles
Beginning options traders often are confused about the organization of option chains. This paper covers the basic concepts surrounding which options are available at any given point in time, and how that may affect the options you trade.
Equity options always have options available for the current month and the following month. In addition, two more months will be available; but those two months will vary, depending upon which of three option cycles your option falls within: the January,...
•There Is No Free Lunch
This time honored saying was one of my father's favorites. It has broad applicability, but it rings especially true for stock and options trading. For example, I recently read the following on the web site of a well known options trading education firm:
"When was the last time you made 300% in three weeks?"
And during a recent webinar by a stock and options trading education and advisory firm, the speaker was discussing his background and experience and explained that he had: "discovered the...
•Facts and Fallacies About Risk/Reward Ratios
One will commonly hear or read the following "rule of thumb" for trading:
Only trade positions with potential profits of at least three times the potential loss.
This sounds like a reasonable rule, risking a little to make a lot. However, it ignores the probabilities involved. Buying a lottery ticket for $1 to potentially make one million dollars certainly meets this criterion for a good trade. But we intuitively know that the odds against us winning are astronomical. This paper will define...
•Vertical Spreads and Implied Volatility
One will commonly hear or read the following "rule of thumb" for options spread trading:
When implied volatility is high, sell credit spreads and when implied volatility is low, buy debit spreads.
Unfortunately, this is simply not true. The credit spread and its corresponding debit spread at the same strike prices will always have virtually identical returns on investment (ROI).
Vertical spreads either require a net investment to initiate (a debit spread) or we initially receive money into...
•Put Time On Your Side
Many conservative income generation trading strategies depend on the time decay inherent in options pricing. When I establish an iron condor well OTM (out of the money), I am selling option spreads and expecting those spreads to slowly lose value as the underlying stock or index trades within a channel. Other traders may use butterfly spreads or place OTM credit spreads on one side only (calls or puts); all of these trades are based on time decay working in the trader's favor. This is in...
•Beware the Hype in Options Trading
Selling education on options trading is a big business. We see infomercials on television and receive emails advertising free trading software and foolproof trading systems. Unfortunately, there are many "snake oil salesmen" operating in options education. They are busy selling the dream of instantaneous riches without effort - and their price tag isn't cheap.
I recently came across the following statements on option education web sites or advertisements for those web sites:
Make all the...
•Squeezing Additional Income From Your Stocks
For the purposes of this article, let's assume we have a stock portfolio of conservative stocks, e.g., IBM, GE, etc. We may be realizing moderate price appreciation of the order of 5% annually plus dividend yields of 3%, for total portfolio growth of 8 to 10% annually. One easy way to boost our annual gains without increasing our downside risk is to sell call options against our stock holdings. This is known as a Covered Call.
A Covered Call is created by selling the appropriate number of...
•Option Expiration and Exercise
Beginning options traders often make costly mistakes due to either a lack of knowledge or misinformation about the basic parameters of options and their exercise. Examples of common errors include being surprised that one is unable to close an index option position on the Friday before expiration, or being surprised by an unhedged option exercise during expiration. This paper covers some of the basic concepts surrounding option expiration and how options are exercised. Be sure you understand...
•The Dangerous Iron Condor
Placing iron condor spreads on the broad market indexes is a relatively conservative, non-directional trading strategy that may be used for consistent income generation. This strategy profits as long as the index trades within the channel formed by the two spread positions. It is best used during sideways or slowly trending markets.
Condor Spreads
A condor spread is a debit spread, established by placing a bear call spread at or above resistance and placing a bull call spread at or below...
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