All About Options

[BlueWaterSailor]

[Though the image you attached "is all Greek to me," I couldn't help but notice that above and below the $4500 P/L Open is ($7523.22) and ($1053.40) with parentheses that would indicate deficits on an Excel spreadsheet—a sight that causes me to suspect I should still remain somewhat wary and cautious regarding options.]

Wise attitude. You should remain cautious.

A fairly good argument can be made in favor of options being safer to trade than stocks, but I'm not going to get into that now. However, I will suggest some rules for a beginner of the "if I could talk to myself a year ago" sort, and I would slap my earlier self silly if he didn't treat them as iron-clad:

0) Don't expect to actually understand puts and calls by memorizing those definitions. You won't, until you see and internalize how they move in an actual trade - and especially what happens as combinations of the two move from ITM to OTM (in and out of the money.) Get familiar with the definitions of the option greeks - at least delta, gamma, vega, and theta - but, again, don't expect to really get how they work until you have seen them in action, again and again.

1) Start by learning a couple of basic strategies from the sites I suggested - in fact, just start with the four vertical spreads - and run them in a simulator until you get the basic mechanics down and feel like you have at least some understanding of what's happening.

2) Get out of simulator mode as soon as you feel even marginally ready. Until you have skin in the game, you will get nothing BUT the mechanics. Real risk = turbo-accelerated learning on nitro fuel.

3) Trade small; stick to the $10-$35 price range. This gives you a notional risk of $1000-$3500 (the real risk is quite a bit less than that, but staying cautious means being aware of the absolute max even if it's overstated), and lets you see and feel what is happening as the price and the remaining time change. HUGE MARIO-STYLE POWER-UP: take screenshots of your trades, including the values of the greeks, as the trade progresses (more frequently as you get closer to expiration), and study them as they accumulate. A lot of the changes are interdependent, but you are trying to build a sense for the boundaries, not develop a scientific thesis.

4) Stay as safe as possible. By that, I mean trade only indexes (which have a very small chance of crashing to zero - much less than almost any single name), always use risk-defined strategies (e.g., vertical spreads and - when you feel comfortable with those - iron condors), and always close the trade before expiration.

5) Bonus: Learn adjustment techniques (rolling) for the strategies you're using, both their pros and cons and when to use them or to simply take the loss and exit the trade. Stops are not nearly as useful or reliable on options as they are in other types of trading, so don't expect them to protect you in most situations. On the other hand, option trades tend to move much slower than stock or Forex, so you usually have time to decide what you want to do.

Other than that - good luck, be decisive in killing off your losing trades, and have fun! If you have a certain bent toward playing with systems, enjoy learning, and like hitting the books, options can be a real joy. And - oh yeah, almost forgot - could even result in a positive P&L (who'd have thought?)

(Also: there's a number of smart options folks here on ET, and their advice is worth listening to. You just have to learn to distinguish those from the... surrounding noise.)

 

[expiated]

Wise attitude. You should remain cautious.

No intended disrespect to MACD, but what you just wrote above has more of the “ring of truth” to my ears based on my personal experience. Internalizing how financial instruments move and understanding how various factors interact only after seeing them behave in real time over and over again is exactly what I would expect.

In glancing at the “spacecraft’s dashboard,” I was wondering what delta, gamma, vega, and theta represented. I can now assume that whatever this might be, it is not inconsequential.

I’ve had some ET contributors try to poo-poo my above-average Forex strategy success rate by suggesting it would likely crumble once I tried using it in my live account. What they failed to realize or notice was that I was already trading it in my cash account along with my virtual account, plus they apparently assumed that years and years of experience had done nothing to essentially numb any tendency on my part to make trading decisions based on emotions.

However, I would anticipate that moving to something that feels unfamiliar will almost certainly resurrect some of those jittery feelings I experienced long, long ago, so I suspect your suggestion to get out of simulator mode as soon as possible, sort to speak, is probably a good idea.

I’ll have to look into what trading small means in practical terms along with notional risk, real risk, and absolute max. But I do have some idea what you mean by trade progression due to my having traded NADEX binary options and watching what happens to bids, offers, and position values and how dramatically position value can fluctuate depending on how close the indicative price is to the strike price as expiry approaches.

I have only heard of equity options—not Forex or index options—but if index options are doable, that will be great since I have already verified that the principles on which I base my Forex trading system work just as well from one major index to another (there tend to sometimes be nuanced idiosyncrasies in price behavior from one stock to another) which ought to make it that much clearer as to how I should handle their corresponding option contracts in response to their price action.

The rest of what you wrote I will take into consideration as I begin building a body of knowledge (which at this point, consists of nothing more other than the definition of what is an option).

 

[dakr]

Also, Forex options seem much more difficult to trade (than equity options) for reasons difficult to explain,

Difficult in what way? Fewer brokers offering options trading or something else? Thanks.

 

[expiated]

LESSON #1: An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a given date.

The above in Spanish - LECCIÓN #1: Una opción es un contrato que le da al comprador el derecho, pero no la obligación, de comprar o vender un activo subyacente a un precio específico en una fecha determinada o antes.

According to Investopedia, if I wanted to purchase a call option at a premium of $3.15, I would have to pay $315 plus commissions (because a stock option contract is the option to buy 100 shares). As best as I can tell, premium is telling me how much above the strike price the value of the stock would have to rise before I would even break even.

So to make any money, the stock would have to rise in value to match the strike price, and then rise even more in order to clear the premium that’s added on top.

According to Joe Duarte, if applying for options trading, the broker will send me a reference guide (Characteristics and Risks of Standardized Options written by the Options Clearing Corporation) prior to allowing me to trade. (I just downloaded what was described as a PDF copy of the document online.)

Supposedly, stock options allow a trader to benefit from upside moves for less money, and to profit from downside moves without the risk of short selling.

 

[MACD]

Options are INSURANCE -- that is what they were initially designed for. Buying opens for speculation is a Fools game. You bought a melting ice cube. Don't make this hard to learn. Learning time for average trader that thinks they can read charts to determine direction is just a few hours. Then practice with small exposure to risk and or use a sim account.

 

[expiated]

Buying opens for speculation is a Fools game.

Perhaps everything you say is 100% accurate, but I became successful trading foreign currency pairs in part by abiding by the biblical principle of testing everything (for myself) and holding fast to that which is true.

In fact, one could argue that the foreign exchange market (Forex) was initially designed to assist international trade so that businesses in one country could import goods from businesses in another country and pay in that other nation’s currency, even though the currency used in its own locality differs, and that the act of trading currency pairs for speculation is a fool’s game—hence the reality of the vast majority of Forex retail traders "losing their shirts" and abandoning their folly in short order.

Indeed, if options are just insurance, there is no point in my bothering with them at all. If I might be so arrogant as to state a genuinely held belief, I make money trading other financial assets on a daily basis almost without fail, thanks be to God—so I don’t need options. And even if this were not true, I already have insurance in the form of stop losses.

Thus, I will continue on this path I have laid out for myself for the reasons stated previously (i.e., options are probably worth looking into, and even if I end up never trading them, at least I will not be rejecting their use out of ignorance).

 

[MACD]

Perhaps everything you say is 100% accurate, but I became successful trading foreign currency pairs in part by abiding by the biblical principle of testing everything (for myself) and holding fast to that which is true.

In fact, one could argue that the foreign exchange market (Forex) was initially designed to assist international trade so that businesses in one country could import goods from businesses in another country and pay in that other nation’s currency, even though the currency used in its own locality differs, and that the act of trading currency pairs for speculation is a fool’s game—hence the reality of the vast majority of Forex retail traders "losing their shirts" and abandoning their folly in short order.

Indeed, if options are just insurance, there is no point in my bothering with them at all. If I might be so arrogant as to state a genuinely held belief, I make money trading other financial assets on a daily basis almost without fail, thanks be to God—so I don’t need options. And even if this were not true, I already have insurance in the form of stop losses.

Thus, I will continue on this path I have laid out for myself for the reasons stated previously (i.e., options are probably worth looking into, and even if I end up never trading them, at least I will not be rejecting their use out of ignorance).

Excellent God based beliefs with reinforcement through your personal experience. Keep up the Good Work !! Congrats...

 

[expiated]

OPTION SYMBOLS

According to Joe Duarte, options symbols can be a little confusing at the beginning because each broker has a slightly different system of displaying the information. Ugh!

Nonetheless, they all include the same basic information. Here is an example of an option symbol based on the Yahoo! Finance website for an Apple Inc. call option with an expiration date of May 5, 2017 and a strike price of 148...

AAPL170505C00148000

The more one studies and trades options, the easier it becomes to decipher the symbols.

Expiration dates are important because as time passes and expiration nears, options lose time value, and thus the value of the option drops at a faster rate as the expiration date approaches.

You should never hold an option that you are planning to sell when there are 30 days or less to expiration because the time value will decay and the option’s price will fall.

Exercising a stock option means purchasing the shares of stock per the stock option agreement. The benefit of the option to the option holder comes when the grant price is lower than the market value of the stock at the time the option is exercised.

 

[Windlesham1]

Options are INSURANCE -- that is what they were initially designed for. Buying opens for speculation is a Fools game. You bought a melting ice cube. Don't make this hard to learn. Learning time for average trader that thinks they can read charts to determine direction is just a few hours. Then practice with small exposure to risk and or use a sim account.

NEVER trade options in isolation but you can be long options and mitigate theta -it's not a play for Micky Mouse traders

 

[expiated]

OPTION STRATEGIES...

Married Put

A married put combines long stock with a long put for protection. The position is created by purchasing the stock and put at the same time, but the key is creating put protection and managing the risks of stock ownership. Buying a put for existing stock or rolling out an option to a letter expiration month remains true to that strategy goal. Long out-of-the-money (OTM) options should be sold 30 to 45 days before expiration. This strategy is best used when you are not 100% sure of the stock in the short term, such as before an earnings announcement or when the market looks risky, but you would like to hold the stock for the longer-term.

Collar

A collar combines long stock with long put protection and a short call that reduces the cost of protection. The call premium is a credit that offsets, at least partially, the cost of the put. Timing this strategy’s execution is a worthy goal. An optimal scenario occurs when you can buy the stock and long put during low volatility conditions, allowing you to buy longer-term protection. Calls are sold as volatility increases, and there are 30 to 45 days to expiration, so that time decay accelerates short call gains. This strategy reduces the risk of loss due to a fall in price of the stock by producing some income via the sale of the call put, but in exchange forfeits upside potential.

Long Put Trader

A long put is a limited-risk, bearish positioned that gains when the underlying declines. This is a much better bet than an unlimited-risk short stock position that requires more capital to establish. The bearish move must occur by option expiration, and out-of-the-money (OTM) puts should be exited 30 to 45 days prior to expiration. Use this strategy when you expect the stock to drop, but are interested in reducing the upside risk of a traditional short sale of the stock.

LEAPS Call Investor

A Long-term Equity AnticiPation Security (LEAPS) call option reduces the cost and risk associated with a long stop position. The position is best established when implied volatility (IV) is relatively low. One drawback is that the LEAPS owner does not participate in dividend distributions, which reduce the stock value. At the same time, the amount risked in the position will be less than owning the stock outright. This is a great strategy when you have got time to let a stock find its groove, but don't want to risk the full capital required to buy shares. In exchange, you are willing to worsen your breakeven price by the amount of the call option’s time value.

Other strategies to read up on...

1. Diagonal Spread
2. Bear Call Credit Spread
3. Straddle
4. Call Ratio Back Spread
5. Put Ratio Back Spread
6. Long Put Butterfly