Don Singletary
Just because the market is open does not mean you have to trade. Cash is a position too. (Location 225)
The surest, safest way to make option income money is to sell options. (Location 245)
Selling options on stocks you already own (or will buy) is a strategy so safe it is approved for use in self-directed retirement accounts. This strategy can easily add 5 to 10% or more to the returns on your account, and the strategy works in bull, bear, and neutral markets. (Location 246)
This is the safest application of option trading that is available and also one of the most common and (Location 251)
easiest. This type of trading is considered smart and passive. Many fund managers use it all the time to increase performance in stock funds. If you own stocks, this is a great way to get your feet wet and gain some experience without significant risk exposure. (Location 251)
For professional (Location 257)
option traders, option spreads – not outright buying of PUTS and CALLS- are preferred trades and there is a reason for this: They are the trades that give you the most control of risk in trade selections. (Location 257)
Investors who own stocks in trading and tax-deferred accounts will want to consider the covered call strategies, collars, and also techniques of rolling out covered options to increase return on equity in these accounts. (Location 260)
Many financial planners allow investors - and even condition them - to expect large losses as an inevitable part of their stock portfolio – and they are not totally wrong. What you may not know - is that sophisticated and wealthier investors will not tolerate that advice; when they have large gains - they understand the good practices of protecting their gains. (Location 269)
If you owned a stable of 100 thoroughbred race horses, and 10% of them won 95% of the races, why would you enter all 100 or even 80 of them in the races? You wouldn’t! And that, my friend, is how easy it is to show you the essence of good investing. (Location 279)
If you made 50% profits in your account in five years, would you spend 1% of your profits to protect it? You probably answered ‘yes’; options can (Location 288)
be an inexpensive way to protect what you’ve already accomplished – and in the long run, keeping what you make will have you making even more. (Location 289)
Have you ever plotted your retirement fund’s performance against an index like the S&P 500? That’s what one does to see if options on that index are a viable way of hedging your profits against downside sliding. Using options on ETF’s -exchange traded funds – that track major (Location 292)
indexes like the DJIA or S&P500 is a great way to use options to protect you from poor stock market performance. (Location 294)
One of the major advantages available to option traders is leverage. (Location 299)
The leverage: Controlling large assets with a small amount of money. Flexibility: Being able to make money in any type of market – bull, bear, neutral Risk Selection: Be in control of the amount of risk you take on any investment play. Protection: Having economical ways of protecting money you have already made. (Location 306)
My second favorite thing about trading options is the strategy of selling them. About 80% of options expire worthless; this means the odds are in my favor from the (Location 310)
very start of these trades. (Location 311)
Options are contracts with obligations and rights. (Location 333)
In stock option trading, each option represents the rights to 100 shares of the underlying (stock). Option prices are quoted in cents per share and one (Location 345)
option represents 100 shares. (Location 346)
All options have an expiration date. The expiration date of an equity option is usually the third Friday of the MONTH for which the option is named. The MONTHLY stock option is the most common type; there are also WEEKLY options - meaning options that are shorter term than MONTHLY options. (Location 354)
In-the-money: commonly abbreviated as ITM A CALL option is in-the-money when the underlying stock price is HIGHER than the strike. (Location 361)
A PUT option is in-the-money when the underlying stock price is LOWER than the strike. (Location 363)
The time value is equal to the option’s premium minus the intrinsic value. If the option is not in-the-money, it has no intrinsic value, so the only value it does have is time value. (Location 387)
There is an attrition of an option’s price (premium) that occurs as its expiration date draws nearer in time. This reduction in the options price due to this, is called time decay. (Location 390)
In trading monthly stock options, it is generally assumed the trader knows a MAR stock option will expire on the third Friday in March. There are also weekly (shorter term) options available on many products, and also LEAPS. These are Long-Term Equity AnticiPation Securities® (LEAPS®). These types of options are priced in a similar fashion as regular monthly stock options. (Location 392)
Volatility is the measure of an underlying’s potential price change in any direction. (Location 402)
Historical volatility refers to the (Location 408)
volatility of the underlying stock. Implied Volatility (IV%) is a term that applies only to options. (Location 409)
One of the most valuable concepts in trading options is to understand time-decay in option pricing. (Location 415)
The LONG and SHORT of it: When you buy an option or stock, you are said to be LONG the product. When you sell a product (you sell when you did not own it), you are said to be SHORT. (Location 418)
SHORTING or selling options by using combination trades called option spreads can be one of the most easy and successful – and less risky strategies in options trading. (Location 421)
To help you build confidence, most vendors allow you to operate in a practice or ‘paper money’ account. (Location 438)
We incorporate this with the other technical and fundamental information about the underlying - to arrive at our market view, which is (Location 453)
our opinion about the magnitude, direction, and timing of price movement. Armed with this information, we are able to use the trading platform’s features to help us analyze the viability of specific trades. This helps us form a strategy. Choosing the option classes, dates, and prices are the tactical decisions. (Location 454)
When you buy a CALL, it’s time value is decaying – working against you. Ideally you buy a low IV% that is rising. Your goal is to have the value of the CALL increase as the price of the underlying goes UP. (Location 491)
When you sell a CALL, its time value is decaying, working for you. Ideally you sell with a high IV% trending lower, decreasing the value of the option. (Location 494)
When you buy a PUT, time decay works against you. You want a low IV% that could rise giving more value to your option. You want the value of the PUT to increase as the underlying goes DOWN. (Location 496)
When you sell a PUT, time decay is working in your favor. Your prefer to sell higher IV% and trend lower. (Location 501)
This matrix of CALL option prices and other stats are for the KO (Coca Cola) JUNE 2015 (top) and the AUGUST 2015 (bottom) classes. The finely shaded boxes represent the ITM options. (Location 508)
In this table are shown the bid/ask, last trade price, delta, implied volatility (IV%), and the probability the option will expire OTM. (Location 510)
The IV% is used as an indicator of ‘how expensive’ an option is. The IV% is relative to each strike and class and is not an absolute value. (Location 515)
On the other hand, the IV% can be used to imply both the underlying stock’s volatility and often (Location 517)
the implied likelihood price movement. The higher the IV%, the more the option will be priced (all else being equal). (Location 518)
Delta is a theoretical estimate of how much an option’s premium may change given a $1 move in the underlying stock (or other product). (Location 544)
This means if the underlying stock price varies by $1, the value of this option might vary about $.55. If KO increased to 41.51, the option price might move up to 1.55 + .55 = 2.10. (Location 548)
Buying the CALL delivered a leverage of about 14.75 times that of buying the stock outright. (Location 553)
As a rule-of-thumb, ATM (at-the-money) options have a delta of about .50. In-the-money strikes have higher than .50 deltas. Out-of-the-money strikes have a delta between .5 and zero. Of course the delta of an option changes all the time; the more towards ITM, or deeper- ITM an option becomes, the higher it’s delta. (Location 557)
It is the coupling of your option knowledge with your skills at reading the possible price movements of stocks that will make you money; the two are inseparably linked. (Location 567)
Plus you will learn how to use covered call options in tax deferred accounts to give some boosts to your savings plans; this is one of the option strategies so safe it is approved for use in those types of accounts. (Location 582)
If you own a stock (or buy it), you can sell a covered CALL option with a striker higher than the stock price (an OTM CALL) and the premium is credited to your account. If at option expiration, the stock is below the strike, the CALL expires worthless and you keep the credit. If the stock is at or above the strike of the CALL option at expiration, you are obligated to sell the stock at the strike price. What you risk is any gains you might have made from the sale of the stock above the strike price (aka: opportunity cost). (Location 595)
Consider timing: If you own a stock and are expecting a price rise soon, you could regret losing the stock during a price rally; this is a consideration before selling a covered call. If you write a covered call and the price rises unexpectedly and you wish to hold on to the stock, the only way out is to buy back the CALL – and this would likely cost you; (Location 617)
Selling Covered Calls in Tax Deferred Accounts Can Be One of the Best Strategies (Location 626)
Having said that, selling covered calls in tax deferred accounts is quite common and done all the time. (Location 629)
Selling covered CALLS in tax-deferred accounts is one of the safest and most dependable ways to increase an investors return from 5%, 10%, or more annually. (Location 630)
Let’s assume you own 100 shares of KO, worth $4,051. Go back to the KO JUN 15 matrix and consider selling one of the KO JUN 43 CALLS for .40 or $40. After the $1.50 commission, (Location 695)
you net $38.50 and you still have the Prob OTM of 80.40%, pretty nice odds. If you tell a friend you are learning to trade options and just ‘made $38.50’ by clicking your mouse or tapping the screen two times - they might not get very excited. (Location 696)
When you sell covered calls on underlying stocks that you own (or buy), as they expire and you collect credits from the premium, it will definitely occur to you to keep doing it. (Location 722)
This process of closing one position and simultaneously selling another option is called rolling out. As you continue to roll out, this strategy will continually reduce your cost basis in the stock. Over long periods of time, these profits can add up – and it might only take you a few minutes each week or month to maintain these trades – and all the while you are continually making money. (Location 726)
The most common mistake in trading is also the most common mistaking in living. We take our profits too quickly and let the losses run until we lose a lot. (Location 754)
Making smart trades is half of investing; the other half is learning to keep what you make. (Location 769)
Log on to: OIC at http://www.optionseducation.org (Location 777)
Selling options is also called writing options. Writing an option is like the written words you are reading right now; until someone wrote them, they didn’t exist. (Location 1162)
It sounds so easy to sell an OTM option with a 90% chance of expiring OTM. You can make money very often with such a strategy but when it goes wrong, it can get ugly in a hurry – and you should never forget it. Since risk and reward are commensurate, selling far OTM options will give you a high chance of success but the trade off is that you won’t get to collect large premiums for taking these smaller risks. (Location 1201)
If you are a beginner, use the discipline to only sell options on a very limited basis until you go through the experience of managing some losers. When you trade, always have an exit plan for all contingencies. (Location 1205)
The classic beginner’s mistake is to be successful four or five times in a row and get overconfident and drop your caution; this is when you can lose it all. (Location 1207)
Using option spreads can allow you to sell options while simultaneously limiting (insurance) your losses. You might not make as much on each trade, but that is merely the tradeoff for limiting the risk. (Location 1211)
Since about 80% of options expire worthless, the general odds are 4/5th’s in your favor. (Location 1227)
One of the common mistakes people make when learning to trade options is to make a risky trade with the feeling that you are out-smarting the market. Within this mistake is another common mistake: thinking that one of your first trades won’t cost you a lot even if you lose and that – win or lose – is a costly habit. (Location 1237)
A reminder that thinly traded strikes might have a wide bid/ask gap and not reflect efficient (fair) option prices. The ideal is to have high OI and high volume, but when you are trading far OTM options, you can’t always find this (Location 1279)
ideal – so you need to pay close attention that you don’t sell options too cheaply. Remember, the price you get is an important factor in your ROI (return on investment), even though the option may have a satisfactory Prob of OTM, High OI, and Vol, you need to know if you must exit a trade quickly, that there will be enough activity (volume) to do so at a fair (efficient) price. (Location 1281)
One sure way to avoid most stock price surprises is to build a stable of your favorites and follow them religiously. By keeping a list on your daily quote screen you use most often, you will constantly be exposed to their prices, you can monitor news items, earnings reports, dividend payments, and dozens of other factors that influence its pricing. (Location 1303)
For example, just being confident that a stock’s price might trade within a wide range for the next 30 to 60 days is enough to place a trade with an over 90% probability of success. It is precisely for this reason that I say option trading is much easier than stock or commodity trading alone. (Location 1336)
The price of one CALL is $1077. This purchase gives the buyer the right (not obligation) to buy 100 shares of the underlying AAPL at a price of $125/share. (Location 1347)
Buying the option instead of the stock, the worst case is to lose the premium of $1077; (Location 1350)
The break-even on the trade at expiration is the strike price plus the premium paid = AAPL would need to be 125 + 10.77 = $135.77. (Location 1351)
The delta of the AAPL OCT 125 CALL is presently .57; this means the option might increase or decrease by .57 for each change in AAPL price of $1.00. (Location 1353)
The far-out-of-the-money 150 CALL has a delta of only .21. If AAPL went up $5.00 per share, the 150 strike will gain about 5.00 x .21 = 1.05 in value from the present 2.69 to 3.74, an increase of 39% in value on the five dollar price move of the underlying stock. (Location 1360)
Note that the CALL bought has an intrinsic value (ITM value) of 2.63 (127.63 minus the strike of 125); the remainder of the premium is extrinsic value, the time value and value due to implied volatility (IV%). (Location 1371)
Managing the Long CALL position: You have choices. Most investors who buy CALLS do not hold them until expiration, nor do they (if they are ITM) exercise their right to buy the underlying at the strike price. Most investors will sell the CALL prior to the expiration date. If the value of the CALL has decreased sufficiently, the owner may choose to sell the CALL and take a loss. At any time prior to expiration , the owner of the CALL may sell it. (Location 1374)
When should a trader take the profits? The answer is: There is no ‘should point’, you must make your own rules, depending on many factors including but not limited to: your opinion of price movement of the underlying in the time left until expiration, the theta (time-decay), target price points that satisfy your goal on the trade, your aversion to risk, your money management plan, and sometimes your ability to closely monitor the trade. Some traders will put in a limit sell order GTC (good till cancelled), if they can’t monitor the trade closely or choose not to do so. Personally, when I have a 36% gain on the trade in a few days, I just shout ‘Thank You’ and take the money. I do know traders that commonly use a 25% or 50% point on their positions as a trigger to exit the trade and move on. Unlike straight stock trading, the option has a finite life. In this way they are like the expiration date on milk and something must be done with them.; they are not totally passive investments. (Location 1384)
When are my options automatically exercised? Short answer: If they are in-the-money at expiration, they will be exercised. (Location 1405)
How important is it to check the OI and volume of an option before trading it? (Location 1407)
Checking the real time bid/ask in any trade is a must; if those bid/ask gaps are wide, just putting in a market order is never a good idea. Until you gain some experience, you are better off not taking a lark on options that are thinly traded with low open interest – these are the flags of skewed option values since there is not enough OI and volume to present an efficient (fairly priced values) (Location 1410)
By the way, an option that is out-of-the-money will not be automatically exercised. If you sold an option and it is expiring OTM (worthless) for sure, you are not required to do anything; the premium has already been credited to your account and it stays there automatically. When do I need to use a market order when purchasing or selling options? If you are buying the option, a market order will fill at the ask-price. Conversely, if you are selling an option a market order will fill at the bid-price. Most traders use limit orders to fix the trade price, but using a market order when there is no wide gap in the bid/ask and (Location 1415)
volume is fast is just fine. (Location 1419)
Why do I need to look at the IV% of options before trading them? Using the IV% parameter can give you some idea of the value of trading a specific option. Generally speaking the higher the IV% the more value the market places on the time value and the volatility of the underlying. IV% values are comprised solely of time-value and the likelihood of the option gaining or losing value. If you are buying an option, check the IV% of nearby strikes in the same class; when compared to nearby options, if the IV% is relatively high – this indicates the market values the option more. (Location 1422)
The goal is to have both the IV% and price trends in favor of your trade. Trading solely on volatility is definitely a very advanced technique for experienced option traders. (Location 1430)
Which class (days until expiration) of option should I use? (Location 1433)
If you are buying a CALL to gain rise in the underlying, the options time-decay works against you, so it probably isn’t wise to use an options with a life of under 45 to 30 days. (Location 1434)
Since this is the same thing that could make buying a CALL cheap, a beginner might not yet understand that an option farther out in time (that cost more) would be a better play because its time-value decay is much slower. (Location 1437)
Which strike price should I use? (Location 1441)
You do a quick check and find the theoretical value (Theo Price) of the option is 1.35. You check the OI/volume and the IV% and compare it to the other options in the matrix in this class – and you feel that paying 1.35 would be a fair price. With a delta of .25, you see the option would likely increase in value by $25 for each 1.00 rise in the underlying XYZ share price. (Location 1443)
How much do you expect the impending (time scope) price move to be in magnitude? If the answer is- you expect about a 4.00 move up from 32.50 to the area of $36 to $40, then –with a delta of .25, you might expect your option to increase in value on a 4.00 move of (.25 x 4) about $100 per option. If you are buying the option to get leverage on your investment dollar, consider that buying 100 shares of the stock outright would cost you $3,250. The good news is that option only cost $135 (1.35), and you could get a profit of $100, a 75% profit. Since the option’s delta is .25, you can buy four of them (4 x $135) for $540 and the combined delta (the delta of the trade) is about 1.0, which means buying four of them will give you the same (potential) gains as owning 100 shares. (Location 1446)
What if I bought a CALL and have profits in the trade, but since it is still a long time until the options expires, I fear my profit could disappear? (Location 1456)
You can do a combination trade that is commonly called a vertical bull spread. When you own a CALL and want to lock-in at least some of the profit without exiting the trade completely, you simply keep the CALL and sell a higher strike CALL. (Location 1460)
If you own a stock and portend a price decline, one choice you have is to sell the stock. Another choice is to buy a PUT; as the price of the underlying goes down, the PUT increases in value. Profits of the long PUT may partially or fully offset losses you incur by being long (owning) the underlying stock- when they are used to hedge. (Location 1508)
No; the delta is .52; if the price goes down by 3.50 per share the PUT should increase in value by (delta x price change) .52 x 3.50 x 100 shares = $182, while the stock value decreases 100 x 3.5 = $350. This only covers 52% of your losses due to the stock price decline. Buying two of these PUTS would give you a delta near -1.04. (Location 1528)