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Found 8 results

  1. Michael C. Thomsett

    Options and Invisible Risks

    The "greed and panic" factor is not unique to options trading. Everyone who has bought stock and lost a big segment of capital knows all about it. The price moves rapidly up so you buy more, and then it all evaporates when the price reverses. Or the price moves down and you panic and get out just before prices rebound. It's the old "buy high and sell low" strategy, when we all should be buying low and selling high. With options, the tendency is the same even while the product is different. Some traders forget that today's price of anything is just the latest in an unending series of price swings. It is not a starting point or the ending point of value, and despite the best intentions, price does not move in the direction we want only because a trade has been opened. Options traders, like everyone else in the market, is vulnerable to wishful thinking. The first step in overcoming this all too human tendency is awareness. Deciding when to enter should rely on several attributes. These include volatility as well as skillful chart reading and recognition of emerging patterns, notably reversal patterns. It also relies on a study of fundamentals and knowing how those affect the technical side. Once in a position, decide when to exit. Set goals for yourself so you know when the timing is right to take profits and move to the next trade. Your goal should set a profit target based either on dollar amount or percentage of return; also set a loss bail-out point, where you will get out of a losing trade to minimize net losses. You're better off booking a small loss than a total loss a few weeks later. This is not as easy to follow through, but it's important to increase overall profits. Succeeding with setting goals and following them is tough, but worth the effort. The key to effective use of options is to use them to manage and hedge risk, not to replace one risk with another one - especially when the new risk is based on greed and panic rather than on trend watching and logical analysis. As the old adage reminds us, bulls and bears can both succeed in the markets, but pigs and chickens get slaughtered. So if you are most interested in low-risk trading, a quick and easy solution is to know your markets. This ultimately may be the secret to success in options trading. Knowing when to act, either on entry or exit, and also being able to follow through on profit and bail-out points, overcomes the tendency to demand either triple-digit profits or complete losses, and settle for nothing else. The true contrarian succeeds in trading options. This often misunderstood method is not merely doing the opposite of the market crowd; it is an observation of motive. Most traders act and react emotionally. The contrarian uses cold calculation and analysis, resisting the emotional urges of greed and panic. The contrarian must apply strong discipline to go against the majority, remembering one crucial point: The majority is wrong more often than not. Michael C. Thomsett is a widely published author with over 80 business and investing books, including the best-selling Getting Started in Options, coming out in its 10th edition later this year. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on his website at Thomsett Guide as well as on Seeking Alpha, LinkedIn, Twitter and Facebook.
  2. Jacob Mintz

    Options Trading Matrix

    And in sideways markets you can make money selling straddles, strangles and iron condors. And there are many more strategies to make money in any market. Below is my Options Trading Matrix which breaks these strategies into Bullish, Bearish, Long Volatility and Short Volatility categories. For beginner options traders I recommend sticking to three core strategies that can make money in any market condition. These are buying calls in a bull market, buying puts in a bear market and selling volatility via a buy-write/covered call. Here is the breakdown on buying Calls: A call purchase is used when a rise in the price of the underlying asset is expected. This strategy is the purchase of a call at a specific strike price with unlimited potential for profits. The maximum loss on this trade is the amount of premium paid. For example, the purchase of the XYZ 100 strike call for $1 would only risk the $1 paid. If the stock were to close at $100 or below at expiration, that call purchase would be worthless. If the stock were to go above $101, the holder of this call would make $100 per contract purchased per point above $101. For the immediate level options trader buying calls, buying puts and buy-write/covered calls should also be used, along with bull call spreads, bull put spreads, bear call spreads, bear put spreads, put-writes and iron condors. Here is my breakdown of an Iron Condor: The Iron Condor position is the combination of a bear call spread and a bull put spread in the same underlying. It’s a strategy that’s a high probability trade, allowing for a modest profit with enough room for error. Also, it’s meant to be a directionally neutral trade, used when volatility is elevated in relation to its forecasted range. It’s my favorite volatility selling strategy. By selling a call spread and a put spread, you gain extra short volatility and decay, while at the same time limiting your risk. Here’s the hypothetical call spread: Stock XYZ is trading at 90. You’d theoretically sell the 100/105 bear call spread for $1. To execute this trade, you would: Sell the 100 calls Buy the 105 calls For a total credit of $1. Here is the graph of this trade at expiration. Here’s the hypothetical put spread: Stock XYZ is trading at 90. You’d sell the 85/80 put spread for $1. To execute this trade you would: Sell the 85 Puts Buy the 80 Puts For a total credit of $1. Here is the graph of this trade at expiration: Now we will combine these two spreads to make an Iron Condor: To do this, you simultaneously: Sell the 100 calls Buy the 105 calls For a total credit of $1. And Sell the 85 Puts Buy the 80 Puts For a total credit of $1. This would give you a total credit of $2. Here is the graph of this trade at expiration: As you can see in the chart, at expiration, you’d make $2 as long as the stock stays between 85 and 100. Meanwhile, your downside is limited to $3 if the stock goes lower than 80 or higher than 105. And for the professional trader, every strategy listed in the options strategy matrix above can be used to profit in any market conditions. To learn more about these strategies and Cabot Options Trader where I use these strategies to create profits in any market visit Jacob Mintz or optionsace.com where I teach and mentor options traders. Your guide to successful options trading, Jacob Mintz
  3. SJosephBurns

    40 Steps In The Trader’s Journey

    We accumulate information, we learn- buying books, asking questions, maybe going to seminars and researching what really works in trading. We begin to trade with our ‘new’ found knowledge. We make profits only to give it back very quickly and then realize we may need more knowledge or information. We accumulate more information. We switch the stocks we are currently following and trading. We go back into the market and trade with our improved system. this time it will work. We lose even more money and begin to lose confidence that we can even be traders. The reality of losing money sets in. We start to listen to other traders and what works for them. We go back into the market and continue to lose more money. We completely switch our style and method. We search for more information. We go back into the market and start to see a little progress. We get ‘over-confident’ in a single trade and put on a big position believing it is a sure thing and the market quickly takes our money. We start to understand that trading successfully is going to take more time and more knowledge than we ever anticipated. MOST PEOPLE WILL GIVE UP AT THIS POINT, AS THEY REALIZE REAL WORK IS INVOLVED AND THAT THIS IS NOT EASY MONEY. We get serious and start concentrating on learning a ‘real’ methodology. We trade our methodology with some success, but realize that something is missing. We begin to understand the need for having rules to apply our methodology. We take a sabbatical from trading to develop and research our trading rules. We start trading again, this time with rules and find some success, but over all we still hesitate when we execute. We add, subtract and modify rules as we see a need to be more proficient with our rules. We feel we are very close to crossing that threshold of successful trading. We start to take responsibility for our trading results as we understand that our success is based on our ability to execute our methodology. We continue to trade and become more proficient with our methodology and our rules. As we trade we still have a tendency to violate our rules and our results are still erratic. We know we are close. We go back and research our rules. We build the confidence in our rules and go back into the market and trade. Our trading results are getting better, but we are still hesitating in executing our rules. We now see the importance of following our rules as we see the results of our trades when we don’t follow the rules. We begin to see that our lack of success is within us (a lack of discipline in following the rules because of some kind of fear) and we begin to work on knowing ourselves better. We continue to trade and the market teaches us more and more about ourselves. We master our methodology and our trading rules. We begin to consistently make money. We get a little over-confident and the market humbles us. We continue to learn our lessons. We learn smaller positions lower the volume of our emotions so we trade smaller and this surprisingly makes us better with our discipline. We learn that risk management is one of the biggest keys to winning as a trader, we start to understand that big losses will make us unprofitable so we finally trade a smaller and consistent position size. We stop thinking and allow our rules to trade for us (trading becomes boring, but successful) and our trading account continues to grow as we increase our position size only as our account grows. We are making more money than we ever dreamed possible. We go on with our lives and accomplish many of the goals we had always dreamed of. Money is our new tool to do what we have always wanted. Steve Burns has been investing in the stock market successfully for over 20 years and has been an active trader for over 14 years. Steve developed eCourses and wrote books to help beginning traders survive their first year in the markets. Read this and more from Steve on his blog NewTraderU. The original article was published here.
  4. Today I'm going to expose 10 common myths about options trading. Myth #1: It's easy to make money with options. I see too many "gurus" promise to make you money with no effort, charging thousands of dollars in the process. They present some of the highest risk strategies (like trading weekly options) as "low or no risk". The truth is that learning how to trade and invest successfully requires a lifetime of work, dedication, and focus. Not only is there a long and difficult learning curve just to learn the basic fundamentals, but you'll soon discover that being a student of the markets never ends. To become an engineer you have to study 4 years, and probably another 4 years (at least) to become a good one. Why people expect it to be different in trading? Myth #2: Trading Options is only for Professionals. Options were always a tool available to investors, but they were not as widely adopted because there was no supporting technology to help the industry. Then came the first online trading platform which brought the trading technology the pros were using to the general public. Since then, technology has improved exponentially and retail trading has started to be adopted by the masses. What was true maybe 10-15 years, is not true today, due to technology changes, reduced broker commissions etc. Myth #3: The only way to trade options is buying calls or puts. This is a very common misconception. While it is true that buying calls or puts can be very profitable, it is also a more risky way to trade. When you buy calls or puts, you have to be right three times: on the direction of the move, size of the move and timing of the move. The underlying has to move in the right direction, and fast. You can predict the direction and the size of the move right, but if the move happens after the options expired, you lose money. Even if everything works in your favor, but Implied Volatility collapses (after earnings for example) you might still lose money. Myth #4: Options are for speculation only. The truth is that options can be used in many ways. They can be used for speculation, but also for hedging, protection, insurance policy, income etc. For example: An investor who is long a stock but is concerned about short term volatility, can buy protective puts to hedge his investment. An investor who believes the market will be trading in a range, can trade range of income producing stratgies, like iron condors, calendars etc. An investor who wants to buy a stock at discount can use a naked put strategy. Myth #5: 90% of options expire worthless. According to The Chicago Board Options Exchange (CBOE) here are the facts: Approximately 10% of options are exercised (The trader takes advantage of their right to buy or sell the stock). Around 55%-60% of option positions are closed prior to expiration. Approximately 30%-35% of options expire worthless. The CBOE goes on to point out that having an option expire worthless says nothing about the profitability of the strategy that it may have been part of. Multi-legged strategies can often require that one leg or more expire worthless although the strategy as a whole is profitable. If you are not a member yet, you can join our forum discussions for answers to all your options questions. Myth #6: Only options sellers make money. The truth is that both option buyers and sellers can profit from option trading. If only sellers made money, there would be no buyers. With no buyers there would be no market. While options selling does have an edge in many cases, it also exposes you to Negative Gamma. As Mark Wolfinger wrote in his article The Road Not Taken: "Premium buying is the less-traveled road, but it can be profitable for the well-prepared, disciplined trader. It doesn't mean it is better or worse than premium selling. It just means that there is more than one road to Rome." Myth #7: You should aim for at least 100% gain in each trade. Here are some questions you should ask: In order to make the 100%, how much do you risk? How much of your capital do you allocate for those positions? How much time do you give the trade to develop? It might be better (and in some cases also less risky) to aim booking many 10-15% winners in short period of time (few days) than one 100% winner that takes 6 months to develop. Myth #8: Selling naked options is very risky. Did you know that selling naked puts has the same P/L profile as selling covered calls? Yet most brokers allow traders to sell covered calls in their IRA accounts, but not naked puts? I find it extremely ignorant. An alarming number of financial professionals, including stockbrokers, financial planners and journalists are in position to educate the public about the many advantages to be gained from adopting naked put writing (and other option strategies), but fail to do so. Many public investors never bother to make the effort to learn about options once they hear negative statements from professional advisors. Writing naked put options is a significantly more conservative strategy and definitely less risky than simply buying and owning stocks. As such it deserves to be considered as an attractive investment alternative by millions of investors. Myth #9: Trade only with at least a 2:1 reward to risk ratio. The truth is that risk/reward is directly related to probability of success. Typically, good risk/reward = low probability of success and bad risk/reward = high probability of success. For example, when you sell a $10 wide credit spread for $1, you risk $9 to make $1, but such trade would usually have about 90% probability of success. So next time someone will ask you: "Would you risk $9 to make $1?" - consider the context. Yes, it is a terrible risk/reward, but considering high probability of success, this is not such a bad trade. It will likely be a winner most of the time - the big question is what you do in those cases it goes against you? At the same time, the answer to the question "Would you risk $1 to make $9?" is also not so obvious. It is an excellent risk/reward, but the probability to actually realize this reward is very low. In trading, there is always a trade-off. You will have to choose between a good risk-reward and a high probability of success. You cannot have both. Myth #10: Trading options is a zero-sum game. The truth is that options may be used as insurance policies. They can be used as risk management tools, not only trading vehicles. As Mark Wolfinger explains here: "If I buy a call option and earn a profit by selling at a higher price, there is no reason to believe that the seller took a loss corresponding to my gain. The seller may have hedged the play and earned an even larger profit than I did. I don’t see anything resembling a zero sum game in hedged options transactions. I understand that others see it as black and white: If one gained, the other lost. But that’s an oversimplification." Conclusions: There is more than one way to trade options. Position sizing is one of the most important elements of trading, especially options trading. Few small winners achieved with low risk might be better that one big winner achieved with higher risk. Selling naked options might be actually safer than trading a stock. What is really important is not an occasional 500% winner, but an overall trading plan. The key to success in options trading is using mix of diversified options trading strategies, like straddles, calendars, iron condors etc. In my opinion, you can rarely succeed in options trading by buying some cheap out of the money options and “hoping” for a big move. Related Articles: Are You EMOTIONALLY Ready To Lose? Why Retail Investors Lose Money In The Stock Market Are You Ready For The Learning Curve? Can you double your account every six months? If you are ready to start your journey AND make a long term commitment to be a student of the markets: Start Your Free Trial
  5. But one of my subscribers was wondering recently about who was on the losing end of these trades. Here was our conversation: Subscriber: “The Nutanix (NTNX) calls, this person that made the market in this particular instance had to lose a boatload of money! How is that cost covered?” Me: As a former market maker on the Chicago Board of Options Exchange I can tell you I was theoretically on the wrong end of many trades like this one. However, if I hedged the trade properly, there is a great chance that I would break even, or even make money on a trade like this. For example, assuming the Cabot subscriber bought 10 calls from me, the market maker, I would instantly hedge the trade. I could do this two ways. The first way is to buy NTNX stock. So if I sold 10 calls (bearish position) I might buy 500 shares (bullish position), which would leave my position net neutral. As the stock shot higher I would lose money on the call sale, but I would make money on the stock position. Or, instead of buying the stock, I might buy 10 other NTNX calls to hedge the position. Because of these hedges trading options, the loss for the market maker on such a call sale is not a forgone conclusion. Subscriber: “What or who is the market maker, some hedge fund or what? How does that entity make money? I assume they have to make money or there would be no sense in doing this, right?” Me: For 10 years I was that market maker on the CBOE, it was my job to make markets for you to trade on. In every trade, I was trying to make money on the spread between the bid and ask of an option. For example, if a call was worth $1, my market was $0.90 – $1.10. I would buy it for $0.90 and sell it for $1.10. So I would theoretically make $10 on every contract bought or sold. And I wanted to do this thousands of times a day. Think of me as a casino. I was taking the other side of your betting action, while collecting the “vig.” Nowadays it’s computers making those markets and trying to collect an edge. For example, let’s take a look at our AAXN trade: When we bought the call options, the market was $3.80 – $4.10. The option was probably worth $3.95. So when we paid $4.10 we overpaid. The market maker theoretically made $15 per contract we bought from him. So if I bought 100 calls from the market maker, he theoretically made $1,500 on that trade. When we sold the calls back out for a big profit the market was $11.30 – $11.60. Again, we gave up some edge selling it at $11.30 when it was likely worth $11.45. Subscriber: “Is there only one Market Maker for all of the brokerage houses?” Me: To be honest, I don’t know who the market makers are anymore. I’ve been off the trading floor for over five years. However, back in the day there were lots of small trading groups who had market makers on the floor as well as some big firms. For example, my trading firm was run by two trading floor veterans. They hired me right out of college to learn how to make markets. Once they felt I was ready to trade, they then put $100,000 in my account and took a percentage of my profits as I built up that account. They backed another five traders like myself to make markets. We were considered a small/medium-sized firm. (I would later join a much bigger trading firm to make markets electronically.) As the years passed, the computers took over, and the markets on trading options tightened. A market that used to be $0.90 – $1.10 became $0.98 – $1.02. My edge in being a market maker was disappearing. And because of that I left the trading floor. This is the case for most market makers. And because of that, when you buy a stock or option you are almost certainly trading with computers from large trading firms. Jacob is a professional options trader and editor of Cabot Options Trader. He is also the founder of OptionsAce.com, an options mentoring program for novice to experienced traders. Using his proprietary options scans, Jacob creates and manages positions in equities based on risk/reward and volatility expectations. Jacob developed his proprietary risk management system during his years as an options market maker on the Chicago Board of Options Exchange and at a top tier options trading company from 1999 - 2012. You can follow Jacob on Twitter. This article is used here with permission and originally appeared here.
  6. 1. Right to BUY or SELL Options give you the right to buy or sell an underlying security at specific price. You can buy and sell options on a variety of different underlying assets including stocks, futures, indices, commodities, Forex, Bonds etc. Today most assets have options. 2. Two Types of Options There are two types of Options: Calls and Puts. Call Option gives you the right to buy the underlying asset. Put Option gives you the right to sell the underlying asset. Generally speaking, you buy Call Option because you have Bullish Outlook and you buy Put Option when you have bearish outlook. Though there are only two types of options, when you factor in other characteristics of options, there are endless trading possibilities. 3. Options Symbols The OCC option symbol consists of 4 parts: Root symbol of the underlying stock or ETF, padded with spaces to 6 characters Expiration date, 6 digits in the format yymmdd Option type, either P or C, for put or call Strike price, as the price x 1000, front padded with 0s to 8 digits Examples: SPX 141122P00019500: This symbol represents a put on SPX, expiring on 11/22/2014, with a strike price of $19.50. LAMR 150117C00052500: This symbol represents a call on LAMR, expiring on 1/17/2015, with a strike price of $52.50. 4. Buying an Option If you buy an option, you are not obligated to buy the underlying instrument; you simply have the right to exercise the option. When you buy a Call Option, you have the right to BUY stocks at your option’s strike price. Similarly, when you buy a Put Option, you have the right to SELL stocks at your Option’s price. 5. Selling an Option If you sell a Call Option, you are obligated to deliver the underlying asset at the strike price at which the Call Option was sold if the buyer exercises his or her right to take delivery. If you sell a Put Option, you have to buy the underlying if exercised. Generally speaking, if you don’t take any action, your friendly broker will most likely do it for you if your Options are eligible for exercise. If you are not a member yet, you can join our forum discussions for answers to all your options questions. 6.Options have Limited Life Options are good for a specified period of time after which they expire and the option holder loses the right to buy or sell the underlying instrument at the specified price. This specified period is called “Expiration”. Options are available for variety of expiration timings such as Weekly, Monthly, Quarterly and much longer durations (known as LEAPs). 7. The Option Premium The price reflects a variety of factors including the option’s volatility, time left until expiration, and the price of the underlying asset. There are several Options Pricing Models that you can use to calculate theoretical Option Price by modeling various parameters. There is no fixed price for an Options. It is dynamic and will keep on changing with respect to time to expiration and other variables. 8. The Strike Price You can choose any price at which you would like to buy or sell underlying instrument. These prices are called Strike Price and Options are available in several Strike Prices at, far or near the current market price of the underlying instrument. 9. Buying Means Debit Options when BOUGHT are purchased at a DEBIT to the buyer. That is, the money is debited from your brokerage account. It’s exactly like Buying a stock. 10. Selling Means Credit You can sell an Option, without owning the shares. Options when SOLD are sold at a CREDIT to the seller. Money is added to the brokerage account. You can’t withdraw this money until the trade has been closed. Usually, this money is used to offset the margin required for selling the options. Related Articles: Understanding Option Trading Options Strategies: An Introduction Trading An Iron Condor: The Basics What Can You Do With An Option? Top 10 Options Strategies Want to join our winning team? Start Your Free Trial
  7. Here are some questions you should ask: In order to make the 100%, how much do you risk? How much of your capital do you allocate for those positions? How much time do you give the trade to develop? The first two questions are directly related to position sizing. Consider the 2% rule described in Dr. Alexander Elder's excellent book "Come Into My Trading Room". The 2% rule is to protect traders from any single terrible loss that can damage their accounts. With this rule traders risk only 2% of their capital on any single trades. This is for limiting loss to a small fraction of accounts. If you adapt the 2% rule and the risk in your trade is 50%, then you can allocate 4% of your account for that trade. If your risk is only 20%, then you can allocate 10% to that trade. So here is another question: Which one is better - one 100% winner which risked 50% and took one week to achieve or seven 10% winners which risked 20% and took one day each? If you followed the 2% rule and allocated 4% of your account to the first trade, it contributed 4% to your account. But you could allocate 10% to each of the seven 10% winners, so they contributed a full 7% to your account during the same week. Our trading strategy is based on consistent and steady gains with holding period of few days to few weeks. Those are not Home Runs, but most of our trades had very low risk, hence you could allocate 10-15% of your account to each trade. Make ten such trades each month with average return of 10% per trade, and your account is up 10% per month. Here are some conclusions: There is more than one way to trade options. Position sizing is one of the most important elements of trading, especially options trading. Few small winners achieved with low risk might be better that one big winner achieved with higher risk. What is really important is not an occasional 500% winner, but an overall trading plan. What really matters is the return on the overall account. Next time someone tells you how he made 500% in an options trade, please ask him the following questions: How many trades you make every month on average? How much do you allocate per trade? How much do you risk per trade? How many trades do you have open on any given time? What is the average duration of the trades? What is your winning ratio and average return per trade? What is an average monthly return on the whole account using your strategy? If you learn to ask the right questions, you can avoid the hype and properly evaluate an options strategy in context of the overall portfolio return. Want to learn more? Start Your Free Trial
  8. However, some critics who have never really participated in a financial market believe that the risk/reward structure and even the inherent strategies are effectively just as problematic as sitting down at a blackjack table or trying to pick sporting outcomes. The difference in general is actually fairly straightforward to define. Investing, or at least doing so responsibly, means a systematic and educated risk based on a thoroughly analyzed process and an expected outcome. By contrast, actual gambling refers to the act of randomly risking money on an outcome – theoretically with no true idea of what that outcome will be (though there are gambling activities that involve at least a degree of knowledge or skill). Put more simply, investors can rightly “expect” to come out on top based on their own analysis; gamblers merely “hope” to win. Despite this clear distinction, however, options are still treated by many as a form of gambling – perhaps in part because of a misunderstanding that options trading is in any way similar to binary options trading. This is a form of investing that actually does come quite close to resembling regular, chance-based gambling – which is why it’s also well on its way to being outlawed. Because trades are determined by outcomes that can essentially be manipulated by trading firms, binary options are dying out, with numerous firms either being shut down or subjected to strict regulations and penalties. As you likely know if you’re reading here, options trading works very differently from binary options trading. But it’s also important to understand, if you’re just now exploring the idea of options trading, how and why it is further from the idea of chance betting or gambling. Options expert JP Bennett may have put it best, saying that in options we target consistent winners, basically creating a diversified portfolio of options strategies to generate income. It is possible to “day-trade” options in a riskier fashion that more closely approximates gambling. But traditional options trading is more about having a strategic outlook and playing different investments against one another so as to increase the likelihood of a net capital gain. Looking at this style of investment from this point of view, it’s clear that it’s vastly different from binary options trading, and as such it is further from something that could justifiably be classified as a gamble. That’s not to say there are ever guarantees, nor that there is never risk. But this is a type of investment that involves a great deal of strategic thinking.