Basics of Options

Posted on May 27th, 2011 admin No Comments

All stories should start at the beginning, so the option basics you should begin with are the definitions of terms that pervade all options trading.

Option Definition – An option is a right, but not an obligation, to buy or sell and underlying asset at a specific price and on or by a stated expiration date.

Call Option – A call options is the right, but not the obligation, to purchase an underlying futures contract at a specified price at a specified time.

Put Option – A put option is the right, but not the obligation, to sell an underlying futures contract at a specified price at a specified time.

Option Premium – The premium is the price you pay for the option. It represents the maximum risk you experience when you don’t exercise the option.

Strike Price – The predetermined price in the options contract at which the underlying asset is bought or sold.

At the Money –  An option is at the money when the strike price is close or equal to the current futures price.

In the Money – An option is in the money when the strike price is less than the market price of the underlying security.

Out of the Money –  The call option is out of the money when the strike price is higher than the market price of the underlying security. Puts are out of the money if the strike price is less than the market price of the underlying security.

Delta – A measure of the effect of change in the price of the underlying asset on the option’s premium. It represents the amount of the change in the price of an option for each move in the price of the underlying asset equal to one point.

Volatility – A measure of how fast and by how much prices of the underlying asset change. It is a measure of the rate of price fluctuations.

Common Misconceptions About Credit Spreads You Should Know

Posted on May 13th, 2011 admin No Comments

The options market has been very busy lately. The volume of options being trades is growing rapidly with more and more investors jumping in. And as the audience grows, so do the articles about how “risky”options trading is for beginners. And it’s completely true if you trade blindly, but there are 3 very common misconceptions about Credit Spreads in particular that I wanted to cover.

1) They Are Used For Day Trading

The most common misconception is the ignorant comparison to day trading. Day trading and Position trading with Credit Spreads are completely different. Unlike day trading, Credit Spreads derive their income from a low risk strategy.

Day trading however involves extreme intra-day risk, massive amounts of capital, nearly constant attention and huge commission costs. It can be extremely time consuming. On the other hand, many investors choose to use Credit Spreads as their primary income vehicle for any market.

2) You Will Get Rich Overnight

I don’t care what seminars you have been too or what books you have read, Credit Spread trading is income oriented and will not make you a millionaire overnight. It’s not a “Get Rich Quick” strategy and you had better understand that right now.

As Warren Buffett says:

Risk comes from not knowing what you are doing.

Learning any options trading strategy involves a certain amount of personal discipline and education. Once you grasp the basics of Credit Spreads you will have a very solid and consistent strategy in your trading arsenal.

3) Credit Spreads Are Only For “Professional” Floor Traders

The reality is this strategy is for anyone looking to make consistent income returns on their money minimized risk. Whether you are a professional or a beginning trader doesn’t matter to the market, so long as you know the in’s and out’s of the strategy. Great trades make money and bad ones lose money; regardless if you are a professional or not.

Actually, most traders use credit spreads because of the relatively low capital needed to start profiting. Unfortunately, many people never even get started because they think they need to have thousands of dollars saved up. This is a far more costly mistake.

The Covered Call Options Strategy

Posted on May 11th, 2011 admin No Comments

When the market is neutral to bullish on the underlying stock, the covered call is an options strategy that is used by investors. It is a classic strategy that is also called a Covered Buy Write or a Covered Call Writer.

This common strategy refers to a situation where the investor writes a call option contract and at the same time owns an equivalent number of shares of the underlying stock. It is when the underlying asset is bought at the same time as the call contract is written that the strategy is called the Covered Buy Write or “buy-write.”  When the investor already owns the stock and then buys call contracts then the strategy is called an “overwrite.”

Generate Monthly Income

This options strategy is used by many beginning investors because it is fairly simple. It is also a strategy used to generate additional income or a monthly income through the sale of call options against the stock. The intent is that the covered call provides some protection against a short term fall in the price of a stock.

The true income comes from the fact the investor is able to keep the premium generated from writing the call. The investor also owns the underlying stock and is still earning dividends. Of course, if the written call is exercised the shares will have to be sold.

The covered call is used when the stock price is expected to be stagnant but the investor still wants to make monthly income from the stock. The covered call is also a good options strategy when the stock price is expected to experience a small price dip.

Easy to Implement

The covered call is easy to implement. You would write 1 contract for out-of-the-money call options for the standard unit of 1000 shares of the underlying stock. There are 3 ways the order can be placed.

You can write the out-of-the money call option at the same time you buy the stock. Another option is to buy the stock after the contracts have been written and you expect the stock to rise a bit in the near future. In that case the stock is bought to hedge against the increase in the stock price.

The third option is to write the options contract on stock you already own. This protects the stock that you expect to fall a bit in price in the near future.

The profit that is earned at expiration if assigned is equal to the premium plus the difference between the stock purchase price and the strike price.  The profit that is earned if the expiration is not assigned is equal to the stock value increase plus the premium received.

The most profit that can be made is when is the price of the underlying stock is at least equal to or above the strike price of the call option. You can lose money if the price of the underlying shares falls as the written call options expire. You can lose the difference in the stock price between the price you bought it at and the price it falls to by the call’s expiration and you can lose the premium received when you sold the call.

Covered Call

Posted on May 9th, 2011 admin No Comments

A covered call is an investment strategy that has to do with options. Options are a type of derivatives alongside futures contracts, forward contracts, swaps and benchmarks. Like all derivatives, they must have an underlying asset. Most common option underlying assets are stocks, in which case the options are stock options.

The attribute covered means the option is safe simply because one already own its underlying stock. This is opposed to naked calls, where the underlying stock is absent. Options can be of two types: call and put. Covered calls deal only with call options, which are rights sold to somebody against a premium. These rights entitle him or her to buy your stock at a pre-determined strike price. These rights may or may not be exercised within the agreed upon time period of the option, or at its end. The determining factor is stock value fluctuation.

If stock goes up, its value exceeding the strike price, the option buyer will exercise it, forcing you to sell your stock. In all other situations, the option will expire unexercised and you are left with the option premium as an income.

Best covered calls are designated depending on your outlook on the market. To begin with, you need to know the company that issued the underlying stock. You should avoid writing options for stock that is about to pay earnings before the expiration of the option, because that stock will likely appreciate a lot and you will end up selling expensive stock for little. Moreover, it is preferable to write short-term options, because this way you can reap more premiums for the same stock.

Options Trading and Technical Analysis

Posted on May 6th, 2011 admin No Comments

Recently, almost no options trading seminar is without some mention or introduction to technical analysis. In fact, almost all of the options trading blogs out there in the internet use technical analysis as their main basis of decision making. Why is that so? Why is options trading so closely related to technical analysis now?

In order to understand the important relationship between technical analysis and options trading, we need to first understand what technical analysis does in the first place.

There are two main methods of analysis; Fundamental Analysis and Technical Analysis.

Fundamental analysis is the reading of fundamental data of a company or economy in order to predict and invest in the future performance of the company or market. Such fundamental data includes profit and loss statements, earnings growth and earnings guidance. The problem with fundamental analysis is that great companies do not always make great stocks. Stocks of great companies also experience periods of downturn, often for extended periods of time. As such fundamental analysis helps an investor mostly in deciding what stocks to buy for the long term (5 to 10 years out), if nothing unpredictable happens to the company in the years down the road. In fact, fundamental analysis is a tool favorable by investors who buy stocks for their dividends and dividend growth.

Technical analysis is the studying of market data of a stock. Yes, while Fundamental Analysis is the study of a company, technical analysis studies its stock exclusively. Such market data includes the price across different time periods and volume transacted. From price and volume, options traders see how the price of a stock is doing no matter what the company data is doing. This helps traders and investors avoid those extended periods of downturn even though a company’s fundamental data looks great. Indeed, while fundamental analysis tells an investor which company is doing well, technical analysis tells an investor when it is time to buy or sell its stocks. Indeed, the strength of technical analysis is in its ability to guide the buying and selling decisions of investors across short time periods through price patterns and price trends.

So, why is technical analysis such a favorite in options trading?

Lets recall that fundamental analysis is favorable for long term investing and technical analysis is favorable for use even in short time periods. Stock traders can hold stocks forever but options expire after a fixed time! Yes, options typically last no more than a year and options traders frequently use options trading strategies that require extremely short outlooks in terms of months or weeks. This is exactly why technical analysis is so closely associated with options trading. Options traders simply do not have the luxury to hold a position for years like stock traders do. On top of that, options traders do not receive dividends like stock investors do. The only way to make money in options trading is for the expected outlook to play out within the expiration period of the options. This makes the fundamental strength of the company it is based on relatively unimportant. On top of that, options traders are able to profit when stocks drop as well. This also makes identifying good companies through fundamental analysis relatively unimportant.

Indeed, reading price trends and price patterns that might show the direction a stock is moving the next week or month has more value to options trading than reading a company profit and loss statement that does not tell you where its stock may be going for the short term at all.

I hope my short article explains why technical analysis and options trading are so closely related and that it will help you better understand the big lack of fundamental analysis whenever the subject of options trading is raised.

Covered calls a popular strategy

Posted on May 4th, 2011 admin No Comments

The sharemarket offers investors various ways of making money. A popular approach is to buy shares with the expectation of a price increase that will deliver a capital profit.

If you already own shares, many will pay dividends that may be enhanced by tax credits under the dividend imputation system. A third source of income for more sophisticated investors who also own shares is via exchange traded options.

Exchange traded options are investments that are offered in parcels of generally 1000 shares over the most prominent companies listed on the stock exchange like the major miners and the big banks. Investors who own such parcels can use them to make extra income through an options strategy described as a covered call.

A covered call is a strategy where investors offer to sell options against the shares they own for the premium income an option buyer is prepared to pay. What attracts the option buyer is the right to acquire the shares for a predetermined price over a certain period of time – say anytime over the next three months. The terms of the transaction are set down in the options contract.

While the premium income that gives the option buyer the right to acquire the share may often be only a modest amount, say 1 to 3 per cent of the contract value, as far as the option seller is concerned it’s a low risk way to earn some extra income.

Most option sellers embark on the strategy with the expectation the share price movement for the period they are willing to sell their shares under an option arrangement will be either neutral or only mildly bullish. This implies a low risk of the options being exercised.

There are good reasons for this. The last thing long term share owners want when offering covered calls is to have the options exercised and their shares called away. Such an event can have undesirable ramifications like capital gains tax implications if the shares are profitable. And if the shares happen to be coming up for a dividend payment, a buyer deciding to exercise the options before the ex-dividend date will cost the investor the dividend plus any franking credit entitlements.

For these reasons options sellers will often set the prices for which they are willing to sell their shares at between 5 to 10 per cent above the current market price.

According to James Staltari of Westpac Online Investing the start of 2011 has seen an increase in the popularity of the covered call strategy. Driving this has been investors observing that many shares have begun the year trading in defined ranges with low expectations in the immediate future they will rise through the levels that could see them being exercised.

As an example, investors who owned parcels of 1000 BHP Billiton shares trading at around $44.50 each late last week were setting levels of $48 at which they would be willing to have their shares called away over a three month period up to the end of March.

In exchange for granting option buyers this right – at a price that was 8 per cent above the market price – they were collecting premium income of around 48c per option or $480 for 1000 options. This income matched the most recent dividend paid by BHP.

Staltari said investors who offer their shares under a covered call strategy need to be aware that a sharp increase in the share price could see option buyers acquiring the shares, which they will do if it is worth their while. Of course any buyer will have to pay the price set under the contract, for example $48 per share plus the premium they paid to acquire the options.

Source: SMH

What I love about Options Trading

Posted on April 29th, 2011 admin No Comments

If you are executing market neutral strategies, which forms the core of many income options traders’ trading approach:

1. If the market goes nowhere you should make really good money.

2. If the market trends mildly up you should make very good money.

3. If the market trends mildly down, you should make very good money.

4. If the market whipsaws, you CAN make money but it’s tougher.

5. If the market trends really hard in either direction, it will be tough, but possible to make money.

6. If the market melts down, or “melts up” you will probably lose money.

If you are trading a strategy based upon your directional bias, and this is the part that most people find really interesting:

1. If you are right you can make really good money.

2. If the market goes nowhere, you can make very good money.

3. If you picked the wrong direction, you can still make very good money, as long as you were not TOO wrong.

4. If you are REALLY wrong, you will struggle, and probably lose money, but, if you are really good, or lucky, or both, you might eek out a small profit, breakeven, or just get dented a little bit.

Options Trading Technique for Novice Options Trader

Posted on April 22nd, 2011 admin No Comments

These are few secrets to successful options trading that every trader must consider.

1.Realize your Current Trading Requirements

One of the most effective reasons why most traders prefer options trading is its single way of trading. If you could possibly overcome your inner thoughts and still have time to trade daytime, you can opt to day trade or momentum trade options. Nevertheless, you might pick swing trade options if you want to put something on a trade then sell it few days or weeks after for a higher price. Another one to try is position trading for mathematically inclined traders wherein you would like to be placed for predictable income that has been predetermined.

They are the four major traditions to trade options: day trading, momentum trading, swing trading and position trading. It is best that you decide on the most appropriate method to follow that involves much of your interest and time.

2.Recognize your Preferred Technique

Regardless of what strategy you decide to practice, you still have to completely comprehend the process, the positive and negative side as well as its risk profile. The factors concerning this are its maximum loss, profit and market conditions. Understanding an options technique is most likely about calculations and how you might respond to all probable results of the strategy that you used. It is always suggested to paper trade prior to your decision on trading live so that you could be able to learn all its pros and cons to avoid losing big amount of money later on.

3.Select the Right Investment

Fundamental analysis and technical analysis are important to succeed in options trading. Being a time responsive tool, technical analysis plays an important role to detect the accurate entry and exit points. Likewise, choosing the right stock with the right options strategy is necessary. Since every options trading technique or strategy produces revenue once the underlying stock performs in a positive way, otherwise it losses money.

4.Risk Management

Regardless of what approach you use in options trading, there will always be possibility for losing profits. In limited risk, you can only lose a fixed amount of money while unlimited risk can result to losing enough that could be able to break your account. Whether you have chosen to stick out with limited or unlimited risk, knowing how to manage your portfolio risk is still unsafe to meet up your long-standing success in options trading.

5.Market Revenue Having Strategy

Getting to know the proper application of options strategy with precise risk management technique for the right stock is definitely a winning piece. Having the skills to determine how you can perform well and combat potential mistakes along your way is significant to withstand every market conditions.

The world trading offers many opportunities and our ability to succeed depends upon how we took the chance to learn and evolve. We should not restrict ourselves to the knowledge of stock trading basics because great financial freedom can be achieved. Through affordable trading education and dedicated effort to learn effective techniques and strategies, it is possible for traders to have withstanding and long term trading success.

Bought Strangles – Strategy Risks

Posted on October 12th, 2010 admin No Comments

The main risk to the bought strangle strategy is the same risk that bought options have. The risks are time decay, volatility decreasing and the share price not moving. The main risk is the share price not moving and the share price expiring between the bought call and put strike prices. If the share price does not move time decay will reduce the value of the bought strangle. Time decay works against the bought strangle as there are two bought option positions. Also if the share price has not moved volatility would have decreased. When volatility decreases the option values decrease and the bought strangle will lose value.

A risk of trading strangles with fundamental factors can be high. The main risk to be aware of is volatility. When share have trading announcements the volatility is often high before the announcement due to the uncertainty and decrease after the announcement. This can mean even if the share price moves the options values may not of increase in value due to the decrease in option volatility.

To receive ASX Option Recommendations or to learn more about straddles and strangles please request the complete Straddles and Strangles eBook by contacting us on 1300 368 316 or info@totaloptions.com.au

Bought Strangles: Options Pay-off

Posted on March 24th, 2010 admin No Comments

A bought strangle is made up of a bought call option and a bought put option. Combine these two trades together and if there is a different exercise price you have a strangle. A bought strangle pay-off is demonstrated below.

Bought Call Bought Put
Bought Strangle


To receive ASX Option Recommendations or to learn more about straddles and strangles please request the complete Straddles and Strangles eBook by contacting us on 1300 368 316 or info@totaloptions.com.au