TRADING IN OPTIONS
Using Options to Make Money
by Dr. Preston T. Bailey
Newton3Law@aol.com
Copyright © 2001 by Preston T. Bailey
WHAT ARE OPTIONS
An option is a derivative that uses leverage to bet on the future direction of a securities value.
THE PRICE OF OPTIONS
•ASK PRICE
The price at which a seller is offering to sell an option
•BID PRICE
The price at which a buyer is offering to buy an option
OPTION POSITIONS
•LONG POSITION
•SHORT POSITION
LONG POSITION
A long position has purchased the call or put option.
SHORT POSITION
The short sold a call or a put and is obliged to take a position in the underlying contract if the option is assigned for exercise
BLACK-SCHOLES MODEL
2 professors were awarded the Nobel Prize for economics in 1997 for developing this model for pricing options.
HOW TO TRADE OPTIONS
GET A COMPUTER
•Fast modem
•Plenty RAM memory
•Connect to the Internet through an ISP
•Have a backup system to preserve data
•Get charting software
GET OPTIONS SOFTWARE
•OPTIONS LABORATORY
www.manticsoft.com
•OPTION WIZARD
www.option-wizard.com
•OPTION SIMULATOR
www.bayoptions.com
•OPTION MASTER
www.options-inc.com
•OPTIONTRADER
www.austin-soft.com
•OPTIONORACLE
www.option-oracle.com
•OPTION VUE
www.optionvue.com
•OPTION PRO ON-LINE
www.essextrading.com
•OPTION STATION
www.omegaresearch.com
OPEN AN ONLINE ACCOUNT WITH A BROKER THAT TRADES OPTIONS
•www.etrade.com
•www.wallstreete.com
•www.wsaccess.com
•www.mrstock.com
•www.accutrade.com
•www.ameritrade.com
•www.preferredtrade.com
•www.edreyfus.com
•www.computel.com
•www.brownco.com
•www.eschwab.com
*www.preferredtrade.com
*www.datek.com
*www.interactivebroker.com
*www.cybertrade.com
DO YOUR RESEARCH ON WHAT STOCKS TO PICK
•Fundamental Analysis
•Technical Analysis
•Market Analysis
•Read "Characteristics and Risks of Standardized Options from the CBOE
FUNDAMENTAL ANALYSIS
•Earnings
•Sales
•Earnings
•Growth Rate
•EPS
•Valuation
•P/E ratio
•Accumulation/Distribution
•Analyst Ranking
•Sector Strength
•Relative Strength
•Timeliness Rate
•Institutional Ownership
•Visibility
•Insider Trading
TECHNICAL ANALYSIS
•Momentum
•RSI
•Stochastics
•Bollinger Bands
•Moving Average
•MACD
•Commodity Channel
MARKET ANALYSIS
•Fibonacci lines of retracement
•Lines of Support & Resistance
•Economic Factors
•Interest Rates
•Futures
•Leading World Events
MARKET WEBSITES:
•www.signalwatch.com
•
•www.parttimetrader.com
UNDERSTAND THE RISK
•Options have a high risk
•Approximately 80% of options expire worthless
•The value of options increases faster than the actual stock price
DECIDE WHAT SECURITY YOU WANT TO TRADE WITH OPTIONS
•Stocks
•Bonds
•Indexes
•Foreign Currency
•Futures
•Commodities
PICK AN EXCHANGE TO TRADE
•Chicago Board Options Exchange
•NASDAQ
*AMEX
•Pacific Stock Exchange
•Philadelphia Stock Exchange
•New York Stock Exchange
COMPONENTS OF AN OPTION
•The underlying security
•
•The type of option
•The strike price
•
•The expiration date
THE UNDERLYING SECURITY
•Stocks
•
•Bonds
•
•Futures
•
•Commodities
•Treasury Securities
•Foreign Currencies
•Market Indexes
CHOOSE WHAT OPTION YOU WANT TO PLAY
Play a CALL if you think it will go up
Play a PUT if you think it will go down
CALL
A call is the right, but not the obligation, to purchase 100 shares of stock at the strike price on or before the expiration date.
PUT
A put is the right, but not the obligation, to sell 100 shares of stock at the strike price on or before the expiration date.
CHOOSE A STRIKE PRICE
The price at which the option holder can buy or sell the underlying stock.
STRIKE PRICE CHOICES
•In the money
A call option is in the money when the strike price is less than the market price of the stock. A put option is in the money when the strike price is more than the current market price of the stock.
•
•At the money
Options are at the money when the strike price is equal to the current market price of the stock.
•
•Out of the money
A call option is out of the money when the strike price is greater than the current share price of the underlying security. A put option is out of the money when the strike price is less than the current market price of the stock.
PICK AN EXPIRATION DATE
This is the last day on which the buyer can exercise an option. If an option has not been exercised, it becomes worthless on the Saturday following the third Friday of the month for which the option was written.
THE VALUE OF AN OPTION
INTRINSIC VALUE
Intrinsic value reflects the amount by which an option is in the money.
TIME VALUE
Time value is the value an option has in addition to its intrinsic value. It reflects what a buyer is willing to pay for an option in anticipation of price increases in the stock before expiration. Before expiration, the time value is zero.
CHOOSE AN OPTION POSITION
OPTION SELLER or WRITER
He is the issuer of an options contract. The option writer is sometimes called the option seller.
OPTION BUYER
The option buyer is the investor who purchases the right specified in the options contract, which is usually the right, but not the obligation, to buy or sell 100 shares at a specified price within a specified period of time.
PREMIUM
The premium is the price that the buyer of an option pays the writer of the option.
PREMIUM VARIABLES
•Stock price
•Market volatility
•Time remaining to expiration
•Supply and demand in the options market
OPTIONS WEBSITES
•www.optionadvisor.com
•www.optionstrader.com
•www.optioninvestor.com
•www.optionscorner.com
CHOOSE AN OPTION STRATEGY
WRITING A COVERED CALL
The strategy of writing a call option while simultaneously owning an equal number of shares of the underlying stock
CALENDAR SPREAD
An option strategy in which a short-term option is sold and a longer-term option is bought both having the same striking price
COVERED PUT WRITING
This is a strategy in which an investor sells put options and simultaneously is short an equal number of shares of the underlying security.
STRADDLE
This is the purchase or sale of an equal number of puts and calls having the same terms
COVERED STRADDLE WRITING
This is the strategy in which an investor owns the underlying security and also writes a straddle on that security.
HORIZONTAL SPREAD
This is a strategy in which the options have the same striking price but different expiration dates
RATIO CALENDAR SPREAD
This is a strategy of selling more near-term options than longer-term ones purchased, all with the same strike price using either puts or calls
LEAPS
This is a term used to describe options whose maturity is longer than one year. It stands for Long-Term Equity Anticipation Securities.
SPREAD STRATEGY
Any option position having both long options and short options of the same type on the same underlying security
UNCOVERED OPTION
This is when the investor is considered to be uncovered if he does not have an offsetting position in the underlying security
VARIABLE RATIO WRITE
This is an option strategy in which the investor owns 100 shares of the underlying security and writes two call options against it, each option having a different striking price.
VERTICAL SPREAD
Any option spread strategy in which the options have different striking prices but the same expiration dates.
EXECUTE THE ORDER
•At-even order
•At-the-opening order
•Day order
•Fill-or-kill order
•GTC
•Immediate or cancel order
•Limit order
•Limit buy order
•Limit sell order
•Market order
•Market-on-open order
•Market-on-close order
•Market-if-touched order
•Stop limit order
•Market-if-touched buy order
•Market-if-touched sell order
•Stop order
Buy Stop
Sell Stop
KEEP ACCURATE RECORDS
•Maintain an option logbook for all trades
•Evaluate your trades
•Keep track of the taxes you owe
Copyright © 2001 by Preston T. Bailey
