Options Theory and Trading E-Book

Ron Ianieri

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Trading Series
• Sprache: Englisch

Seitenzahl: 572

Veröffentlichungsjahr: 2009

Beschreibung

When used correctly, options can greatly enhance your profits. The leverage they provide allows small accounts to trade like big ones, without the normally associated risks. And, in times of financial turmoil, options can keep you from incurring catastrophic losses. There are many ways in which options can both protect your portfolio and help you profit--but in order to take advantage of these opportunities, you have to learn how to properly use options in your investment endeavors. As the cofounder and former chief options strategist for the Options University, and now as founder of ION Options, author Ron Ianieri is one of the most well-respected, and well-informed, individuals in this field. Over the course of his successful twenty-plus-year career in the options market, he has trained many professional traders, as well as numerous active investors. Now, with Options Theory and Trading, he shares his extensive experience with you. Based on a proven option-trading course created by Ianieri, which follows a logical step-by-step progression, this book opens with an in-depth explanation of option terms and theory in Part One--because learning the language and understanding the theory is the foundation upon which successful option strategies are built. Continuing along these lines, Ianieri takes the time to explore the unique risks and rewards of call and put options, and introduces you to the option pricing model, the "Greeks," and synthetic positions. In Part Two, Ianieri moves on to basic trading strategies involving stock and options, including the covered call/buy-write strategy, the covered put/sell-write strategy, the protective put strategy, the synthetic put/protective call strategy, and lastly, the collar strategy. In addition to this, you'll also discover the role of the "lean" in options trading and how to "roll" your position to establish a stream of income. While Ianieri demonstrates how well options function in unison with a stock position--enhancing potential gains, providing profit protection, and limiting the risk of the entire investment--he also examines how they can be even more effective when traded against each other. In Part Three, you'll gain an in-depth understanding of how to use vertical, diagonal, and time spreads in this way, and discover how straddles and strangles--which both feature the use of options in unison with one other--can help you achieve strong premium collection. Rounding out this detailed discussion of options is a close look at combination strategies. Part Four of Options Theory and Trading takes you through fully hedged strategies known as the Butterfly and the Condor, and offers practical advice on how and when to use them. In an environment of increasing volatility, there's great risk of market corrections endangering the capital of individual investors around the world. What you need to achieve long-term success in today's market is the right guidance. With Options Theory and Trading, you'll quickly discover how to use options to increase your portfolio's profit potential and reduce the risks you'll inevitably face.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Preface

Acknowledgements

PART I - Understanding Terms and Theory

CHAPTER 1 - Options Basics and Terms

CALLS AND PUTS

CLASSES AND SERIES

IN THE MONEY, OUT OF THE MONEY, AND AT THE MONEY

PREMIUM AND TIME DECAY

INTRINSIC VERSUS EXTRINSIC VALUE

VOLATILITY

CHAPTER 2 - Calls and Puts

CALL OPTIONS

PUT OPTIONS

CHAPTER 3 - Option Theory

OPTION PRICING MODELS

FUNDAMENTALS OF PRICING MODELS

TYPES OF PRICING MODELS

INPUTS OF THE OPTIONS PRICING MODEL

OUTPUTS OF THE PRICING MODEL

CHAPTER 4 - Option Theory and the Greeks

DELTA

GAMMA

VEGA

THETA

SECOND-TIER GREEKS

CHAPTER 5 - Synthetic Positions

DEFINING SYNTHETICS

SYNTHETIC STOCK

SYNTHETIC CALL

SYNTHETIC PUT

PART II - Basic Strategies

CHAPTER 6 - Introduction to Trading Strategies

DIRECTIONAL TRADING STRATEGIES

IN-THE-MONEY, OUT-OF-THE-MONEY, AND AT-THE-MONEY OPTIONS

LEVERAGE AND RISK

CHAPTER 7 - Covered Call/Buy-Write Strategy

FOUNDATIONS OF THE STRATEGY

PERFORMANCE IN DIFFERENT SCENARIOS

LEAN

ROLLING THE POSITION

EXAMPLES

COVERED CALL/BUY-WRITE SYNOPSIS

CHAPTER 8 - The Covered Put/Sell-Write Strategy

REVIEWING SELLING SHORT

FOUNDATIONS OF THE STRATEGY

PERFORMANCE IN DIFFERENT SCENARIOS

LEAN

ROLLING THE POSITION

EXAMPLES

COVERED PUT/SELL-WRITE SYNOPSIS

CHAPTER 9 - The Protective Put Strategy

FOUNDATIONS OF THE STRATEGY

PERFORMANCE IN DIFFERENT SCENARIOS

LEAN

WHEN TO USE THE PROTECTIVE PUT STRATEGY

EXAMPLES

PROTECTIVE PUT SYNOPSIS

CHAPTER 10 - The Synthetic Put/Protective Call Strategy

FOUNDATIONS OF THE STRATEGY

PERFORMANCE IN DIFFERENT SCENARIOS

LEAN

WHEN TO USE THE PROTECTIVE CALL STRATEGY

EXAMPLES

SYNTHETIC PUT SYNOPSIS

CHAPTER 11 - The Collar Strategy

FOUNDATIONS OF THE STRATEGY

PERFORMANCE IN DIFFERENT SCENARIOS

LEAN

EXAMPLES

COLLAR SYNOPSIS

PART III - Advanced Strategies: Spread Trading, Straddles, and Strangles

CHAPTER 12 - Vertical Spreads

CONSTRUCTION OF A VERTICAL SPREAD

VALUE AND THE VERTICAL SPREAD

SPREAD PRICES FLUCTUATE

FACTORS THAT AFFECT SPREAD PRICING

ROLLING THE POSITION

TIME DECAY AND VOLATILITY TRADING OPPORTUNITIES

AN IMAGINARY SPREAD SCENARIO

RECAP WITH SPECIAL INSIGHTS

EXAMPLES

BULL SPREAD SYNOPSIS

BEAR SPREAD SYNOPSIS

CHAPTER 13 - Time Spreads

CONSTRUCTION OF THE TIME SPREAD

BEHAVIOR OF THE SPREAD

EFFECTS OF STOCK PRICE ON THE TIME SPREAD

EFFECTS OF VOLATILITY ON THE TIME SPREAD

BUYER RISK AND REWARD

SELLER RISK AND REWARD

ROLLING THE POSITION

CONCLUDING THOUGHTS

EXAMPLES

TIME SPREAD SYNOPSIS

CHAPTER 14 - The Stock Replacement/ Covered Call Strategy (Diagonal Spread)

WHEN TO USE THE DIAGONAL SPREAD

ROLLING THE POSITION

CONCLUSION

CHAPTER 15 - Straddles

WHAT IS A STRADDLE?

STRADDLE SCENARIOS

HOW IT WORKS

FACTORS THAT AFFECT STRADDLE PRICES

RISKS AND REWARDS

BREAK-EVEN, MAXIMUM REWARD, AND MAXIMUM RISK

CONCLUSION

EXAMPLES

LONG STRADDLE SYNOPSIS

SHORT STRADDLE SYNOPSIS

CHAPTER 16 - Strangles

WHAT IS A STRANGLE?

STRANGLE SCENARIOS

HOW IT WORKS

FACTORS THAT AFFECT STRANGLE PRICES

RISKS AND REWARDS

BREAK-EVEN, MAXIMUM REWARD, AND MAXIMUM RISK

CONCLUSION

EXAMPLES

LONG STRANGLE SYNOPSIS

SHORT STRANGLE SYNOPSIS

PART IV - Combination Strategies

CHAPTER 17 - The Butterfly

CONSTRUCTING THE BUTTERFLY

WHY USE BUTTERFLIES?

BUTTERFLY AND SYNTHETIC POSITIONS

WHAT WILL A BUTTERFLY COST?

BUTTERFLY AND THE GREEKS

IRON BUTTERFLY

LONG IRON BUTTERFLY

USING THE BUTTERFLY

LONG BUTTERFLY SYNOPSIS

SHORT BUTTERFLY SYNOPSIS

CHAPTER 18 - The Condor

LONG CONDOR

SHORT CONDOR

WHY USE CONDORS?

HOW IT WORKS

CONDORS VERSUS BUTTERFLIES

CONDORS AND THE GREEKS

IRON CONDORS

HOW DO WE USE CONDORS?

LONG CONDOR SYNOPSIS

SHORT CONDOR SYNOPSIS

Conclusion

APPENDIX - Five Trading Sheets

About the Author

Index

Copyright © 2009 by Ron Ianieri. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data

Ianieri, Ron, 1964-

Options theory and trading : a step-by-step guide to control risk and generate profits / Ron Ianieri.

p. cm. - (Wiley trading series)

Includes index.

eISBN : 978-0-470-50289-1

1. Stock options. 2. Portfolio management. 3. Risk management. 4. Options (Finance) I. Title.

HG6042.I36 2009

332.63′2283-dc22

2009004113

To my family and friends

Preface

Over the last several years, more and more investors have taken on the responsibility of managing their own investments and retirement accounts. The numbers of those doing so is steadily increasing for a variety of reasons. Investing your own money is not an impossible task but requires a conscious commitment to that endeavor. Private investors can make profitable investment decisions if they are willing to dedicate the time and effort necessary to learn how to invest wisely.

Options Theory and Trading is designed to help you, as an investor, take a more proactive approach to managing your money and controlling your financial future. Its aim is to help you learn how to use options to protect your portfolio, manage risk, and enhance returns. Keep in mind that no one cares more about your money than you do. So it makes sense that you, more than anyone else, should know where your money is and how it is performing.

As diligent investors, we rely on research, analysis, and experience to turn the odds in our favor. Having access to the right information is often the key factor to an investor’s long-term success in the market. To be successful in any endeavor, you must know what to do, and how and when to do it.

My goal in Options Theory and Trading is to give you the key information needed to excel in the financial markets. I will discuss the ins and outs of options, and how they can significantly improve your returns and dramatically reduce risk. My job is to educate you in the field of option investing just as I have educated many professional traders and active private investors.

Options, when used smartly and correctly, can greatly enhance your profits. The leverage in options, again when used correctly, can help small accounts trade like big accounts without the normally associated risks. And in times of financial turmoil, when the markets are constantly trading down, options can keep you from catastrophic losses. Options are life insurance policies for your portfolio and, when used in a judicious manner, can be an investor’s best friend.

Used appropriately, options can serve as valuable additions to an investor’s arsenal of effective investment and hedging vehicles. A proper understanding of option strategies will completely change how you invest. That understanding will show you how to increase profits and reduce risk while limiting the amount of capital you put at stake.

As we move forward into a future where world economies are becoming more and more globalized, we are finding that the effects of one economy directly affect all. This results in an environment of increasing volatility in the financial markets and a greater risk of market corrections endangering the savings of individual investors around the world. Investors’ only hope for stabilizing the growth of their investments may well depend on their acceptance and use of options.

Over the course of my 20-plus years in the options market, I have read many books on options. Some have been general but oversimplified; others have been very specific but too technical. During those years, I have also trained many professional traders and, recently, many individual investors. I learned many valuable lessons about how people learn and how instructors teach. From those experiences, I have made some interesting observations concerning education in the field of options.

One observation is that many option instructors—by far the large majority I have encountered—have trouble being easy to understand and still completely thorough in the depth of their teachings. Easy to understand should not mean that important but difficult topics are omitted. It does mean that those difficult topics must be broken down into understandable pieces. That is what will happen in this book.

Another observation is that options are constantly taught backward. Option theory is taught last as an “advanced topic” while the strategies based on that theory are taught first. These topics should be taught the other way around. Logically, option theory should be, and needs to be, first in instruction . . . before the strategies. Option theory is the foundation on which strategies should be built. Those who do not understand the theory first never fully understand options. If you do not fully understand options, then you cannot truly understand the strategies based on options. And those who do not understand their positions in all market situations are not around for too long.

The topics of option theory are the cornerstones, the foundations of understanding an option. Having investors truly understand options and their uses is my goal. When investors understand options, they are able to select the optimal strategy on a consistent basis and to construct that strategy in the most cost-efficient way. Understanding options helps when things do not go the way you thought they would. Remember, we all have losing trades from time to time. Understanding options allows you to be in a position to cut losses quickly. Understanding will let you know where your risks are before you put on the trade and will give you the tools to counter those risks.

Options are a more sophisticated product than their underlying instruments, such as stocks. As they are more sophisticated, there are many more topics and concepts to master in order to use their power properly. With options, as with any other highly technical vehicle, a solid foundation is the key to understanding.

The ability to truly understand the options you are trading is critical to consistent profitability in all markets: up, down, and sideways. So, when I designed my option trading course for the professional floor trader, I built it in a way that forced students to learn in a logical step-by-step way. Individual investors also can use this method to understand options.

In this book, I present basic option theory and strategy in the same manner and specifically following the same order that I use in my options classes to retail and professional traders, As you move through the book, a logical progression of topics will become evident. This logical progression will enable you to learn in a way that leads to a quicker understanding of options and, in turn, quicker understanding in your option use. I know many people who trade options. Some win, but many lose. Those who truly understand options are those who win, making money consistently and with less risk.

Having said all that, let me add a caveat. Understand that just reading this one book will not make you an expert. Just as you cannot read one book on golf and expect to be in a class with Tiger Woods or any pro, reading my book is by no means the end of your learning process. In fact, it is my hope that this is just the beginning of your option education. Options Theory and Trading should provide a strong foundation for your understanding of options. But you will need to read more, take classes, practice paper trading, and continue your education; in other words, you must take the steps necessary to be proficient not just in understanding options but in using them to safeguard your financial future.

Acknowledgments

To Think or Swim (www.thinkorswim.com), for allowing me to use their charts and graphs to illustrate this book.

To my friend John Person of nationalfutures.com, for the inspiration and gentle kick in the butt I needed to get this book started.

To John Wiley & Sons, especially Meg Freeborn and Kevin Commins, who made my next-to-impossible transition from trader to author as smooth as possible, considering who they had to work with: me. One book down, two more to go. Thanks, guys.

To my partner and friend Brett Fogle, in appreciation for the tireless hours of work and personal sacrifices it took to make the dream a reality.

To my parents, in appreciation of the love, support, and encouragement they have given me not only through this process but through life itself . . . not to mention the tireless hours of editing and proofing. Thanks, Mom and Dad.

To my son Christopher, who sacrificed potential quality time with his dad during the time it mattered most without a whimper or complaint. I could never ask for a better son than you. I am proud and honored to be your father.

Finally, and most especially, to my wife, Sherry, whose undying and unwavering love, loyalty, devotion, and friendship made this book and everything else that’s good in my life possible. When no one else believed in me, you did. You deserve much better than me. I hope to live up to all you deserve in a husband and a friend.

PART I

Understanding Terms and Theory

As with any field of study, an understanding of the vocabulary and special terms used is essential. Options use a special language. Specific terms that you should master are noted in italics. Learning the language of options is the first step in learning how to use them.

Continuing the development of our foundation toward option understanding, we devote time to the study of the two types of options, the call and the put, and their unique risk/rewards for the investor.

From there, we move on to option theory with special emphasis on the pricing model, the Greeks, and synthetic positions.

The pricing model gives you an overview of those components that contribute to the price of options; the Greeks provide the tools necessary to manage risk; and the synthetic positions set the groundwork for the versatility of option use.

CHAPTER 1

Options Basics and Terms

An option is a traded security that is a derivative product, a product whose value is based on or derived from the price of something else. A stock option is based on, among other things, the price of the underlying stock. Options also exist on other traded securities, such as currencies, commodities, bonds, indexes, and interest rates.

A distinguishing factor of an option is that it is a depreciating asset; that is, it has a limited life. It has to be used before the date on which it expires. As time goes by, the option loses value as it moves closer to its expiration date.

When we speak of options in terms of volume, we refer to contracts. Each stock option contract is equivalent to 100 shares of stock. When we talk about two contracts, we are talking about 200 shares; 10 contracts, 1,000 shares; 75 contracts, 7,500 shares; and so on.

It is important to understand the dollar cost of options before actually trading them. When an option is quoted at $1.00 per contract, the investor must realize that the $1.00 represents a price of $1.00 per share, not per contract. Remember that each contract represents 100 shares. This means that if you buy one option contract at a quoted price of $1.00, your total cost would be $100.00 (1 contract × $1.00 per share × 100 shares per contract). If you buy 10 contracts for $1.00 per contract, your total cost will be $1,000.00. Use the following formula when calculating total dollar cost of the option, and review Table 1.1.

TABLE 1.1 Option Dollar Costs ($1.00 Quoted Price of Option)

Option contracts are literally a sales agreement between two parties. The two parties are the buyer (or holder) and the seller (or writer). When you buy an option contract, you are considered long the option. When you sell an option contract, you are considered short the option. This, of course, is assuming you have no previous position in that option.

In an option contract, although it seems as if the buyer and seller must be tied together, they are not. You see, the buyer doesn’t really buy from the seller and the seller doesn’t really sell to the buyer. In reality, an organization called the Options Clearing Corporation (OCC) steps in between the two sides. The OCC buys from the seller and sells to the buyer. This makes the OCC neutral, and it allows both the buyer and the seller to trade out of a position without involving the other party.