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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
An easy-to-read and authoritative collection of strategies, tools, and resources for new and experienced options traders
In the newly revised fifth edition of Options Trading For Dummies, experienced finance writer, investor, and money manager, Joe Duarte, walks you through practical and actionable strategies for traders seeking to boost their income while keeping risk in check. The book explains the most common kinds of options contracts and helps you select the options most suited to your financial situation, capabilities, and goals. It also shows you exactly how to deploy options contracts to help reduce the risk associated with your trades.
This plain-English resource for both beginning and advanced traders demystifies the world of options contracts and how to trade them. You'll learn about index, equity, and ETF options, as well as how to incorporate technical analysis to create a solid trading strategy. You'll also find:
- Up-to-date info about covered calls, butterfly positions, and other return-enhancing techniques
- Strategies to protect your assets and avoid common mistakes and pitfalls experienced by many first-time traders
- Accessible explanations of the risk-reward structure of options trading
An exciting and easy-to-read resource for investors and traders at any skill level, Options Trading For Dummies is an insightful, comprehensive toolkit for anyone interested in using trading as a source of income.
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Seitenzahl: 699
Veröffentlichungsjahr: 2025
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Options Trading For Dummies®
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Table of Contents
Cover
Table of Contents
Title Page
Copyright
Introduction
About This Book
Foolish Assumptions
Icons Used in This Book
Beyond the Book
Where to Go from Here
Part 1: Getting Started with Options Trading
Chapter 1: Options Trading and You, the Individual Investor
Rewiring Your Thinking
Preparing to Trade: Take a Pre-Trading Flight Check
Understanding Options
Differentiating between Option Styles
Using Options in Challenging Markets
Chapter 2: Introducing Options
Digging Into Option Contracts
Valuing Options
Making Sense of Options Mechanics
Creating Option Contracts out of Thin Air
Keeping Some Tips in Mind
Chapter 3: Trading Places: Where the Action Happens
Identifying the U.S. Options Exchanges
Navigating the Markets
Weighing Option Costs and Benefits
Grasping Key Option Pricing Factors
Chapter 4: Identifying Option Risks and Rewards
Understanding Risks of Trading
Reaping Your Rewards
Visually Analyzing Risk and Reward
Part 2: Evaluating Markets, Sectors, and Strategies
Chapter 5: Looking Inside the Algo-Controlled Market
Considering a Few Words about Select Macro Factors
Assessing the Market’s (the Algos’) Bias
Watching Call and Put Extremes
Using Volatility to Measure Fear
Chapter 6: Sector Analysis: Technical and Fundamental
Getting Technical with Charts
Identifying Relatively Strong and Weak Sectors
Using Sector Volatility Tools
Projecting Prices for Trading
Chapter 7: Practicing Before You Swing
Monitoring Option Greek Changes
Making Sense of Paper Trading
Using Trading Systems
Mastering Your Strategies
Chapter 8: Designing a Killer Trading Plan
Developing a Reliable Plan
Getting Granular: Setting Up Accounts and Getting Paid
Managing Your Costs
Optimizing Order Execution
Part 3: What Every Trader Needs to Know About Options
Chapter 9: Getting to Know Different Option Styles
Delving Deeper into Index Options
Watching Out for Style Risk
Exercising Your Options, American Style
Exercising Your Options the Euro Way
Satisfying Option Obligations
Breaking It Down: American-Style Index Options
Chapter 10: Protecting Your Portfolio with Options
Protecting Long Stock
Limiting Short Stock Risk with Calls
Hedging Your Bets with Options
Avoiding Adjusted Option Risk
Chapter 11: Increasing Profit Potential and Decreasing Risk
Leveraging Assets to Reduce Risk
Combining Options to Reduce Risk
Chapter 12: Combination Strategies: Spreads and Other Twists and Turns
Combining Options with Stocks
Varying Vertical Spreads
Chapter 13: Understanding ETFs, Options, and Other Useful Tricks
Exploring the Exchange-Traded Fund
Reducing Portfolio Volatility with ETFs
Tilting Your Portfolio with Sector ETFs
Part 4: Advanced Strategies for Options Traders
Chapter 14: Making Money without Worrying About the Market’s Direction
Limiting Directional Risk
Examining a Neutral View versus a Neutral Position
Trading with Delta
Understanding Trade Adjustments
Chapter 15: Letting Volatility and Price Charts Show You the Way to Trading Opportunities
Analyzing Implied Volatility Levels
Understanding Ratio Spreads
Using Ratio Backspreads
Chapter 16: Trading Profitably When Markets Move Sideways
Identifying Winning Positions in Sideways Markets
Understanding Butterfly Positions
Understanding Condor Positions
Part 5: Part of Tens
Chapter 17: Ten Top Option Strategies
Married Put
Collar
Long Put Trader
LEAPS Call Investor
Diagonal Spread
Bear Call Credit Spread
Straddle
Call Ratio Backspread
Put Ratio Backspread
Long Put Butterfly
Chapter 18: Ten Dos and Don’ts in Options Trading
Do Focus on Managing Risk
Don’t Avoid Losses
Do Trade with Discipline
Don’t Expect to Remove Your Emotions
Do Have a Plan
Do Be Patient
Don’t Suffer from Analysis Paralysis
Do Take Responsibility for Your Results
Don’t Stop Learning
Do Love the Game
Index
About the Author
Connect with Dummies
End User License Agreement
List of Tables
Chapter 2
TABLE 2-1 Traditional Option Expirations by Cycle
Chapter 3
TABLE 3-1 Option Values for ABC Call and Put
Chapter 6
TABLE 6-1 Lining Up Probabilities
Chapter 7
TABLE 7-1 Advantages and Disadvantages of Paper Trading
Chapter 8
TABLE 8-1 Option Order Entry Process
TABLE 8-2 Order Types by Guarantee
Chapter 9
TABLE 9-1 Who Created Which Indexes
TABLE 9-2 Stock Option Expiration Summary
Chapter 10
TABLE 10-1 Put Option Chain Data for XYZ on Aug 22nd
TABLE 10-2 Put Short List for XYZ on Aug 22nd
TABLE 10-3 Theta Values for XYZ Oct 37.50 Put
TABLE 10-4 Bearish Positions for XYZ on Aug 22nd
TABLE 10-5 Put Option Chain Data for the OEX
Chapter 11
TABLE 11-1 Partial Option Chain for Alphabet with LEAPS
TABLE 11-2 Risk, Reward, and Breakeven for Vertical Debit Spreads
TABLE 11-3 Risk, Reward, and Breakeven for Vertical Credit Spreads
Chapter 13
TABLE 13-1 ETF Resources
TABLE 13-2 IV Rank and IV Percentage
TABLE 13-3 Relative Risk Levels
TABLE 13-4 Sector ETF List
Chapter 14
TABLE 14-1 Position Delta
Chapter 16
TABLE 16-1 Narrowing the Spread for Aug DIA Butterflies
TABLE 16-2 Widening the Spread for Aug DIA Butterflies
Chapter 17
TABLE 17-1 Married Put Summary
TABLE 17-2 Collar Summary
TABLE 17-3 Long Put Summary
TABLE 17-4 LEAPS Call Investor Summary
TABLE 17-5 Call Diagonal Spread Summary
TABLE 17-6 Bear Call Credit Spread Summary
TABLE 17-7 Straddle Summary
TABLE 17-8 Call Ratio Backspread Summary
TABLE 17-9 Put Ratio Backspread Summary
TABLE 17-10 Long Put Butterfly Summary
List of Illustrations
Chapter 4
FIGURE 4-1: Risk graph for a long stock position.
FIGURE 4-2: Risk graph for a short stock position.
FIGURE 4-3: Risk graph for a call option position.
FIGURE 4-4: Risk graph for a put option position.
FIGURE 4-5: Risk graph for a married put position.
Chapter 5
FIGURE 5-1: Daily Advance-Decline line with the S&P 500 – 20, 50, and 200 day m...
FIGURE 5-2: Daily SPY chart with P:C ratio.
FIGURE 5-3: Daily VIX (1/VIX) chart with SPX.
Chapter 6
FIGURE 6-1: Daily chart for XLF displaying performance relative to SPY.
FIGURE 6-2: Bollinger Bands.
FIGURE 6-3: SPY daily candlestick chart with AVR and SD.
FIGURE 6-4: XLI daily candlestick chart with ATR, SD, and RSI.
FIGURE 6-5: Six-year review of SPX with 200-day SMA, 2SD, 3SD, 4SD Bollinger Ba...
FIGURE 6-6: Dutch Bros (BROS) candlestick chart with multiple support and resis...
FIGURE 6-7: Dutch Bros (BROS) with trend lines and trend channels.
Chapter 7
FIGURE 7-1: Tracking price and time changes for option premiums.
FIGURE 7-2: Simple trading system featuring support resistance (VBP bars) and 5...
Chapter 10
FIGURE 10-1: Risk graph for a long stock-protective put position.
Chapter 11
FIGURE 11-1: Overlay risk graph for XYZ long stock and XYZ call option position...
FIGURE 11-2: Overlay risk graph for XYZ short stock and XYZ put option position...
FIGURE 11-3: D.R. Horton (DHI) August 2024-July 2025.
FIGURE 11-4: Risk graph for ABC Jan 35–40 bull call spread.
FIGURE 11-5: Risk graph for XYZ bear put spread.
FIGURE 11-6: Risk graph forbear call spread.
FIGURE 11-7: Risk graph for bull put spread.
Chapter 12
FIGURE 12-1: D.R. Horton (DHI) setup for selling cash covered puts.
FIGURE 12-2: Core & Main (CNM) setup for selling covered calls.
FIGURE 12-3: Risk graph for a long ABC stock with a collar.
FIGURE 12-4: AMD Bull Call Spread setup.
Chapter 13
FIGURE 13-1: Six-month chart for S&P 500 Futures.
FIGURE 13-2: Relationship between IV, HV, and price for SPY ETF.
FIGURE 13-3: Daily graph for SOX index.
Chapter 14
FIGURE 14-1: Straddle risk chart (long call + long put).
FIGURE 14-2: Daily bar chart for AMAT with volume and Bollinger Bands.
FIGURE 14-3: Price action of underlying MCK stock during put option trade.
Chapter 15
FIGURE 15-1: S&P 500 implied volatility (IV) and historical volatility.
FIGURE 15-2: SPY ETF in relationship to SPX.
FIGURE 15-3: Microsoft Corp. Seasonal HV/IV patterns.
FIGURE 15-4: Typical IV skew for XYZ.
FIGURE 15-5: Forward price skew (left) and reverse price skew (right) for XYZ.
FIGURE 15-6: Skew scan output table.
FIGURE 15-7: Risk graph for call ratio spread.
FIGURE 15-8: Risk graph for put ratio spread.
Chapter 16
FIGURE 16-1: Academy Outdoors (ASO) with Accumulation Distribution (ADI), On Ba...
FIGURE 16-2: Risk chart for call butterfly spread.
FIGURE 16-3: Risk chart for XYZ Aug 103-106-109 long put butterfly.
FIGURE 16-4: Risk chart for XYZ — iron butterfly.
FIGURE 16-5: Risk chart for XYZ iron condor.
Chapter 17
FIGURE 17-1: Married put risk profile.
FIGURE 17-2: Collar risk profile.
FIGURE 17-3: Long put risk profile.
FIGURE 17-4: Call diagonal spread risk profile.
FIGURE 17-5: Bear call credit spread risk profile.
FIGURE 17-6: Straddle risk profile.
FIGURE 17-7: Call ratio backspread risk profile.
FIGURE 17-8: Put ratio backspread risk profile.
FIGURE 17-9: Long put butterfly risk profile.
Guide
Cover
Table of Contents
Title Page
Copyright
Begin Reading
Index
About the Author
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Options Trading For Dummies®, 5thedition
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Introduction
Welcome to Options Trading For Dummies, 5th Edition!
If you asked me in 2006, when I wrote Options and Futures For Dummies, whether I’d be writing a 5th edition, I might have given you a blank stare in response. But here we are, thanks to you, the readers and supporters of this book. I can’t thank you or John Wiley & Sons enough for sticking with me for the last 20 years. And oh my! Have things changed since that first edition in the markets, the world, and even the title of the book.
In the 4th edition of Options Trading For Dummies, I focused on the effects of electronic algorithmic trading (algos) on the options market. Perhaps the most notable such effect is that on any given day, the volume of trading in options dwarfs the volume of trading in stocks. And while the influence of algos is now a structural (not likely to change anytime soon) component of the trading environment, outside the data centers where the trading action takes place, other structural changes are notable in the real world. Indeed, in the post-pandemic world the financial markets are a major source of income, both primary, and supplementary for many. In many instances, the markets have replaced the economy as the major drivers of significant policy changes. Consider that every time the market crashes, there are widely heard calls for a reduction of interest rates.
What you’re seeing is what seemed impossible 20 years ago; options trading, fueled by algos, may have become the primary catalyst in how the financial markets and the economy function as the price fluctuations in the options market work through the elaborately connected and highly complex system composed of the financial markets and the economy.
Thus, while the algos move money in and out of options and stocks, in the real world, their influence is felt throughout the employment landscape, which has morphed into a mix of work from home, side hustles, working multiple jobs in short periods of time, and the steady deployment of artificial intelligence (AI, algos). This dynamic has further changed the reliability of once reliable occupations in professional services, technology, and even traditional upscale professions such as health care, as AI can do the job of people (code new programs, analyze data, make schedules and appointments). The net effect is that more people than ever make ends meet via stock and options trading.
Yet, there is hope in this new world. Given that financial markets are a central cog in the way money works — becoming the primary source of income for many and leading the economy’s trend as the wealth effect from rising stock prices increase purchasing power and corporate earnings — those of us who trade options are in a sweet spot. Thus, this 5th edition will be a more hands-on, practical, and actionable trading manual for those who use the markets as a source of current income and for those who want to join the growing club.
This concept may sound daunting, but the reality is that the stock and options markets have become fertile pools of accessible funds for those who can trade. And this 5th edition, while maintaining the strong instructional content foundation of the past four editions, builds on the principles put forth in the 4th edition while transitioning to the next step, providing the tools to tap the easily accessible liquidity pool of the options markets as a steady and reliable source of income.
In turn, this income, rather than used to build long-term wealth, can be used for paying monthly bills such as car payments, groceries, and fuel. In other words, the goal of this book is to instruct the reader on using the options market as a tangible income producing vehicle, whether it is used as a side hustle or a primary profession.
Therefore, while maintaining its Dummies style and substance throughout and offering updates on trading techniques, figures, and price charts throughout, the 5th edition will feature significant revisions and updates throughout, but especially in the income-producing–related sections beginning with Chapter 1 — starting with the section titled “Rewiring your thinking” where the stated goal of “getting paid,” via low-risk steady gains rather than by hitting home runs, is emphasized — even as the other important aspects of options trading remain in place. This approach is enhanced and emphasized throughout the book, but is expanded further, especially in the latter part of the book, in Chapter 11 and beyond where the focus is on income production via the already present strategies.
One of the new features is the in-depth creation of a trading account designed solely as an income-producing vehicle. This account should be independent from 401(k) plans, IRAs, and other long-term investment vehicles and should operate with the goal of a periodic paycheck.
I also provide more granular examples of winning trades and emphasize the use of spreads and options writing strategies to produce income, while providing new income-producing strategies such as the Wheel Strategy where investors set up trades with the goal of being assigned (receiving the underlying stock in the trade at a lower price) and then use the newly acquired stock to generate income by writing covered call options. Moreover, I further expand the current content on other income generating strategies, especially using “naked” put options to reliably generate income.
Although this book is still about introducing you to option strategies for managing risk, delivering profits, and navigating a variety of market conditions, a lot has changed since the last edition. The new focus is on how you can enhance the presence of traditional income sources — jobs, side hustles, rental income, consulting — with options trading into an income stream which you can use to pay current bills in an inflationary environment.
Still, options trading is very different from stock trading, and while income is the primary goal, options trading should be balanced with risk management. Thus, I show you how to reduce potential losses from traditional stock positions and how to build an option strategy repertoire designed to increase your chances of making sound trades in up, down, and sideways markets.
Finally, an option contract is a unique security with both contract rights and obligations. This combination strikes a balance between the risk of loss, the amount of money you put at risk, and your potential reward, while using amplifying profit potential through leverage and margin, combined with risk management. Certainly, margin, the practice of trading with borrowed money, must be used judiciously. But don’t worry, I show you how to use margin safely.
When you apply for your options trading account, your broker sends you the Characteristics and Risks of Standardized Options, written by the Options Clearing Corporation (OCC), which describes option contract specifications, mechanics, and the risks associated with the security. Combine it with this book and you can understand your risks and use options effectively.
About This Book
This 5th edition means that this book has stood the test of time. Yet even better is the fact that I address the quirks and other technical matters in prior editions. Indeed, repetition is the key to proficiency, as the more you do anything, the better it gets. Still, don’t expect instant miracles. Options trading isn’t a simple task. Please, don’t get discouraged. After all, if options trading were too difficult, then why would so many people do it?
Moreover, unlike other books, this one is geared toward producing income. In addition, if you’re an experienced trader looking for something specific, feel free to jump around to areas that interest you most. Otherwise, if you’re a beginner, start at the front and work your way carefully through each chapter before you risk any money. If, as you read through the book, you find a strategy that’s particularly appealing, paper trade it and check it out fully before putting real money to work.
You can read this book cover to cover or use it as a reference guide, as the risks and rewards and implementation of every strategy listed is thoroughly reviewed. Just be patient as I give you all you need to succeed.
Foolish Assumptions
Unfortunately, some readers skip this section and complain in reviews. I read them. And I thank you because your reviews help me to make the next edition better. So, let me get this out now; you don’t need a math degree to trade options. I don’t have one and I’m the world’s worst calculus practitioner. So, I’m right there with you.
But if you don’t know much about options, you may find this topic challenging. And that’s not your fault, or mine. That’s just the way it is because, over time, they have been revamped by guys with PhDs and further altered via trading algos (bots). Thus, even though my goal is to simplify the topic, there is only so much I can do. So please be patient and stick with it. You’ll be glad when you start collecting your options paychecks.
Remember: I’m a dummy, too. But dummies can become options traders too as Dummies books are designed to make challenging topics such as options trading (and algebra and anatomy and the LSAT) easier to understand. By reading this section, you can see where I’m coming from. Here’s what I assume about you:
This isn’t your first rodeo.
Even if you’ve never traded options, I assume you trade stocks. You know that leverage increases risk and that options are leveraged financial instruments and are thus riskier than stocks. You also know that options trades can be structured to manage risk and that I cover option fundamentals and mechanics to help you manage the ins and outs of both risk management and income production.
You’re smart enough to know when you’re over your head.
If you’ve never traded stocks or are new to investing, I assume that you can figure out whether this book is right for you at this time. I also hope that if it’s too much for you right now, you can come back to it in the future when you’re ready.
You read investing books before and you can read this section carefully at some point in order to avoid pitfalls and misunderstandings as you go through this book
. I assume, and hope, you know that this book won’t have all the answers to your trading needs, but you also know that I wrote it carefully and thoughtfully, because I trade options and use these methods to make a living.
You hold longer-term investments.
I assume that options are part of a diversified portfolio and that, as I describe, you can use a separate account to trade them for income generation.
You have computer and Internet access.
I can’t imagine trading or investing without a computer and reliable access to the Internet … so I assume you have both. And the faster the connection the better.
You use a discount broker.
I assume as a self-directed investor, you use a discount broker.
Icons Used in This Book
I also add icons to highlight and reinforce different core ideas and give you some hard-earned trading insight. I use the following ones to point out these insights:
This icon is used to give you an insider’s insight to the topic. Consider this icon to be an aside that any trader may mention to you along the way.
This icon flags important details to keep in mind and reinforces key concepts. If you struggle when reading the core content, check for one of these icons to clear matters up.
This icon signals ways to stay out of trouble.
This icon offers you a deeper dive into the details of a topic but isn’t absolutely necessary to your understanding of the topic at hand.
Beyond the Book
In addition to the material in the print or ebook you’re reading right now, this product also comes with some access-anywhere goodies online. Check out the free Cheat Sheet at www.dummies.com. Just search for options trading.
If you’re looking for trading ideas, you can also visit my website: smartmoneypassport.substack.com.
Where to Go from Here
If your goal is to craft a steady paycheck by trading options, this book’s got you covered. By using the techniques on these pages and viewing yourself as a risk manager looking for a paycheck, you can develop a new income stream.
Ready to go? You have lots of options ahead.
If you’ve recently been perplexed with action in the markets, you may want to start with Chapter 5. It details how everything works, highlighting key indicators to help you gauge the direction of the trading trend.
Part 1 builds a strong foundation for those with less experience. If you want to get started on setting up your paycheck mechanism, check out Chapter 8.
If you have some experience and want to jump straight to making trades, consider jumping to Part 4, which describes a variety of trading strategies you just can’t match with stocks.
Chapter 18 summarizes what it takes to be a successful option trader. If you’re one of those people who wants to know the end before you start at the beginning this chapter is for you.
Part 1
Getting Started with Options Trading
IN THIS PART …
Understanding the basics of options trading
Discovering where the action happens
Identifying option risks and rewards
Chapter 1
Options Trading and You, the Individual Investor
IN THIS CHAPTER
Thinking of options as income-producing tools
Analyzing options with any market in mind
Making the markets work for you
Whether you’re an experienced risk taker, a trader, or a longer-term investor, you can trade options on individual stocks, indexes, and exchange-traded funds (ETFs) with the information in this book. And the best reasons to trade options is that you can manage risk and develop a reliable income stream risking less money than by trading stocks without having to wait for dividends.
The ultimate goal for any trader is to make money. For options traders in the post-pandemic era, the primary goal is income — money to use for paying bills, buying groceries, and paying expenses that have risen due to inflation. This chapter is about providing the mental foundation (rewiring of your brain) to become a successful income generator via options trading.
Rewiring Your Thinking
Generating income via trading options takes some time and requires patience, so stay patient, study the trading techniques, and understand associated risks and rewards. The information in this book will slowly rewire your brain and reshape the way you look at the markets with the ultimate goal of grabbing a paycheck. Moreover, rewiring your brain can help you to use volatility (the fluctuation of prices) to your advantage. Higher levels of volatility raise option premiums and allow you to sell options for income at a higher price. The best part is it doesn’t hurt. Chapters 7 and 8 are also great for rewiring your brain.
Keep these points in mind about the rewiring process:
Options trading, as all types of trading, is a competition.
Whoever or whatever is on the other side of your trade is trying to take your money; and you theirs.
Trading algorithms dominate the market, making trades lightning fast. Once, long ago, stocks were the key to options. Now, the options market influences stocks because 80 percent of all trades in the stock and related markets are now made by trading algorithms. These machine traders are also known as algos. In effect they’re computer programs, also referred to as artificial intelligence (AI) or bots. And bots follow the money, which often starts its journey in the options market.
I refer to trading bots as algos. But no matter what I call them, they’re the major influence on prices, and they’re everywhere in the markets just waiting for your order. Indeed, the market makers, the entities that match buy and sell orders, are all computerized. As a result, events in the markets now happen literally at the speed of light due to the involvement of algos.
I explore this concept throughout the book, showing you how to spot them and how to trade against them with frequent success and reliable income. For now, my goal is to plant this thought in your mind and start your rewiring. Chapters 5, 6, and 8 dive headfirst into the rewiring process.
Algos, day traders, and whoever else is trading at any time, don’t have your best interest in mind. And neither do you in their regard, which means you should have your act together before you start real-time trading.
In addition, because algos move fast, prices also change rapidly in the market, especially in options. As a result, options are not to be used for long-term wealth-building strategies. Let me be clear: Investing is all about using the power of time and the benefits of compounding to build wealth over long periods. The traditional buy-and-hold strategy for stocks is a perfect example, as is the owning of rental properties for long periods to generate income. This long-term oriented, patient mind-set often, but not always, works well for stocks and mutual funds. It doesn’t work for options because of the way the algos move the markets and because of the time limit in the life of an option. One partial exception, that of trading long-term options, is a viable trading tactic that I address in this book (see Chapter 11).
The bottom line is that you may trade any option for a few minutes, a few days, or a few weeks, but no matter how long you’re in an options position, even if it’s part of your long-term investment plan, it’s a trade, and your focus should be primarily on producing income or hedging via the trade. Simultaneously, don’t confuse options trading with some random, haphazard activity. Options trading is a cautious and very precise exercise. Chapter 8 shows you how to produce income through a “killer” trading plan.
Preparing to Trade: Take a Pre-Trading Flight Check
Imagine if a pilot tried to fly a plane without doing a pre-flight check. In similar fashion, before you start trading options, it’s a good idea to know three elements:
Your risk profile
Your financial situation
Your time commitment possibilities
Please be patient and be prepared to spend as much time as you need learning the craft, or you can lose money, often in a hurry, because the algos aren’t your friend.
Even if you’re experienced in other forms of investing or have experience with options, it’s still worth considering the following:
Review your financial balance sheet.
Before you start trading any financial instrument, go over your living expenses and review your credit card, loans, mortgages, and life and health insurances. Put together a financial net worth statement. Make sure it’s healthy before you take extraordinary risks.
Be honest with yourself.
Don’t trade beyond your experience levels, and don’t risk too much money in any one trade.
Bottom line:
If you have $1,000 in your account, don’t trade more than one options contract at any one time and don’t go for big returns. Instead concentrate on learning the craft and adding money to your account. But don’t be discouraged. With patience and attention to detail, you will improve.
Manage your risk.
If you’re a cautious person who thinks that mutual funds are risky, you may not be a good options trader. But don’t count yourself out either. Many different options strategies may suit you, especially as you focus on income production via options and you understand the built-in safety nets that make them attractive. Read through the book and find the most suitable strategies to your risk profile.
Part 4
covers this in detail.
Become a good analyst.
If you like to gamble without doing your homework, options trading may be painful at times. To maximize your odds of success, improve your technical and fundamental analysis skills on both the markets and the specific trade setups for individual securities that can optimize your success.
Part 2
is a must-read in order to strengthen your market analysis chops.
Don’t be afraid to test your strategies before deploying them.
Doing some paper trading on options strategies before you take real-life risks is an excellent idea that is certain to provide both practice as well as saving you some headaches.
Chapter 7
guides you through this process.
Set up a separate account for your options trading.
I have the full details in
Chapter 8
.
Never trade with money that you aren’t willing to lose. Even though options are risk-management vehicles, you can still lose money trading them, especially with the algos in the mix. And as you progress to more sophisticated and riskier option strategies, your losses can be significant if you don’t plan your trades beforehand. Bottom line: Don’t trade options with your car payment or your rent money. Part 4 is all about advanced trading strategies.
Understanding Options
Options are financial instruments priced based on the value of another underlying asset (known as the underlying) in the language of the markets. At the same time, because of algo mechanics, the price action in the options markets inversely influences the price of the underlying asset. As you plan a trade, you must think in terms of three details:
The underlying
The option
What the algos and other market participants such as day traders may do at any time during your trade
Incidentally, in this book, I focus mostly on options on individual stocks, but you can apply these general concepts to all markets. The following sections address these key components of options trading.
Getting the complete picture
To fully understand and use options to generate income or to limit risk, you must understand the asset on which the option is based, which may require deeper analysis and detail beyond your current routine. For example, because volatility is a key component of option prices, reviewing the underlying’s historical volatility more carefully as part of your analysis is necessary.
This book helps you by focusing on techniques that compare options to their underlying security or other securities. Chapter 9 details several approaches that you can apply when you analyze stocks and index options.
I primarily think of options as income producing as risk-management tools and trading them separately as income vehicles and as hedges in overall portfolio strategy. In other words, I always ask myself three questions before I make any trade:
Is this an income producing trade or a hedging trade?
Am I trading with the trend? (
Chapter 5
helps you with both.)
If it’s a hedge, I ask how will this trade affect the overall value of my account? (Refer to
Chapter 7
for more information.)
If it’s an income producer, I ask what I will use the money for? This question helps me to manage the trade as I may reach my goal before the expiration date.
Can my account handle the potential loss for this trade? (Check out
Chapter 8
to answer both of these questions.)
In other words, your primary focus varies with the goal of the trade, although in both cases, managing your risk is wise (lose as little as possible if trading goes wrong) by making sure the trade is right for your goal and by understanding the risks associated with the trade and the underlying. Always focus on safety by:
Knowing applicable conditions both in the markets and in the individual security, to consider when planning a trade
Using the right trade for the right setup
Following trading rules and requirements for the trade
Understanding what individual variables make any position gain and lose value
Trading anything, especially options, is complex. But attention to detail helps you work things out.
Knowing option essentials
The two kinds of options are calls and puts. After you add them to your current trading tools and strategies, you can participate in both bullish (rising markets) and bearish (falling markets) moves in any underlying you select. The primary use for options is income production via spreads and related strategies. But a very close second and equally important use is to limit your total portfolio risk — to protect an individual existing position such as a stock or ETF, via hedging strategies.
Making quick work of definitions
A listed stock option is a contractual agreement between two parties with standard terms. All listed options contracts are governed by the same rules. When you create a new position, one of two events is triggered:
By buying an option, you’re buying a specific set of rights.
By selling an option, you’re acquiring a specific set of obligations.
These rights and obligations are standard and are guaranteed by the Option Clearing Corporation (OCC), so you never have to worry about who’s on the other end of the agreement — assume it’s an algo. Chapter 3 provides more information and detail on the OCC and its central role in options trading.
Time is everything to option traders. Indeed, the one particular wrinkle in options, and the primary risk involved, is twofold:
Time-value decay:
Where the time value of the option falls on a daily basis until the expiration date.
Leverage:
The factor that causes option prices to change in larger percentages moves both up and down more aggressively than stocks under conditions of high volatility.
Pricing relationships
The price of a call option rises when its underlying stock goes up. But if the move in the stock is too late, because it happens too close to the expiration date, the call can expire worthless. You can literally buy yourself more time, though — some options have expiration periods as late as nine months to 2½ years.
When you own call options, your rights enable you to
Buy a specific quantity of the underlying stock (exercise).
Buy the stock by a certain date (expiration).
Buy the specific quantity of stock at a specified price (known as the
strike price
).
Thus, the price of the call option rises when the underlying stock price goes up because the price of the rights you bought through the option is fixed while the stock itself is increasing in value.
Conversely, a put option gains value when the underlying stock falls in price, while the timing issue is the same. The move in price still has to occur before the option contract expires or your option will expire worthless. Your put contract rights include selling a specific quantity of stock by a certain date at a specified price. If you own the rights to sell a stock at $60, but events such as bad news about the company pushes the stock price below $60, those rights become more valuable.
A significant part of your skill as an options trader is your ability to select options with expiration dates that allow time for the anticipated moves to occur. As you discover more, it will make perfect sense because successful options trading is all about giving yourself and the option time to deliver on your expectations. Of course, some basic trading rules can help, including the development of proper trade design, based on the right setup for the right trade and management techniques, such as planning your exit from a position before you trade in order to cut losses.
All stocks with derived options available for trading have multiple expiration dates and strike prices. The two important pricing factors to keep in mind are
Options with more time until the expiration date are more expensive.
Options with more attractive strike prices are more expensive.
Information about options and your available choices are widely available on the Internet. For serious trading using the pricing data from your broker’s platform and a premium charting service for the trade setup is best.
Trying different strategies before deploying them in real time
Options are different from stocks both in terms of what they represent — leverage, rights, and obligations instead of partial ownership of a company — and how they’re created, by demand. These important distinctions result in the need for additional trading and decision making beyond the basic buy or sell considerations, especially in the context of income generation in complex markets.
To successfully expand your trading repertoire from stock trading to options trading, you have to think like an options trader, which means you’re evaluating the underlying asset as a potential income producing asset or a hedge, how your trade fits into the market maker’s trading decisions. The trick is to look at the right price chart setup as I discuss in Chapters 10 and 11.
Your final decision, as the trade develops, may be to exercise your rights under the contract or simply exit the position in the market. Fortunately, market prices will help you with those decisions, and so will some thoughts from Chapters 9 and 18.
If you think you’re reading a familiar concept, you probably are. Repetition is an important part of rewiring your brain. Indeed, the more you hear or read something, the more it’s likely to stick!
Crawling before walking
If you haven’t traded options in the past, your best approach (as I mention repeatedly throughout this book) is to try some trading strategies on paper and see how things work out. Your goal here is simple: You want to get to the point where you think of your option trades based not just on the option, the underlying security, and what the trader on the other side is doing by learning to spot telling price chart setups.
Before you invest real money, you should be able to do the following:
Gain a comfortable feel for the activity and characteristics of underlying stocks or indexes — on which you’re looking to trade options and understand their relationship both to the market and to the options related to them, through the eyes of a price chart analyst.
Be able to mix and match sound option strategies to particular market situations and specific price chart setups.
Is this extra work worth it? Absolutely! Let me put it this way: You wouldn’t want to trade a bullish strategy if a stock has a bearish chart. On the other hand, a correctly constructed bearish strategy based on a bearish chart pattern is more likely to deliver that sought-after income.
Relying on paper trading and backtesting
Certainly, trading options isn’t all fun and games. For instance, an important aspect involves paying special attention to how passage of time affects the value of options over time. After you get this part of the puzzle locked in, the rest will fall into place more easily, and your paper trading will be more satisfying. Along with paper trading, you can also backtest options trading. Backtesting means that you review how a set of strategies has worked in the past. Don’t worry about how long this rewiring process may take. Any time you spend on decreasing your risk of big losses in the future is worth your trouble. Chapter 7 is all about paper trading.
Widely available options trading and technical analysis programs let you backtest your strategies. Some brokerage houses offer sophisticated analytical packages to their active traders for low prices or free of charge.
Paper trading and backtesting an options-based trading approach may take a little more time than a stock approach. The flip side is that they can save you a lot of money. Even though paper trading may slow down your pace, and possibly delay your getting started in real-time trading, this type of studious approach lets you address different option-trading nuances in advance and gets you in the habit of being a disciplined trader.
Putting options in their place
Take your time when trading options. There is a time and a place for everything, and options are used best when deployed optimally — meaning when the risk-reward ratio offers you the best mix of both profit potential as well as risk reduction. That’s why the price chart setup is crucial. When you see a bullish or bearish pattern, that’s the time to start looking at your strategy choices.
When you buy an option contract, you have two choices: You can exercise your rights, or you can trade your rights away based on current market conditions and your trading objectives. If you made that car payment before expiration, take the money and run. You can do either one based on what is happening in the markets or to any individual position at the particular time and by executing the best strategy for what the situation calls for. The most important detail is that you know what your choices are before making the trade because you have planned for the trade to deliver a predetermined sum with a purpose.
If your goal is risk management, you can use options by hedging a particular position or by hedging your whole portfolio. The goal of a hedge is to reduce the potential loss when the market turns against you. That’s because a properly designed hedge is one in which the value of the option goes in the opposite direction of the underlying, thus keeping the total value of the combined position as high as possible when the underlying falls in value. What that means is that if your analysis of the situation makes you so bearish that you are looking to capitalize from a falling market, options are much less expensive and have lower risk of dollar losses than selling individual stocks short. Chapter 10 is all about portfolio protection.
Options also let you leverage your positions. Because options cost less than stocks, you can participate in a market for less than if you owned the actual shares. For example, a $500 investment in an option strategy may give you as much profit potential as a $5,000 investment in an individual stock. This is an excellent way to reduce risk, because you’re spending less capital but potentially getting a similar percentage rate of return to what you might receive if you owned the actual underlying stock, depending on your position size. You can apply this leverage even more astutely if you’re speculating and are willing to cap your profits.
Speculating with options, via strategies such as buying call options based on a bullish-looking price pattern on an underlying stock can make more sense than stocks in small accounts, especially when the stock trades at a lofty price.
Differentiating between Option Styles
This book focuses mostly on options related to individual stocks. Yet, index options are also important and may be of interest and use to you at some point in your trading life, especially when analyzing what the big money traders are doing at any one time.
That’s because even if you don’t trade index options, by analyzing what those traders are doing, you may be able to have a better idea as to what the stock market is thinking at the moment in terms of safety and expectations. For now, the most important matter is to understand the major differences between options on indexes and individual stocks. Here are some important general facts:
You can trade stocks but you can’t trade indexes.
The dates for exercise (of your option rights) and the last trading date for the option fall on the same date. These two important dates can be variable for index stocks, meaning that you may be able to trade the option on a different day than the exercise date.
Two types of options are: American and European style. Each has its own set of characteristics that will affect your ability to make decisions about exercise. Always know which style option you are using and the particular factors associated with it before you trade.
Chapter 9
is all about option styles.
Even if you don’t trade index options, big traders do. Therefore, make sure you know how they work so that you can at least keep track of where the big money is moving and consider whether it makes sense to follow them.
Using options to produce income and limit your risk
Getting the details of option risk profiles is important and is useful. But designing and using strategies in trading is even better, and you start by evaluating the many options that are available for income production and asset protection. Sure, you may not think that asset protection is sexy, but if the market turns on you and you’re prepared, spending the time upfront to figure out what options work better than others in different situations isn’t only a good step in your learning process, it’s also practical. When using options to limit your risk:
You can reduce risk for an existing position partially or fully and adjust the hedging process gradually based on changing market conditions. Check your price chart setup. See
Chapter 10
.
You can reduce risk for a new position to a very small amount by using a combination of options or by using single long-term options. Refer to
Chapter 12
.
You need a margin account for these strategies, and you can get one by filling out and signing the margin account agreement that you obtain from your broker. You can work toward these complex strategies as you gain experience. Some of these more complex strategies include
Vertical spreads are great for income (refer to
Chapter 11
).
Calendar spreads let you fine-tune your time frame (check out
Chapter 12
).
Diagonal spreads are useful for hedging (head to
Chapter 12
).
The most influential factor in determining when to use these spreads are market conditions and price chart setups. And this book helps you make those decisions.
Applying options to sector investing
The creation and proliferation of ETFs offers a new set of opportunities for options traders. Through these vehicles, you can make sector bets without having to drop down to the individual stock level of decision making or research beyond some basic steps. ETFs are great trading vehicles because
You can trade them like stocks.
That means you can buy and sell shares and trade options for income production and hedging purposes through them at any time during the trading day instead of waiting until the market closes, as with nonexchange-traded traditional mutual funds.
ETFs offer listed options.
You can apply all option strategies to sectors of the stock market by trading and setting up income -producing option trades on the underlying ETF. You can also make index bets without using index options with expiration and last day of trading may cause you some extra steps.
You find ETFs based on commodity indexes.
These let you participate in commodity markets without trading futures. When you add the extra dimension of options being available, you have a nice array of different strategies available.
ETFs are an excellent trading vehicle category, for all those reasons and more. You can design entire diversified portfolios with ETFs and then use options to hedge individual positions or the entire portfolio. Chapter 13 gives you all the details. You can trade ETFs via my Sector Selector service (buymeacoffee.com/wsdetectivx).
Using Options in Challenging Markets
You can participate in rising or falling markets directly through stocks and ETFs, via owning these securities in up markets, or selling them short in down markets. On the other hand, it’s often less expensive to use options for similar purposes depending on the market’s direction. But what do you do in a sideways market, except maybe sitting it out or collecting a few dividends?
Guess what? You can craft option strategies such as spreads, condors, and butterflies (but not animal crackers) as I discuss in Chapters 14 and 16 for sideways markets, to produce income, whether you have any underlying positions or not.
Reducing your directional bias and making money in flat markets
Directional bias refers to the connection of profits to the direction of prices. To make money when you’re long, you need prices to rise. And to make money when you’re short, you need falling prices. When you use option combination strategies, you design trades that let you earn income when the underlying stock moves up or down. Consider this:
You can set up strategies that let you profit whether the underlying rises or falls, depending on your trade setup.
Chapters 14
and
15
tell you all about these trades.
Options let you set up strategies that earn income in sideways markets.
Controlling your emotions
The most difficult part of trading is the effect of emotional responses triggered by price movements in open positions, or in positions you wish you had pulled the trigger on. Being emotional is part of being human. The problem is that emotional trading is usually the path to big losses. That’s why option traders have rules and why you design an anticipatory trading plan, in order to control the emotion that goes along with trading.
A good options trading plan has these key characteristics:
A concise definition of purpose whether income production, hedging, or a mix of both.
Access to the proper equipment.
Make sure you have all the technology you need: computers, mobile devices, reliable Internet, and backup systems along with a quiet place to work.
Knowledge of time commitment.
Think about how much time you’re willing to give to your trading endeavor. Start with your learning phase and transfer the good habits you learned to your trading. If you can’t devote or manage the appropriate time to monitor a position, review your plans.
Access to good information.
Put together a good list of websites and a reliable real-time quote-charting service.
Flawless trade execution.
Pick an online broker that has some scale and can execute your trades in a timely fashion without leaving you in the cold.
An excellent educational component.
Work on your analytical skills, technical and fundamental, every day. You need to be a crack chartist and hone your decision-making skills.
Each chapter is this book reveals new information that is intended to make it easier to appreciate and execute the end game, the successful trading of options. Chapter 2 is all about the different types of options.
