Profiting from Weekly Options - Robert J. Seifert - E-Book

Profiting from Weekly Options E-Book

Robert J. Seifert

48,99 €


Generate consistent income with a smart weekly optionsstrategy Profiting from Weekly Options is a clear, practical guideto earning consistent income from trading options. Rather thanconfuse readers with complex math formulas, this book concentrateson the process of consistently profiting from weekly option serialsby utilizing a series of simple trades. Backed by the author'sthirty years of experience as a professional option trader andmarket maker, these ideas and techniques allow active individualtraders and investors to generate regular income while mitigatingrisk. Readers will learn the fundamental mechanisms that driveweekly options, the market forces that affect them, and theanalysis techniques that help them manage trades. Weekly options are structured like conventional monthly options,but they expire each week. Interest has surged since theirinception three years ago, and currently accounts for up to thirtypercent of total option volume, traded on all major indices as wellas high volume stocks and ETFs. This book is a guide to usingweekly options efficiently and effectively as income-generatinginvestments, with practical guidance and expert advice on strategyand implementation. * Discover the cycles and market dynamics at work * Learn essential fundamental and technical analysistechniques * Understand the option trading lexicon and lifecycle * Gain confidence in managing trades and mitigating risk Weekly options can be integrated with any existing optionsstrategy, but they are particularly conducive to credit spreadstrategies and short-term trades based on technical patterns. Forinvestors looking for an easy-in/easy-out method of generatingconsistent income, Profiting from Weekly Options providesthe wisdom of experience with practical, actionable advice.

Sie lesen das E-Book in den Legimi-Apps auf:

von Legimi
zertifizierten E-Readern

Seitenzahl: 438


Table of Contents

Title Page






Chapter 1: Market Psychology: The Mind-Set of a Trader

The Herd Mentality: Bubbles

The South Sea Bubble 1711–1721: Trade, War, and Government Collusion

The Cotton Panic of 1837: Land, Commodities, and Government

The Panic of 1893: Railroads Have No Upper Limit

September 11, 2001: Price Can Never Go Up Again

The Commodity Bubble of 2008: Price Can Never Go Down Again

Bitcoin 2009 to Present: Crypto-Currency Meets Greed

Lessons to Be Learned

Chapter 1 Quiz

Chapter 2: Modern Markets

Equity Markets


Flow of Funds

Futures Markets: Origins

Calculating Futures Contract Values

Tick Size


Stock Index Futures

Index Futures versus Stock

Forex: Currencies



Chapter 2 Quiz

Chapter 3: Technical versus Fundamental Price Analysis


Chapter 3 Quiz

Chapter 4: Phases of the Market


Breakout to the Trend



Chapter 4 Quiz

Chapter 5: The Relationship of Time and Price


Chapter 5 Quiz

Chapter 6: Introduction to Options

Basic Option Glossary

Working Option Vocabulary


Chapter 6 Quiz

Chapter 7: The Option Model

Games of Chance

Air in the Balloon


Chapter 7 Quiz

Chapter 8: The Option Chain


Chapter 8 Quiz

Chapter 9: Option Trading Strategies

Why Selling Naked Options Is Always Wrong!

Suitable Option Trades

The Credit Spread


Chapter 9 Quiz

Chapter 10: Why Trade Weekly Options?

Buying a Call or a Put Outright


Chapter 10 Quiz

Chapter 11: Midterm Review



Market Pricing

Phases of the Market

Relationship of Time and Price

Option Vocabulary


Test for Chapters 1–10

Chapter 12: Standard Deviation—The Mathematics of the Price Cycle


Chapter 12 Quiz

Chapter 13: Trading in a Congestion Phase of the Market

Trade One: Buying an Outright Option

Trade Two: Credit Spreads

Trade Three: Risk Reversals

Trade Four: Backspread (1 × 2 for Even)


Chapter 13 Quiz

Chapter 14: Trading in a Trending Phase of the Market

Trade One: Buying an Outright Option

Trade Two: Credit Spreads

Trade Three: Risk Reversals

Trade Four: Backspread (1 × 2 for Even)


Chapter 14 Quiz

Chapter 15: Trading in the Blowoff Phase of the Market

Trade One: Buying an Outright Option

Trade Two: Credit Spreads

Trade Three: Risk Reversals

Trade Four: Backspread (1 × 2 for Even)


Chapter 15 Quiz

Chapter 16: Selecting a Portfolio to Trade



Diversification by Product

Diversification by Dollar Risk


Chapter 16 Quiz

Chapter 17: Managing Your Equity

Risk of Ruin

Risk Capital


Win Rate

Starting Capital


Chapter 17 Quiz

Chapter 18: Organizing Trades and FAQs

Step One: Observing Your Portfolio

Step Two: Observing the Major Trend and Making a Trade

Step Three: The Amount of Equity Needed to Trade Each Strategy

Frequently Asked Questions


Final Exam: 100 Questions

Appendix I: Answers to the Chapter Quizzes

Chapter 1

Chapter 2

Chapter 3

Chapter 4

Chapter 5

Chapter 6

Chapter 7

Chapter 8

Chapter 9

Chapter 10

Chapter 11 Midterm

Chapter 12

Chapter 13

Chapter 14

Chapter 15

Chapter 16

Chapter 17

Chapter 18 Final

Appendix II: Days until Expiration Straddle Values

Glossary of Option Terms

About the Author


End User License Agreement
















































































































































































































































Table of Contents


Preface to the Second Edition

Begin Reading

List of Illustrations

Figure 4.1

Figure 4.2

Figure 4.3

Figure 4.4

Figure 4.5

Figure 4.6

Figure 4.7

Figure 4.8

Figure 5.1

Figure 5.2

Figure 5.3

Figure 5.4

Figure 5.5

Figure 5.6

Figure 7.1

Figure 7.2

Figure 8.1

Figure 8.2

Figure 8.3

Figure 8.5

Figure 8.6

Figure 8.7

Figure 8.8

Figure 8.9

Figure 9.1

Figure 9.2

Figure 9.3

Figure 9.4

Figure 10.1

Figure 10.2

Figure 10.3

Figure 10.4

Figure 10.5

Figure 10.6

Figure 10.7

Figure 12.1

Figure 12.2

Figure 12.3

Figure 12.4

Figure 13.1

Figure 13.2

Figure 13.4

Figure 13.5

Figure 13.6

Figure 14.1

Figure 14.2

Figure 14.3

Figure 15.1

Figure 15.2

Figure 15.3

Figure 16.1

Figure 16.2

Figure 16.3

List of Tables

Table 16.1

Table 16.2

Table 17.1

Table 18.1

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.

The Wiley Trading series features books by traders who have survived the market's ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional, or somewhere in between, these books will provide the advice and strategies needed to prosper today and well into the future.

For more on this series, visit our website at


How to Earn Consistent Income Trading Weekly Option Serials

Robert J. Seifert


Cover image: © smigielski

Cover design: Wiley

Copyright © 2015 by Robert J. Seifert. 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, (978) 750-8400, fax (978) 646-8600, or on the Web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at

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.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.

Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at For more information about Wiley products, visit

Library of Congress Cataloging-in-Publication Data:

Seifert, Robert J.

Profiting from weekly options : how to earn consistent income trading weekly option serials / Robert J. Seifert.

pages cm. –(Wiley trading series)

Includes index.

ISBN 978-1-118-98058-3 (Hardcover) – ISBN 978-1-118-98095-8 (ePDF)–ISBN 978-1-118-98094-1 (ePub) 1. Options (Finance) I. Title.

HG6024.A3S437 2015



To Ryan, Aly, and Steph, how could I be so lucky?


Todd “Bubba” Horwitz

I first walked onto a trading floor at the CBOE in September of 1982. I was 24 years old and I knew that I wanted to be involved in the option market. I was one of the original market makers in the SPX, and it was quite a thrill. When you trade for a living, every day is a new adventure; you never know what is going to happen next but you know that it will be interesting. Over 30 years later, I still can't wait for the opening bell!

So much has changed since I started to trade that it isn't the same business anymore. Now there is really no open outcry, the markets have shifted upstairs to the electronic platforms, and the trading pits are almost empty. When I started to trade, the option markets only had four expirations per year. Gradually, the powers that be figured out that if you had an expiration each month, that would bring more customers into the markets and provide greater liquidity. Another major policy change was to narrow the bid–offer spreads to $1, and that brought even more business into the market. All of the changes made it better for the retail customer.

In 2010, the SEC decided that it would allow customers to trade options on a weekly basis, bringing the expiration total to 52 times a year. Finally, three years ago, the exchanges were approved to list weekly options that would fill out the rest of the month so that they could be used for calendar spreading and rolling positions back one week instead of one month. The weekly option market has grown so much in the last year or so, it is now liquid enough to allow the retail trader to compete with the giants of Wall Street.

I am very pleased to have helped to educate scores of students on how to successfully integrate weekly options into their arsenal of trading tools, and I am very happy to be a part of this book. I have known Bob Seifert for more than 25 years, and we have collaborated on a great number of projects. I personally think that weekly options are the best investment tool that I have seen in that time. They are so versatile it is hard to believe that it took so long to bring them to the marketplace. If you have a stock position in place, the weekly options can be used to hedge your risk. If you have cash that is on the sidelines and you want to enhance your yield, weekly options offer you that opportunity, and if you want to speculate, the weekly options offer you the best possible opportunity.

When you read this book, you will probably need to study the material several times to take full advantage of the concepts presented. Anything that is worthwhile takes effort, and learning to trade weekly options is no different. Although the trades are very basic, they will offer you the chance to make money in any market condition.

I wish you good luck in your trading, and I can assure you that if you have the patience to learn the principles presented in this book, you will make your own luck!


For many years, it was difficult for individual option traders to compete with the banks and professional market makers in the derivative market. The bid–offer spreads were too big, the premium levels were so high that a retail trader could not afford to be involved, and finally, if their trade of choice was spreading, they had to wait months for the trade to mature.

Four years ago, weekly options didn't exist, and now they represent more than 30 percent of all options traded. There must be a reason for the phenomenal growth in such a short period of time. There is a reason, and it is very simple: Weekly options offer the best opportunity for any retail trader to get involved in the derivative market. This book is designed to reach any level of option trader, from the novice to successful traders that have yet to learn the power of weekly options.

The book is organized into sections, and after each part there is a quiz that reviews the key points that are emphasized in the chapter. The first section deals with market psychology and is designed to help you learn “the other side of the trade.” If you think you can just pick up a book and magically defeat your opponent without understanding the psychology of the market, then you must also believe that if you can hit a golf ball you could beat Tiger Woods. In both cases, you are only fooling yourself.

The second section teaches you that underlying asset groups have different characteristics, and it is important to learn how each type of asset can be traded. It will show you that some markets are ideal for trading and other markets are simply impossible to beat. Once you learn what markets can be played, you need to see how they look when you study them, the patterns that constantly repeat, and how to spot those patterns. In addition, you must be able to communicate to the broker or to your software execution platform the trades that you want to make. Options have a distinct vocabulary and you must learn certain terms in order to participate in the market.

The third section is devoted to the option model, how it is unique in the world of finance, and why you must familiarize yourself with how it is priced in order to succeed. Simple mathematical examples are given to help you adjust your vision of markets to the viewpoint of an option trader. The option chain is introduced and how comprehension of this vehicle will be all-important to your trading success.

The second-to-last section deals with four simple trades that you can continuously make. It explains when and how the trades should be initiated, what market conditions give you the best chance for the individual trade to succeed, and how to manage the trade once it is in place.

The final section demonstrates how to manage your greatest asset—cash. It clarifies how to utilize your capital in a manner that will ensure that you don't run the risk of ruin when the inevitable capital drawdown occurs, and it identifies which trades can be employed using your available capital levels.

After the final chapter, there is a final exam made up primarily of questions that you have been asked before. If you can score 90 percent or better, you should be ready to tackle the big players in the option market!


I would be remiss if I didn't start this section with mentioning the influence of my parents on my life and trading career. My father, “Lefty,” and mother, Rita, introduced me to the wonderful world of numbers when I was a small child. My parents would best be described as “characters,” immense personalities with a positive view on living that enhanced my life and all those who were fortunate enough to meet them.

Cards were the pastime in our house, and it was my father who introduced me to probabilities and odds. At the time I didn't know what they were, but Lefty taught me that if you held a pair of aces, you were a big favorite going into the draw. That simple explanation helped me to understand how to make certain decisions based on probability. I had a magical childhood, great parents, and have had good luck throughout my life.

I want to thank Ablesys Corporation, Dr. John Wang, Grace Wang, and Jesse Wang for their help in getting this book to be printed and for their permission to use the charts and graphs from the AbleTrend and Abledelta platforms as illustrations.

I want to thank Todd “Bubba” Horwitz for his Foreword section and for all of our years together working with students on how to trade, as well as for his input into many of my trading models.

I want to thank Ryan Seifert for his contribution and the time that he spent editing the manuscript. And finally, Bonnie Pittenger, without whose support this project would never have been completed. Not only did she help me with the text of the book, but her positive attitude toward life and her ability to overcome adversity continue to inspire me and all who know her.

Chapter 1Market Psychology: The Mind-Set of a Trader

“90 percent of the game is 5 inches wide, the length of the space between your ears.”

—Bobby Jones, Golfer 1932

“Anyone who has never made a mistake has never tried anything new.”

—Albert Einstein, Scientist 1937

“You can observe a lot by just watching.”

—Yogi Berra, baseball player, New York Yankees 1956

“Greed is good.”

—Gordon Gekko, Wall Street 1987

“Bulls and bears make money; pigs get slaughtered.”


“Coulda, woulda, shoulda.”

—Every Investor 5000 BC to Present

The Herd Mentality: Bubbles

History is our great teacher. As Yogi Berra, the Yankees great, once said, “You can observe a lot just by watching.” The past is the key to the present; if we do not learn from observing past events, we are doomed to repeat them.

In the spring of 2014, we still have a vivid memory of the financial meltdown in the summer and fall six years ago. TV commentators pleaded with investors to “get in there and sell, Wilson sell.” Irate investors looked to hang their broker. Pictures of hysterical homeowners seeing years of hard work going out the window in a matter of months were gut-wrenching. Fingers pointed and tongues wagged. Crooked politicians, dishonest mortgage brokers, greedy Wall Street traders, shady rating agencies—there was enough blame to spread around.

Who could have possibly seen this one coming?

Comedians had a field day. Internet cartoons of stick figures explained to other stick figures where their money went. Hitler learning that his generals had tied up all of his cash in AIG and Lehman Brothers stock. Surely, this was the first time such a financial disaster had affected so many so quickly.

Or was it?

Because of its impact, it is crucial to recognize that the Great Recession was not an isolated incident. The market psychology that triggered this disaster goes back at least as long as history has been recorded. The panics will come in all forms and will start with many different patterns. Usually, the common thread is that some commodity or new technical revolution has no upper end. Demand for the product will be so great that it can only get bigger. There will be no upper limit to price, and any naysayers will regret their doubt. The thought process is:

“This time will be different.”

Let's review a few of these “bubbles” that have occurred in the past 300 years and see what they have in common.

The South Sea Bubble 1711–1721: Trade, War, and Government Collusion

The South Sea Company was established in 1711 as a partnership between the British Treasury and the merchant class. England had been in a battle with Spain since the early 1700s in what is referred to as the “War of Spanish Succession.” The war had been very costly; the Crown need to finance its debt, and the Lord Treasurer Robert Harley came up with a good idea: Sell a franchise!

He granted exclusive trading rights to a group of merchants in the “South Seas.” It is a common misconception that the “South Seas” were in the Pacific, but in eighteenth-century Europe, the term referred to South America and the Caribbean Sea, not the Pacific.

The first round of financing granted the company “exclusive” trading rights for the sum of £10 million (approximately £500,000 million in 2014 £). In effect, the merchants convinced investors to take stock in the company and replace the bonds issued by the English Treasury. In exchange, the government granted the company a permanent annuity paying a little more than 5 percent. The merchants quickly resold the notes and guaranteed a profit to investors from the Treasury “in perpetuity.” Today, we would call this arbitrage, and it is the way many investment banks generate billions in profit: Buy debt for one price, sell it for a discounted amount to investors, and take the difference and put it in their pocket.

The British government viewed the transaction as a layup. It would charge tariffs on trade from the “South Seas” to fund the interest and pocket the difference.

When the war with Spain was finally settled in 1713 by the treaty of Utrecht, the terms were not as favorable as the Crown or the merchants had hoped. Although there is no evidence the company had ever made dollar one, the Treasury was able to float another round of financing in 1717 for £2 million. The original notes were converted to the new debt and the government continued to pay the interest. Nowadays, financiers call this type of sovereign debt replacement Brady bonds in honor of the US Secretary of the Treasury whose ingenuity bailed out US banks and Latin America in the 1990s.

The new debt funded the original loans from 1711. Nevertheless, as time passed and the company still did not flourish, the Crown needed to raise more capital. In 1719, the company conceived of a new idea.

Exchange the existing debt for equity in the Crown!

The company proposed to buy the majority of the Treasuries debt for £30 million. In exchange, the government guaranteed to pay interest on the shares at a preferred rate of 5 percent for a period of eight years, and then 4 percent “in perpetuity.” To sweeten the deal, the shares were allowed to be traded, and any “appreciation” could be used to buy more shares.

Needless to say, this arrangement benefited the company and the Crown. Rumors circulated that the trading rights granted the South Sea Company in the “New World” were far in excess of what was being revealed (can you say “new economy stocks”?), which caused frenzied speculation. Trading in the winter and spring of 1720 drove the price of the stock up almost 400 percent. Greed pulled in even more investors anxious to be in on the big payoff. Insiders and the Crown were rumored to have made a killing.

In June 1720, after scores of joint-stock companies joined in the feast, Parliament—fearing a revolt by the general population—passed the “Bubble Act,” which forbad joint-stock companies from participating in unregistered issuance of stock. Unfortunately, this did not curb the bubble, but triggered even more aggressive buying of the South Sea Company stock. In a perverted way, the South Sea Company was viewed as a flight to quality!

Shares prices exploded, peaking at 1,000 percent of their issuance price from the final conversion of debt to stock in 1719. Finally, in August 1720, “No greater fool could be found,” and the prices started to tumble. In six weeks, it was all over. The price was back to £150.

What became of the South Sea Company?

It continued to exist until 1763, when it was disbanded. In between wars, it continued to serve as a front for the Crown's debt. In times of war, it virtually disappeared.

The hangover lasted for decades. Scores of ordinary citizens were broken. Bitterness was unbridled and knew no class. One of the biggest losers in the scam was Sir Isaac Newton, one of the most brilliant minds of all time. He never recovered financially and died in virtual poverty March 31, 1727, in an apartment with his niece and her husband.

The Cotton Panic of 1837: Land, Commodities, and Government

The first bubble addressed took place in Europe. Let's turn our attention to the original panic in the United States. This bubble is not nearly as celebrated as its European counterpart, but it was equally as deadly. It occurred during the presidency of Andrew Jackson, 1829–1837. When the bubble burst on May 10, 1837, Martin Van Buren was the president, but make no mistake—the stage was set in the prior 10 years.

The war of 1812 was really America's second Revolutionary War. The British invasion was almost successful, and the United States came very close to being “the colonies” again. As with most wars, there is a positive effect on the economy, as manufacturing and commerce in general have a tendency to grow. Capital goods must be replaced at a far greater rate than during times of peace. Usually, the prosperity lasts a few years; however, once the “war effect” ends, a general slowdown is almost sure to occur. In the United States, it manifested itself with the downturn of 1819–1821.

By the middle of 1821, the country was on its way to a recovery. The United States was expanding it western borders; new agriculture opportunities and trade brought in an era of exceptional wealth. The population went up by almost 60 percent, primarily shifting to the West, where commerce flourished North and South along the Mississippi River valley.

When the Jacksonian Era began in 1829, the United States had expanded its borders, and had also built an infrastructure of roads and canals that allowed for a flow of goods not only North and South on the Mississippi but also from the East Coast ports to the western colonies as far as Ohio.

Jackson was a very tough and vengeful man. He had been a war hero, a US senator, a landowner—and his nickname “Old Hickory” said it all. It was the merciless streak that helped to set the wheels in motion for the disaster that was to follow.

As with any time of prosperity, the demand for commodities and the land to produce them continued to increase. By law, public land in the West and Mississippi Valley could be purchased for $1.25 per acre. Sales of land increased steadily in the 1830s, and landowners started to feel the first wealth effect. Land in some prime growing areas of the Mississippi more than quadrupled in value in five years (Iowa farmland in 2014?).

In government, a nasty personal feud between President Jackson and Nicholas Biddle, the owner of the Second Bank of the United States, resulted in the revocation of its charter. Jackson replaced the Second Bank of the United States (lender of last resort) with “Specie Circular” (gold and silver coins bimetal standard) and began to deposit money in state-chartered banks.

Unfortunately, the move to gold and silver coins did not allow for any expansion of the banking system. Consequently, when individual banks needed credit to cover land transactions, there was no institution to loan them the funds. This put banks in a huge dilemma. To counter the problem, the state banks actually exacerbated the situation by lending in “paper,” or “kiting” their own notes to cover the land speculation. The thirst for “King Cotton” in Europe was thought to be unquenchable. Conversely, with inflation on the rise, signs of darkness started to emerge in late 1835. Cotton prices doubled and it fetched nearly 20 cents a pound, and inflation was headed toward double digits.

In 1836, Britain forced new and punitive trade agreements on the United States, and greatly reduced exporting and importing with America. For any trade that did take place, the British demanded payment in hard currency, not cotton. As it turned out, the demand for cotton was not infinite. By the winter of 1837, rising inflation led to social unrest. On February 14, a large assembly of angry men met in New York City to demand that the government curb exploding prices. When their demands for lower prices fell on deaf ears, the meeting turned ugly. The assembly turned into a mob and took to the street with torches. The military was called out to quell the violence, but before peace could be restored, several warehouses filled with grain were burnt to the ground. One of the unfortunate flour merchants noted with sarcasm that “burning the goods would not have a tendency to lower price.”

Commencing in April, a number of large dry-goods companies went under. These companies were the nineteenth-century equivalent of Walmart, and their demise shook the foundations of American finance. The price of cotton began to collapse; in less than six weeks, it lost 50 percent of its value. By the first week in May, the banking system was in a state of panic. On May 10, 1837, with cotton and land prices collapsing and with nowhere to turn for “a lender of last resort,” all banks in New York City stopped paying in Specie. Within two months of the New York Bank failure, 40 percent of the banks in the United States went broke. Interest rates turned negative as the ensuing panic drove the country into a financial depression.

Although not as famous as the Great Depression of the 1930s, the collapse of the banking system in 1837 led to six years of “unprecedented misery” in the United States. By some estimates, in the industrial areas of the Northeast unemployment reached a staggering 30 percent. It took another war to pull the nation out of the funk.

The Panic of 1893: Railroads Have No Upper Limit

Railroads had been a reliable form of transportation for nearly a quarter of a century in Europe before they arrived in America in the late 1820s. Between 1830 and 1860, America saw a great period of expansion when the country more than doubled in size. The nation needed a way to move goods and people to new markets quickly, and the railroad was the perfect vehicle. It combined the ability to move bulk goods, as the river and canal system had, and it added the value of speed. It could move goods up to 400 miles a day; a trip that used to take weeks could now be accomplished in a couple of days.

Prior to 1850, most of the railroads were short lines that joined with other short lines to form an irregular system. However, in 1850 the US Congress decided it was time to try and establish longer-haul routes that were contiguous and made available the first railroad land grants. During the next 20 years, legislators granted 170 million acres to roughly 85 railroad companies. Although substantial portions of the grants were never developed, the country still had enough track in place to circle the globe.

One of the problems that Congress had not foreseen was the standardization of track. There was no Bill Gates to figure out that if one railroad had a different width of track than the next, it could create a problem, and, unfortunately, it created a massive one. With hundreds of railroads across the land and several different gauges, it became increasingly difficult to move goods over large areas without transferring to a new railroad each time the track size changed.

The problem gradually resolved itself in the decades after the Civil War as the standardization of track took place and Congress continued to extend free land to the railroads in an attempt to connect the West to the rest of the country. As with any new technology, it seemed that this time was different and the market for railroads had no limit. It allowed for both a revolution in commerce as well as a social revolution. By 1880, you could travel from New York to San Francisco in less time than it took to go from New York to Washington, D.C., 50 years earlier.

With innovation came the need for financing the next project, and who was better suited for that than Wall Street? By 1890, there was more than $12 billion (nearly $300 billion in 2014 dollars) invested in the industry. As with any successful product, competition came into play. Within 10 years of Leland Stanford driving the “golden spike” that completed the transcontinental railroad on May 10, 1869, at Promontory Summit in the Utah Territory, there were four competing railroads carrying passengers and goods across the country. Revenues began to shrink, but the cost of infrastructure continued to climb, latecomers started to have troubles, and some smaller railroads went under.

On February 23, 1893, a major carrier, the Philadelphia and Reading Railroad, declared bankruptcy. This created a crisis of confidence (Lehman Brothers?), and investors began to panic and withdraw their money from the banking system. The federal government sought to stop the run by repealing legislation that tied the price of silver to the dollar, but that effort failed when more major railroads ceased to do business.

The final result was that hundreds of railroads went broke; over 500 banks, the majority of them in the West, closed; and 15,000 other businesses went under. Unemployment in major manufacturing cities moved above 18 percent at the peak of the depression in 1894 and remained in double digits until the recovery began in 1897 with the Klondike Gold Rush.

September 11, 2001: Price Can Never Go Up Again

Although the three bubbles that we have observed were from different times and different places, they all had a common origin: speculation fueled the bubble. In each case, the perceived opportunity overcame rational thought. Even one of the most brilliant men in recorded history fell victim to the mass hysteria. So now the question must be asked: Is it possible to have a deflationary bubble?

Could the price of an asset class be deflated with the same logic that causes the inflationary bubble?

Consider Tuesday, September 11, 2001.

I doubt that any living American will ever forget that morning. The impossible had happened; terrorists were able to take down American financial icons, the World Trade Centers in New York City. The markets reacted swiftly and viciously. If you were not lucky enough to close your positions, there was no way to reach financial safety.

Within minutes of the second tower being hit, the exchanges were forced to close. The infrastructure damage was immense, and it would take a full week before they could reopen. Although authorities pleaded for calm, as a professional trader you sensed the result before the markets reopened: panic.

When the markets resumed trading on Monday, September 17, the financial devastation of the attack was immediately apparent. The DJIA plummeted more than 4 percent on the opening bell. When the carnage stopped at 4:00, the Dow was down more than 7 percent.

Rumors on the street flourished. Bin Laden was not only the mastermind of the attack but he had purchased millions of dollars of puts on the OEX. New attacks were on the way. The economies of the Western Allies had lost hundreds of billions, and it would take decades to recover. The rest of week was even worse. Every day, the decline accelerated. Investors refused buy any US asset. Treasury Bonds, which had been used as a “flight to quality” for more than 80 years, joined the rout.

Friday morning, September 21, the economic news was horrible. There was no tomorrow; in a single stroke of violence, Bin Laden had realized his dream to bring the decadent Western world to its knees. The market opened down almost 5 percent from Thursday's close. The worst week in over 140 years was in the making. The futures markets were locked limit down. Economic Armageddon had arrived, and this time there was no bottom!

And then it stopped.

Some anonymous investor stepped up to the plate and bought. The market rallied the rest of the day to finish marginally lower; by December 31, 2001, it had rallied 23 percent from the bottom. Bin Laden did not accomplish his goal.

The United States not only survived but continues to flourish. The masterminds of the plot are either dead or in captivity.

The Commodity Bubble of 2008: Price Can Never Go Down Again

The housing bubble has gotten extensive coverage in all forms of media, so it will not be discussed here. But one of the largest meltdowns in world history was in the works in a parallel universe, the commodity bust of 2008.

The commodity panic was not limited to a specific country or a specific product. Modern trade and the speed of information allowed the panic to spread quickly across the world. The list of culprits is long. Evil speculators, farmers who overplanted fields, hoarders who withheld goods from the market, consumers who raced each other for more goods than they could possible use, and, of course, the pigs on Wall Street. Rather than take the time to go over each individual market, the focus of this story will be placed on the biggest commodity market in the world—crude oil.

Crude oil has been a major source of energy for more than 150 years. Fortunes have been made and lost acquiring it. Nations have been built on its back. Nations have gone to war to acquire it. It is a god of wealth to some and the devil for others, but one thing is clear: Twenty-first-century society needs crude oil.

The bubble in crude oil started as countless panics that preceded it, with a gradual inflation of price. Less than 10 years before the bubble burst, the price of crude oil was $17 a barrel.

Iraq was selling as much as it could produce to cover its costly mistake with Kuwait and the resulting war with the US-led coalition. In addition, financial problems in the Far East reduced the demand, making it unprofitable to recover crude from marginal fields.

Demand was not suppressed for long, though, and crude oil prices reached $60 a barrel in June 2005. By the summer of 2006, crude oil futures at the NYMEX peaked at $77 a barrel. After the summer surge, prices retreated and closed on New Year's Eve at $63. However, the uptrend did not halt for long. In September 2007, crude took out the previous year's high and closed at over $80 a barrel.

Multiple factors were cited for the increase in price.

US oil reserves had fallen to dangerous levels, OPEC was reducing production, leftist rebels had attacked and destroyed pipelines in Mexico, an El Nino was predicted, the US dollar was getting pummeled, there was social unrest in Turkey, and Elvis had been sighted in Reno. In November 2007, oil hit $90 a barrel on fears of social unrest in Turkey; the US dollar was getting pummeled. Every bit of news, no matter how bizarre and unrelated, was a reason to buy oil.

On January 2, 2008, crude hit the magic $100 a barrel level. Prices continued to skyrocket throughout the spring and early summer. Finally, on July 11, 2008, oil peaked at $148 a barrel. Now under extreme pressure from the public, President George W. Bush issued an executive order on July 14 removing the ban on offshore drilling that had been in place since 1990. This was largely a political tool, as it did not change production or distribution capacity. By the end of July, oil had retreated to $125. It appeared that the worldwide demand for oil, which six months before could never be satisfied, was now overwhelmed by supply. The global meltdown in housing prices further reduced the amount petroleum by-products needed in construction.

Throughout the fall, oil prices continued to collapse, as the global stock markets plummeted and cash was poured into US Treasury Bonds. The world didn't seem to care that the yield on the 30-year investment was less than 3 percent, the lowest return in 80 years. The cash price of West Texas crude oil bottomed at $38 a barrel on December 21, 2008. In less than six months, the price had fallen by 75 percent, and trillions of dollars had been lost.

Who was to blame for this unprecedented implosion?

Well, according to testimony before congressional committees, the government claimed that there was a single source—the usual suspects, the greed on Wall Street. On June 3, 2009, testimony before the Senate Committee on Commerce, Science, and Transportation, former director of the CFTC Division of Trading & Markets Michael Greenberger fingered the Atlanta-based Intercontinental Exchange founded by Goldman Sachs, Morgan Stanley, and British Petroleum as the agency playing a key role in the speculative run-up of oil futures prices traded off of the regulated futures exchanges in London and New York. In January 2011, crude oil reached the $100 a barrel mark once again.

Bitcoin 2009 to Present: Crypto-Currency Meets Greed

The last bubble we will examine is one that is current, and the final results are not in. Proponents claim that this is the techno-currency of the future; detractors claim it is a way for criminals to hide transactions and is most likely a Ponzi scheme.

Look at the results thus far and you can be the judge.

Bitcoin first appeared in a scientific paper and is credited to the name Satoshi Nakamoto. Since no one has come forward to claim its authorship, it is difficult to determine if it is a pen name or simply an individual or a group that wants to remain anonymous.

Bitcoin is a digital currency that doesn't have any ties to a central bank. The point-to-point payment system allows for transactions to be made in complete anonymity. The coin is created by a complex set of computer codes that create the currency through a process called mining. Unlike central bank–issued currency, which can expand and contract the money supply, bitcoins have a finite number, and once the final coin is mined, it is a closed environment. In addition to being untraceable, the value of the currency is not being manipulated by a central bank. Proponents claim that in the long run, it will allow for a stable market and that supply and demand will establish its value. Opponents claim the opposite—that this trait gives it all of the features that promote extreme price manipulation and can give seeds to a massive Ponzi scheme.

The price history of Bitcoin suggests that the opponents' view is hard to argue.

In 2011, the price of a single Bitcoin fluctuated from a low of 30 cents per US dollar to as high of $32 before crashing back to $2. If this is supposed to be a way to put stability in a currency system the initial result seems to indicate the opposite. In March 2013, the Bitcoin exchange known as Mt. Gox had a software meltdown and triggered another massive selloff in the crypto-currency, as prices plunged by 70 percent in less than three hours. The market recovered and rallied back to over $1,100 a Bitcoin before a selloff in January of 2014 saw the price go down to $500 in less than a month. A rally in February of 2014 took the price back to $1,000 until money laundering and Internet scandals involving one of its strongest proponents rocked the currency. Later in February, Mt. Gox was again the victim of a computer glitch and suspended withdrawals. This time, the exchange closed and admitted that $350 million worth of Bitcoin was missing from its vaults. The victims of the loss are currently looking for a legal jurisdiction to pursue criminal action. The irony of this is that the traders who are searching for their money ($) were using the Bitcoin to avoid legal detection, and were manipulating the crypto-currency for profit; they are now complaining that they were scammed!

Isn't this the same defense that Bernie Madoff's minions used to defend the millions that they helped to steal off of investors? They also claimed that they were the victims because they took the stolen money and invested it with Mr. Madoff!

As of this writing, the Bitcoin is trading around $350, a drawdown of over 70 percent from its peak value during the height of the mania in December of 2013. Whether it will turn out to be a highly speculative investment or just another Ponzi scheme can't be determined at this point, but one thing is certain—it has not proven to be anywhere near as effective as advertised in combating the weakness of central bank–issued currency. In fact, it has multiplied any of their shortcomings many times over!

Lessons to Be Learned

Six famous markets have been examined. The time frame stretches for almost 300 years. Four of these markets resulted in bubble tops, one ended in an implosive bottom, and one is not a final score. Various reasons were given in order to justify the price action. Various underlying assets were involved in the bubbles.

Can we find a common thread?

At market extremes, emotions drive the markets, not rational thought!

When the markets were rallying, it was not the value of the underlying asset that drove the market higher; it was the mind-set of the investors.

Investors become overwhelmed by greed


When it seemed that anyone could get rich in the South Sea Company, no one wanted to miss that ship.

Investors become paralyzed by fear


In the case of the implosion after the 2001 terrorist attacks, fear drove investors to unload their stocks in a hurry.

All market extremes are driven by two forces—fear and greed


Markets might generally pay attention to asset value, earnings, and global trends, but when emotion starts driving price, it can take over in a hurry.

You might be wondering why a book on how to trade weekly options would start with a chapter about economic history. I believe in order to be successful trading in the markets, you must be able to understand how the price got to certain levels and how to control your emotions when everyone around you is losing control of theirs.

Without an understanding of market psychology, it is almost impossible to be successful. You have to know what the other side of the trade is thinking and how they are reacting.

After each chapter, there will a brief quiz. Take it and check your responses in the answer section in the back of the book. The questions will be multiple choice, and the number of points you can earn on a question will vary from one to three. If you can score 90 percent on any of the tests, you are ready to go to the next chapter. If you struggle with the quiz, please reread the material before going to the next section. This book is a building-block system to approaching the markets, and, therefore, if you don't build a solid foundation, the whole structure can come crumbling down.

Chapter 1 Quiz

1. The South Sea Company was set up to:

take advantage of new trade routes to the South Seas

be the world's first franchise

fund the Crown's debt from the Spanish War of Succession

do all of the above

2. Who funded the South Sea Company?

investment bankers

the British Crown

individual investors

all of the above

3. Why did Sir Isaac Newton lose his fortune in the South Sea bubble?

The South Sea stock was allowed to trade freely.

The Crown lost a great deal of money developing the trade routes to the South Seas.

Land companies drove up the price of the trade routes.

He was greedy.

4. What caused the Cotton Panic of 1837?

Andrew Jackson's feud with Nicholas Biddle

the move to a bimetal system to back the dollar

the expansion to the Western territories

none of the above

5. The lack of a lender of last resort in the 1837 Cotton Panic:

had little to do with the panic; greed was the villain

was accomplished by state banks

created a panic in the cotton market

caused the price of cotton to collapse

6. The 1836 British tariff on cotton:

caused cotton prices to collapse

caused land prices to collapse in the Mississippi delta

caused inflation

had little to do with the panic

7. What caused the railroad panic of 1893?

Congress allowed too many free acres for railroad construction.

There was competition among railroads.

Wall Street's greed led it to finance unneeded infrastructure.

Demand for coast-to-coast travel declined.

8. The stock market crash of 2001 was primarily caused by:

the terrorist attacks in New York City

an inflated market that was primed for a selloff

the Federal Reserve's lack of response to the crisis

the fear created by the attack

9. What was the Bitcoin bubble of 2014?

a classic example of a new technology that had no upper limit

an event caused by the collapse of the Mt. Gox Exchange

an event caused by government corruption

a classic example of greed

10. All the bubbles reviewed had which of the following common characteristics?

Technology had produced a product that had no upper limit.

Government regulations contributed to the problem.

Inflation caused the markets to collapse.

Greed or fear overwhelmed reason.

If you scored 90 percent or better, congratulations! If not, please reread the chapter to make sure that the first block of the foundation is in place.