The dates for exercise (of your option rights) and the last trading date for the option are the same for individual stocks, meaning that they 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.
✔ There are two types of options: American and European style. Each has its own particular 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.
Using options to limit your risk
Getting the details of option risk profiles is important and will be useful. But actually devising and using strategies in trading is even better. You start by evaluating the many options that are available for asset protection. And although, you may not think that is sexy, spending the time up front 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. 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. See Chapter 12.
You will 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. These are complex strategies that you can work toward as you gain experience. Some of these more complex strategies include
✔ Vertical debit spreads
✔ Vertical credit spreads
✔ Calendar spreads
✔ Diagonal spreads
The most influential factor on when to use these spreads will be market conditions. And this book will help you make those decisions.
Applying options to sector investing
One of the best recent advances in the financial markets has been the creation and proliferation of ETFs. 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 in them at any time during the trading day instead of waiting until the market closes, as with non-exchange traded traditional mutual funds.
✔ ETFs offer listed options. That means you can apply all option strategies to sectors of the stock market by trading options on the underlying ETF. This often lets you make index bets without using index options with expiration and last day of trading may cause you some extra steps.
✔ There are 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 participate in rising or falling markets through stocks and ETFs, assuming that you are comfortable with both owning these securities and selling them short. But what do you do in a sideways market, except maybe sitting it out or collecting a few dividends? You can craft option strategies for sideways markets whether you have any underlying positions or not. Chapter 16 tells you all about this great set of strategies.
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 are 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 make money when the underlying stock moves up or down. Consider this:
✔ You can set up strategies that let you profit if 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 can make money in sideways markets.
Controlling your emotions
Perhaps the most difficult part of trading any market is the emotional responses that can be triggered by price movements in things you own, or wish you owned. Let’s face it, we are all emotional. It’s part of being human. The problem is that emotional trading is usually the path to big losses. That’s why we have rules and why you design an anticipatory trading plan, in order to control the emotion that goes along with trading.
A good trading plan has these key characteristics:
✔ Access to the proper equipment: Make sure you have all the technology you need: computers, mobile devices, and backup systems along with a quiet place to work.
✔ Knowledge of time commitment: Think about whether you will day trade or be a longer time position trader. If you can’t devote a couple or three hours at a time to monitor a position, day trading is not for you.
✔ 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.
Chapter 2
Introducing Options
In This Chapter
