Part I: The Basics 1
Chapter 1: Calls and Puts: Defining the Field of Play 3
Equity Investments 3
Debt Investments 4
Investments with No Tangible Value: Options 5
Trading Options on Exchanges 7
Calls and Puts 10
The Call Option 13
The Long-Term Call Option 20
Investment Standards for Call Buyers 21
How Call Selling Works 22
The Put Option 26
Option Valuation 32
Picking the Right Stock 37
Intrinsic Value and Time Value 38
Chapter 2: The Life of an Option 45
Expiration and Exercise 45
What is "Clearing"? 46
Bid and Ask 47
Order Entry 48
Types of Orders 49
Who Are the Players? 49
Chapter 3: Opening and Tracking: How It All Works 51
Terms of the Option (Standardized Terms) 51
Strike Price 51
Expiration Date 52
Type of Option 53
Underlying Stock 54
A Note on the Expiration Cycle 54
Opening and Closing Option Trades 56
Using the Daily Options Listings 56
Understanding Option Abbreviations 59
Calculating the Rate of Return for Sellers 61
Chapter 4: Buying Calls: Maximizing the Rosy View 65
Understanding the Limited Life of the Call 66
Judging the Call 70
Call Buying Strategies 76
Strategy 1: Calls for Leverage 76
Strategy 2: Limiting Risks 80
Strategy 3: Planning Future Purchases 81
Strategy 4: Insuring Profits 82
Strategy 5: Premium Buying 84
Strategy 6: Pure Speculation 85
Defining Profit Zones 87
Chapter 5: Buying Puts: The Positive Side of Pessimism 93
The Limited Life of the Put 95
Judging the Put 101
Put Buying Strategies 106
Strategy 1: Gaining Leverage 107
Strategy 2: Limiting Risks 109
Strategy 3: Hedging a Long Position 110
Strategy 4: Pure Speculation 114
Defining Profit Zones 115
Chapter 6: Selling Calls: Conservative and Profitable 119
Selling Uncovered Calls 121
Assessing Uncovered Call Writing Risks 126
A Question of Suitability 127
Selling Covered Calls 129
Assessing Covered Call Writing Risks 133
Calculating the Rate of Return 134
Chapter 7: Selling Puts: The Overlooked Strategy 139
Analyzing Stock Value 143
Evaluating Risks 145
Put Strategies 146
Strategy 1: Producing Income 147
Strategy 2: Using Idle Cash 149
Strategy 3: Buying Stock 150
Strategy 4: Writing a Covered Put on Short Stock 153
Strategy 5: Creating a Tax Put 153
Part II: Closing the Position 157
Chapter 8: Closing Positions: Profit, Exercise, or Roll 159
Defining Possible Outcomes of Closing Options 159
Results for the Buyer 160
Results for the Seller 160
Exercising the Option 162
Timing the Decision 168
Avoiding Exercise 171
Chapter 9: Paper Trading: A Test Run of the Theory 183
The Case for Paper Trading 185
Sites Worth Checking 187
Proceeding with a Paper Trading Plan 188
The Dangers of Paper Trading 189
Chapter 10: Calculating the Return: A Complex Aspect to Options 193
Finding a Realistic Method 193
Annualizing Models and Guidelines 195
An Overview of Basic Calculations for Calls 198
You Close the Position and Calculate Option-Based Net Return 199
You Close the Position and Calculate Net Return Based on the Entire
Position 199
The Covered Call is Exercised, and You Calculate Option and Stock Profits
Separately 200
Any Covered Call Outcome Is Computed Strictly Based on Capital on
Deposit 200
Anticipating the Likely Return 201
Chapter 11: The Basics of Risk: What Every Trader Needs to Know 205
Volatility as the Definition of Risk 205
Historical Volatility 207
Implied Volatility 210
Pricing Models 213
Risk and Human Nature 215
Confirmation Bias 216
Anchoring 216
Herding 217
Framing 217
Selective Memory 218
Loss Aversion 218
Chapter 12: Strategies in Volatile Markets: Uncertainty as an Advantage 221
Avoiding 10 Common Mistakes 222
Modifying Your Risk Tolerance 228
The Nature of Market Volatility 229
Market Volatility Risk 230
Options in the Volatile Environment 235
Part III: Advanced Strategies 241
Chapter 13: Combinations and Spreads: Creative Risk Management 243
Overview of Advanced Strategies 246
The Spread 246
The Hedge 251
The Straddle 252
The Strangle 253
Vertical Spread Strategies 255
Bull Spreads 256
Bear Spreads 258
Box Spreads 262
Debit and Credit Spreads 265
Horizontal and Diagonal Spread Strategies 265
Altering Spread Patterns 270
Varying the Number of Options 271
Expanding the Ratio 274
Strategies with Moneyness Close to Underlying Prices 277
Variations on the Butterfly 280
Multi-Leg Option Orders 281
In Conclusion 282
Chapter 14: Hedges and Straddles: More Creativity 283
The Two Types of Hedges 283
Hedging Beyond Coverage 286
Hedging Option Positions 288
Partial Coverage Strategies 292
Straddle Strategies 295
Middle Loss Zones 295
Middle Profit Zones 298
Theory and Practice of Combined Techniques 301
In Conclusion 302
Chapter 15: Options for Specialized Trading: Leveraging the Technical
Approach 303
Swing Trading Basics 305
The Setup Signal 308
Testing the Theory 311
A Strategic View of Option for Swing Trading 313
Selection of Stocks Based on Value 313
A Stock's Price Volatility 314
Price History (Recent and Potential) 315
The Price-To-Earnings (P/E) Ratio of the Stock 315
Fundamental and Technical Tests of the Company and Stock 316
Options Used for Other Trading Strategies 316
Swing- and Day-Trading Advanced Strategies 317
Taking Partial Profits 318
Partial Exercise 319
Add More Option Contracts in Times of Price Momentum 319
In Conclusion 320
Chapter 16: Options on Futures: Leveraging Your Leverage 321
Important Distinctions 322
Regulatory Differences 326
In Conclusion 328
Chapter 17: Synthetic Positions: Tracking the Stock 331
Synthetic Put (Protected Short Sale) 333
Synthetic Long Call (Insurance Put, or Married Put) 334
Synthetic Long Stock 336
Synthetic Short Stock 338
Split Strike Strategy (Bullish) 340
Split Strike Strategy (Bearish) 342
Collars 343
Synthetic Straddles 350
In Conclusion 353
Part IV: Risk Evaluation 355
Chapter 18: Risk: Rules of the Game 357
Identifying the Range of Risk 357
Margin and Collateral Risk 360
Personal Goal Risks 360
Risk of Unavailable Market 361
Risk of Disruption in Trading 362
Brokerage Risks 363
Trading Cost Risk 363
Lost Opportunity Risks 364
Tax Consequence Risk 365
Evaluating Your Risk Tolerance 366
In Conclusion 367
Chapter 19: Taxes: The Wild Card of Options Trading 369
Tax Rules for Options 369
Qualified Covered Calls-Special Rules 373
Looking to the Future 378
In Conclusion 379
Chapter 20: Choosing Stocks: Finding the Right Ingredients 381
Developing a Covered Call Action Plan 385
Selecting Stocks for Call Writing 387
Benefiting from Price Appreciation 388
Analyzing Stocks 390
Fundamental Tests 394
Technical Tests 398
Deciding Which Tests to Apply 400
Applying Analysis to Options-the "Greeks" 401
Beta 402
Delta 402
The Rest of the Greeks 404
Acting on Good Information 406
Putting Your Rules Down on Paper 407
In Conclusion 408
Glossary 409
Index 409
