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Preface .......................................................................................................................................................... 2
Legal Disclaimer ............................................................................................................................................ 4
1 Introduction to options......................................................................................................................... 9
1.1 What are options? ........................................................................................................................ 9
1.1.1 Explanation 1......................................................................................................................... 9
1.1.2 Explanation 2......................................................................................................................... 9
1.2 Core Terms and Concepts ........................................................................................................... 10
1.2.1 Basic Definitions.................................................................................................................. 10
1.2.2 Intermediate Concepts ....................................................................................................... 11
1.2.3 Advanced Concepts............................................................................................................. 12
1.2.4 Further Explanation ............................................................................................................ 14
1.2.5 Additional Resources .......................................................................................................... 14
1.3 Why trade options? .................................................................................................................... 16
1.3.1 Leverage.............................................................................................................................. 16
1.3.2 Protection............................................................................................................................ 16
1.3.3 Advanced trading strategies ............................................................................................... 17
1.4 Why do people avoid options? ................................................................................................... 17
1.4.1 Lack of exposure ................................................................................................................. 17
1.4.2 Risk ...................................................................................................................................... 17
1.4.3 Complexity .......................................................................................................................... 18
2 Option strategies................................................................................................................................. 19
2.1 Basic strategies ........................................................................................................................... 19
2.1.1 Buying a Call ........................................................................................................................ 19
2.1.2 Selling a Call ........................................................................................................................ 21
2.1.3 Buying a Put ........................................................................................................................ 24
2.1.4 Selling a Put......................................................................................................................... 26
2.2 Intermediate Strategies .............................................................................................................. 28
2.2.1 Covered Calls....................................................................................................................... 28
2.2.2 Married Puts ....................................................................................................................... 31
2.2.3 Spreads................................................................................................................................ 31
2.3 Advanced Strategies ................................................................................................................... 38
2.3.1 Straddle ............................................................................................................................... 39
2.3.2 Strangle ............................................................................................................................... 42
2.3.3 Butterfly .............................................................................................................................. 45
2.3.4 Iron Butterfly....................................................................................................................... 48
2.3.5 Condor................................................................................................................................. 51
2.3.6 Iron Condor ......................................................................................................................... 54
2.3.7 Advanced Strategy Recap ................................................................................................... 58
3 Forums ................................................................................................................................................ 64
4 Blogs.................................................................................................................................................... 64
5 Videos.................................................................................................................................................. 65
5.1 Introduction/Overview ............................................................................................................... 65
5.2 Intermediate Concepts ............................................................................................................... 66
5.3 Advanced Concepts..................................................................................................................... 66
5.4 Strategies .................................................................................................................................... 67
6 Websites.............................................................................................................................................. 69
6.1 CBOE............................................................................................................................................ 69
6.2 OIC............................................................................................................................................... 69
6.3 My Options Community.............................................................................................................. 69
6.4 Options Buddy............................................................................................................................. 69
6.5 Samoa Sky ................................................................................................................................... 69
7 Brokerages .......................................................................................................................................... 70
7.1 OptionsXpress ............................................................................................................................. 70
7.2 Charles Schwab ........................................................................................................................... 72
7.3 ChoiceTrade ................................................................................................................................ 73
7.4 E*Trade ....................................................................................................................................... 74
7.5 MB Trading.................................................................................................................................. 77
7.6 eOption ....................................................................................................................................... 78
7.7 OptionsHouse.............................................................................................................................. 79
7.8 Questrade ................................................................................................................................... 81
7.9 TD Ameritrade............................................................................................................................. 82
7.10 TradeKing .................................................................................................................................... 83
7.11 Zecco ........................................................................................................................................... 84
7.12 Brokerage Trade Cost Comparison ............................................................................................. 86
8 Investment Tools................................................................................................................................. 88
8.1 Software...................................................................................................................................... 89
8.1.1 Optionetics Software Tools................................................................................................. 89
8.1.2 Visual Options Analyzer ...................................................................................................... 89
8.1.3 OptionStar........................................................................................................................... 90
8.1.4 OptionVue ........................................................................................................................... 90
8.1.5 OptionEdge ......................................................................................................................... 91
8.2 E-books and Newsletters ............................................................................................................ 92
8.2.1 Terry’s Options Strategies for Stock Market Success.......................................................... 93
8.2.2 Build Your Wealth in Minutes a Day ................................................................................... 94
8.2.3 Market Neutral Options ...................................................................................................... 95
8.2.4 Optionetics Newsletters...................................................................................................... 95
8.3 Signals and Systems .................................................................................................................... 96
8.3.1 Commodity Option Secrets................................................................................................. 97
8.3.2 Stock and Option Trading (Online Option).......................................................................... 99
8.3.3 OEX Options ...................................................................................................................... 100
8.3.4 Trading Pro System ........................................................................................................... 101
8.3.5 Options Income Generator ............................................................................................... 102
8.3.6 Stackers Signaling Service ................................................................................................. 103
8.3.7 Trading Addicts ................................................................................................................. 104
8.3.8 Optionetics Home Study Courses ..................................................................................... 105
8.4 Websites.................................................................................................................................... 106
8.4.1 iVolatility ........................................................................................................................... 107
8.4.2 Call Writer ......................................................................................................................... 108
8.4.3 Optionistics ....................................................................................................................... 108
8.4.4 The Power Financial Group ............................................................................................... 109
8.4.5 Option Investor ................................................................................................................. 110
8.4.6 Optionetics........................................................................................................................ 111
8.4.7 AIQ Systems ...................................................................................................................... 111
8.4.8 Option Monitor ................................................................................................................. 111
8.4.9 The Options Hunter........................................................................................................... 111
About My Options Community ................................................................................................................. 112
This chapter provides a brief introduction to options, options examples, why one should trade options, and why people avoid options. It also has a list of key terms and concepts one should know before trading options.
Many people have difficulty when trying to understand the concept of options. This is due to the many different concepts involved with options. There are various ways of looking at options, as well as a variety of ways of explaining them. We have included several explanations in the following subsections. These include two of our own, as well as those on other sites, including video introductions. We hope these clarify the concept of options.
1.1.1 Explanation 1
Options are different from normal transactions between two parties. Normally when people purchase an item, the buyer receives the item at the agreed upon price. The seller gives the buyer the item, and the transaction is finished.
An option, on the other hand, doesn’t allow someone to buy an item. With options, they are buying the right to buy, or sell, the item. More formally, an option is a formal agreement or contract between two parties to either buy or sell an asset, known as the underlying, for an agreed price, known as the strike price. The underlying can be either a single stock or a collection of stocks. There is a cost, known as the option premium, for entering this contract. The buyer of the option pays this premium to the seller. Thus, for the buyer, there is a net debit. For the seller, there is a net credit. Once the contract is formed, the option buyer has the right, or option, to go through with buying or selling the item. If (s)he so chooses, the seller must fulfill the obligation.
Options differ from normal transactions in another way - they also have a timeline. This is the period of time for which the buyer can go through with, or exercise, the option. The expiry, or expiration date, is the date at which the option is no longer valid.
1.1.2 Explanation 2The best way to understand an option is to use an illustration. (This example is for illustration purposes only, and should not be construed as expected values for options, or expected returns.) Imagine a savvy investor is looking to buy some real estate. During his search, he notices someone is selling 10 acres of land for $10,000 each ($100,000 total). During this time, he also comes across a very interesting rumor. A friend of his that works at the planning office tells him that there is talk of a new shopping mall being built in a particular section of town, just a couple miles from the land he saw. He knows that if the mall is built, the price of land will skyrocket. However, if it isn’t built, he knows he’ll be stuck with some property he didn’t want.
He presents the seller of the land with an interesting proposition: he will give her $10,000 to let him buy the land within the next three months. If he decides to purchase, he’ll pay the full $100,000. If he decides not to purchase, the seller can keep the money. Thus, he’s not buying the land…he’s buying the right to buy the land.
This would be referred to as a CALL option, because it’d allow him to buy within a given period of time. (A PUT option would allow him to sell within a given of time.) The underlying would be the 10 acres of land, because that’s what he would receive if the purchase took place. The premium would be $10,000, because this is the amount he must pay to enter into the agreement. The strike would be $100,000, because that’s the price he’d pay the seller for the underlying. The expiration would be the end of three months, because that is how long the agreement is valid. If the rumor became true, he could exercise his option, and buy the land for the agreed upon price of $100,000. (Note: the $10,000 paid to enter the agreement wouldn’t go toward this purchase…it is NOT a deposit).
1.2.1 Basic Definitions
Premium: Expiration/ Expiry:
A contract between a buyer and seller that gives the buyer the right, but not the obligation, to buy or sell an asset at agreed price within an agreed time period. The seller must honor the contract if the buyer chooses to exercise the option. Options come in two varieties: Call and Put
A call option gives the buyer the right to buy the underlying, at the strike price, before expiration.
A put option gives the buyer the right to sell the underlying, at the strike price, before expiration.
The fixed price that an option owner can buy (for calls) or sell (for puts) the underlying asset
The price the buyer pays the seller in order to enter the contract. The date at which the option expires, or is no longer valid.
Expiration Saturday/ Cycle
Underlying: Assignment:Options have a date by which they must be exercised. For a given month, the expiration is the Saturday after the third Friday. For example, the June 2009 options expired on June 20. However, option holders must notify their brokerage of their intent to exercise by the previous trading day, since the exchanges are closed on Saturdays. Therefore, for all intents and purposes, they expire on the third Friday. The available months for expiration are typically the current month, the following month, and then future months, based on one of three cycles:
· January, April, July, October
· February, May, August, November
· March, June, September, December
(Note: The “current month” actually changes to the following month once expiration Friday has passed. The subsequent months also change accordingly. For example, the current month would be August up until the Saturday after 3rd Friday in August. Then, the “current month” would be September, even though there would still be days remaining in August.)
The asset that the corresponding option is derived from.
When the seller of an option contract is forced to fulfill the option contract. For calls, this means the option seller must sell the underlying asset at the strike price, regardless of the current market price. For puts, this means the option seller must purchase the underlying asset at the strike price, regardless of the current market price.
When the buyer of an option chooses to go through with the contract. For calls, this means the buyer purchases the underlying at the strike price. (The call seller must deliver the underlying to the buyer at the strike price). For puts, this means the buyer sells the underlying at the strike price. (The put seller must purchase the underlying from the buyer at the strike price).
The market value of the underlying asset is approximately equal to the strike price of the option.
The market value of the underlying asset is at a value that makes the option profitable for the option buyer (excluding the premium). For calls, this means the market price of the underlying is greater than the strike price. (This would be profitable because the buyer can purchase the underlying at a price lower than market value.) For puts, this means the market price of the underlying is lower than the strike price. (This would be profitable because buyer can sell the underlying at a price higher than market value.)
The market value of the underlying asset is at a value that makes the option unprofitable for the buyer. For calls, this means the market price of the underlying is lower than the strike price. (This would be unprofitable because it would be better for the option buyer to purchase the underlying at the market price.) For puts, this means the market price of the underlying is higher than the strike price. (This would be unprofitable because it would be better for the option buyer to sell the underlying at the market price.
The change in the price of the option in relation to a 1 point change in the price of the underlying. For example, if the price of the stock goes from $50 to $51, and the price of the option goes from $5 to $5.50, the delta is 50%. Delta is positive for calls and negative for puts, since puts decrease in value as the price of the stock rises.
The option premium is the sum of the intrinsic value and time value. Intrinsic value is the portion of the