Six days after the IPO opens rule will permit that Facebook becomes available for options trading. Traders will have thoroughly analyzed fundamentals and will closely watch market sentiment. If the expected excitement of private investors comes to pass, the stock will likely become overbought. Traders seeing that situation coming will buy puts on Facebook. Traders who expect to see the stock keep climbing will buy calls. Hedging risk with options will also be useful for those who get in early and see a substantial stock rise. Investors who believe that Facebook will replicate the Google experience will not want to sell their stock too early. On the other hand they may choose to protect their gains. They can do this by buying puts on Google while holding their stock. If the stock continues to rise the investor will simply have paid insurance in the form of his put contracts. However, if the stock falls in price he will be able to sell the stock at the options contract price and purchase again at the now lower price. On the other hand he can also simply exit the options contract and use his profits to offset a loss of share price.

As volatility of the stock increases that could also increase the price of both puts and calls when trading Facebook options. As we often remark, selling options tends to be more profitable over time than buying them. However, selling options in a volatile market is the work of professionals backed by large institutions with deep pockets. For small investors selling can be risky business. One useful tactic for anyone interested in trading Facebook options could a long straddle. The trader buys both calls and puts with the same expiration date. He will win whether the stock goes up or if it goes down. His cost of doing business is the price of the options contracts. The worst he will do is lose the price of these contracts if the stock price does not move. As always do your homework and stay out of trades that you do not thoroughly understand.

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The Much Anticipated Demise of the Euro

In an attempt to bring fiscal order to the European Union the members of the EU amended their treaty. One of the things they did was give more power to the European Central Bank. The bank also has a new president, Mario Draghi. Mr. Draghi not only went to MIT, like US Fed chairman Bernanke, but Mr. Draghi may well be following the prescriptions of the Fed chairman as well. Bernanke is a recognized expert on the causes of the Great Depression. His recipe for avoiding another depression is commonly referred to as the Bernanke doctrine. A key facet of this doctrine is that printing money and buying the country’s own debt, with printed money, will keep credit flowing and avoid another Great Depression. Soon after Draghi took office he issued loans to banks across Europe in excess of $600 Billion when measured in US dollars. The point is to keep banks solvent and provide money for business to function. The point is also to bail out the faltering economies of the southern tier of Europe. With the printing pressing going at full speed it may well be the profitable options trading in Forex may well be to buy puts on the Euro keep counting one’s profits.

Gold, Oil, and Chinese Real Estate

Trading gold options has had the potential for profit for the last decade as the price of the shiny stuff has both risen and fallen as the price has moved upward for a decade. Gold bugs are still predicting $3,000 an ounce but many contend that the recession, at least in the US, is nearly over and that stocks will take off. If that is the case take a look at what happened to gold at the start of 1980’s. Oil should go up if the Euro and dollar inflate but that assumes an economic recovery. A new recession in Europe, the world’s second largest economy could put a damper on oil prices but profitable options trading could result from successfully reading the ups and downs of oil prices. A wild card that many do not seem to see is the state of China, especially its real estate market. Remember in the late 1980’s when Japan, Inc. was about to take over the world. When things went to heck in a hand basket over there it turned out that there were a lot of back room, handshake, good old boy loans that supported the system. China apparently has the same situation. The country is soon to have half of the skyscrapers in the world. But, when there is no one to fill them profitable options trading on Chinese stocks could well be all puts. And, as usual use this discourse as means of stimulating thought and do your own research before trading options on anything.

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The economic picture in the European Community is not clear. The southern tier nations have come near going into default on their sovereign debts. The risk of a breakup of the EU has driven stocks and the Euro up and down for the last couple of years. Now that the EU ministers have agreed to closer economic integration there may be light at the end of the tunnel. However, no one expects quick fix and a renewed recession in Europe could lead to a global economic downturn. Folks who are buying puts on SAP may be looking exclusively at Europe or at the bigger picture. However, a recession will likely hit SAP sales and stock price. The stock has traded between $50 and $68 a share in the last year and is at the bottom of that range and heading lower if the folks buying puts on SAP are correct. To a degree some traders may be simply hedging risk with options . Anyone who bought the stock nearly a decade ago bought at below $20 a share. They may still expect the stock to rise but do not want to get caught in a short term fall in stock price.

Although these may not be a good times for owning stocks these may well be good times for options trading . Buying puts or calls on a stock, provides investment leverage for the options trader. It also allows the trader to hedge investment risk. The buyer of an options contract is under no obligation to buy or sell the stock in question. However, if the price of the equity moves as expected the options trader can do so and profit thereby. The price of an options contract is significantly less than that of the stock in question. In chaotic times such as these traders take advantage of options trading in order to earn profits while limiting risk. Those buying puts on SAP expect the stock price to fall and will profit if it does. However, they have limited their risk in case of a rise in stock price to the price of the options contract.

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Hedging risk with options is done to protect investments and cash flow. Thus the company or individual doing this limits himself to the stocks he owns, the currencies he trades, or the commodities that he buys and uses or makes and sells. Beet farmers trade options on beet futures and airlines trade options on aviation fuel of simply crude oil. Companies in the US dealing with companies in Europe may need to trade options on the Euro. This limits the range of equities that these folks trade but, since they are protecting their investments that is the limit of their interest. On the other hand a currency speculator can choose the currency on which he wants to trade options based solely on profit potential. He can buy calls on gold or sell puts on oil simply because he expects to profit from a big price move.

The risk scenario is different for those hedging risk with options versus speculators. A US company buying machine parts from a German company will need to pay in Euros, no matter what the exchange rate. The only risk the company sees is a change of the exchange rate between signing a business contract and payment for receipt of the product. The company already has the cash or credit to make payment and there is typically no leverage involved. On the other hand a currency speculator may sell puts on the Euro versus the Yen if he expects the Euro to recover. He will be making this trade using a margin account and stands to lose the entire margin account or even more if the EU comes not come to happy resolution of the debt dilemma and the Euro falls significantly instead of rising. This same scenario plays out when buying puts on LinkedIn or any other stock. The risk of substantial loss when selling puts and calls is why the business of selling puts is commonly limited to large institutional traders with very deep pockets. Large US multinationals may have even deeper pockets but their business in hedging risk with options is commonly limited to reducing currency risk in international business transactions.

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Starbucks has been a great success story. The stock sold for less than a dollar share twenty years ago and sells for forty-four dollars a share today. However, the company has grown in two waves, separated by a dive in stock price from around thirty-seven dollars a share in late 2006 to roughly eight dollars a share in late 2008. When sales began to lag during a period of continued expansion Howard Schultz resumed control of day to day operations. Hundreds of stores were closed in the US and worldwide. Food menus were changed and the company moved back to a more coffee-based experience, its original and ongoing intent. Along the way trading options on Starbucks has been profitable a number of times as the stock has advances and retreated on its way up, in both waves. How to trade options on Starbucks over the years and now does not really differ from trading other stocks.

Successful options traders watch stock fundamentals. There is a widespread belief that Starbucks cannot keep growing forever without diluting its value. That is certainly what seemed to have happened in 2006 when same store sales in many locations were dismal and the company was putting up store across the world. The bloodletting of then next two years removed hundreds of unprofitable stores and refocused Starbucks strategy. Nevertheless traders watch Starbucks financials every quarter looking for weakness in sales. The company is moving in China in a big way with five hundred stores as of late 2011 and a goal of 1,500 stores by 2015 in a so far successful effort to convert a tea drinking culture to coffee drinkers. A successful options trading strategy for Starbucks will likely include a close look at technical price patterns in order to anticipate changes in market sentiment. As the company continues to grow it is likely that the issue will continue to arise as to whether Starbucks can increase return on investment along the way.

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The end of October market adjustment is consistent with profit taking by those who successfully anticipated the rise in stock prices over the month. Many believe that US fundamentals are improving and that the many US companies sitting on substantial sums of cash will eventually start using that cash for R&D, expansion, or other purposes that will result in job growth and a stronger economy. Those folks will likely use the most recent retreat to buy calls on promising stocks. Those day trading options, on the other hand will likely just follow the shorter term corrections of the market. These folks virtually never buy stocks but rather buy and sell options contracts, essentially scalping profits from the market as it moves up and down. Successful options trading does not come from trading options on rumors . It comes from skillful analysis and execution of trades.

In day trading options traders look at both fundamentals and what other traders are doing. In options trading education traders learn than fundamental analysis for day trading options is really no different than what one does for trading stocks directly. Traders look at the intrinsic value of a stock and at its margin of safety. Then they use technical analysis to track stock prices and options prices. Markets tend to repeat themselves and technical traders believe that by watching a specific price pattern develop that they can predict, solely on this basis, where a stock price or options price will go next. This approach is especially useful when day trading stocks directly and day trading options. The fundamentals of the stock many not have changed from when the market opened until it is ready to close but traders will often have bid a stock price up and down in an effort to profit from further expected movement.

In day trading options, as in other stock options trading , smart traders always use trading stops. This means that when a trader buys calls on a stock at a given price he sets a limit order for the opposite trade on the same stock at a slightly lower price. In this way he avoids losing the value of his contract if new, negative fundamentals emerge. As the price of the stock and the option rises he will steadily increase his stop loss limit order. He will also decide on a reasonable amount of profit to expect and, hopefully, execute at the top of the price curve before a fall, when day trading options.

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S&P 100 Index (American style) – OEX

S&P 100 Index (European style) – XEO

S&P 500 Index – SPX

Dow Jones Industrial Average – DJX Index

Nasdaq-100 Index – NDX

Russell 2000 Index – RUT

Those interested in trading bank stock options as weeklies can trade CitiGroup – C or

Bank of America Corp – BAC. Available options for trading the energy sector include EXXON – XOM and British Petroleum – BP and ETF’s United States Oil Fund – USO, United States Natural Gas Fund – UNG and Energy Sector SPDR – XLE. A current stock of interest, Boeing – BA, is not available for weekly options trading. However, its fortunes are more greatly tied to long term results than short term market movement.

Trading weekly options requires a precise and short term focus. This is not a business of finding a forgotten out of the money stock option, doing sound fundamental analysis on the stock, buying at a very low price and profiting three months later when ones fundamental and technical analysis pays off. Trading weekly options relies more on technical analysis of the underlying equity itself and on the market in general. The value of trading weekly options instead of buying or selling the stocks or index funds involved is that one’s losses are limited to the price paid for puts or calls on the options contract. Traders commonly use a combination of a short and long options strategy . They commonly trade both buy and sell puts and calls. They receive a premium for selling calls or puts on a stock while paying for the purchase of calls or puts. The rational is to limit the investment cost and especially the risk of loss when selling calls or puts.

The short term focus of trading weekly options requires that traders stay absolutely current on news affecting the equities underlying the options that they are trading. Traders will often not wait for the contract to expire and commonly will not execute the options contract. Rather in trading weekly options the trader may simply execute the opposite trade in order to exit his options positions, hopefully pocketing his money in the process. As always a successful options trading strategy in trading weekly options, like all options, include a clear view of fundamentals and up to the second technical analysis. And, as always we are not recommending the options listed above or advising against them but merely hoping to provide a bit of insight and options trading education.

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Buying options on stocks allows an investor or trader to secure his opportunity for a profit with only a small portion of the price of buying the stock itself. This investment leverage allows an options trader to spread his investment capital among several options investment opportunities instead of tying his funds up with a single stock purchase. Buying options on stocks also reduces investment risk as the most a trader can lose is the price of the options contract.

Buying options on stocks also allows investors to profit from both rising and falling stock prices. Some time back we wrote about buying puts on oil. A trader buys puts on a stock (or on a commodity futures contract) if he expects the price to fall. In the case of oil stocks or oil futures the unrest in the Middle East vies with the potential for decrease in demand coupled with an economic downturn as reasons to expect a rise or a fall in oil prices and oil company profits. If a trader buys put on an oil stock such as ExxonMobil he is expecting to see the price fall. If his reading of the market is incorrect he will lose no more than the price of the options contract. If the price of the stock in question falls he can take his profits two ways. He can go ahead and buy the stock at the now-lower price and then exercise his options contract and sell the stock the contract price, pocketing the profit, minus fees, commissions, and the price of the options contract. He can also simply exit the options contract before expiration by executing the opposite trade.

Buying options on stocks provides traders with a very flexible means of profiting from the stock market and a means of limiting investment risk. The US options market is not limited to just stocks. It is possible to trade options on interest rate futures, carbon credits, live cattle, gold bullion, and Durham wheat, to name a few choices, as well as stocks. Buying options on stocks can be done in conjunction with selling options. When a trader buys and sells calls on the same stock with the same expiration date he often uses the money earned from selling a call or put to pay for the cost of buying a call or put. Because he owns both sides of the trade he reduces his risk of loss and increases his opportunity for profits. The business of selling options, without offsetting trades, can be very profitable in the long term but selling puts runs the risk of occasional but very substantial losses and is typically the province of large institutional traders with very deep pockets. In discussing buying options on stocks we are suggesting an approach to trading options and not recommending specific stocks.

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“CAT” designs, manufactures, markets, and sells engines and heavy equipment throughout the world. It also sells insurance and financial instruments to its customer through its global dealer network. It is the largest maker worldwide of industrial gas turbines, natural gas engines, diesel engines, mining equipment, and construction equipment. It is often a bellwether of the global economy. Given that large construction projects often take two years from conception to get underway it is not uncommon for Caterpillar to know its production needs two and more years in advance. Thus buying calls on Caterpillar is typically not trading options on rumors !  

The primary issue for buying calls in Caterpillar is just how soon the market will catch up to Caterpillar’s promising future. Recent manufacturing figures show a leveling off of production in North America, Europe, and China. Dual debt issues still plague the world’s two largest economies, the EU and the USA. Such concerns may overshadow Caterpillar’s projected earnings for many investors.  

However, the point of buying calls on Caterpillar instead of buying stock is that if the stock takes an unexpected dive the investor does not lose any more than the premium he pays for buying calls on Caterpillar. An often successful options trading strategy is to roll over options every month or so, exiting the position by executing the opposite trade and repurchasing calls on Caterpillar with a later expiration date. This strategy keeps the trader in a position of benefitting from a rise in Caterpillar share price, eventually.  

While the timing of buying calls on Caterpillar is uncertain, traders have a number of alternatives. The use of a long straddle will protect options traders against an unexpected fall in stock price. Trading options with later expiration dates will gain traders the time needed for the market to be impressed and drive up stock price.  

Although fundamentals eventually drive stock and options prices it is market sentiment that pulls the trigger on rallies and retreats. By watching the technical aspects of Caterpillar stock trading options traders will be able to more successfully anticipate a jump in stock price and profit thereby.  

Such a stock price jump could be related to next quarter’s financial reports or a response to a successful vote to deal with the spiraling US debt. When the European Community successfully deals with the so called PIIGS debt crisis, which could be another cue for the markets to react. As always we are not suggesting that traders buy calls on Caterpillar, sell puts, or buy the stock but that traders evaluate promising stocks in the options market and practice risk management in options trading .

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If congress cannot get its act together, the dollar will very likely fall in value. Japan, Taiwan, mainland China, and others already hold large amount of US debt in the form of treasury bills as well as dollars. In order to avoid a loss on these holdings central banks may be tempted to sells these assets. The problem is that if Japan, mainland China, Taiwan, and other sell dollars they will force the dollar down anyway. If the dollar falls the Asian exporters will find their competitive price advantages dwindle and their sales fall. Thus the current US fiscal dilemma may lead to falling Asian stocks and the dollar. An options trader may decide to buy puts on Asian stocks but when to buy puts and on which stocks to buy will depend upon analysis of the stocks involved and on a reading of the day by day soap opera playing out on Capitol Hill.

Falling Asian stocks and the dollar may not be the only events in the coming financial news. To a large degree the status of the dollar as a safe haven currency has helped keep the dollar strong. Over the years is has been US consumer buying power that has been large responsible for lifting the world economy out of recession after recession. If the US cannot borrow to deal with short term debt issues and if the US congress does not come to an agreement on how to reduce US long term debt the effects will be global. On the other hand a resolution of US debt issues could spark a US market rally and alleviate concern about a coupled fall in Asian stocks and the dollar. Using a long straddle trading strategy might be useful here as the trader could profit from either a fall or rise of the dollar or endangered Asian stocks, no matter how the situation plays out. As always we are not suggesting any specific trading strategy but suggesting that traders take a broad view of events when formulating trading strategy.

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