Options Trading Education » Options Trading

Can You Make a Living Trading Options?

T.D. Thompson — Sun, 05 Sep 2010 04:42:49 +0000

Can you make a living trading options? Many do. Potential options traders need to know that options trading bears investment risk just like any trading or investing. It requires learning a lot of information, practice, diligence, and a willingness to learn from mistakes. So, can you make a living trading options? Yes, if you are willing to apply yourself, learn what you need to know, and continually audit your own trading results in order to constantly improve performance. Making a living trading options is easier if the trader abides by a few principles. These are to know the basics of the equity underlying the option. Decide how much investment capital to devote to options trading and trade within the limits of the margin account to preserve capital. Sell puts and calls only on equities that you know very well or be willing to lose a substantial amount of capital. Remember that you never have to trade if the conditions are not right or if you are confused about the market.

Options to buy or sell a stock can be bought or sold. The trader will decide which route to take based upon both stock fundamentals and technical factors of the underlying stock. For example a trader options trading CBOE itself will decide if the stock is likely to go up, go down, or stay where it is. Can you make a living trading options on stocks like CBOE? You can if you correctly assess the stock’s prospects and buy or sell puts or calls accordingly.

A very basic decision in options trading is how much capital to devote to the enterprise. The amount you will need will vary with how much you want to trade and how much you will invest in a trade. It will also have to do with whether you are buying or selling. Buying puts or calls may not always be successful but it will only cost the price of the premium. Selling puts and calls in the hands of experienced options traders is more profitable over the long run but it also can lead to occasional large losses when the market moves unexpectedly. Succeeding in options trading will depend heavily upon the trader staying very conservative when selling puts and calls and only doing riskier trading when buying.

In the end the answer to “Can you make a living trading options?” is, yes, if you want to apply yourself, remain diligent and learn from your mistakes. One sees figures to the extent that most options traders (85%) lose money. That means the trader loses money and quits trading. This is comparable to anyone starting a small business. A Dun and Bradstreet report of some years ago noted that a business with fewer than 20 employees had a 37% chance of being in business five years hence and a 9% chance of making it ten years. The same report noted that only a fifth of restaurants made it five years. The point of this comparison is that trading options is a business and in business the fit survive and make money and the unprepared find other work. Can you make a living trading options? The answer is definitely, yes. As with all business endeavors there is work to be done but in the end those who do the job right will prosper.

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How to Trade Futures Options

T.D. Thompson — Sun, 29 Aug 2010 21:45:03 +0000

Learning how to trade futures options starts with the fundamentals. A good place for a beginner to start learning how to trade futures options is where trading occurs, the Chicago Board Options Exchange (CBOE). The CBOE has online tutorials in how to trade options and how to trade futures options. If you are interested in just what is a long straddle the process starts with learning options and futures basics. The Options Institute of the CBOE is a set of comprehensive online tutorials. The three categories are Options Basics, How a Trade is Made, and Advanced Strategies. So, the best place to start learning how to trade futures options is with the basics. The basics have to do with the fundamentals of listed options and just what puts and calls are. How to trade futures options includes options strategy and includes the details of futures options pricing.

Before learning what is an options strategy the beginning futures options trader should learn about options premiums, pricing models and using the options calculator. How to trade futures options will include learning about put/call parity, time premium, and volatility as well as in, at, and out of the money contracts. More detailed information will include using what is called the Black-Sholes model in making decisions in trading. Beginners will learn about how fundamentals determine the price of an option, its theoretical value. As the beginner learns how to trade futures options he will move into the electronic world of trading. Learning about trading options on futures will involve learning many options trading terms.

Learning trading starts with learning about how the CBOE trading floor works and the different roles of investor, brokerage firm, market maker, and floor broker in a futures option transaction. The trader will learn about the various types of options orders. Learning how to trade futures options will also include information about various types of markets and how they may affect trading. The trader will come to understand options trading leverage as it applies to trading futures options as well.

Advanced strategies for how to trade futures options will go into detail about selling puts. This is overall a profitable options trading strategy but can be dangerous for the beginner. The CBOE tutorial will cover the obligations incurred in selling puts on futures and the risk versus profit potential of selling puts in general. It will also help the new trader understand when and how conservative traders sell puts and just when aggressive traders will do the same. The reasons are commonly different. There are a number of specific trading considerations when selling puts that must be taken into account by all traders. Advanced traders learn vertical spreads such as a bull call spread. In each case the trader needs to understand the profit potential and the risk involved. A basic factor in how to trade futures options is learning the six pricing components of options, how volatility changes options values, and how values change with time. Options trading of futures can be quite profitable for the well informed and diligent trader. It starts with learning the basics and progresses from there.

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Buying Puts on Intel

T.D. Thompson — Mon, 16 Aug 2010 23:05:12 +0000

A number of investors seemed to think that Intel had peaked in share price because they were buying puts on Intel. Buying a put gives the buyer the option but not the obligation to sell the underlying equity, such as shares of Intel, any time up until the expiration of the options contract. If, as investors seemed to think, Intel were to have gone down in price, exercising the put option would have allowed the buyer to sell the stock at the strike or contract price and then buy it back at the new, lower, market or spot price. Buying puts can be a long options strategy or a short options trading strategy. That is, the investor does not need to own the stock in order to be buying puts on Intel.

There are always buyers of calls and buyers of puts in the options markets. In fact there were more calls being purchased on Intel than puts prior to its quarterly announcement. Traders and investors buy and sell according to their own analysis. The difference between put buyers and call buyers had to do with expectations of how badly the Eurozone’s economic problems will affect PC sales and if the expected rebound in hardware upgrades will be soon enough and sufficient enough to substantially boost earnings. Then Intel came in with a positive earnings report and the stock went up in price. In this environment what is an option worth on Intel?

If Intel had given a poor report, put options would have been in the money and traders could have sold at the old strike price, bought at the new spot price and pocketed their profits. However, now the same Intel put options are out of the money. Their only value is their “time value” which is the value the market gives the option because, conceivably, anything could happen from now until the option expires. The advantage that the investor who was buying puts on Intel has is that he or she is only out the price of the premium and, in the long position, still has a now more valuable stock. For the short options trader he or she is out the premium but, if Intel goes up substantially, would be be better off than if they had sold short. Again, this is because of the limiting effect of the premium as the greatest amount of loss possible in buying options. Using the premium as a type of insurance is part of risk management in options trading.

To a degree Intel is a bellwether stock as steel and autos used to be years ago. As ubiquitous as computers are and as wired as companies are the purchase of computer hardware is an indicator of where the economy is going next. Likewise investors buying puts on Intel or buying calls is an indication of how investors read the situation. Intel having reported positive earnings and beating estimates may well send more traders to buying calls across the board and ignoring puts. What is an options trading strategy for Intel now that it has shown stronger than expected earnings? It depends upon how investors read the ongoing problems in Europe. To the extent that investors still worry about a downturn in sales or a slowing of the economic recovery hedging their bets by buying puts on Intel may still be in order.

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Succeeding in Options Trading

T.D. Thompson — Thu, 29 Jul 2010 02:39:24 +0000

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The beginning options trader may run across ads on the internet promising automatic profits in trading options. Anyone making a living trading options knows that profits are not automatic and that succeeding in options trading requires knowledge, dedication and skill. On the other hand succeeding in options trading is absolutely possible for those involved in occasional options trading as well as the professional.

The basics start with things like knowing the difference between strike prices and spot prices in options trading. The strike price is the price agreed upon in an options contract. This is the same price whether the contract is a put or a call. The spot price is the current market price. Succeeding in options trading comes down to the ability to accurately forecast whether the spot price of the equity underlying the option will diverge significantly from the strike price. If so the question is how much of a difference will occur which will determine potential profit. Traders who expect the strike and spot price to diverge will either buy calls or puts depending upon if they thing the spot price will go up (calls) or down (puts). Traders who do not believe that the spot price will to up from the strike price will sell calls and those who do not believe that the spot price will go down from the strike price will sell puts.

The next part of succeeding in options trading is the dedication needed to learn the tools used in predicting equity price movement. This is the world of technical analysis. Markets tend to repeat themselves and the repetition of equity price patterns is predictive of subsequent price direction. Learning the multiple price patterns that predict subsequent market price movement is one of the bases of succeeding in options trading. The other basic aspects of trading that a trader needs to learn and integrate into either a long options strategy or short options trading strategy is when to trade and when to observe. The advantages of options trading are that the trader only invests a small amount of his or her money to buy the contract premium. This provides a substantial leverage in the event that the underlying equity price moves dramatically. However, more often than not price movement does not lead to profits in options trading. This is why large institutional investors typically make their money selling calls and puts and not buying them. Learning when to stay out of a trade can be as important as knowing when jump in.

The final part of succeeding in options trading is realizing that the act of trading is essentially a performance art. It is done by human who get nervous, get cocky, get tired, and can do dumb things. It is also an art that be performed with stellar results. Part of risk management in options trading is keeping a cool head in a volatile market. Part of succeeding in options trading is knowing that times of chaos and high volatility are good times for options trading when the trader is knowledgeable, dedicated, and skilled in his art.

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Buying Puts on the Financial Select Sector SPDR

T.D. Thompson — Tue, 29 Jun 2010 15:01:31 +0000

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Buying puts on the financial select sector SPDR multiplied recently as the government entered into consideration of new regulations. Puts to sell outnumbered calls to buy by roughly twenty to one as the SPDR fund price fell nearly two percent, to just above $14 a share. The huge difference has arisen as congress is debating the final terms of new regulations for the financial industry. Poor oversight and banking sector excesses are commonly blamed as major causes of the 2008 market crash. However, many banking insiders are concerned that the upcoming restrictions will damage the financial industry as it tries to get on its feet again. An example of the proposed regulations is that banks may be restricted from trading derivatives. SPDR funds are shares of a family of exchange-traded funds (ETFs) traded in the United States. These funds are managed by State Street Global Advisors. The acronym SPDR comes from the first ETF in the fund, Standard and Poor’s Financial Services Depository Receipts which is designed to track the S&P 500. These funds are set up as unit investment trusts. The financial select sector SPDR a range of financial service firms including JPMorgan Chase, Wells Fargo, and BankAmerica Corp. With new regulations on the way it may be bad times for the financial sector but times of volatility are good times for trading options.

The kinds of options trading that are most profitable will depend upon what the market in the underlying equity is doing. Put call ratios are running around sixteen to one on individual stocks across the financial sector as traders fret over the consequences of tougher regulations on financial sector profitability. Traders buying calls is a sign of faith in the likelihood of stock prices going up. Traders buy puts in the belief that a stock price will go down. If the large majority of traders buying puts are correct then they will be able to sell Financial Select Sector SPDR shares at the strike or contract price at a time when the spot price or market price has dropped substantially. Traders will buy at the spot price and sell at the strike price, pocketing the profit. Traders believe that buying puts on the financial select sector SPDR will lead to profits.

As usual we are not suggesting buying puts on the financial select sector SPDR or buying calls for that matter. This is an exercise in watching market indicators such as the daily put to call ratio and using that information to find advantageous situations for uncovered options trading. When a trader sees a great deal of market volatility but does not know which way the market will go he or she may engage in a long straddle options strategy. In this strategy the trader will buy a call and buy a put on the same equity with the same option expiration date. This strategy costs the trader two premiums but insures that he or she will profit no matter which way the equity price goes. The only way to lose on a long straddle is if the market quiets down and the equity price remains stable. In that case the trader is out the cost of two premiums. If the trader really believes that the equity in question has stabilized then selling both puts and calls can be profitable. This is a short straddle. The profit is two premiums if the equity price does not change but the loss can be substantial in either direction if the price moves dramatically. The point of being aware of the fact that the market is buying puts on the financial select sector SPDR is that knowledge properly used leads to profits in options trading.

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Trading Steel Options

T.D. Thompson — Tue, 22 Jun 2010 02:41:41 +0000

There is opportunity in steel price volatility. North American steel producers are pressuring officials in Canada, Mexico, and the USA to put pressure on China to revalue the Yuan. Their goal is a “large and sustained appreciation” of the Chinese currency. A more expensive Yuan would drive up the price of Chinese steel and make North American steel more competitive. The argument goes that a stronger Yuan would lead to a faster economic recovery in the West, more jobs, and more wealth. Trading steel options could be lucrative at this moment as stock prices of US steel manufacturers are severely “corrected” and ready to rebound. Bad times for owning stocks are often good times for trading options. The issue of currency rate changes, possible bans on Chinese imports if congress declares China a currency manipulator, and the question of a double dip recession all lead toward stock price volatility and possible profits in trading steel options.

There are several factors that could affect steel prices, the price of steel stocks, and profits in trading steel options. The currency manipulation issue is about to move into congress where there is substantial bipartisan support for labeling China a “currency manipulator.” If a bill passes administration will be forced to take action through the IMF and WTO. US industries, including steel manufacturers, will be allowed to sue in US courts for damages. Whether these actions change the price of steel and the profits of US steel companies is not as important is the various perceptions that will tend to drive stock prices up and down. There are various kinds of options trading that could be applied to trading steel options. Certainly, if one believes that US steel makers have taken their hit and are due for an upswing, buying calls on these stocks could be lucrative. If one believes that US efforts to adjust China’s currency are going to be successful then buying calls could be doubly effective. If it is the volatility of steel prices and the price of steel stocks that seems most worrisome, then using a straddle strategy (long) will position the trader to profit whether steel stock prices rise or fall.

As usual the point of all this is not to go out and buy or sell options on steel stocks or to avoid doing so. It is to find opportunity in the chaos that is the larger equity market of today. The trader will need to stay abreast of changes in the larger economy and in the fortunes of individual companies finding markets for new products. The use of covered options trading or uncovered options trading, a short straddle or a long straddle, will have to do with individual options trading strategies based upon reasonable expectations what the market will do before given options expiration dates. Although you may expect the Chinese to revalue the Yuan or for their economy to stagnate under a load of debt the question is how soon and how soon is critical to options trading. If China decreases steel production how long will stockpiles last and how soon will prices climb in the West? Trading steel options could be quite lucrative, depending upon what happens in many arenas, and how soon.

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Trading Gold Options

T.D. Thompson — Wed, 09 Jun 2010 00:25:54 +0000

As the price of gold overtakes the dollar’s rise, trading gold options could be a good idea. In tough economic times there tends to be a flight to the dollar and a flight to gold when other currencies appear threatened. Part of the recent rise in the value of gold was masked by the rise of the dollar a couple of days ago. Nevertheless gold went up $12.20. Which way will gold go? Which way will the dollar go? Trading gold options will give the trader the option to buy or sell gold based investments but not an obligation. Gold mining stocks and gold funds offer the trader the opportunity for hedging their bets on gold with strategies such as a long straddle.

Gold mining stocks typically outperform gold bullion during an upswing in gold prices and may fall more dramatically when the price of gold drops. For gold bugs it is a matter of buying at the bottom and trying to get out at the top of the curve. The options trader has, well, more options. Buying puts on gold mining stock will allow the trader to profit from a downswing in the stock price and buying calls on the stock will allow him or her to profit from a price surge. Using a long straddle strategy the trader will buy both calls and puts on the same gold mining stocks with the same options expiration dates. Companies such as Barrick Gold, Newmont, Kinross Gold, Freeport McMoran, Anglo Gold Ashanti, Goldcorp, Newcrest Gold Fields, Harmony, Eldorado Gold, IAMGOLD, Lihir Gold, Centerra Gold, and Highland Gold are a short list of gold mining and exploration companies. Using a long straddle strategy in buying puts and calls on gold mining stocks will cost the trader the price of two premium but will offer the opportunity of a profit on either a rise or fall in stock price as the price of gold varies with the price of the dollar and world wide economic uncertainty.

Gold funds offer a similar opportunity in trading gold options. Because gold funds are more closely tied to the price of gold they may be amenable to different kinds of options trading than gold mining stocks. For example, if a trader believes that the price of gold will trade within a reasonably tight range over the next few months a short straddle strategy might be profitable. In this case the trader stands to earn the price of two premiums on his or her trades. However, it is important to realize that, although selling puts and calls tends to be more profitable over the long run, a short straddle opens the trader up to risk if the price of gold and the stock move substantially in either direction. It is because of the risk of substantial loss in selling puts and calls that most of this sort of options trading is done by large institutional investors with deep pockets. As usual we are not suggesting that one engage in trading gold options or avoid trading gold options. The point is to be aware of how market movement, investment uncertainty, and economic difficulties open the door to opportunity in trading options.

Crisis Options Trading

T.D. Thompson — Mon, 31 May 2010 01:35:14 +0000

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Crisis options trading is emerging as European debt worries continue and investors ignore promising US job data. In times of great volatility and brewing crisis options traders tend to use strategies such as a long straddle where they buy both a call and a put on the same stock with the same expiration date. In crisis options trading the trader is not sure which way the market will go but is certain that volatility will take it one way or the other. Also in times of crisis traders typically sell their stock and deal almost exclusively in options until the current storm blows over. The Chicago Board Options Exchange (CBOE) volatility index, the VIX, has been high recently, hitting a peak on May 7. The VIX is often referred to as the anxiety index and high numbers often lead to crisis options trading.

Many traders are forsaking covered options trading as they are selling their stock. However, because very few traders are interested in selling puts or calls because of the uncertainty of the market the stampede to uncovered options trading does not really matter. No buyer has to execute a contract unless he or she will profit and then the trader will simultaneously execute the contract and execute a covering trade, pocketing the profit. In times of great market volatility such as these the only ones selling options contracts are the large institutional investors with really deep pockets and even those folks seem to have backed off a bit.

The use of a long straddle options strategy in crisis options trading works to provide opportunity at limited risk. It is one means of implementing risk management in option trading. The trader believes, based upon both market fundamentals and technical charts, that the market is set to move up or down, perhaps dramatically. By buying both a put and a call on a stock the trader is assured of a profit either way the stock moves. The risk is that the market will stabilize and the trader will be out two premiums. Timing can be everything in crisis options trading. It is important that the options expirations dates for contracts purchased in this type of trading are far enough out that whatever is going to happen will have time to happen. There are few things worse than buying a cheap options contract that has a few days to go and then having the stock price move dramatically the day after the contract expires.

There are different kinds of options trading for different times and different purposes. A more conservative approach is often warranted in times of pending economic crisis. Despite a well publicized trillion dollar aid package aimed at supporting debt repayment in the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) countries. Thus we see than many traders are divesting themselves of their stock and only buying options. Thus they have a large cash position and the option to buy stock or sell stock at the strike price should the spot price move substantially up or down.

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Good Times for Trading Options

T.D. Thompson — Wed, 26 May 2010 14:12:17 +0000

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Bad times for investing in stocks are often good times for trading options. Such are the times today. Volatility is the order of the day. One is reminded of Alvin Toffler’s book, “Future Shock,” in which he, correctly, predicted 40 years ago that society would not only change going forward but that the rate of change would progressively increase. So it seems with current market volatility. For someone with a nest egg looking forward to a comfortable, safe, and secure retirement the market today stinks. For the options trader with sufficient capital today’s volatile market provides virtually unlimited opportunity. Today would seem to be a much better time for a long straddle on many stocks than for a short straddle on almost anything in sight.

The uncertainty that produces volatility is infectious to the point where many strong companies with good balance sheets and lots of cash get pulled into a cycle of fear. Companies selling things like basic laundry soap, basic phone service, and replacement spark plugs will not likely ever go out of business although such companies, according to fundamentals, will never see their shares multiply a hundred fold. Nevertheless these companies often suffer as the market fear factor sinks all ships. Just like the value investor looks for intrinsic value in stocks the options trader can look past the fear factor for strong fundamentals, watch for technical indications of price movement, and buy options where there is promise of profit. Using a long straddle the trader is betting on price movement and is not sure if it will be up or down. He or she is betting on extreme price volatility. Using a short straddle strategy the trader believes that price volatility, at least for the stock in question, will cease, entirely. If he or she is wrong the results can be devastating. This is why much of the business of selling options resides in the halls of large institutional investors with very deep pockets. Looking at the two kinds of options trading, buying versus selling, buying seems a safer and potentially more lucrative proposition during these good times for trading options.

Good times for trading options can also be expensive times for options. Because of the risk inherent in a volatile market the sellers of puts and calls will be asking for higher premiums. The view of the buyer will be that the price is high. The view of the seller, who is assuming all risk, is that the price could be far too low. Thus the trader need be mindful of the degree of opportunity a option offers and just how much the underlying need change in price for the purchase to be profitable. Risk management in options trading entails a clear view of know cost versus potential profit. However, periodic performance review is essential because potential profits are not profits. The wise trader keeps track of what he or she traded and exactly why he or she picked the underlying to trade at a given premium and given market conditions. This way a trader can trade successfully during bad times as well as good times for trading options. This is how traders develop successful strategies and is a step towards making a living trading options.

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Options Trading CBOE

T.D. Thompson — Thu, 18 Mar 2010 16:22:00 +0000

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After 37 years as a private member owned organization the Chicago Board Options Exchange (CBOE) is filing an initial public offering for up to $300 million. CBOE was the world’s first marketplace for options. Founded in 1973 CBOE’s daily trading volume has reached to over a billion contracts a year. Options trading CBOE seems like a contradiction in terms but options trading CBOE could be quite profitable. All different kinds of options trading you engage in with the CBOE ought to be right at home at the world’s first options exchange.

The CBOE oversees roughly four and a half million trades a day and will soon be overseeing its own. CBOE Holdings Inc. does not say when they will present the IPO or how many shares they will sell. The question for the options trades is if with the ever increasing use of derivatives such as options and online trading the business of CBOE will continue to flourish, making the company an attractive investment. The question for options traders will soon be, what is an option worth if the option is on CBOE?

Once the Chicago Board Options Exchange becomes public it will be eligible for options trading. The same options strategies will apply to CBOE as to any equity. A long straddle will provide the trader with the opportunity for profit is the new stock moves substantially up or down. Options expiration dates will be the same as other options. The only difference from other stocks will be that CBOE options could be listed on their own exchange.

An issue in options trading CBOE is the attention being given to regulating derivatives by the Obama administration. Changes in short selling rules that will take effect in May will include a ban on flash orders. These trading tools give a very brief trading edge to investors. CBOE spokespersons have been quoted as saying that their business will be adversely affected by changes in the rules regulating options trading. What is an option worth may become an issue with trading CBOE options if the government comes down hard on derivatives in general or options in particular. The White House Economic Advisor, Paul Volcker, has been quoted as saying that institutional trading in hedge funds by banks should be restricted which could be a harbinger of less volume in options trading.

Part of risk management in options trading as will apply to options trading CBOE will be keeping up with new regulations. It will also mean keeping up with trader sentiment. There can be a psychological tendency in trading options that will predict a disaster in the options market and for CBOE. That disaster may well not happen. When is trading call options a good option? When is trading put options a good option? If they were good options yesterday they still are today and will be tomorrow. Just because there is current concern about trading volume and flexibility in options trading does not ever mean that trading will go away. Don’t let the current hype about trading regulations distract you from the knowledge that markets go up and down and there is profit to be made going either way.

Options exchange CBOE files for $300 million IPO (seattletimes.nwsource.com)
U.S. Options Exchange CBOE Files for IPO (seekingalpha.com)
Is Option Greed a Worrisome Sign? (seekingalpha.com)

Options Trading Education » Options Trading

Can You Make a Living Trading Options?

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How to Trade Futures Options

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Buying Puts on Intel

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Succeeding in Options Trading

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Buying Puts on the Financial Select Sector SPDR

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Trading Steel Options

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Trading Gold Options

Crisis Options Trading

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Good Times for Trading Options

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Options Trading CBOE

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