Introduction 1
About This Book 2
Foolish Assumptions 3
Icons Used in This Book 4
Beyond the Book 5
Where to Go from Here 5
Part 1: Getting Started with Options Trading 7
Chapter 1: Options Trading and You, the Individual Investor 9
Rewiring Your Thinking 10
Preparing to Trade: Take a Pre-Trading Flight Check 11
Understanding Options 12
Getting the complete picture 13
Knowing option essentials 14
Trying different strategies before deploying them in real time 16
Putting options in their place 18
Differentiating between Option Styles 19
Using options to limit your risk 19
Applying options to sector investing 20
Using Options in Challenging Markets 21
Reducing your directional bias and making money in flat markets 21
Controlling your emotions 21
Chapter 2: Introducing Options 23
Understanding Option Contracts 23
Tuning in to option basics 24
Comparing options to other securities 26
Valuing Options 27
Knowing your rights and obligations as an options trader 28
Identifying useful terms of endearment 28
Making Sense of Options Mechanics 30
Identifying options 30
Rotating with the expiration cycle 31
Making a decision: Expiration time is key 32
Detailing your rights 33
Creating Option Contracts out of Thin Air 33
Opening and closing positions 34
Selling an option you don’t own 35
Keeping Some Tips in Mind 36
Chapter 3: Trading Places: Where the Action Happens 39
Identifying the U.S Options Exchanges 40
Navigating the Markets 40
Executing trades 41
Naming the option market participants 42
Eyeing transactions and orders unique to options 43
Making sure you know these trading rules 44
Weighing Option Costs and Benefits 47
Recognizing option risks 47
Identifying costs unique to options 48
Valuing options benefits 49
Grasping Key Option Pricing Factors 52
Introducing option Greeks 53
Connecting past movement to the future 54
Chapter 4: Identifying Option Risks and Rewards 57
Understanding Your Trading Risks 58
Risking money with stocks 58
Calculating option risks 61
Reaping Your Rewards 62
Benefiting from stocks 62
Breaking even with options 63
Profiling Risk and Reward 65
Profiling stock trades with risk graphs 66
Profiling option trades with risk graphs 67
Combining option positions 69
Considering the worst-case scenario 71
Part 2: Evaluating Markets, Sectors, and Strategies 73
Chapter 5: Looking Closer Inside the Algo-Controlled Market 75
Considering a Few Words about Select Macro Factors 76
Assessing the Market’s (the Algos’) Bias 77
Judging the strength of a move 78
(Psycho)-analyzing the market 84
Watching Call and Put Extremes 87
Understanding put/call ratios 88
Using Volatility to Measure Fear 90
Measuring volatility 90
Recognizing impact from changing volatility 90
Spelling fear the Wall Street way: V-I-X 91
Chapter 6: Sector Analysis: Technical and Fundamental 93
Getting Technical with Charts 94
Understanding chart basics 94
Adjusting your time horizon for the best view 95
Visualizing supply and demand 96
Identifying Relatively Strong Sectors 99
Relative ratios 99
Rate of change indicator 102
Using Sector Volatility Tools 104
Displaying volatility with indicators 105
Analyzing volatility with Bollinger Bands 109
Projecting Prices for Trading 111
Support and resistance 111
Trends 113
Channels 115
Price retracements and extensions 117
Projections and probabilities 119
Chapter 7: Practicing Before You Swing 123
Monitoring Option Greek Changes 124
Tracking premium measures 124
Changing volatility and option prices 126
Making Sense of Paper Trading 128
Eyeing the pros and cons to paper trading 128
Implementing electronic paper trades 129
Using Trading Systems 130
Knowing what you’re getting 130
Performing a backtest 131
Adding risk management to a backtest 135
Mastering Your Strategies 137
Setting the right pace 137
Achieving mastery through longevity 139
Chapter 8: Designing a Killer Trading Plan 143
Developing a Reliable Plan 144
Managing Your Costs 145
Optimizing Order Execution 147
Understanding option orders 148
Entering a new position 152
Executing a quality trade 155
Exiting an existing position 157
Part 3: What Every Trader Needs to Know about Options 161
Chapter 9: Getting to Know Different Option Styles 163
Delving Deeper into Index Options 163
Getting to the nitty-gritty of indexes 164
Capitalizing on an index with options 166
Watching Out for Style Risk 169
American-style options 169
European-style options 170
Considering the exceptions 171
Exercising Your Options, American Style 173
Knowing the nuts and bolts 173
What you see is what you get 174
To exercise or not, that is the question 174
Exercising Your Options the Euro Way 175
Tracking index settlement (the SET) 175
Cashing in with exercise 176
Satisfying Option Obligations 176
American-style stock options 177
Expiring options 179
European-style options 182
Breaking It Down: American-Style Index Options 182
Exercising rights 183
Meeting obligations 183
Chapter 10: Protecting Your Portfolio with Options 185
Putting Protection on Long Stock 186
Combining puts with long stock 186
Weighing protection cost versus time 191
Limiting Short Stock Risk with Calls 194
Protecting a short stock position 194
Further reducing short stock risk 195
Hedging Your Bets with Options 196
Protecting a portfolio partially 197
Protecting a portfolio completely 200
Avoiding Adjusted Option Risk 203
Justifying option adjustments 203
Adjusting from adjustments 205
Chapter 11: Increasing Profit Potential and Decreasing Risk 207
Leveraging Assets to Reduce Risk 208
Determining your total dollars at risk 208
Relying on market timing 213
Combining Options to Reduce Risk 216
Spreading the risk with a debit trade 217
Spreading the risk with a credit trade 223
Chapter 12: Combination Strategies: Spreads and Other Wild Things 229
Combining Options with Stocks 230
Creating covered positions 230
Covering the covered call position 232
Reducing protected stock costs 235
Varying Vertical Spreads 237
Changing your vertical spread risk profile 238
Spreading time with calendars 239
Chapter 13: Understanding ETFs, Options, and Other Useful Tricks 245
Exploring the Exchange-Traded Fund 246
Comparing ETFs to indexes 246
Distinguishing ETF and index options 250
Reducing Portfolio Volatility with ETFs 253
Revisiting volatility 253
Investing with ETFs 259
Tilting Your Portfolio with Sector ETFs 266
Adding sector ETFs to tilt your portfolio 267
Selecting the right strategy 271
Part 4: Advanced Strategies for Options Traders 273
Chapter 14: Making Money without Worrying About the Market’s Direction 275
Limiting Directional Risk 276
Capitalizing on a big move — A straddle 276
Reducing straddle risk and reward — A strangle 282
Examining a Neutral View versus a Neutral Position 285
Identifying neutral positions 286
Calculating delta for combination positions 287
Trading with Delta 288
Monitoring two key Greeks 288
Creating a delta-neutral straddle 289
Understanding Trade Adjustments 293
Deciding when to adjust a trade 293
Deciding how to adjust a trade 294
Chapter 15: Letting Volatility Show You the Way to Trading Opportunities 295
Analyzing Implied Volatility Levels 296
It’s all relative but not overly scientific 296
When options are skewed 303
Understanding Ratio Spreads 306
Reviewing ratio spread risk profiles 306
Identifying best conditions for ratio spreads 310
Deciding your strategy 311
Using Ratio Backspreads 313
Defining ratio backspreads 313
Spotting best conditions for ratio backspreads 321
Chapter 16: Trading Profitably When Markets Move Sideways 325
Identifying Winning Positions in Sideways Markets 326
Managing existing positions 326
Identifying other option strategies for sideways moves 331
Understanding Butterfly Positions 334
Defining the butterfly 334
Digging deeper into butterfly risk 343
Creating an iron butterfly 345
Understanding Condor Positions 349
Defining a condor spread 349
Recognizing condor risks 351
Part 5: The Part of Tens 355
Chapter 17: Ten Top Option Strategies 357
Married Put 358
Collar 359
Long Put Trader 361
LEAPS Call Investor 362
Diagonal Spread 363
Bear Call Credit Spread 365
Straddle 366
Call Ratio Backspread 367
Put Ratio Backspread 369
Long Put Butterfly 370
Chapter 18: Ten Do’s and Don’ts in Options Trading 373
Do Focus on Managing Risk 374
Don’t Avoid Losses 375
Do Trade with Discipline 375
Don’t Expect to Remove Your Emotions 376
Do Have a Plan 377
Do Be Patient 378
Don’t Suffer from Analysis Paralysis 379
Do Take Responsibility for Your Results 380
Don’t Stop Learning 381
Do Love the Game 382
Index 383
