Roger Cox asked:


Hello, this is week eight in my ten week series on how to trade options successfully. This week we are going to discuss saving.

Savigs is one of the most critical parts to any successfuly financial strategy; if you spend your gains as soon as you have them you will never reach true wealth. It is only by the miracle of compound interest that your gains will truly turn into a fortune.

Compound interest is the process whereby annual returns are added to the original investment and reinvested, rather than being spent or taken out, thereby creating a larger amount to invest again, as this process is repeated the compounding exponentially increases the returns over the lifetime of the investment. For example if you invest $10,000 a 20% return increases your portfolio to $12,000. A 20% return on that increases your portfolio to $14,400, 20% on that is $17,280, 20% on that is $20,736 and 20% on that is $24,883 which is a total return of $14,883.

Now assume as soon as you made the original 20% return you took it out and spent it, your next 20% return would only be the same $2000 on your $10,000 investment. If you kept doing this 5 times your total return would only be $10,000, $4,883 or almost 50% LESS than if you left your money in your account. The longer you leave your money in your account the more pronounced your returns will be and the greater the effects of compounding will be.

Einstein once said “Compound interest is the 8th wonder of the world”. When applied to options trading we can replace the word “interest” with “return on investment”. That means if you are winning and have a good return on your investment don’t take out the profits in your account to spend on a new boat, car or house. Re-invest your profits and if you are doing everything correctly the miracle of compounding returns will exponentially increase the size of your portfolio.

This is only a short article this week. Next week we have a lot to discuss when we talk about money management.

US Government required disclaimer: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of the Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 (1-800-678-4667).



Ernest

James Thomas asked:


Beyond all the ‘hype’ what is it that makes option trading so good?

This is a question that I wish more people would ask, but the thing is not too many people know they even exist!

The main reason that I love option trading is that options provide the opportunity to turn a small or modest amount of money into a large amount of money quickly!

How is this possible you might ask?

Well before I get into the ‘how’ that let me show you exactly ‘what’ options are.

Options are simply ‘contracts’ that give the buyer the right or choice (but not the obligation) to buy or sell shares in a particular company, at an agreed price, on or before a set date.

Now the thing is, as an option trader I am not interested in buying or selling stocks, I am only interested in buying and selling the options on stocks.

I want to buy an option for one price and then onsell it to someone else for a higher price and make a profit before the option expires.

Now whether or not I am able to do this depends on two main things:

1) Whether the underlying stock (the stock that the option is concerned with) goes UP or DOWN in price.

and

2) The type of option that I have bought.

Now, there are 2 types of options, CALLS and PUTS.

Call options give us the right to BUY shares in the underlying stock.

PUT options give us the right to SELL shares in the underlying stock.

As I said before, we are not interested in buying or selling the underlying stock, only in making a profit by buying the options (on a stock) and then onselling those options to someone else for a profit.

However, the only way we can make a profit is if the option itself increases in value.

So What makes options go up or down in price?

CALL options increase in value when the underlying stock goes UP.

PUT options increase in value when the underlying stock goes DOWN.

This may sound confusing if you are new to option trading, but basically what we want to do is to buy CALL options on a stock when we think it is about to go UP in price or buy PUT options if we think the stock is about to go DOWN in price.

If we are right and the stock moves in our desired direction, UP for CALLS or DOWN for PUTS, we will make money.

The concept is really quite simple once you accept that it is possible to make money whether the underlying stock moves UP or DOWN.

Now here’s the thing that makes option trading so appealing.

Options only cost a fraction of what it would cost to buy the underlying stock itself and a small move in the price of the underlying stock, creates a much larger move in the price of the option by 10 times to sometimes 100 times!

Let me give you an example, let’s say that GE is trading at $31.00 per share. If we wanted to buy 1000 shares in GE today it would cost us $31,000.

However, the option to BUY GE (CALL options) for $30 at any time during the next 60 days is only $2.00 per share. If we bought enough options to give us control over 1000 shares in GE it would only cost us $1,500.

Now let’s say that GE goes up by $1.00 to $32.00 during the next 3 weeks.

If we had bought the shares in GE we would have have made a $1,000 profit (1000 shares x $1.00 per share) or 3%+ return and if we bought the options on GE we still would have only made $1,000 (1000 shares x $1 per share) however as we would have only invested $2,000 into the trade, this would be a return of 50%!

By trading the options instead of the stock it is possible to make far greater returns and at the same time risk only a fraction of the capital.

This is called LEVERAGE and this is the main advantage to option trading over other wealth creation strategies.

However, just as leverage can work for you it can just easily work against you.

This is why you need a solid trading system that stacks the odds of success in your favor on every trade and at the same time reduces your risk.



Jonatan Wolma

Ron Ianieri asked:


To be able to calculate the volatility of the spread, we must equalize the volatilities of the individual options.

First, let’s move the June calls by moving June’s implied volatility down from 40 to 36, a decrease of four volatility ticks. Four volatility ticks multiplied by a vega of .05 per tick gives us a value of $.20. Next we subtract $.20 from the June 70 option’s present value of $2.00 and we get a value of $1.80 at 36 volatility. Now the two options are valued at an equal volatility basis.

Looking at this first adjustment where we moved the June 70’s volatility down to 36 from 40, we have a value of $1.80 at 36 volatility. The August 40 call has a value of $3.00 at 36 volatility. So the spread will be worth $1.20 at 36 volatility.

If you wanted to move the August 70 calls instead, you would take the August 70 call vega of .08 and multiply it by the four tick implied volatility difference.

This gives you a value of $.32 that must be added to the August 70 call’s present value in order to bring it up to an equal volatility (40) with the June 70 call. Adding the $.32 to the August 70 call will give it a $3.32 value at the new volatility level of 40 which is the same volatility level as the June 40 calls.

Now, our spread is worth $1.32 at 40 volatility. August 70 calls at $3.32 minus the June 70 calls at $2.00 gives the price of the spread at 40 volatility.

It does not make any difference which option you move. The point is to establish the same volatility level for both options. Then you are ready to compare apples to apples and options to options for an accurate spread value and volatility level.

Since we now have an equal base volatility, we can calculate the spread’s vega by taking the difference between the two individual option’s vegas. In the example above, the spread’s vega is .03 (.08 - .05). The vega of the spread is calculated by finding the difference between the vega’s of the two individual options because in the time spread, you will be long one option and short the other option.

As volatility moves one tick, you will gain the vega value of one of the options while simultaneously losing the vega value of the other. Thus the spread’s vega must be equal to the difference between the two options vega’s. So, our spread is worth $1.20 at 36 volatility with a .03 vega or $1.32 at 40 volatility with a .03 vega.

Going back to our original spread value of $1.00 with a vega of .03, we can now calculate the volatility of that spread.

We know the spread is worth $1.20 at 36 volatility with a vega of .03. So, we can assume that the spread trading at $1.00 must be trading at a volatility lower than 36.

To find out how much lower we first take the difference between the two spread values which is $.20 ($1.20 at 36 volatility minus $1.00 at ? volatility). Then we divide the $.20 by the spread’s vega of .03 and we get 6.667 volatility ticks. We then subtract 6.667 volatility ticks from 36 volatility and we get 29.33 volatility for the spread trading at $1.00.

We can also determine the volatility of the spread as the spread’s price changes. Let’s fix the spread price at $1.30. To calculate this, we must first take the value of the spread ($1.20 at 36 volatility) and find the dollar difference between it and the new price of the spread ($1.30). The difference is $.10. This dollar difference must now be divided by the vega of the spread. The $.10 difference divided by the .03 vega gives you a value of 3.33 volatility ticks. Then add the 3.33 ticks to the 36 volatility and you get 39.33 as the volatility for the spread trading at $1.30.

Let’s double-check our work by calculating the volatility the other way.

This time we will do the calculation by moving the August 70 calls up to the equal base volatility of the June 70 calls. As calculated earlier, the August 70 calls will have a value of $3.32 at 40 volatility.

The June 70 calls are worth $2.00 at 40 volatility. Thus the spread is worth $1.32 at 40 volatility.

Now let’s again move the spread price to $1.30, $.02 lower than the value of the spread at 40 volatility. As before, we take the difference in the prices of the spread. The result is $.02 ($1.32 - $1.30). Then, divide $.02 by our spread’s vega of .03 (remember that the vega of the spread is equal to the difference between the vega of the two individual options). $.02 divided by .03 gives us a value of .67. That .67 must be subtracted from our base volatility of 40. That gives us a 39.33 (40 - .67) volatility for the spread trading at $1.30. This volatility matches our previous calculation perfectly.

At first glance, you might be wondering why we went through all of these calculations. With the June 70 calls at 40 volatility, price $2.00, vega .05 and the August 70 calls at 36 volatility, price $3.00, vega .08 why not just take an average of the volatility? This would give us a 38 volatility for the spread with a price of $1.00 when in actuality $1.00 in the spread represents a 29.33 volatility.

This would be almost a nine tick difference which represents a whopping 30% mistake! Because, as stated earlier, vega is not linear; you can not weigh each month evenly and just take an average of the two months. For argument’s sake suppose you did. Let’s say you found the difference of the vegas of the options and came up with a spread vega of .03 which is correct. However, when you try to calculate the spread’s volatility and price you would have difficulty.

Now, recalculate the spread with the trading price of $1.30, or $.30 higher than your value at 38 volatility. Divide that $.30 higher difference by the spread’s vega of .03. You get a 10 tick volatility increase. Add that increase to the base 38 volatility. That would mean you feel the spread is trading at 48 volatility instead of a 39.33 volatility! This type of mistake could be very, very costly. Remember, apples to apples, oranges to oranges. It doesn’t matter which option’s volatility of the spread you move as long as you get both options to an equal base volatility.



Mike

Richard Bastien asked:


How would you like to get 20-25% a year on your investment money without risk. Sounds crazy would you say. What If I am telling you I have been making that kind of money in the past 4 years without one single bad trade.

On top of that what would you say if I am telling you that my investment method generates regular monthly revenue no matter which direction the stock market is taking. In fact when the market goes down sharply we make more money without risk?

Who would believe something like that ? Well think again. My name is Richard Bastien and I am a specialist in trading major Indexes like SP500 Dow and Russell 2000. I don’t trade individual stocks. I trade only instruments related to Sp500 Dow and Russell 2000.

I created my proprietary Index Trading System many years ago and tried to improve it along the years. You can find a lot of information on this index trading system on my site (see below). I worked very hard to be able to handle very well bad market conditions as well as normal market conditions.

I realized 5 years ago that I could use this system to generate regular monthly revenues using options on SP500 and Russell 2000. We can also use options on Sp100 and NASDAQ 100. Instead of buying Calls (Buy option) to play the market Up or buy Puts(sale option) to play the market down, why not sell Uncovered Puts under the current market position at a safe strike price and collect premiums month after month.

May sound weird but here is some examples of the past so you will understand better.

At the end of July I recommended 2 trades on Sp500 and Russell 2000. At that time SP500 index was trading at around 1500 and Russell 2000 at 810. I then recommended to sell Puts(sell options) on SP500 September 1350(strike price) at 7$ and sell puts on Russell 2000 September 710 at 6.30$.

On September 21st each contract sold for Sp500 carried profit of 700$ and 630$ for each Russell 2000 contract. Of course you need to have about 13000$ in your account for Sp500 and about 8000$ for Russell 2000 because selling uncovered Puts requires margin.

I publish on my site Options Trades page the result of several portfolios size like 10,000$ 25,000$, 50,000$ and 100,000$. All portfolios carried yielding of 20% in 10 months only. The trades were called in real time.

You can actually play this system with less than 10,000$ using what we call spreads. If we take our same example we would sell an SP500 September 1350 at 7.00 and Buy a September put 1340 at 5.50 for a net credit of 150$. This way you need only about 1200$ cash in your account.

I have a special method to determine the right strike price on each market so we never get caught in a sudden bear market. I developed my own software to graph each index and analyze carefully where we stand in each market daily. In the latest bear market last August-September we made big money while most of the traders lost. Imagine how easy it is when the market is sideways or up.

So don’t wait any further and visit the following pages on my site:

Options trading page

trading signals page

Index Trading System page

Main page

If any questions feel free to email me (see contact us page on the site) or even call me directly.

Thanks

Richard Bastien



Joseph

Wincent Loh asked:


A lot of traders now favor option stock trading because of its many advantages. For one it can be highly profitable if used rightly, it offers the investor more flexibility and a larger option to diversify. This trading system offers more protection to the portfolio gives more control to the investor and offers a higher possibility to generate more returns on investment. They can be used under any market condition. They offer the investor the advantage of making returns on a change in stock price without actually owning the stock. Options stock trading can be used in combination with other option contracts and/or other financial tools to maximize returns.

Furthermore, a lot of trading is done on the floor of the stock exchange; one of such is referred to as stock option trade. Sometimes the trading could just be more of speculative activity. Speculative activity trading is done on stock exchanges through stock options trading. The term option in stock parlance means “a right”. There exists the right to sell as well as the right to buy. In a deal involving an option, the right to buy or sell a certain amount of securities, within a particular period at a given price can be bought off a dealer. If the purchased right was an option to buy securities it would be called a “call option”. If the right was the option to sell, it is called a “put option”. Instances where the two possible options are combined, to buy or sell a certain quantity of securities at a particular price up to a given future date, it is then referred to as “a double option”, or “a put and call option”

Speculative activity or stock option trade is carried out for anticipated profit. Here is how it works. If a speculator expects the price to go up, he buys a call option. This allows him in future when the price has arisen to buy at the old lesser price and sell at the higher prevailing price. When the reverse happens and a drop in price is anticipated he buys the put option.

When a speculator notices that his predicted or expected rise or fall in price did not occur he can chose not to exercise his right or stock trade option that he had purchased. The party that grants or sells the stock option trade to the speculator is paid a premium for granting it.

This premium is also called the option money. This is the fee that is earned by the trader who grants the speculator the stock option trade. When the speculator desires not to exercise his option he loses the option money or premium. But his loss is restricted to the option money alone. Stock option trade is useful for speculators who want to protect their capital and yet seize advantage of fluctuations in prices. He has the choice to decide whether to exercise his option or not.



Peter