Jason Ng asked:


Robert Kiyosaki says that Option Trading is the investment of the rich.

Indeed, option trading is the most versatile form of investment in the world today. Its versatility has been the topic of many speakers all over the world. Terms such as “Covered Calls” and “Credit Spreads” have become well known amongst traders new and veteran alike.

Option Trading Explained - Simply put, it is the trading of option contracts on a particular stock.

Options Explained - A contract that allows you to sell or buy a stock at a predetermined price within a set time frame.

There is enough material written explaining the technical make up of an option and I shall not dwell into it further in this writing. The purpose of this writing is to explain to you what the effects of option trading is. … let’s go into Option Trading Explained!

Option Trading Explained - What Can Stock Options Do?

Let us first examine the effects of this thing called stock options. Knowing all the effects of stock options allows us to better understand why it is such a celebrated investment tool and also why so many people go bust doing it. Let’s start from the Positive Effects of stock options.

Stock Options are:

Leverage. It allows you to control more shares (100 shares per option) with the same amount of money thereby exponentially increase your returns per dollar.

Discount. Just as you control more shares with just one option, you will then be able to control the same amount of shares with lesser money than before.

Protection. It allows you to protect the stock you hold by owning the right to sell them at a predetermined price no matter what happens.

Regardless of market direction. It allows you to profit from both upward and/or downward moves in the stock.

Creative. It allows you to put different types of options together to form all sorts of investment positions. It can even make money no matter which way the market goes.

And the Negative Effects are:

No value beyond expiration. You can potentially lose all your money along with the expiration of the option.

Negative Leverage. Just like it can amplify your gains, options will also amplify your loses.

Time Decay Effect. Options reduce in value over time and sometimes can completely obliterate any gains from movement in the underlying stock.

Looking at the above effects, it is clear that Option Trading indeed is an extremely versatile investment tool that allows its investor to profit from any market direction, protect his/her stock positions, reduce capital commitment and lots more, based on the way it is utilized.

Conversely, once such power of leverage is being abused, the investor could then lose everything he/she have put in by expiration or lose more from the same stock move than he/she is comfortable with. Also, by holding on to Options, time decay sometimes can obliterate your profits if the movement in the underlying stock is not big enough.

Therefore, investing in options requires careful planning on the part of the investor. You must know for what effect are you using options for and how much you are putting at risk. In essence, using options for Leverage confers the highest risk and the highest rewards and demands that you use only proven strategies with a proven track record.

Using options creatively even allows us to structure investment positions to reap a fixed monthly return that beats the market regardless of which way the market goes! Just like in the Ride the Flow System offered at http://www.mastersoequity.com/MOE_ridetheflow.htm . Where your capital can be fully protected no even if the market enters a severe drop. Sounds amazing?

Option Trading Explained - Conclusion

I hope this “Option Trading Explained” has given you a good overview of the effects of options.

For a full and complete education in option trading, please visit http://www.mastersoequity.com/OptionUni.htm



Martha

Alexander Chong asked:


Option is a very popular derivative because its price is cheaper than other derivative such as future. Blue chip stock is a very volatile stock but it is very expensive. However, by buying option of the blue chip stock, we could earn profit just similarly like buying the stock. Investing and trading option seem to be very easy just like buying stock. However, due to the existence of time value and also the expiration date of the option, buying naked option is very risky. This is because if the stock price is going down a lot just after you have bought the naked option, after a certain period of time, although the stock price has gone up, the option price may still below the ask price that you have used to buy this option. That why we need strategy to invest or trade option. Option is a very powerful tool in investing and trading stock. By utilizing option, we could earn profit from the stock that moves upside, downside and sideway. Moreover, option also could be used to execute arbitrage strategy to earn a profit no matter the stock price is going up, down or sideway.

Back spread is one of the option trading strategies that is quite popular. This strategy is quite similar to a Chinese gambling called big and small. In this gambling, when we stake big and the three dices after shook and opened show the total point is big, we will win one fold of the money that we have staked. That means if we stake 100, we will get back one more 100. But if we loss, we will loss 100. Back spread strategy is quite similar to this gambling game. That means if we invest USD 1000, we either get back one more USD 1000 or loss USD 1000 that has been staked in. The maximum profit and loss is USD 1000. That has fixed. You won’t loss more that that. Actually, back spread is the reversal of the ordinary spread. The maximum profit and loss is not always the same. Sometimes, it will differ a little bit and depend to current price of the stock.

This strategy could be executed by buying out-of-the-money option and selling in-the-money option. Because the price of the in-the-money option is more than out-of-the-money option, the amount of money that has been received after selling in-the-money option will be enough to buy the out-of-the-money option. Although like this, we still need to put an amount of deposit in our trading account and the amount usually is equivalent to the maximum loss that you could incur if the stock price goes to the reverse direction. So, if we are expecting the stock price will go up in the near future, we should buy out-of-the-money and in-the-money put option. Conversely, if we are expecting the stock price will go down in the near future, we should buy out-of-the-money and in-the-money call option. Just for easy to understand, we try an example. Table below shows a list of put options for MMM company stock, which will expire in Apr 07.

http://www.makemoneystocks.com/back-spread-table1.jpg

Table 1: List of put options for MMM company stock.

Current price of the stock is USD 80.94. Put option with its strike price more than current price is in-the-money option and less than current price is out-of-the-money option. If we are expecting the stock price will go up in the near future, we will buy one contract of 80 put option (MMMPP) and sell one contract of 85 put option (MNZPQ). When we sell option, we will receive an amount of money that is equivalent to the bid price multiplying with the number of unit that has been purchased. The amount of money that has been received per unit option is USD 5.2 and the amount of money that we need to pay per unit option when we buy out-of-the-money option is USD 2.7. Therefore, the net amount in your trading account after executing this strategy is USD 2.5 per unit option. That means there will be USD 250 net in your trading account. The maximum profit and loss are calculated as follow:

Maximum profit = In-the-money option bid price Out-of-the-money option ask price

Maximum loss = (upper level strike price lower level strike price) (In-the-money option bid price Out-of-the-money option ask price)

Upper level strike price is 85 and lower level strike price is 80. In-the-money option bid price is USD 5.2 and the out-of-the-money ask price is USD 2.7. After substituting all values into the equations above, we will know that the maximum profit is USD 2.5 and the maximum loss is also USD 2.5. So, if we buy one contracts each of the in-the-money and out-of-the-money option, the maximum profit is USD 250 and the maximum loss is also USD 250. The breakeven point for this strategy could be calculated using equation as follow:

Breakeven point = Upper level strike price maximum profit

Or Breakeven point = Lower level strike price + maximum loss.

In this case, the breakeven point is 82.5. As long as the stock price goes up more than 82.5, we will earn a profit from this strategy. We only could earn the maximum profit if we keep the position until the expiration date. If we sell off early before the expiration date, we could not earn the maximum profit. But we still can earn money but with a little bit lesser than if we could keep the position until the expiration date. This is due to the incomplete gaining of the time value of the sell off in-the-money option.

So, by utilizing this option trading strategy, you could earn a profit as long as your prediction accuracy is more than 50 %. That means you have to be accurate for at least six bets within ten bets. From here, the maximum continuous loss is four times. Therefore, in order that you won’t lose all your money until you could not continue to bet, you have to keep four back up moneys or more. So, if you lose one bet, you still have the money to continuously stake for the following bet. Like this, as long as you could keep your prediction accuracy more than 50 %, your money will continuously grow along the time. So, if you interested to know more about option trading strategy, just drop by our homepage and we will show you how to utilize option to maximize your profit.



Samuel