Trading Options for Dummies

Introduction 1About This Book 1Foolish Assumptions 2Icons Used in This Book 4Beyond the Book 4Where to Go from Here 4Part 1: Getting Started 7Chapter 1: Options Trading and the Individual Investor 9Giving Yourself a Financial and Strategic Checkup 10Understanding Options 11Knowing option essentials 12Trying different strategies before deploying them in real time 14Putting options in their place 15Differentiating Between Option Styles 16Using options to limit your risk 17Applying options to sector investing 17Using Options in Challenging Markets 18Reducing your directional bias and making money in flat markets 18Controlling your emotions 19Chapter 2: Introducing Options 21Understanding Option Contracts 21Tuning in to option basics 22Comparing options to other securities 23Valuing Options 25Knowing your rights and obligations as an options trader 25Terms of endearment and importance 26Making Sense of Options Mechanics 27Identifying options 27Rotating with the expiration cycle 28Options expiration is decision time 29Detailing your rights 30Creating Option Contracts out of Thin Air 30Opening and closing positions 31Selling an option you don't own 31Keeping Some Tips in Mind 33Chapter 3: Trading Places: Where the Action Happens 35The U.S Options Exchanges 36Navigating the Markets 36Trade execution 36Option market participants 37Transactions unique to options 38Trading rules you should know 39Weighing Option Costs and Benefits 42Identifying costs unique to options 43Valuing options benefits 44Grasping Key Option Pricing Factors 47Introducing option Greeks 48Connecting past movement to the future 49Chapter 4: Option Risks and Rewards 53Understanding Your Trading Risks 54Risking money with stocks 54Calculating option risks 57Reaping Your Rewards 58Benefiting from stocks 58Breaking even with options 59Profiling Risk and Reward 61Profiling stock trades with risk graphs 61Profiling option trades with risk graphs 63Combining option positions 65Considering the worst-case scenario 67Part 2: Evaluating Markets, Sectors, and Strategies 69Chapter 5: Analyzing Mood Swings in the Market 71A Few Words About Select Macro Factors 72Assessing the Market's Bias 73Judging the strength of a move 73(Psycho)-analyzing the market 79Watching Call and Put Activity 81Understanding put-to-call ratios 81Using the put volume indicator 84Using Volatility to Measure Fear 85Measuring volatility 85Recognizing impact from changing volatility 86Spelling fear the Wall Street way: V-I-X 86Applying Breadth and Sentiment Tools 88Locating neutral areas for indicators 88Identifying indicator extremes 89Chapter 6: Sector Analysis: Technical and Fundamental 91Getting Technical with Charts 92Chart basics 92Adjusting your time horizon for the best view 93Visualizing supply and demand 94Identifying Relatively Strong Sectors 97Relative ratios 97Rate of change indicator 99Using Sector Volatility Tools 101Displaying volatility with indicators 102Analyzing volatility with Bollinger bands 106Projecting Prices for Trading 107Support and resistance 108Trends 110Channels 111Price retracements and extensions 114Projections and probabilities 116Chapter 7: Practicing Before You Swing 119Monitoring Option Greek Changes 120Tracking premium measures 120Changing volatility and option prices 121Paper Trading a Trading Strategy 123Trading on paper: Pluses and minuses 124Implementing electronic paper trades 124Using Trading Systems 125Knowing what you're getting 126Performing a backtest 126Adding risk management to a backtest 130Shifting from Knowledge to Mastery 132Setting the right pace 133Achieving mastery through longevity 135Chapter 8: Designing a Killer Trading Plan 137Developing a Reliable Plan 138Managing Your Costs 139Optimizing Order Execution 141Understanding option orders 141Entering a new position 146Executing a quality trade 148Exiting an existing position 150Part 3: What Every Trader Needs to Know about Options 153Chapter 9: Getting to Know Different Option Styles 155Nailing Down Index Options 155Getting to the nitty-gritty of indexes 156Capitalizing on an index with options 158Watching Out for Style Risk 160American-style options 161European-style options 162Exercising Your Options, American Style 164Knowing the nuts and bolts 165What you see is what you get 165To exercise or not, that is the question 166Exercising Your Options the Euro Way 167Tracking index settlement (the SET) 167Cashing in with exercise 167Satisfying Option Obligations 168American-style stock options 168Expiring options 170European-style options 173Breaking It Down: American-Style Index Options 174Exercising rights 174Meeting obligations 175Chapter 10: Protecting Your Portfolio with Options 177Putting Protection on Long Stock 178Combining puts with long stock 178Weighing protection cost versus time 183Limiting Short Stock Risk with Calls 185Protecting a short stock position 185Further reducing short stock risk 186Hedging Your Bets with Options 187Protecting a portfolio partially 188Protecting a portfolio completely 191Avoiding Adjusted Option Risk 194Justifying option adjustments 194Adjusting from adjustments 196Chapter 11: Increasing Profit Potential and Decreasing Risk 199Leveraging Assets to Reduce Risk 200Determining your total dollars at risk 200Relying on market timing 205Combining Options to Reduce Risk 207Spreading the risk with a debit trade 208Spreading the risk with a credit trade 215Chapter 12: Combination Strategies: Spreads and Other Wild Things 221Combining Options with Stocks 222Creating "covered" positions 222Covering the covered call position 223Reducing protected stock costs 226Varying Vertical Spreads 228Changing your vertical spread risk profile 229Spreading time with calendars 230Defining diagonal spreads 233Chapter 13: ETFs, Options, and Other Useful Tricks 237Exploring the Exchange-Traded Fund 237Comparing ETFs to indexes 238Distinguishing ETF and index options 241Reducing Portfolio Volatility with ETFs 244Revisiting volatility 244Investing with ETFs 249Tilting Your Portfolio with Sector ETFs 256Adding sector ETFs to tilt your portfolio 256Selecting the right strategy 260Part 4: Advanced Strategies for Options Traders 263Chapter 14: Making Money without Worrying About the Market's Direction 265Limiting Directional Risk 266Capitalizing on a big move 266Reducing straddle risk and reward 272Neutral View versus Neutral Position 275Identifying neutral positions 276Calculating delta for combination positions 276Trading with Delta 277Monitoring two key Greeks 278Creating a delta neutral straddle 279Understanding Trade Adjustments 282Deciding when to adjust a trade 283Deciding how to adjust a trade 284Chapter 15: Letting Volatility Show You the Way to Trading Opportunities 285Analyzing Implied Volatility Levels 286It's all relative but not overly scientific 286When options are skewed 293Understanding Ratio Spreads 296Reviewing ratio spread risk profiles 296Identifying best conditions for ratio spreads 300Deciding your strategy 301Using Ratio Backspreads 303Defining ratio backspreads 303Spotting best conditions for ratio backspreads 312Chapter 16: Trading Profitably When Markets Move Sideways 315Winning Positions in Sideways Markets 316Managing existing positions 316Option strategies for sideways moves 321Understanding Butterfly Positions 323Defining the butterfly 324Digging deeper into butterfly risk 332Creating an iron butterfly 334Understanding Condor Positions 338Defining a condor spread 338Recognizing condor risks 340Part 5: The Part of Tens 343Chapter 17: Ten Top Option Strategies 345Married Put 346Collar 347Long Put Trader 348LEAPS Call Investor 349Diagonal Spread 351Bear Call Credit Spread 352Straddle 353Call Ratio Backspread 355Put Ratio Backspread 356Long Put Butterfly 357Chapter 18: Ten Do's and Don'ts in Options Trading 359Do Focus on Managing Risk 360Don't Avoid Losses 361Do Trade with Discipline 361Don't Expect to Remove Your Emotions 362Do Have a Plan 363Do Be Patient 364Don't Suffer from Analysis Paralysis 365Do Take Responsibility for Your Results 365Don't Stop Learning 366Do Love the Game 367Index 369