Archive for the 'trading options' Category

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Folk wanting to know how to trade options will quickly come to understand why trading options is a much more sensible and less risky business than trading stock, provided of course that they have taken the necessary steps to minimize risk.

So, why are options a better trading vehicle than stock? Let me illustrate with the following example. Let’s imagine that stock in company XYZ is selling today at $50. If I was to purchase 1000 shares of stock XYZ, in the expectation that this stock is going to go up, (in other words I am bullish on the stock), the stock will cost me $50,000. Although the stock may indeed go up, if things go belly up I stand to lose the whole $50,000 I have invested.

The alternative is to seek out a call option on the XYZ stock. Let’s assume that a three month call option contract on stock XYZ, which today has a strike price of $50, is selling at a premium of $12. If I take this up, I have the right but not the obligation under the contract to buy 1000 shares of stock XYZ for $12 a share. If I choose to exercise this option (no pun intended), my cost for the stock is $12,000. Immediately I have saved myself $38,000 by choosing to trade options and not stock and this saving can be used to purchase further option contracts.

Now in the same way that stocks can go up they can also go down. If I had purchased the stock for $50,000 and the price plummets to $25 a share, I have lost $25,000. If I had invested in options? $12,000. But that of course does not reflect the reality of the situation. As you will already have discovered from my earlier posts knowing how to trade options is all about covering your calls (akin to hedging your bets at the racetrack) so as to minimize risk and ensure you will want to continue learning how to trade with confidence! And the secret is not just to simply walk away once you have done this but to return to adjust your position(s) as and when the need arises. More on that in my next post!

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April 17, 2009

Well .. I am delighted to say that last months trading produced a 24.4% return on margin .. not an outstanding outcome by some standards, but a healthy yield on investment for that one month, just the same.  But do remember .. I am still paper trading.

As I have previously mentioned, knowing how to trade options with confidence involves a number of factors.

I thought to share with you today some of my own perceptions when I came to close off trading for the month of April. I stress .. these are just a few things which got me to thinking, as a newcomer to the world of online options trading.

It is recommended that one does not try to extract maximum profit by holding on right through to expiry. It is not uncommon to see quite  a lot of price volatility in the last week of trading and so it is strongly recommended that for most situations you close off no later than a week or so before expiry date. So effectively that is around 7-10 days before.

With April trading I decided to close off  on the Thursday before Easter figuring that by holding off to when trading re-opened on the Tuesday I might strike problems with price movements. In retrospect a good move, but I had also placed some opening positions on for May a couple of days earlier.

I won’t pretend that I have mastered the Think Or Swim trading platform fully but I’m getting there by degrees. One of the first things I observed was that trading results for the two months were scrambled together in the listing of positions on and I was left to guess which keystrokes to use to highlight the spreads I wished to close out (my fault solely, as I should have familiarized myself with that first) . That was after I had to put on my thinking cap to establish just which of the trades showing up, I wanted to close out.

On the day before (The Wednesday) I’d seen quite a profit hike but the trend was to be reversed on the Thursday as prices moved against me. No great drama because I was well ahead for the month as I said .. but hassles I’d have preferred not to encounter when things started to heat up.

It is recommended that when trading options for any given month you set up your spreads between 30 to 40 days before expiry. I had put the May spreads on nearer the 40 days and this gave rise to the overlap. Next month, I will place my opening positions on, nearer the 30 days and after I have closed out May. This is something I would be recommending to newbie traders, at least until they feel they have completely mastered the TOS platform.  This will overcome any prospect of confusion when it comes to closing out and putting on the new trades. Another reason for doing this is because shortly after placing the positions I had price move quite quickly up on me and I was forced to adjust.  Then followed a few days of sideways movement so I made the decision to add a few more positions across all of the indexes. And now again I see price creeping up a bit .. so the next few days may prove interesting.

My journey through the world of online options trading I find increasingly fascinating, with each day bringing  just a little more newfound knowledge and a ton of excitement as I master the art and science of how to trade options profitably and with confidence.

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