Archive for the ‘Stock option basics’ Category

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Developing Stock Market Trading Systems

Wednesday, December 9th, 2009

There are as many stock market trading systems in the world as there are traders, or at least it often seems like there is. This is primarily due to the fact that each investor has their own needs, goals and objectives which their personal approach must support.

Consider that stock market trading systems can be designed around creating current cash flow or simply accumulating capital over the long term. They might also involve hedging against loss or risking a great deal for a big return. There are all kinds of goals, and the many different and individualized stock market trading systems exist because of this simple fact.

If you are interested in beginning the process of developing a system for your stock market investments you must first understand your capabilities, the amount of risk you are comfortable in taking, and the various approaches that you have open to you.

For example, you may already be the happy owner of many long-term holdings, but you might be looking for some additional sources of revenue. You could contact a day trader who can provide profit through a large number of small daily gains (if you are comfortable with the risks involved), you could meet with a value investor who can help you develop a plan to capitalize on many long-term financial trends, or you could begin doing a few small investments on your own to explore the various opportunities.

All of these approaches could be used as exclusive systems, or they could be combined to create a diverse approach to economic growth. The thing to remember is that you must identify your goals, understand the rate of return necessary, and invest only the capital that you can afford to put in jeopardy. There are no risk-fee systems, there are simply plans that can reduce and hedge risk to minimal levels.

For example, among all of the various trading systems there is one that almost anyone can quickly understand and enter into without assuming too much risk. This is something known as “options trading”, and it can involve the purchase and sale of stocks, but is geared more towards the creation of special contracts that can reward the investor based strictly on a stock’s performance. Many savvy investors use options trading as a sort of insurance against loss, but also to yield reliable returns on the current market conditions, regardless of whether they are “bearish” or “bullish”. This is often considered a system in its own right, but it can also be incorporated into an overall plan as well.

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Can You Explain Option Trading?

Thursday, November 12th, 2009

As individual and institutional investors continue to try and chase positive returns out of the stock market, there is no doubt that stock options are a hot topic.  However, option trading isn’t for everyone.  It most definitely may not be for you.  As a test, ask yourself honestly whether or not you can explain option trading.

Being able to really explain option trading to another person is a sure sign that you’ve mastered the basic requirements of the market.  Yet there are many people who get into options trading armed with a willing broker and absolutely no understanding of what they are doing other than “making money” in the stock market.  You usually can find these same people six month later with tales of woe that will curl your hair and make you want to bury your nest egg in the backyard.

Option trading doesn’t have to be scary, although it is definitely complex.  The basic principles are straightforward, but there are elaborate variations and a unique vernacular that surrounds the practice.  Sorting through all of this is critically important.  You can have a European option on a futures contract that has a favorable outlook when run through the Heston model, but if you don’t know what you need to do with it on Tuesday when it expires you may as well just burn your money now.

To get around this and ensure that your options trading strategies are profitable ones, it is important to get a solid education in option trading principles and practices.  Not only will this help you protect your nest egg from your own personal ignorance, but it will also help you sort through the many different stock tips and analyst reports to latch onto the truly valuable bits of information.  You will be able to understand if you are getting good advice from your broker, and have better control over your portfolio’s volatility.

Learning about options trading is easy enough, as there are courses available both online and offline.  These courses are offered by experienced traders, private financial educators, and the boards of exchange themselves.  The main trading exchange for American options, the Chicago Board Option Exchange, has extensive online tutorials covering both the terminology and the regulations governing domestic options trading.  You can also enroll yourself in a number of specialty niche courses for specific kinds of option trading, such as commodities, bonds, or futures.

If you’ve been trading options for a while and have not been having the success that you had hoped for, it might be time to go back to the beginning and study the fundamentals.  Your savings and your nest egg are too precious to be simply thrown away on an impulsive trade or something your broker recommends but you don’t really understand.  Thus, if you can’t honestly explain option trading, or if you feel that you are less than fully confident in your understanding of the process and the terms, it is time to revive your portfolio and your self confidence by studying option trading in depth.

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Common Strategies For Options Trading

Thursday, November 12th, 2009

Becoming a brilliant options trader—or even just a profitable one—doesn’t mean you need to go out and reinvent the wheel.  There are many strategies for options trading that have already been tried and tested by thousands of traders.  To find an options trading strategy that works best for your personality and your personal financial situation, don’t try to build one from scratch.  Instead, familiarize yourself with the four most common strategies for options trading.

1. Long Call

The long call strategy for options trading is a way to express your bullish sentiments in the marketplace.  With this strategy, you use calls to lock in a future price for the right to buy a stock that you think will go up over time.  If your prediction is wrong, you are merely out the call premium, rather than the full value of the stock drop, and if you are right you earn a profit on your investment.

2. Protective Equity Puts

The protective equity puts strategy allows you to take out a virtual insurance policy on adverse market movements.  Typically, this strategy is used when you have invested in a stock at a certain level and while you are reasonably certain that the stock will trend upward, you can’t afford to take a substantial lose on the play.  Thus, you buy a put at a level just below your current investment price, allowing you to cut your losses even if the market tanks.

3. Buying Put Options

Buying put options is one of the strategies for options trading when you are bearish on the overall market environment.  With this strategy, you do not own the underlying stock, as you do with equity puts.  Instead, you are placing a bet that the stock will fall.  You profit on this strategy from the increase in the value of the put while the stock falls, and from the elimination of the need to own the underlying stock.

4. Covered Call Selling

Covered call selling is one of the most popular strategies for options trading.  With this strategy, you can profit even if you are relatively neutral on a given stock or even the overall market, priced via index fund share holdings.  The “covered” in this strategy means that you already own the stock underlying the call.

You can profit in two ways from covered call selling.  The first way is with the cash credit you get for selling the call, since you can pocket the premium on the option.  The second method is through the pricing of the call—even though you don’t feel as though the market is going to move the stock, you should still price your call at a point just above its current level.  In this way, if the call is exercised, you profit on the delivery of the shares.

If the stock falls with a covered call, you still get to keep the money you got when you sold the option, as the holder will be unable to exercise the contract.  This money will help offset the loss you will be taking on the underlying stock in your possession.

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Day Trading Basics: Ensuring Profitability

Thursday, November 12th, 2009

Day trading certainly sounds like an enticing proposition, and day trading basics make it sound relatively easy.  By making short term investments and closing them out profitably, you can set yourself free from your boss, your mortgage, and your debts.  Unfortunately, ensuring profitability is one of the biggest challenges for professional day traders.

You can overcome this challenging element of day trading basics and set yourself apart from other day traders who struggle to make back their original investments day in and day out.  By employing proper day trading training basics, you will be able to ensure your profitability as a day trader, and truly enjoy all of the lifestyle benefits day trading can bring to you.

1. Focus on one market area

One of the biggest obstacles for most traders is the sheer volume of market activity.  Short-term trading lends itself easily to impulsive reactions to market movements.  Good information is critical to profitability, but it is easy to be overwhelmed.

To compensate, focus on one market area and become an expert on the leading companies and trends in that market area.  Maybe you like resource metals, or green energy firms.  Study the movers and shakers, understand the regulatory environment, and get to know their client market.  In this way, when something happens in your market area, you will be able to understand and correctly interpret the data to get to a profitable trading position.

2. Get fundamental

Before making any trade, ask yourself if it is an emotional or a fundamental decision.  One of the most important day trading basics is to never lose sight of the fundamental values and properties of what you’re buying and selling.  It’s easy to think only in terms of numbers on a screen, but you can miss opportunities when you don’t base your decisions on the tangible products behind those numbers.

3. Limit your losses

The easiest way to ensure your personal profitability is to limit your losses.  Have discipline with your trading, and firm rules about what happens when a given trade drops.  With day trading training, buy and hold is not the name of the game.  You’re not in this for the long haul—you’re in this for the money.  Have stop-loss metrics and stick with them no matter what your “gut instincts” are telling you about the stocks.  Numbers don’t lie, and when it’s time to get out, cut your losses and live to trade again another day.

4. Leave your emotions at the door

In order to master your day trading basics, you’ll want all the volatility to be in the marketplace, not at your place.  When you get to the place where you do your trading, you need to be able to leave your personal emotions at the door.

Invest objectively, and learn to watch for your own personal warning signs to avoid investing out of anger, frustration, despair, or euphoria.  You want to make smart trades and walk away a winner.  Do your research and be a calculating, calm trader.  The money you make over the span of a smart career will feel much better than any temporary high of emotional investment.

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Learn How To Trade Options Objectively

Thursday, November 12th, 2009

A large part of the problem with any stock market investment is the emotional component of the trade, as many never learn how to trade options objectively.  Far too many traders get emotionally invested in their portfolios, hanging on to options longer than they should, falling in love with bad stocks, and buying impulsively.  The result is heavy losses, a loss of self-confidence, and a blooming risk aversion that can shrink profitability.  Avoid this all takes a bit of work, but it can be done.

To learn how to trade options objectively, it is important to understand the psychology of the trading game.  In theory, it is all about maximizing the return on each dollar invested.  In practice, it often becomes a game of trying to out do other traders, prove something, or show-off.  Even the most advanced traders claim that no one in the market is objective enough—but you can work towards greater objectivity when you:

1. Focus on the fundamentals

People lie.  Analysts lie.  The numbers never lie.  If you want to learn how to trade options objectively, cut out all the human factors and focus on what the numbers are telling you.  Ignore the talking heads completely, if you can, and focus on the research and your charts.

The fundamentals of a given trade are shown in black and white on paper.  They don’t like or dislike you.  They simply go up or down in reaction to market movements.  Learn to read and understand the numbers side of trading options, and you will be set for success.

2. Recognize when emotion is in play

To learn how to trade options objectively time and time again, you need to be able to recognize when emotion is in play.  Get to know your own trading personality.  What are your triggers?  What makes you feel aggressive, angry, frustrated, depressed, bitter, or euphoric?  How do those emotions influence the way you trade?

Understanding your personal emotional influences on your trading strategy will help you pick the trading strategy that best suits you.  When writing about the Holy Grail of trading and investments, the case has repeatedly been made that your emotional compatibility with a trading strategy can make it your personal Holy Grail.  Learning what strategies require too much patience for you, or which make you too nervous to think objectively is key to avoiding being trapped in a losing system.

3. Set and follow your own rules

When you learn how to trade options objectively, you set and follow your own rules.  It’s the second part that is the most important.  You can create all the rules you want, but if you can’t follow them you don’t have a functional system.

Most trading rules are in place to limit the size of trades, eliminate risk, and cut losses.  You set them when you were calm and thinking clearly.  Being able to follow them in the heat of the moment will make the difference between successful portfolio management and heavy losses.

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Stock Market Trading Systems For Beginning Traders

Thursday, November 12th, 2009

When you are just getting started as a trader, you may be overwhelmed by the abundance of stock market trading systems in existence.  It is tempting to simply start trading and forget about having any kind of system, but expert traders show that those with a system are more profitable than those without a system.  Thus, you need to identify the stock market trading systems that are going to work for you as a novice trader.

Rather than feeling like you need to be riding the short bus, remember that you are a novice on every new trade you make.  Keeping the hesitant and risk adverse attitude of a beginning trader throughout your trading career may help you avoid the arrogance and overconfidence that hamstrings many trading careers.

The first step in identifying which stock market trading systems will help you get started is to determine your overall outlook on the market.  There are bullish strategies for the hopeful, bearish strategies for the pessimist, and neutral strategies.

1. Call Option Trading Systems

With call option trading systems, you are working with an overall bullish outlook.  You generally feel the market will go up, and you trade accordingly.  When you have long call options, you are looking for the right to buy stocks at a predicted future price, which can be a good way to buy into an uptrending stock.  When you have short call option, you have an obligation to sell a stock when it hits a given price.

2. Put Option Trading Systems

These stock market trading systems are based around an overall bearish outlook on the marketplace.  You are looking for the right to sell stock you currently own, but also willing to take on obligations to buy shares if the price drops far enough.  Long put strategies can be a good way to exit a stock position, while short put strategies let you buy into stocks that have dropped down to the price at which you consider them to be appropriately priced.

3. Neutral Trading Systems

Neutral trading systems allow you to make a bit of money or cover small losses even when you don’t think that the market or a given stock is going to go anywhere.  With neutral stock market trading systems, you use call and put strategies to earn money from the sale of options, even if the stock remains dead in the water.  There are options for neutral trading even if you don’t own the underlying stock, although the most popular neutral trading system is the covered call, where the underlying stock is in your possession.

Concluding Thoughts

Whichever trading system you ultimately choose, remember to stick with it consistently.  If you are losing money, changing your system for every new trade will only accelerate the process.  Instead, analyze your trades and determine if you were really following the rules of the system before making any changes.  Many novice traders change their minds about their systems too often and lose money unnecessarily.

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The Basics Of How To Trade Options

Thursday, November 12th, 2009

In order to launch a successful career as a trader, you need to understand how to trade options.  This is true whether you are planning to be an options trader, a day trader, and even if you have a broker.  Understanding how to trade options will help you earn a profit with your investments, and eventually lead you to the kind of financial freedom that will allow you to live off your investments in comfort.

Naturally, this article can’t be an exhaustive guide.  You wouldn’t attempt to perform surgery after reading a quick overview, and neither should you trade until you feel you are completely grounded in the fundamentals.  However, these are some of the key areas of trading that you will need to know to trade options successfully.

1. Know your exchange.

The Chicago Board Options Exchange is the largest and busiest options trading clearing house, but there are others around the world.  Some specialize in niche product, such as commodities options or metals.  Choose the exchange that is best suited to your trading background and your intended area of specialization.

2. Know your terms.

Trading options, like any other professional craft, has its own special language.  It is highly recommended that you get a glossary of key terms and read it before launching into any kind of trading activity.  While it may seem silly to read the trading equivalent of a dictionary, when you read that the stochastic are your Bermudan is looking good for the third date on the contract, you want to know what on earth you need to do.

3. Know your emotions.

One of the little known secrets of how to trade options successfully is to get a firm grip on your emotions.  You are playing a game of risk with your money.  How much can you really handle?  What will make you break down and make poor decisions?  Expert after expert will tell you that any trading system is only as solid as the person running it, and if watching the market makes you impulsive and jittery, you won’t be doing a good job managing your investments.

4. Know your limits—and stick to them.

Along with your emotions, knowing your own personal limits is important.  What is the cap on your investments?  What are your stop loss marks?  What trades don’t you know enough about to do successfully?  Understanding the parameters within which you will be able to operate successfully is critically important to having a good experience in the market.

Concluding Thoughts

The fundamental of how to trade options can be taught in books.  However, the core areas of personal and professional knowledge that you need to succeed can only be discovered with reflection and objective examination of your skills, abilities, and comfort zone.  Don’t load yourself up with technical tools if you don’t understand them or if you are stressing yourself into an early grave.  You can use options to live a life of ease and financial freedom, but only if you master the basic areas of knowledge needed to set yourself up for success.

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Options Trading Video – Learn Options Trading Fundamentals Using This Easy-to-Follow Video.

Monday, November 2nd, 2009

Learn options trading fundamentals, and a few additional strategies for options with this 10 minute video created by The Ideal Trading Academy and Trading-Courses.org.

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Explain Option Trading – The Call Option & Put Option.

Friday, October 30th, 2009

As you may know by now, there are two types of stock options - call options and put options.

You buy a call option if you expect the future price of a stock to rise (also known as a long position), as opposed to a purchasing a put option, which is what you’d purchase if you expect the future price of a stock to go down (also known as a short position).

You can use a simple example to help you remember the difference: When you call some one on the phone the receiver goes UP. When you put down the phone, the receiver goes DOWN.

Getting back to call options specifically, remember that they’re concerned with the right (not the obligation) to purchase a stock at a future time, at a pre-determined price. A previous example provided could be the purchase of shares of Apple Corporation at a predetermined price, for a 3-year period.

The put option is a little trickier to grasp for most people. That’s because, unlike with stock trading, options trading strategies allow  you to make money when stocks go up and down.

Exactly the opposite to a call option, a put option gives the right – not obligation – to sell stock at a future date.

The put buyer, either believes that the underlying asset’s price will fall by the exercise date, or hopes to protect a long position in it. (a technique known as “hedging”). The advantage of buying a put over short selling the asset is that the option owner’s risk of loss is limited to the premium paid for it, whereas the asset short sellers risk of loss is unlimited. The put buyer’s (risk) of gain is limited to option’s strike price, less the underlying’s spot price, and the premium/fee paid for it.

explain option trading1 Explain Option Trading The Call Option & Put Option.

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Explain Option Trading – The Definition of a Stock Option.

Monday, October 12th, 2009

In the area of finance, an option – simply put – is a contract between a buyer and a seller that gives the buyer the right (not an obligation however) to buy or sell a particular asset (called the “underlying asset”) at a particular price (also known as the option’s “strike price”) on or before the option’s expiration time. The “underlying asset” can be a piece of property (not our focus on this blog), a security such as a stock or bond, or a derivative instrument like a futures contract. There are two main types of stock options – a call option and a put option.

A call option gives the buyer the right to buy the underlying asset at a certain price before the option’s expiration date. A put option gives the buyer the right to sell the underlying asset at a certain price before the option’s expiration date. As reward for granting the option, the seller collects a payment or premium from the buyer.

Options are traded through options exchanges. The principle options exchange is located in Chicago, and is known as the C.B.O.E (The Chicago Board Options Exchange).

An example of a stock option contract would be the right to purchase shares of Apple Corporation within a 3-month period, at a pre-defined price.

Another popular way explain option trading is to use a real estate example. Let’s say you’ve found a beautiful property out in the country that you wish to purchase. The land owner is asking $250,000.00 for the property, and you don’t have the funds on hand to purchase the property at the present time. You know that in six months, you will have the funds in your bank account to purchase the piece of land in question, so you negotiate an “options contract” with the seller. You negotiate a payment of $5,000.00 as a right to purchase the seller’s property within 6 months, at the future price of $260,000.00.  (which takes into account a future price rise in this case). In six months, if you decide to purchase the property – no matter what the present value of the property – you owe the seller $260,000.00. If for some reason you do not wish to purchase the property in six months (for instance, some information has come to light which causes a drop in property value, or if you have a change of heart about the purchase) you lose only your initial $5,0000.00 deposit.

explain option trading2 Explain Option Trading The Definition of a Stock Option.

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