Options Trading

Crash Course
• The #1 Beginner's Guide to Start
Making Money with Trading Op-
tions in 7 Days or Less•

By Frank Richmond

Copyright© 2018
Disclaimer
Please note that the information contained within this
document is for educational purposes only. Every attempt
has been made provide accurate, up to date and reliable
complete information. No warranties of any kind are ex-
pressed or implied. Readers acknowledge that the author is
not engaging in the rendering of legal, financial, medical
or professional advice. The content of this book has been
derived from various sources. Please consult a licensed pro-
fessional before attempting any techniques outlined in this
book.

By reading this document, the reader agrees that under

no circumstances is the author responsible for any losses,
direct or indirect, which are incurred as a result of the use
of information contained within this document, including,
but not limited to errors, omissions, or inaccuracies.
Table of Contents
Talcing the Risk
What is an Option?
Why Options Rather than Stocks?
Why is Options Trading Worth the Risk?
How to Get Started in Options Trading
Learning the Lingo
The Role of the Underlying Stock
Understanding the Strike Price
Basic Trading: Selling Covered Calls
Strategy for Selling Covered Calls
Outcomes of a Covered Sell
Stepping Up a Tier: Buying Calls
Strategies for Buying Calls
Understanding Time Value
Understanding Volatility
Keeping an Eye on Your Calls
Exercising Your Right to Buy the Stock
How to Buy and Sell Puts
Strategies for New Options Traders
In Conclusion
Before we begin, I would like to give you something back
in return - exclusive ONLY to my readers - an IMPERATIVE
bonus chapter of my options trading book. FOR FREE .

This offer is extremely time limited, so go get

it now while it's still available:

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Now that you have everything you need, let's begin ...
Taking the Risk
For the novice, options trading is a daunting concept.
Packed with jargon and seeming to need a degree in math
to figure out, the very idea of learning the basics has put off
countless curious traders.
I've written this book to bridge that gap, taking you from
thoroughly confused to fully aware of what options trading
entails. It's aimed either at complete beginners who have no
idea where to get started or at readers who have dipped their
toes in the waters and found themselves flailing.
It's also aimed at readers who think that options trading is
far more risky than its siblings- stocks, shares, bonds and
mutual funds. If you think these are the safer way to go and
you've avoided options trading until now, I'm here to show
you that they are just as fruitful a direction, if not more.
Much as with any other skill in life, options trading gets
easier over time. Once you've mastered the basics and are
fluent in the language, you'll find that it becomes less and
less difficult to decipher the possibilities in front of you and
pick the best one. In fact, eventually, it becomes like learn-
ing to use a tool or ride a bike - you know it so well that you
barely need to think about what you're doing.

So put your feet up, grab a coffee and prepare to start that
process of understanding. Trust me when I tell you that it's
not nearly so daunting as you thought.
What is an Option?
Let's start out with a basic overview of what options are. An
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option 1s a contract that confers upon you the right to buy

or sell an underlying stock at what's known as a "specified
strike price". It comes with a deadline - a date by which you
must buy or sell in order to attain that price.
You are not obligated to buy or sell by that date - hence it
being called an "option" rather than a "demand". However,
the cost of purchasing that possibility is set at a premium.
There are two types of contract on offer: one allows you to
tuy·a·stock-at·fiie-i>rfce si,eci"tie,( wiiici-i Is kiiown·as·a''cai1",
and the other allows you to sell a stock at the price specified,
which is called a "put".

In order to start options trading, you first need to select a

broker and open a "margin account". These usually have a
minimum starting amount attached to them that is often
set at around $5000.
These are the basics of options trading, but what does it
actually mean and why would you want to do it? This is
where the risk comes in: options trading is all about predict-
6$1-ilgt:Uol' ~«ll"" • - - - • - - - .. - - - .. - - - • - - - • - - - • - - - -

ing what a certain stock is going to do in the near future.

To illustrate, let's use an example that's easily familiar from
everyday life: buying a car. You've been saving up for a few
months, but you're not quite ready to head to the dealership
- except, one day, you drive past a local sales room and spot
the hatchback of your dreams.

Because you want to buy that car, you decide to speak with
the dealer and negotiate. You work out a deal that will allow
you to buy the vehicle from him in two months for the price
of $10,000. Because the dealer is agreeing to keep the car for
you and fix the price, you will also be paying $300 to secure
that option for yourself.

The two months start to pass and one of two things might
happen:

• The dealer opens the hood of the vehicle and

discovers it has an engine system that's com-
pletely one of a kind and was a test by the man-
ufacturer. That makes the car ultra valuable as
a collector's item. Under normal circumstances,
the dealer would instantly double its asking
price - but, because he made an agreement with
you, he can't. He is obligated to sell that car to
you as long as you buy it before the two months
are up. Obviously, you're keen to exercise that
right, so you purchase the car for $10,000 and
decide to sell it on for $20,000, doubling your
money in the process.
 • The dealer opens the trunk of the vehicle and
discovers that it contains a dead body. It's re-
moved and the car is cleaned, but the police
investigation causes quite a bit of damage. The
value of the vehicle halves and, under normal
circumstances, the dealer would slash the
asking price to $5000. However, because you
entered into the agreement, the dealer must still
sell you that car at the agreed price of $10,000.
On the other hand, because you as the buyer
are not obligated to make the purchase, you can
always decide to walk away and see what the
Toyota dealer has in stock instead. You won't lost
the $5000 value, but the dealer will get to keep
the $300 you paid to create the opportunity for
yourself in the first place.

This, in a nutshell, is how options trading works. As the

buyer of an option, you are in exactly the same position
as you would be if you had gone out to buy that car. You
cannot know what the future will bring - and it does have a
habit of throwing out the unexpected - but you can make a
decent prediction.
Now, let's zoom in a little bit closer. Though options trading
really is as simple as the example we just looked at, there are
a few more things you need to know in more detail before
we move on.
Firstly, there are two types of options:

. Calls: These give the right to BUY an asset at

the specified price before the time limit expires.
You'd do this, for example, if you felt confident
that a certain stock is going to continue rising
in price for a period of time, allowing you to
purchase that stock at its current price at a time
when it has risen to a much greater value.

. Puts: These give the right to SELL an asset at

the specified price before the time limit expires.
You'd do this, for example, if you felt confident
that a certain stock is going to continue drop-
ping in price for a period of time, allowing you
to sell that stock at its current price at a time
when it is worth a whole lot less.

Let's translate what we know into a trading example so that

you can see how options trading works in the real world.
This time, we'll look at a put, because, as you are now aware,
the example we covered of purchasing a vehicle was an il-
lustration of a call: you obtained the right to BUY before the
deadline.

This time, we'll look at what might happen if you purchased

a put option, giving you the right but not the obligation to
SELL before a deadline. We'll assume you're looking at a
particular stock in your portfolio that is currently trading at
$1. Knowing the market, you have predicted that it is going
to drop to 50 cents within the next three months.
You purchase an option with a trader that will allow you
to sell the stock in three months at 7 5 cents. If, during the
interim, it turns out you are correct and the stock drops to
50 cents, you have made a 25 cent profit on the sale. If, on
the other hand, you were wrong in your prediction and the
stock climbs to$ 1.20, you have no obligation to sell it and
lose that 20 cent profit.
To decipher this example fully, it's important to understand
the difference between a buyer and a seller, as it's likely that
you'll end up filling both roles over the course of your op-
tions trading experience:

· A buyer is NOT OBLIGATED to actually buy or

seif'i:'ne -optfon·wlien·fhe-deaa.iine·amves:wiiat
he or she has bought is the right to make that
sale or purchase, not the obligation.

• A seller is OBLIGATED to buy or sell that stock

when the deadline arrives. As the seller, you
made a promise when the contract was agreed
and you must fulfil it when the time comes, no
matter the consequences.

If follows, therefore, that you could find yourself in four

very different situations during the options trading experi-
ence. Let's outline them for your reference, as this is often
where it can start to seem confusing:
. Call buyer - you have the choice to buy a stock
at the deadline, but are not obligated.

. Put buyer - you have the choice to sell a stock at

the deadline, but are not obligated.

. Call seller - you are obligated to sell a stock at

the deadline and will keep the premium that
was included to secure the deal.

• Put seller - you are obligated to buy a stock at

the deadline and will keep the premium that
was included to secure the deal.
There are more intricacies to the experience of stock trad-
ing, but we'll cover those in more detail later. First, make
sure you have a full understanding of these basics - they are
the essence of options trading and the heart of your experi-
ence as a trader.
Why Options Rather than Stocks?
One very good question that newcomers often ask is why
a trader would want to trade in options rather than stocks.
What's the difference? Is one better than the other?

It's true that the stock market is less complicated to work

with. All you really need to worry about in the case of the
stock market is the direction things are heading: down is
bad for your shares but could be good for buying; up is good
for your shares and could be good for selling.

With stocks trading, you are also seldom going to lose 100
percent of your investment if things go sideways. If you
pick a stock thinking it will climb but instead it plummets,
you can sell quickly and lose only the difference between
your initial investment and the price of that stock as you
sell.
Not so with options trading, where you will lose the lot if
you make a bad judgment call. Stocks trading can be a great
introduction to the market, but it's less flexible and less
likely to win big than an options trade.

When you enter the options trading market, you quickly

find out that you actually have three things to worry about
- and what those things are doing is not so simple as "down
is bad, up is good". You are interested in the direction stocks
are heading, but you can make big money on a downward
direction as easily as upward, if you make the right call.
Meanwhile, you are also concerned about your timing and
the magnitude of the trade.

In a nutshell, the biggest reason to choose options over

stocks is that it provides you with flexibility within your
own portfolio and allows you to play the market at its own
game, whether bull or bear.
So let's take a closer look at options trading and its benefits,
shall we?
Why is Options Trading Worth the Risk?
So what's the point of all this horse trading? If, while read-
ing the previous chapters, it seemed that options trading
involves a lot of risk and an uncertain gain, you might be
interested to know that that's not necessarily the case. It all
depends how you go about trading your options.

While, yes, you can place your focus on a whole slew of

risky ventures and you would stand to either lose a fortune
or gain even more, that's not the only way to options trade.
Let's take a look at the advantages of options trading:

• When you trade in options, the uncertainty

lessens. You create an option that tells you ex-
actly how much you will either lose or gain once
the deadline arrives - unlike trading in stocks or
shares, you are not at the mercy of the markets.
You have confirmation from the outset of what
you will either receive or spend on that particu-
lar date.

• Options are more versatile than stocks or shares,

which means you can make money no matter
the state of the market. It doesn't matter if stocks
are dropping as it would if you were simply
trading in stocks. With an option strategy, you
can take advantage of what's happening in the
 markets in either direction.

• You can also use options trading as a form of

security to protect your investments. That
might sound strange, but it's actually a very
common strategy known as "hedging". If, for in-
stance, you are concerned that a stock you own
a large amount of is set to drop, but you're not
completely sure, you can use an options trade
to protect yourself against that possibility. You
would simply buy a put that would allow you
to sell that stock at a greatly reduced loss on the
deadline - you wouldn't be obligated to make
that sale if you turned out to be wrong, but you
can do so if your fears prove to be founded.

• You can also "hedge" to protect yourself against

rts1taitoge1:iiei. ·ir fr-seems tiiat the-market -as-a-·
whole is set to drop over the coming months,
you can hedge your entire portfolio by buying
certain options known as exchange-traded
funds. These will actually gain value as the mar-
ket drops in value - it's a very common strategy
among the experts.

. The opposite of "hedge" is "speculate", and it's

one of the most profitable ways to invest if it's
 done properly. Beware, however, that it is also
the strategy that carries the most risk. By spec-
ulating, you can leverage the investments you
have made and you have the chance to make a
lot of money in the process, all for a relatively
small cost.

• Finally, arguably the most important advantage

of options trading is that you don't need to know
the complicated and advanced strategies to pre-
vail. Actually, it's the simple strategies that are
very often the best, which means you can dive
into options trading with confidence that you
can learn as you go without sacrificing your po-
tential for profit.
How to Get Started in Options Trading
Walking you through the learning curve of options trading
will always start with the most basic move you'll need to
make: setting yourself up in a position to actually be able to
trade.
To do that, you're going to need an options account. Don't
worry, we're going to talk a whole lot more later about what
to do with your account once you have it in the coming
chapters. For now, it's important that you know your start-
ing point - and just how easy it is to reach it.

One thing to know before you pick your firm: times have
changed considerably over the last couple of decades when
it comes to options trading. Back before the internet became
such a constant part of our lives, your brokerage firm - or, at
least, your personal representative at the firm - would make
your options trades on your behalf and you paid a hefty
price for their services. Nowadays, however, you'll be doing
most of your trades yourself.
Commission for your representative is thus a whole lot
lower than it used to be, which means it won't cost you an
arm and both legs to rely on your rep in the early days of
your experience. While you are learning, feel free to make
use of your firm's services to place and confirm your trades,
if it helps you feel more comfortable getting to know the
process.

With this in mind, there are going to be certain things to

look for when you select your firm:

• Compare commission prices to make sure you're

getting a great deal .

. Make sure the firm has up to date software and is

capable of setting up trades quickly and reliably
to make sure you get those trades you want at
the best prices.

• Check out the hours of service to ensure they

are compatible with your needs. In these days of
online firms, you could be dealing with a firm
that's across the ocean from the markets you
have an interest in, or you might find that a firm
only makes its reps available for the length of
the working day, which might not suit your own
timing.

• Speak personally with the reps at the firm, as

these are the people who are going to help you
during the process of setting up your strategy.
You want someone who is personable and
knowledgeable - and, most importantly, who
speaks in terms that you personally find easy to
 comprehend.

• Take a look at the additional services the firm

supplies. Many will offer learning materials,
guides and even classes or webinars to help you
hone your strategies. Even if you feel that you
know all you need to know already, there's no
harm in a refresher course or a little nugget of
inspiration every once in a while.

Once you select a firm, you'll then need to consider signing

a "margin agreement" with that firm. This agreement
allows you to borrow money from the firm in order to pur-
chase your stocks, which is known as "buying on margin".

Understandably, your brokerage firm is not going to allow

you to do that if you don't have the financial status to pay
them back. They will therefore run a credit check on you
and ask you for information about your resources and
knowledge.

A margin account is not a necessity for options trading -

you don't actually use margin to purchase an option, be-
cause it must be paid for in full. However, it can be useful as
you graduate to more advanced strategies - in some cases,
it will be obligatory. If you opt to sign a margin agreement,
talk it through thoroughly with the firm as there are certain
restrictions on the type of money you can use that may
apply to you.

Next, you'll need to sign an "options agreement" - and, this

time, it's an obligatory step. This agreement is designed
to figure out how much you know about options and how
much experience you have of trading them. It also aims to
ensure that you are absolutely aware of the risks you take by
trading and make sure that you are :financially able to han-
dle those risks.

By ascertaining these things, your firm can determine what

level of options trading you should be aiming for. It will
therefore approve your "trading level", of which there are
five:

• Level 1: You may sell covered calls

. Level 2: You may buy calls and puts and also buy
strangles, straddles and collars. You may also sell
puts that are covered by cash and by options on
exchange-traded funds and indexes
. Level 3: You may utilize credit and debit spreads
• Level 4: You may sell "naked puts", straddles and
strangles
• Level 5: You may sell "naked indexes" and "index
spreads"
Don't worry if you're not sure yet what each of these things
means - you will be by the time you finish reading this
book. For now, all you need to be aware of is that your firm
will determine for you which level you should be at. As a
beginner, don't be surprised if you only reach the first two
levels.

Once you've signed the agreement, you'll be handed a

booklet that contains a mine of information about risks and
rewards within options trading. Right now, if you were to
read that booklet, it would seem to be in a foreign language.
By the time you finish this crash course, it will be a lot more
decipherable - and it's very important for your success that
you do read it.

Finally, your firm will present you with a "standardized

option contract". It's the same for every trader, which means
you stand the same chance of success as every other person
out there in the options market.
By trading an option, you are entering into a legal agree-
ment that is insured by the Options Clearing Corporation,
which guarantees the contract will be honored in full. Make
sure you read that contract to be aware of not only the rights
you have as a trader, but also the obligations you must fol-
low in the same role.

Congratulations, you have an options account. This is the

conduit through which you will create and implement your
strategies and begin your adventure in options trading.
Learning the Lingo
Options traders speak their own language - it's not meant to
confuse you, it's just the natural process of creating a short-
hand by which one trader can converse with another more
easily and thoroughly.
Of course, it does make it difficult to plunge into the waters
of trading if you can't speak that language. A lot like trying
to decipher road signs in a foreign country, it makes it hard
to know the right direction - or even where you're standing
right now.

We're going to take a look at the common terms you'll be

dealing with as you enter the world of options trading be-
fore we begin taking a deeper look at your strategies.
Don't worry about trying to learn them by rote - they will
all become clear as you forge onwards. This glossary will al-
ways be available to you to check on a meaning if you need
to:
• Strike Price: A price per share agreed upon
before an option is traded. At this price, stock
may be bought or sold under the terms of your
options contract. Also known as the "exercise
price".

• Bid/Ask: The latest price that a market maker

 has offered for an option is its "ask" price. In
other words, it's what the seller is willing to
accept for the trade. The latest amount that a
buyer has offered for an option is the "bid" price.

. Premium: The premium is a per-share amount

paid to the seller to procure an option. The seller
will keep this premium no matter whether the
buyer exercises their right to buy or sell the
stock at the deadline.

. In-the-Money: Often shortened to ITM, this

means that the stock price is above the strike
price for a call or below the strike price for a put.
In other words, it is now at the right price to be
traded.

. Out-of-the-Money: Often shortened to OTM,

this means the price is below the strike price
for a call or above it for a put. Such an option is
priced according to "time value".

. At-the-Money: The strike price is equal to the

stock price.

. Long: In this context, "long" is used to imply

ownership. Once you purchase a stock or option,
 you are "long" that item in your account.

. Short: If you sell an option or stock that you do

not actually own, you are "short" that security
in your account.

. Exercise: The owner of the option takes

advantage of the right to buy or sell that they
purchased by "exercising" it.

. Assigned: When the owner exercises their

option, the seller is "assigned" and must make
good on the trade. In other words, they must
fulfill their obligation to buy or sell.

• Intrinsic Value/Time Value: The intrinsic value

of an option refers to how much it is ITM. Most
options also include time value, which refers
to how long left until its expiry. This time has
value because, during that time, the stock can
still change in price. An OTM option has no in-
trinsic value because it's a loss, but it does have
time value because that loss might change.

• Time Decay: Linked to time value, this term

refers to the fact that, as time ticks on, the
amount of time value slowly decreases. At the
 expiration date of the options contract, the con-
tract has NO time value and is worth only its
intrinsic value.

• Index Options/Equity Options: Index options

are settled by cash, whereas equity options
involve trading stock. The main difference be-
tween these two types of option is that an index
option usually cannot be exercised before the
expiry date, while an equity option usually can.

. Stop-Loss Order: This is an order to sell either

an option or a stock when it reaches a particular
price. Its purpose is to set a point at which you,
as the trader, would like to get out of your posi-
tion. At this price, your stop order is activated
as a market order; in other words, by looking for
the best available price at that moment in order
to close out your position.
These are the most common terms you will hear used as
you venture into the world of options trading. It's worth
mentioning that, as you extend your understanding, you'll
encounter more. However, these are plenty to help you deci-
pher your first trades and get stuck in.
The Role of the Underlying Stock
It's vital to understand that stocks do play a fundamental
role in options trading, even though they are not what you
are buying and selling. Bear in mind that an option is only
a piece of paper that gives you the right to buy or sell that
stock- without the stock, you would have nothing to buy or
sell.
You might say that the stock is Oz behind the curtain,
changing and moving while your attention is fixed else-
where. Letting Oz get up to his tricks without you is a bad
idea - you need to be keeping an eye on your stocks just as
much as you do the options themselves.
Not every stock is allowed its options to be traded on an op-
tions exchange. In total, you'll find somewhere in the region
3600 stocks spread across 12 different exchanges, though
this number changes all the time.
What does this mean? Well, the exchanges have in place
some very solid rules that dictate which stocks may and
may not participate in options trading. You'll find some of
the biggest business names on the planet there, and you'll
also find what are known as "penny stocks", which buy and
sell for less than $3.
In general, the latter won't do you much good for options
trading. There simply isn't enough liquidity in such a small
number for you to bother with the effort required to trade
on them.
Instead, I would recommend sticking with the big names
- the recognizable companies, such as Microsoft, Apple,
Google and McDonalds.
Another point to bear in mind is that there is a fixed rela-
tionship between options trading and its underlying stock.
One option contract will always equal a hundred stock
shares.
In other words, a single contract will give you the right to
buy or sell 100 shares (or one stock). Multiply the number
of contracts involved in a trade by 100 and you'll know how
many shares are also involved.

A third factor of that relationship between an option and its

underlying stock: whenever the stock goes up or down, in
most cases so too will the option contract.

Because the two are so inextricably linked, you will need

to study the stock market in detail to be a whizz at options
trading. You will need to be able to predict which stocks are
going to head in which direction and when - only if you get
this right will your trading be truly successful.
For that reason, a lot of options traders started with the
stock market itself, giving themselves experience of its
whims before taking a step up to the next level. If you
haven't done this, it will be worth spending a month or
three trading on the stock market. Even a theoretical port-
folio that you manage in a folder rather than on your own
desktop and never pay a penny to invest in is a helpful step.

Doing this will allow you to get a sense of how the market
functions overall and will familiarize you with some of the
stocks you might be interested in trading on with options.
The best options traders have almost a sixth sense of how
an underlying stock is going to perform. The only way to
develop that uncanny ability is through exposure, research
and experience.
Understanding the Strike Price
We've touched on the idea of the strike price before, but it's
such a fundamental aspect of options trading that it bears
looking at in greater detail.
To review: the strike price is the fixed price at which the
underlying stock can be either sold or bought. When you
purchase a call option, what you are purchasing is the right
to buy that stock at this price, while selling a call option
means that you are selling the right for your buyer to pur-
chase the stock at that price.

The strike price is an aspect of every options trade that you

will want to hone in on every time - it's that important.
Never forget that, if the underlying stock never reaches that
strike price, the trade is worthless because the option will
simply expire on the deadline.
The difference between the current market price of the
stock and the strike price of the option also represents the
profit-per-share you can expect to make.

Let's say, for example, that you find two trades on a stock
that is currently worth $150. One has a strike price of $12 5
and the other has a strike price of $100.
In the first trade, the stock price will need to drop to $125
before you have the right to buy or sell it (depending on
whether the option is a call or a buy). In the second, it will
need to drop to $100 before you get that right.
The value of the option is simple to calculate: it's the differ-
ence between the strike price and the current worth of the
stock. In the first of these examples, the trade has a potential
worth of $25; in the second, the potential worth is $50.
At first glance, that would seem to mean that the second op-
tion is the one to go for, because its value is so much higher.
However, you also need to bear in mind that you cannot dic-
tate what the market does.

This is where risk comes in. How confident are you, in this
example, that the stock will plummet $50 before the expi-
ration date of the option? If you're as certain as it's possible
to be, it's a great investment. If you're not, you stand to lose
the premium you paid for the option, because it will never
reach the price at which you have the right to realize the
trade.

The trade that has a strike price of $2 5 is therefore a surer

bet - it's always going to be more likely that a stock will rise
or fall by the smaller amount than the larger one. The trade-
off, as you can see, is that you won't make nearly the profit
you would on the riskier option, so you have to ask yourself
whether the premium you'd be paying is worthwhile.
Basic Trading: Selling Covered Calls
As a beginner, most people choose to dip their toes in the
complicated waters of options trading through selling
covered calls. It's arguably the most basic level of options
trading and, while also not the most adrenaline-inducing, a
great way to find your feet before moving on to more com-
plicated strategies.
Selling covered calls is also likely to be an aspect of your
options portfolio in the long term. Many traders use it as a
steady way of generating income - a conservative baseline
for their account.
A third benefit to starting with covered calls is that it
includes the majority of the knowledge and strategy that
you will use as an options trader, so it's a perfect training
ground.

Using this strategy, you are going to be selling the right to

buy underlying stocks that you own. A "covered" call is so
called because you own those shares, therefore you have the
sale covered.

Before you can begin, therefore, you will need to own at

least 100 shares, or one stock. By writing an option for those
shares, you are offering buyers the right to buy them by the
expiration date if the share price hits your strike price.
When a buyer takes advantage of your offer, you will
receive the premium. That's yours to take home - you will
never have to give it back, whether the strike price is met
and the buyer exercises their right or not. That, right there,
is your reason for selling covered calls: the steady influx of
cash from the premiums.
It's also a good way to sell your stock- a clever trader will
use this type of strategy to clear their portfolio of shares
they no longer want to own. There are advantages to own-
ing that stock in the interim, too. If it goes up in price, you
may receive dividends and you'll receive capital gains (the
difference between the price now and the increased price at
time of sale) when the deadline arrives.

One final advantage of this strategy is that it can usually be

used in a tax-deferred account or an IRA; you won't be taxed
on the revenue from your trade until you take that money at
the time of your retirement. There are caveats to this rule, of
course, so you may want to book an appointment with your
accountant to make sure it works for you.
The downside? There is always the danger that your shares
skyrocket before the deadline is up and you are forced to sell
them to your buyer anyway, which means you're losing out
on a potential big win. That's the gamble, and the truth is
that even this risk will even out in the end because you'll be
making money on the premiums for those trades that didn't
turn out to be a bad idea.
When the deadline arrives, you will EITHER have the
premium in your pocket and no shares, or you will have
both the premium and the shares because the buyer didn't
choose to purchase them after all. Either way, you're always
walking away with something.
So let's work through selling a covered call, step by step, and
take a look at every aspect of the process:
1. First, choose a stock that's already in your port-
folio and has been performing well recently. It
also needs to be one that you are willing to no
longer own if the buyer exercises their right to
buy it.

2. In your account's online space, you will first

bring up the underlying stock by entering its
symbol. This will allow you to see its option
chain; in other words, all the bids and calls cur-
rently on the table for those particular shares.
Obviously, we're interested right now in the
calls. You're going to be picking one of these
offers to sell your shares.

3 . First, take a look at the premiums on those calls.

Take a look at the "bid price" column. These are
 displayed per share, so it's the amount you will
receive for every share that you trade on. You'll
probably find that there is a huge range of pre-
miums for the same stock- that's a function of
the market. To be clear on your potential profits:
for every option (one stock, or 100 shares), you
will receive that premium for every share. If, for
example, the premium is listed as $2.50, you'll
make this amount for every share in the stock.
If it's a single stock, that's $2.50 multiplied by
100, which is $250.

4. You want to focus on pulling up options a few

months from now, so pick a date range about
two or three months down the line. This is be-
cause the premium will increase the later the
expiration date. You want to be reasonable in
your expectations, because there are downsides
to going too far out, so a few months is usually a
golden spot.

5. Take a look at the other columns. Compare the

"bid price" and "ask price" columns on that list
of options. The bid price is the amount that
a trader out there somewhere is prepared to
pay to own the call option. The ask price is the
amount that a trader somewhere has said they
 are prepared to sell that call option for. You
can accept that bid price and you'll sell your
covered call instantly for that amount. Alter-
natively, you can instruct your broker to sell
your option at a certain ask price or better. This
won't be fulfilled immediately, but it will mean
a better return for you in the long term if there's
a buyer out there who is willing to accept your
negotiation.

6. Take a look at the list for options that are

currently "in the money". Most lists will have a
mark of some kind to denote the ones that are.
If an option is in the money, that means that ex-
ercising it instantly will yield a profit - though
it does not factor in the cost of buying that op-
tion in the first place, i.e. the premium. As an
example to illustrate this, if there is a contract
with a strike price of $50 and the stock is worth
$52 right now. If the buyer exercised their right
to buy this stock immediately, they'd make a
profit of $2 per share. However, if the premium
per share is also $2, the buyer hasn't actually
gained any net profit.

7 . What you are looking for is a contract with a

strike price that's slightly "out of the money".
 You want to unload your shares at a slightly
higher price than they are currently worth to
make it a good purchase for your buyer and
because you will make a profit on the actual sale
as well as on the premium. If the shares never
reach that price, you won't have to sell them, of
course. If that happens, you can simply pocket
the premium and list the shares again.

8 . You can also consider a contract slightly "in

the money" if the premium is high enough to
offset the loss you would make on the sale. You
should be calculating overall profits rather than
relying on just the sale price or the premium
alone. The bottom line is that you will need to
calculate a strike price you're happy to sell that
stock at, whether it's a loss or a gain, and a pre-
mium that makes the sale worthwhile.

9. Once you've chosen the contract that best

suits your needs, you can simply enter into it
and wait for the expiration date. At that time
(though sometimes before), your broker will
let you know whether the buyer exercised their
rights or you still own the stocks. Keep in mind
that, if your buyer does NOT exercise their
rights, you have generated a certain amount of
money through the premium. When you repeat
the exercise, you can factor this overall profit
into your thinking to help guide you towards
the right contract.

10. Select the "Action" that says "Sell to

Open", as this is the one that applies for selling a
covered call. Now enter the number of contracts
you want to sell - and, remember, one contract
equals 100 shares.

11. Now you must choose between a mar-

ket order or a limit order. A market order allows
the market makers to figure out the price to fill
your order, while a limit order allows you to
choose your own price. The latter is usually the
better option. Once you've selected it, you can
decide on your price.

12. Now enter the information how long

you want the option to appear on the mar-
ketplace. I would recommend selecting "day"
rather than "until cancelled", because you want
to be able to re-list with new information if it
doesn't get bought.

13. Next, set your bid price, which will

likely appear under the heading "Limit Price".
Ignore the information about last sale when
you are doing this as there is no way to tell
when that last sale actually happened, so it
may not reflect the current bid and ask prices
you should be using to guide you.

14. That's it- hit the order button. Your

first covered sell is now on the marketplace
and awaiting a buyer.
Strategy for Selling Covered Calls
We've covered the process, but what about the strategy be-
hind it? In the last chapter, we looked at the absolute basics
of that strategy, but an experienced trader knows there's al-
ways going to be more to an option than meets the eye.
There's a whole list of considerations that you will eventu-
ally want to bear in mind as you expand your knowledge
and develop your own, personal strategy. Every trader has
a different attitude towards what works and what doesn't -
there are plenty of ways to make selling a covered call work,
but you'll probably find yourself preferring one or two
strategies.
We'll take a look now at those considerations in more detail
to guide you as you delve into the covered call more deeply:
• The Market Environment: You are no doubt
aware that traders of stocks and shares are happy
in a bull market and disgruntled in a bear mar-
ket. You may also know that such traders hate
a flat market most of all, because very little is
happening and there aren't many big profits to
be made. For you, as a seller of covered calls, the
opposite is true. I highly recommend waiting
for the market to temporarily flatten before
embarking on a spate of covered call sales. This
 is because you're only really interested in small
changes to your share prices - if they are sky-
rocketing, you're losing more money on your
contract. There also isn't as much danger of the
bottom falling out of the market and your stock
prices plummeting at the same time, which
would be problematic.

. Your Underlying Stock: There is nothing more

important to your success than choosing the
right stocks to invest in in the first place. I can-
not stress strongly enough that your success
will be heightened if you pick stocks that move
up very slowly. You don't want stocks that rise
and fall very quickly, especially as a beginner,
because they have a habit of making surpris-
ing moves that ruin your strategy. If they drop
too far, you stand to lose a lot of money in the
sale; if they rise too high, you lose the money
you could have made if you'd sold them at that
price. Traders who deal in risk often enjoy these
stocks because they have higher premiums and
a chance for huge profits, but that goes against
the idea of selling covered calls: you're looking
for a steady income that will underpin your
riskier strategies elsewhere. By all means go for
the riskier stock elsewhere in your strategy, but
 avoid it like the plague for this particular func-
tion.

. The Premium: Always remember that the

premium is your guaranteed profit. Whatever
else happens, you're going to walk away with
that cash. When you factor in the cost to list
the option and any commission you will lose to
your broker, you'll be able to calculate the actual
profit you'll make on that premium. Set your-
self a minimum premium - a number that you
consider to be enough to provide a profit you'll
be happy with, on the assumption that it's the
only profit you make. When you move ahead on
setting the strike price, you'll likely adjust this
base figure up or down based on what you think
the underlying stock is going to do before the
expiration date. Remember that the premium
is only one component of the overall profit you
will make - if you then set a strike price that
means you lose the same amount of cash on
selling the shares as you made through the pre-
mium, the trade wasn't worth doing in the first
place.

. The Expiration Date: There's a reason that the

premiums on covered calls get higher the fur-
 ther out the expiration date. It's because, much
like the weather forecasts we all deride on a daily
basis, it gets harder and harder to predict what's
going to happen to a share price the further out
you go. Also bear in mind that your money is
going to be tied up until the expiration date, so
the premium will increase as a nod to that sac-
rifice. Most investors believe that a time span of
between a month and three months works best.

. The Strike Price: You might think that the strike

price you set should be based on what you, as
the seller, are comfortable with, but actually it's
the opposite. You're looking for a strike price that
your buyer will feel comfortable with, because
otherwise they aren't going to buy. That, in turn,
is going to be dictated by the expiration date you
set, as well as the premium you're asking for and
how stable or volatile the underlying stock is.
Your best bet is to put yourself in the shoes of
your buyer: would you purchase that contract?
How much would you stand to gain? Set your
strike price accordingly and then take a look at
it from your own point of view. Would this be
an acceptable profit for you? If so, you've hit the
nail on the head.
With all these factors in mind, you are likely starting to see
that there is no single "correct decision" when it comes to
selling covered calls. It's going to take practice and concen-
tration to figure out which ones work best for you.

It's also important to note that your strategy is probably

going to change as you gain experience. The more options
you sell, the more you will see new and more advanced
ways to take advantage of the market. For now, I urge you
to be conservative in your approach and accept that selling
covered options is not going to win you your fortune - but it
is going to help you increase the seed money you have avail-
able to do just that.
Outcomes of a Covered Sell
As we're using the idea of selling covered calls as a trade ex-
ample to help you learn the basics of option trading overall,
let's now take a close look at what is going to happen to your
option once you've listed it.
. The stock increases in value: If the stock moves
up and hits your strike price, this means that
your buyer can now exercise their right and buy
the shares. The more it rises, the more likely that
the buyer will do exactly that. When your goal
is to sell shares, this is what you want to happen
- and you will pocket the premium as well as,
of course, the difference between the shares as
they were valued when you listed them and the
value they are at on the expiration date (in other
words, capital gains).

. The stock value doesn't move: If the shares

don't change either up or down during the time
the option is open, then they won't hit the strike
price and you won't have to sell. You will pocket
the premium and can factor it into your overall
profits when you relist the stock. Many options
traders actually count on this outcome - it's the
one they are hoping for because it means they
 make a profit AND keep the shares. Feel free to
follow the same logic, but make sure your entire
plan doesn't hinge on it. You don't control the
market, so you could find yourself met by a
nasty surprise .

. The stock drops in value: If this happens, the

outcome is very similar to the share price not
moving at all. The difference is that you are los-
ing money on the shares themselves all the time
they are dropping. They might bounce back,
but if they don't then the expiration date will
arrive and you'll be holding shares that are now
worth a lot less than they used to be, which con-
stitutes a loss. If, while monitoring your option
contracts, you see that a stock is starting to drop,
you need to prepare to take emergency action.
Do this by calculating your "breakeven" price:
subtract the premium per share from the price
of the share at the time you listed it. For exam-
ple, if the share was worth $50 and the premium
per share is $1. 50, your breakeven price per
share is $48.50. If it falls below this price, you
have the option to buy back your option - not
something you should rely on or do often, but
good as an emergency action. To do this, go back
to the order entry and select "Buy to Close". Enter
 either the current ask price or something lower,
depending how risky you want to be. Once the
trade goes through, you are back in control of
your shares and can either keep or sell them, as
you deem fit.
As an aside, you should know that buying back your op-
tions is actually a deliberate strategy used by some people
who trade in covered calls. Doing so allows you to manage
your own risk, ending trades that are likely to be disadvan-
tageous for you so that you can list those stocks again at a
later date.

For instance, let's say that your underlying stock is rising

fast and you think you're going to lose out on a lot of poten-
tial profit as it continues to skyrocket. You could "roll up"
your options by buying back your call at the current ask
price or lower and then selling them again at a higher strike
price.

Simply setting your stock to sell is enough to gamer you a

regular income to support your options trading, but there
are other ways you can make the most of the market.
A typical strategy for a person who deals in selling covered
calls is to purchase a stock and sell a covered call on that
stock at the exact same time. It's called a "Buy-Write Strat-
egy". Your brokerage firm will almost certainly allow you
to do this and may even have it listed on their online order
screen for you to select.
So what would you be looking for if you did this?

• A stock that you would be happy to have in your

share portfolio, assuming that the buyer never
realized their right to purchase it.

. A stock that is showing a premium rate on the

marketplace you would be happy to accept.

. A stock that is predictable in that it is rising or

dipping in worth slowly over time.

Keep your eyes firmly on the stock market over time and
you will start to see those trends. You'll also develop an eye
for spotting good trades - the ones where you can make a
quick profit by selling a few contracts at a good premium
price.

A second advanced strategy is to use options trading to get

rid of stocks you don't want to own any more. Maybe, for
instance, they've been flat for a long time and you aren't
seeing enough movement to make them worthwhile. You
can set up a sell that would return a good premium while al-
lowing you to get rid of your stocks at close to their current
price. Instead of simply unloading them, you'd walk away
with the premium as a potentially tidy profit.
Thirdly, you can choose to use the "half and half" strategy:
keep some of your stocks in a particular company and sell
the rest. This works well if you aren't really sure whether
you should sell them all, but make sure you are keeping
records of what you have done.
Stepping Up a Tier: Buying Calls
We're ready to move on to the more sophisticated areas of
options trading. You have tested the waters, made a little
cash and you feel comfortable with the mechanics of the
market. Now, you can start actually buying those calls and
hopefully begin to make some real money as you do.

It's actually a simpler business to buy a call, in terms of

physically going ahead and doing so. However, it's not quite
so easy to make a profit. You're going to need to start small
and dedicate yourself to the learning curve - and you need
to understand that there is a risk involved in buying calls, so
you don't want to stake your life savings on your efforts.

Let me take the opportunity to advise you to build up

slowly over time rather than jump straight in with a
hundred buys in a single day. Be circumspect about your ac-
tions: a small profit is better than no profit at all. Save your
riskiest ideas for when you've set up a nest egg through
your sells and you feel confident enough in your own judg-
ment that you're as sure as it's possible to be that your risk
will pay off.

As a reminder, what you are actually doing when you buy

a call is purchasing the right to buy the underlying stock
if it reaches the strike price before the deadline. You aren't
obligated to buy it - if you choose not to, all you have lost is
the premium you paid for that right.

The best case scenario for you, as the buyer, is that the stock
suddenly starts rising at a high speed before the deadline ar-
rives. You want it to go beyond the strike price so that, when
it comes time to exercise your right, you are purchasing
your stock at a lower rate than it is now worth. Obviously,
you then have the option to instantly list that stock as a
covered sell, which would allow you to realize that profit in
real money.
That final piece of the puzzle is the important one. As an op-
tions trader, you are not in the business of building a stock
portfolio. You don't really want to actually own those shares
- you want to make a profit on them as they pass through
your hands. You want to buy them for less than they are
worth and then sell them on, perhaps even for more than
they are worth if you are lucky. It's within that transaction
your money will be made.
Buying calls has several advantages for you as an options
trader:
• It doesn't cost much to get involved in the
movement of a particular stock. You only need
fork out the amount for the premium, after
which you can sit back and wait to see what the
stock does before making your purchase deci-
sion based on actual information, rather than on
 speculating what the market will do.

• It allows you to make use of the kinds of "tips"

that market experts have a bad habit of swear-
ing by. You read the news, you're watching the
markets and you have information that makes
you think a certain stock is about to rise fast and
hard. You want to take advantage of that, obvi-
ously, and options trading allows you to do so
much more safely than simply buying the stock.
If you're wrong, you'll only lose your premium
and you may even make a small profit. If you
were wrong and purchased the stock and then it
plummeted rather than rose, you stand to lose a
whole lot more cash.

• Buying calls also allows you to consider shares

that would ordinarily be out of your price range.
You can play around with the big boys, like
Walmart and Apple, without putting a second
mortgage on the house. Buying options on those
stocks is a whole lot less expensive than buying
the stocks themselves, so if you see something
on the horizon that makes you think the trade
would be worthwhile (a new product or service,
for instance, or a change in leadership), you
can use call buying to get in on the game. This
 is called "leverage": the ability to control thou-
sands of dollars in stock for just hundreds of dol-
lars in premium.

One thing to note before you start buying calls is that you'll
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want to wait for the right time. You are no longer interested
in a flat market - this time you want a bull market where
stock prices are rising.
What you are looking for is an underlying stock you have
faith in - you think it's going to rise in value over the next
few months. Let's say you've found a stock that's currently
at $50 and you believe it will continue to rise steadily. Pre-
dicting the rate of its growth, you think it will be at $80 in
two months' time.

What you would be looking for in that scenario is a call

contract that would allow you to purchase shares for LESS
than the $80 you think they will rise to at that time. You
must also juggle the math to make sure that you will not
be paying a premium that would wipe out the profit you
would make.

For example, you might find a contract option that will

allow you to buy the stock at $80 per share on the deadline,
with a premium of $1 per share. You think the stock is ac-
tually going to be worth $85 on that date, so you would ac-
tually be making a profit of $4 per share. Had the premium
been $5, you'd have made no profit at all.
Bear in mind, of course, that you won't walk away from
a call option with cash in hand. The profit we are talking
about in this case is "intrinsic value". You can now take
that stock and write a buy contract on it, selling it on and
making that tangible profit in the process. This was what
we were discussing in the previous chapter: as an options
trader, you're not looking to keep hold of a stock portfolio.
You're purchasing stocks through contracts to tum around
and sell for a profit.
Strategies for Buying Calls
I have urged you several times throughout this book to start
paying attention to the stock market and learn how to spot
trends in the ups and downs of particular shares. As you
become increasingly familiar with that part of your options
trading career, you can also make use of a column in the
trading screen itself to guide you.
That column is titled "Open Interest" and it represents the
total amount of open contracts on that particular underly-
ing stock that are still running at the time you are viewing
the page.

What you are looking at is the supply and demand on that

stock. The more open interest on a particular contract, the
more people believe it's a sure bet. You can also watch for
sudden changes - if a call contract has 500 in that column
one day and 2000 the next, it means that a significant num-
ber of traders believe that stock is going to move in that
direction.

Those people aren't necessarily right, so it's up to you to

use your judgment. Nevertheless, it can be a very helpful
addition to your tool kit when it comes to predicting the
movement of the stock market and making the right calls in
your own trading.

At the same time, there are a number of factors that should

be guiding you as you choose the right contract. As a call
seller, you were mostly interested in the premium. As a
buyer, you want a bargain. These factors include:
. In or Out the Money: As a call seller, you were
mostly interested in the premium. As a buyer,
you want a bargain. You'll find that the premium
is cheaper the more out of the money a contract
is. In other words, the further the stock needs
to climb before you can call in your option,
the cheaper the premium will be. That doesn't
mean it's the best bet - if you don't believe the
stock will climb that high, it doesn't matter how
cheap the premium is as you're not going to be
able to purchase that stock. Calls that are slightly
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in the money are a good option for beginners

and more likely to bring you a modest (or some-
times larger) profit.

• Stock Movement: There is absolutely no point

buying a bargain call that has a strike price
higher than you believe it will go. If it never
reaches that price, you've lost the premium you
paid. Sometimes it can be worth the risk if you
are reasonably sure the stock has a chance of
rising that high, but not very often.
• Time Value: If you're purchasing a contract that
would require the stock to rise above a price, it
stands to reason that you need to give it enough
time to do that. Premiums also are lower on
short term contracts, but that's because there's
probably not enough time for the stock to reach
its target. Be circumspect when looking for con-
tracts with cheap premiums - the lowest price
is often not the best one. It's important to give
your strategy breathing room, so lean towards
the calls with long enough expiration dates to
allow the stock to do what you hope it will.

• Spread: This is the difference between the bid

and ask price and it has a direct impact on the
price you will pay. A fair price usually falls
somewhere between the two - the higher you
pay, the more you are taking from your profit.
Bear in mind that you will usually begin at a
loss in your trade; if you pay $1.50 when the bid
price was $1, that's a 50 cent loss on each share.
As the whole idea is that the stock will rise in
value, that's not necessarily a big issue - though
it can be. As a general rule, if there is a wide
spread, you should aim for somewhere in the
middle. If it's narrow, you can probably pay the
ask price without too much concern.
To make a profit buying covered calls, you have to be right
on all these fronts. You need to choose the right time, the
right direction and the right contract price if you're going to
be successful. If you get one of these things wrong, you will
likely lose that profit. Be aware that buying calls is where
the risk comes in for options traders-which is why I highly
recommend balancing your activity and relying on covered
sells for your steady income, while keeping your buying ac-
tivity relatively modest.
Understanding Time Value
At this stage, let's take a deeper look at one of the factors
influencing the price of the options you are considering.
Time value, as we've mentioned before, is what's left after
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you take the intrinsic value away from the premium.

In other words, if your option is priced at $2 and the intrin-

sic value is $1.50 (the stock price minus the strike price),
then the time value will be 50 cents. The time value will
slowly bleed away as you get closer to the expiration date.
Time value is your friend as a buyer, but as a seller it's quite
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that call because, the closer you are to the deadline, the less
time there is left for the underlying stock to do what you
want it to do and for your option to increase in its value.

The closer you get to the deadline, the faster the time value
will trickle away. Be very aware of the time value, because
it's far more important than a lot of beginners realize. This is
why you will want to factor it in very carefully to any deci-
sion you make.
Too far out and your contract could start moving in the
opposite direction again - plus the premium will be daunt-
ingly high. Too close and you simply won't have enough
time to watch your stocks head for the magic value you
were hoping for, leaving you out of pocket on the premium.
Aim for two to three months, plenty of time for your
strategy to see fruition without risking it heading in the op-
posite direction or paying a fortune in premiums.
Understanding Volatility
There's one final factor that affects the prices of contracts on
a fundamental basis, though it's not really something we've
touched on so far. The volatility of a contract is, however, an
incredibly important concept to grasp for an options trader.
Volatility refers to the movement of the underlying stock.
Some stocks will slowly wend their way up and down in
a predictable manner - those are not very volatile. Others
change on a day to day basis and change between up and
down along the way.
To sum up the effect of volatility in a single sentence: the
m-~~,~ ---------------------------------------------------·
more-volatile the stock, the more that an options trader is
willing to pay for it. A volatile stock has a better chance of
reaching the strike price and perhaps shooting far beyond it
before the expiration date.
However, it's also the most dangerous of the factors that you
need to bear in mind because it's arguably the most likely
one to force you into a bad decision. A volatile stock, for
example, can lead to a much higher premium and therefore
a higher contract price; unless that stock shoots through the
roof, you could actually end up losing money even when
you should be making it.
One way to estimate the volatility of a stock is to take a look
at what it has done in the recent past. This tells you how
much it has moved up and down already, which some use
as an indicator of how much it will move up and down in
the future.
Unfortunately, it's not always true that the past repeats it-
self and you can't predict the future based on what's already
happened. Instead, options traders use "implied volatility"
to make their guesses: the value that the market believes
the option is worth.
You can see this reflected in the activity on the options for
that stock. Buyers will be keen to get their hands on options
before a certain event takes place, such as the announce-
ment of a new product or a release about the company's
earnings. Because of this, options increase in price because
there is implied volatility- the market thinks the stock is
going to shoot up.
You'll see lower demand on a stock that's flat or moving
gently, because there is no implied volatility and therefore
no hurry to get in on the action. You'll also see correspond-
ingly low prices for the option.
Volatility is obviously a good thing- as a buyer, you want
the stock to be volatile, because you need it to climb to the
strike price and beyond. However, there is also such a thing
as too much volatility. It's at that point the contracts be-
come popular, the prices rise and you stand to pay more for
a contract than you will ultimately profit.
Your brokers will likely be able to provide you with a pro-
gram that will help you determine implied volatility, asking
you to enter certain factors and then calculating it for you.
However, it's only through experience that you'll learn how
to spot a stock that's just volatile enough to justify its higher
price - again, practice is key.
It's also worth noting that a lot of the risk in options trading
comes from volatility, largely because it's impossible to be
accurate in your estimates. What happens if an earthquake
destroys that company's headquarters? Stocks are going to
plummet, and you had absolutely no way to see it coming.
That's why options traders are forced to accept that their
fancy formulas are not going to be perfect predictors. They
will help, but you should still be conservative in your trad-
ing and avoid the temptation to sink everything into a trade
you believe could make your fortune thanks to its volatility.
Keeping an Eye on Your Calls
Once you've purchased a call contract, your job is not over.
In fact, it has only just begun. From now until the expira-
tion date, you need to keep an eye on what your stock is
doing to see whether it goes up, down or nowhere at all.
. Down: If the stock unexpectedly begins to move
down, it's moving further and further away
from the strike price. If that trend continues, it's
going to mean that you can't exercise your right
to buy at the expiration date and you've lost out.
You could choose to try to sell your option to
regain some of that potential loss if there's still
time value enough to justify someone taking it
off your hands. If you choose to keep hold of it,
remember that you don't actually have to buy
the stock - you are only going to lose the pre-
mium on that expiration date.

. No Movement: The stock is hovering around the

strike price and is losing time value as it does.
Again, you may want to think about selling on
the call option to reap back some of that pre-
mium. However, if you think there's a chance
that things will change before the expiration
date and the stock will start moving up, that's
 not always a good idea. It's a tough call to make
because you could end up losing out on a tidy
profit if you don't give the stock breathing room
to start moving. Again, remember you'll only
lose the premium if it doesn't reach the strike
price or you decide not to buy.

• Up: Here's where options traders have a habit of

getting antsy. You're watching the stock rise and
it's gone far beyond the strike price. Naturally,
you want to call in the contract right away and
hit the "sell to close" option so you can sell it
on and bank that profit. If the stock has indeed
reached the top of its curve and is about to start
dropping again, that can indeed be the right call.
However, you also have the option to "roll up"
your call, closing out your position and moving
it to one with a higher strike price or "roll over"
to one with a later expiration. And then there's
your third option: actually exercising the right
to buy that you purchased in the first place.

Exercising Your Right to Buy the Stock

Bearing in mind that an option is all about the right to buy
a stock, it might seem strange that most traders are not
looking to do that. Instead, they are looking to immediately
pass the stock on as a sell, making the profit by taking the
premium along with the increased price on the stock from
what they paid for it.
That's what you should be basing your strategy around: the
idea of gaining stocks to instantly sell back onto the options
market, making your profit in the process. In 99 out of 100
cases, that's what you will be aiming to do.
Nevertheless, there are still going to be times when you
want to exercise your right in order to purchase the under-
lying stock itself. Usually, this is when you genuinely want
to add a particular stock to your portfolio. It's up to you to
decide when those times arrive.
First things first: be very aware that you will automatically
exercise your right at the expiration date if the option is in
the money unless you tell your broker not to take that ac-
tion. That won't happen if it's out of the money, but it's still
imperative that you keep a calendar of your trades so that
you aren't surprised by the sudden arrival of stocks in your
portfolio you'd completely forgotten about.

If and when you decide to exercise your right, you should

almost always do it at the expiration date and not before, be-
cause you'll lose the time value if you exercise early. When
you alert your broker to this decision, it's also important to
know that you cannot then change your mind - the deci-
sion is permanent.
How to Buy and Sell Puts
Buying puts can be a winning strategy if done right. The
stock market wouldn't be the stock market if it only moved
in one direction; by buying puts as well as calls, you're mak-
ing the most of the market by profiting no matter which
direction it's heading. Puts, during a bear market, are your
ally.

Buying a put means that you are going to make a profit

through the stock declining in price. Just as you're looking
for the stock to skyrocket in a call, you're looking for it to
plunge in a put. The strategy is therefore very similar, it's
just that you're looking in the opposite direction.
Most traders buy puts either because they're speculating on
a stock and think they can make a profit in a short term as
that stock plummets, or because they can function as insur-
ance for your overall portfolio. If you actually own the stock
in question, you can buy puts on it if you believe it's at risk
of heading downwards.

For instance, let's say you own stocks in a company and you
think the business environment is going to see the share
price drop. You aren't sure, but you can make an educated
guess. Simply leaving that stock sitting in your portfolio
means potentially watching as its value bleeds away.

On the other hand, you could buy a put and give yourself
the option to offload that stock if it does drop to a certain
value. As the buyer, you are not obligated to sell your stock
when the deadline arrives - you're just giving yourself
the option to do so. Of course, as always, you'll lose the
premium.

The biggest difference between buying calls and puts is that

the stock market has a habit of falling much faster than it
rises. A stock can drop through the floor in just a single day,
whereas it can take weeks or months to climb to magical
figures.
To buy puts for the sake of speculation, you'll need to
master the art of spotting weaker stocks - the ones that are
likely to fall. This is easiest during a bear market and when
the overall economic outlook is poor.

Even the most successful companies have down times,

after all, and if you own a put contract when that happens,
you stand to make money.
When buying a put, you'll need to think in reverse. The
lower the strike price, the cheaper the option will be (in
other words, the opposite of buying a call). You should also
factor in the speed of the market when looking at expiration
dates. If you think the stock is going to drop hard and fast,
you probably want a shorter deadline. If you think it will
take a while for the full effects of the drop to realize, then
you will want a longer one.
The most successful put strategies, at least at first, will
probably be slightly in the money, because you can profit
from a smaller change in the underlying value. Conversely,
you'll make more money on a smaller premium with an out
of the money put, but you have less chance of actually mak-
ing that money.

Selling puts can be a gamble. The idea behind it is that, by

selling your promise to buy stocks, you are earning a steady
premium, but you're choosing contracts that you believe
will never hit the strike price. That way, you walk away
having been paid for the contract without having to actu-
ally own the underlying stock.
It's also a way to increase your stock portfolio and get paid
for doing so. This can be useful if you think a stock's drop-
ping price is temporary and you want to snap up a few of
them before they start to rise again, when you can sell them
on.
Be aware, of course, that when selling a put you are obligat-
ing yourself to buy that stock if it does reach the strike price,
so it's a bad gamble if you lack the funds to do that when the
deadline comes.
Strategies for New Options Traders
Now you know the basics of options trading, you're no
doubt raring to get stuck in with your first trades. All that
remains is to introduce you to some of the strategies you
now have open to you.
First up, the Greeks. You're going to see these all over the
place and they can really help you understand your chances
with a particular trade, so it's important to understand what
they are:

• Delta: This stands for the change in price of the

option when compared to the change in price
of the underlying stock. For call options, it will
be between 0 and 1; for put options, it will be
between 0 and -1. The closer to 1 or -1, the more
likely that the price of that option will increase
or decrease dollar for dollar as the stock price
changes. If it's at 0.5 or -0. 5, it will increase or
decrease by 5 0 cents for every dollar of change
on the stock. The further in the money the op-
tion is, the higher its delta will be. The higher
the delta, the more likely your option is going to
finish in the money.

. Gamma: This stands for the change in the delta

of the option relative to the change in the price
 of the underlying stock. It therefore tells you
what the rate of increase of the delta is. As a
buyer, a high gamma is good assuming that your
assumptions about what the underlying stock is
going to do are correct. If you're wrong, it can be
very bad indeed, because your mistake is going
to work against you more quickly.

• Theta: This stands for the change in the price

of an option relative to how much time is left
until it expires. It is directly related to the time
value and will decrease as that value does. You
want a low theta risk with options more than 90
days before expiration if you are long on your
position (because you don't want the time value
to drop) and high theta if you are short with op-
tions less than 30 days to deadline.

• Vega: This stands for the change in price relative

to the option's change in volatility. Premi-
ums increase with volatility, so vega will too.
Specifically, it will tell you how every 1 percent
point change in the implied volatility affects the
premium. If the volatility drops or disappears al-
together, it's possible that your option could lose
value, so vega is important to keep an eye on.
Now for some of those all-important strategies you've been
waiting for:
. Straddling a Stock: If you are good at spotting
market trends, this strategy is for you. Let's
say that you know a company is about to have
a big event or release an announcement, but
you don't know exactly what that will do to its
shares - just that it's bound to affect them. You
could use a straddle strategy to purchase both
a put and call option at the same strike price,
setting the expiration shortly after the date of
the event in question. Your breakeven point on
this is going to need to factor in both trades -
you need to be doubling your profit, in other
words, to justify the spend on two contracts.
Therefore, you'll need to include this thought
in your choice of strike price and you'll need to
watch out for volatility- you need higher im-
plied volatility for this to work. You should also
be aware that you won't be the only one who
sees the change coming, so the contracts could
be pricey.

• The Strangle: This can be a better way to tackle

the situation we looked at just now. It's the
same idea, except that the call and put are set to
 different prices, with the put strike price usually
lower. When you do this, you will break even
if the stock rises above a certain price OR drops
below a certain price, "strangling" the possibili-
ties from both ends.

• Bull and Bear Spreads: This strategy again

tackles the question of, "What is going to hap-
pen to this stock?" by giving you a surefire way
to see some cash, but with the possibility of
trading away a serious profit. Again, it's all about
flexibility. In this example, for a stock that's now
trading at $50, you could buy a call with a strike
price of $55 and sell a call with a strike price of
$60. You'll likely pay more to buy your call than
you gain from selling the second call: let's say it
was 2 5 cents for the $ 5 5 contract and 60 cents
for the $60, leaving you paying 35 cents in total
to set your position. For this to work best, you're
hoping that the stock will end up somewhere
between $55 and $60 at the deadline, because
the second contract will not be exercised and
you will make a profit. If it rises above the $60,
you'll still make a profit, but it will be capped
at that exact profit if your buyer exercises their
right to purchase the stocks. The downside is
that your stock could skyrocket to $65 and you
 won't see a profit above the $60, but this can be
acceptable if you're looking to cut down your
costs and still make a profit. The example above
is a bull spread - this can also work on a bear
spread if you reverse the trades and sell your call
lower than you buy your call.

• Cash Secured Puts: This can be used as a way

of purchasing a particular stock at a discount. It
only works if your account has enough money
to actually buy the stock, because you will be
obliged to do so if the option is exercised. If it
isn't, you've made some money because it will
expire without forcing you to buy, but you'll still
bank the premium in the process. Either way, as-
suming you really do want that stock, you win.
In this strategy, you'll set the strike price at the
exact price you're looking to obtain that stock
for. The only downside is that it could drop a lot
lower, at which point you really won't feel like
you got the best bargain. Out of the money puts
have a better chance of expiring without being
exercised so, if you're only looking to make profit
on the premium or you're not desperate to own
the underlying stock, that can often be your best
bet. If you do end up owning the stock, your
usual hope is that it will change direction and
 you can trade it on while making another profit.

. Married Puts: To do this, purchase stock and a

put at the same time. This provides an insurance
for you and a "floor" to protect you if that stock
suddenly plunges. It will make sure you don't
lose the clothes on your back if the stock does
plummet, but also has the chance to make a
little money if your timing is good and the stock
. .
price rises.

. Rolling Your Positions: We've covered this

briefly, but just as a reminder: rolling your
position can help you increase your profit over
time. When you do this, you simply set up a
new call as soon as the old one expires in the
hope that the stock will continue to move in the
same direction it has been until now. You will
be looking to go up in strike price and out in
time to deadline. It can be risky, because there is
no guarantee that the stock will continue to do
what it's doing, so it's only worth taking the risk
if you think there is a reasonable chance it will.
If you roll a put, on the other hand, you're going
down in strike price and out in time to deadline
because you want to avoid actually selling the
stock. For both these alternatives, you'll be en-
tering a buy to close order and initiating a new
contract.
In Conclusion
From novice to initiated, you've now gained the basics of
knowledge that will help you enter the exciting world of op-
tions trading. It certainly isn't everything there is to know,
but you now have enough of a grounding to get started.
From here out, it's all about practice and being conservative
as you improve your understanding and develop your own
strategies. Only you will know what works best for you,
how much risk you want to play with and how your per-
sonal ability to predict and determine the stock market can
be best put into practice.
As you dip your feet into the water, you'll start to see profits
coming in and you'll feel that buzz all options traders enjoy.
The more you trade, the more you'll see all these fundamen-
tal mechanics at play and the more you'll start to connect
the dots and figure out your own personality as a trader.
You're in for a treat - options trading is rewarding and
exciting when done right. Remember to keep that calendar
updated and to stay conservative at least in the beginning
and you'll enjoy that learning curve every step of the way!
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