Options | Options as a Strategic Investment

Facts and Fallacies About Risk/Reward Ratios

Dec 272009

One will commonly hear or read the following “rule of thumb” for trading:Only trade positions with potential profits of at least three times the potential loss.This sounds like a reasonable rule, risking a little to make a lot. However, it ignores the probabilities involved. Buying a lottery ticket for $1 to potentially make one million dollars certainly meets this criterion for a good trade. But we intuitively know that the odds against us winning are astronomical. This paper will define risk/reward ratios, define the concept of expected value, and begin to explore the relevance of these concepts to success in trading strategies.Risk/Reward RatiosIf we are considering an investment where the maximum gain we can expect is $100 and the maximum loss that we may incur is $500, we would compute a risk/reward ratio of 500/100 or 5:1 (five to one) . This is a high risk/reward ratio in that we stand to lose a large amount compared to the maximum gain. The trading rule above of “potential profits of three times the potential losses”, would result in a small risk/reward ratio of 1:3.Expected ValueThe probabilities of the various outcomes of a proposed investment are often overlooked. When someone tells you an investment will return 300%, but doesn’t tell you the probability of success, you are missing critical information necessary to make a decision about that investment. When one accounts for the probability of the profitable outcome, one computes the expected value, sometimes called a risk adjusted return on investment.For example, let’s assume we are considering a covered call on IBM and the called out return is 4% for IBM closing over $90. If we were to determine the probability of IBM closing over $90 is 65%, then we would say that the expected return or risk adjusted return is 2.6% (0.65 x 4%). We can take this analysis one step further by accounting for the probability of loss. Using the same IBM covered call, let’s assume we have a stop loss order entered that we believe will take us out of the trade with a 8% maximum loss. Now our expected return has two terms:Expected Return = (probability of gain) x (maximum gain) – (probability of loss) x (maximum loss), or,Expected Return = (0.65)(4) – (0.35)(8) = (2.6) – (2.8) = -0.2%Therefore, if we were to place this trade many times, our expected return, based on the probabilities of gain or loss, would be a net loss of 0.2%. One could improve this strategy by either improving the probability of success or tightening the stop loss to reduce the maximum loss.High Probability TradesTrading strategies can be positioned in a variety of ways resulting in a broad range of risk/reward ratios. One extreme category may be called the high probability trades, i.e., trades that have probabilities of success of 85-90%. One type of option spread strategy, known as the iron condor, can be positioned in such a way as to have an 85% probability of profit. On the surface, that sounds very attractive. However, the losses for these trades can be quite large, even though their occurrence is unlikely. For example, a typical iron condor might be characterized as having an 85% probability of achieving a 19% return but a 100% loss with a 15% probability of occurrence. The expected return:Expected Return = (0.85)(19) – (0.15)(100) = 1.2%Or the calculation can be done with the dollar amounts. The 19% gain could correspond to a $1,600 gain and a maximum loss of $8,400. The expected return is:Expected Return = (0.85)(1600) – (0.15)(8400) = 1360 – 1260 = $100Therefore, trading this strategy over time and many trades is going to be close to break even, and probably a loser after trading commissions are included. Let’s consider the opposite style of trading and then draw some conclusions.Low Probability TradesLow probability trades are akin to the lottery ticket, i.e., the maximum loss is small, but the probability of success is also extremely small. There is a category of option spread known as “far out of the money vertical spreads”. The basic characteristic of this trade is a small maximum loss, but with a high probability of incurring that loss. An example might be a vertical spread that only cost $130 to establish, but could potentially return $870. Since the maximum loss is $130 with a probability of success of 12.5% and the maximum profit is $870, the potential gain is 669%, so the expected return is:Expected Return = (0.125)(669) – (0.875)(100) = 83.6 – 87.5 = -3.9%or,Expected Return = (0.125)(870) – (0.875)(130) = 109 – 114 = -$5So, the expected values of this low probability strategy result in small losses over time.ConclusionsTrading strategies come in all sizes and shapes to suit anyone’s style and risk preferences. But the reality is that none of these strategies have an inherent advantage. Some trading education firms and authors of trading books will often claim that they have found the holy grail of trading and have the “best” trading strategy. Each trading strategy has its own set of advantages and disadvantages. In addition, if each trading strategy was applied in a blind, “ put it on and let it run” methodology, the net results would be very similar: near break even or a small loser over time. However, the pattern of the results would be quite different. For the examples above, the high probability trading strategy would have many small positive gains throughout the year, but would be expected to have a small number of large losses that wipe out the gains. Whereas the low probability trading strategy would have a small number of large gains, but those gains would be wiped out by a large number of small losses.Therefore, one must manage the trade in such a way as to develop a probabilistic edge. The best analogy is a Las Vegas casino. If you analyze any of the games played in the casino, you will see that the odds favor the casino. The casino has a small probabilistic advantage, so the owners know that over time, they will come out winners. In stock and options trading, one must understand the probabilities and have developed a trading system that gives the trader a positive edge. You want to learn to trade like the casino, not the gambler at the tables.

Squeezing Additional Income From Your Stocks

Option Trading No Responses »

Dec 272009

Many people think of options trading as very risky and suitable only for the “high rollers”. This article briefly surveys how options can be used in conservative financial portfolios to boost the income from your stocks.For the purposes of this article, let’s assume we have a stock portfolio of conservative stocks, e.g., IBM, GE, etc. We may be realizing moderate price appreciation of the order of 5% annually plus dividend yields of 3%, for total portfolio growth of 8 to 10% annually. One easy way to boost our annual gains without increasing our downside risk is to sell call options against our stock holdings. This is known as a Covered Call.A Covered Call is created by selling the appropriate number of call options against stock in our portfolio. Let’s assume we own 500 shares of shares of IBM and IBM closed at $104.69 on May 28, 2009. We are concerned the stock may trade sideways or only slightly upward for the next few weeks. We could sell 5 contracts of the June $105 call options for $2.35, or $235 per contract. This brings $1,175 into our account. If IBM closes at any price less than $105 on June 19, the calls we sold expire worthless and we keep the $1,175 we received and this represents a 2.2% return on our investment in IBM. However, if IBM rallies to any price above $105 by June 19, our stock will be “called away”, i.e., whoever holds those calls that we sold, will exercise them to buy our 500 shares of stock for $105/share. In this case, our account balance will stand at $105,000 plus the $1,175 we received for the calls or $106,175. This represents a gain of 2.5% for about three weeks.There are always trade-offs for any investment strategy and the covered call is no exception. The downside of the covered call strategy, illustrated by this example, is that we gave up any stock price appreciation beyond $105. In return for surrendering that upside potential, we were paid $1,175, or 2.2%. If we are using the covered call strategy with conservative stocks like IBM, it is unlikely that we will see big moves in the stock price very often. Most months will see our call options expire worthless and we will take in additional cash as the stock price moves sideways or slightly upward. Adding one to two per cent income per month to our conservative stock portfolio adds up over the year.Some traders use the covered call to increase the income from a conservative stock portfolio when the market seems a little slow. Others select and buy stocks with the express purpose of selling calls against those positions. In either case, the position should have a stop loss contingency order placed with the broker to protect the downside. The covered call strategy can be expected to yield about 2-3% per month. Of course, every trade will not be a winner, so it would be foolish to project annualized returns of 24-36%, but one can use this strategy to boost the income from a conservative stock portfolio.One forewarning is in order when using covered calls with blue chip, dividend-paying stocks. If the call options you sold are in-the-money, or ITM, as you approach expiration, the calls are rarely exercised early if there is more than $0.05 to $0.10 of time value left in the option premium. However, if the stock is about to go ex-dividend, the call may be exercised early to take advantage of receiving the dividend. The dividend paid to the stockholder may outweigh the time value lost upon exercise.The Covered Call is a conservative strategy for boosting the income of a blue chip stock portfolio. However, the disadvantage of this strategy is the sacrifice of the gains above the price of the call option sold. Selling calls against highly volatile stocks would be a much different strategy than our example with IBM. A Google (GOOG) covered call would be much more aggressive; when GOOG is quiet and trading within a range, we would make a nice return, but when GOOG makes one of its $100 runs within a few weeks, as it did recently, we would be caught with a $10 or $20 return instead of the $100 return. When covered calls are used in conservative stock portfolios, boosted returns of an additional 5% to 10% per year are reasonable expectations, and this can be done without increasing the downside risk.

The Volatility Edge in Options Trading: New Technical Strategies for Investing in Unstable Markets (Kindle Edition)

Option Trading No Responses »

Dec 252009

Jeff’s analysis is unique, at least among academic derivatives textbooks. I would definitely use this material in my derivatives class, as I believe students would benefit from analyzing the many dimensions of Jeff’s trading strategies. I especially found the material on trading the earnings cycle and discussion of how to insure against price jumps at known events very worthwhile.’

From the Back Cover

‘…a brilliant and thoroughgoing presentation. Five Stars, Highly Recommended. John A. Sarkett, Stocks, Futures, and Options Magazine.. “Jeff’s analysis is unique, at least among academic derivatives textbooks. I would definitely use this material in my derivatives class, as I believe students would benefit from analyzing the many dimensions of Jeff’s trading strategies. I especially found the material on trading the earnings cycle and discussion of how to insure against price jumps at known events very worthwhile.” —DR. ROBERT JENNIN (more…)

Stocks Bonds Options Futures: Investments and Their Markets (Hardcover)

Option Trading No Responses »

Dec 222009

From arbitrage to zero-coupon bonds, this all-inclusive guide explains the fundamentals of investments and their markets. Covers how broker/dealer firms function, option trading, technical and fundamental futures, exchange and over-the-counter transactions, and more.

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Credit Option Spreads

Option Trading No Responses »

Dec 222009

What is a credit spread?
Investopedia says… “An options strategy where a high premium option is sold and a low premium option is bought on the same underlying security.”
OK I know that is very vague, so lets see if I can do better.
It is a trading strategy in which you buy an out of the money option at a certain strike price and then you sell an out of the money option at a different strike price of the same month. As time goes on the options will decay in value and as long as the price of the stock does not go past the sold strike price at the end of expiration you will receive a full credit winning trade.
For example,it is January and XYZ stock is currently at $54 and it looks as if it is bullish or will increase in price over the next month and you firmly believe that the stock will not go below $50. You would trade a Bull Put Credit Spread on a Feb expiration. You would buy the Feb 45 put for $.25 and you would sell the Feb 50 put for $1.00. This leaves you with a credit of $.75 in your account or actually $75 per contract you trade. The risk of the trade or the amount of money per contract you need in your account is $425 per contract. This gives you a return on investment of 17.5% in how ever many days till Feb expiration.
Lets take it out like a real trade – It is January 13 and Febuary expiration is in 35 days. You place the trade for 5 contracts. So you now buy 5 FEB XYZ 45 PUTs for $.25 or $125 total and you sell 5 FEB XYZ 50 PUTs for $1.00 or $500 giving you a credit of $375 in your account. Now to back the trade up with collateral in case the trade goes wrong you need to have $2125 in your account for just this trade. If XYZ closes above $50 in 35 days you will have received $375 which is a 17.6% gain. There is a break even price of $49.25 that if the stock closes at this number you will neither gain or lose money. If the stock closes between $49.25 and $45 you will lose some money and if it closes below $45 you will lose $2125.
If you like the idea of knowing exactly what your profit will be, exactly when the trade is closed, and exactly how much money you will risk then credit option spread trading is for you. Your profit margins will be between 10 and 20% on each trade – on some of the aggressive credit spreads you can make over 50% – and there are techniques for changing your trade if it becomes a losing trade to help you recover some of the loss and in some cases even make it a winning trade again even though you were wrong on the direction of the movement of the stock.

Getting Started in Options (Kindle Edition)

Option Trading No Responses »

Dec 192009

Amazon.com Review

Anyone mystified by stock options or who simply dismisses them as too speculative will find Getting Started in Options an excellent first read on the subject. Beginning with the premise that it’s not the complexity of the investment but that of its language that makes options difficult for new investors to understand, author Michael C. Thomsett has created a guided tour through the lexicon. The result is a nontechnical introduction to these specialized markets. The book carefully and completely defines the terminology, explains options investing step by step, and presents strategies so that it is easy to understand at each level of risk involved. Choosing the right stock, buying and selling options, and combining techniques are all covered in increasing complexity, but this is a book for beginners, and those with basic knowledge of the subject will want to seek out more advanced reading. The biggest drawback of this book is that, for (more…)

Getting Paid to Take Risk

Option Trading No Responses »

Dec 192009

As a professional options trader, there are two things I will remember most as I look back at this bear market of 2008, and that is; a.) How covered call writing investors are receiving substantial option premiums to take risk and; b.) How the certainty of a “buy and hold” approach of a well diversified, structured portfolio was not spared from the devastating effects of this bear market liquidation.

REIT’s, commodities, large cap, international, emerging markets, convertible bonds, defensive stocks, took severe beatings in 2008. Every company that was considered “too big to fail”, or so conservative that it shouldn’t have failed, did just that. Whoever said “No two bear markets are alike” certainly got that right. Even Warren Buffet’s Berkshire Hathaway stock (Symbol: BRK) experienced a -54% peak-to-trough trading range in since December 2007. There has never more uncertainty among Investors approaching retirement, CFA’s and mathematically minded financial services participants, as the market’s nervous reaction to every “take it to the bank” arbitrage in 2008 became temporarily disconnected.

Author Roger Lowenstein has spent considerable time analyzing those who come to trading by way of the traditional route. In his book, When Genius Failed: The Rise and Fall of Long Term Capital Management1, Lowenstein wrote that “those who are attracted to mathematics and analysis are drawn to fixed income and convertible bond arbitrage because much of what determines their value is readily quantifiable.”

I suspect financial planners and sophisticated investors in general, are a similar breed. The financial planners I know are well educated, mathematically minded, and contemplative. They’re attracted to the certainty of planning, and their vocabularies are peppered with terms like annuity, CAGR, estate planning, efficient frontier, MPT, asset allocation, risk-adjusted return, and diversified portfolio.

On the other hand, those attracted to floor trading, like me are typically emotional, anxious, and highly intuitive. Like hungry street urchins, we rely on quick reflexes and the general belief that it’s more important to be first on a trade than it is to be right. And like any self-respecting trader, we thirst for a little excitement. In fact, we can be described as the liar’s-poker-double-espresso-filled-undiagnosed-ADD-patients-who-trade-triple-beta-ETFs-because–anything-less-than-a-Volatility-Index-level-of-70-is-too-boring orphans of the industry.

Terms that an options floor trader may use on any given day are a bit different than those of a typical financial planner and include skew, kurtosis, theoretical edge, risk reversal, I-Wham (Russell 2000 ETF; Symbol: IWM), implied volatility, assignment, dollar-weighted deltas, and slop.

When I started on the trading floor of the CBOE in 1982, I was 22, and the majority of the traders in those days were from blue collar, Irish families who treated day-trading with the same mentality as a plumber who lays pipe or a carpenter who frames a wall: it was a job.

I spent the majority of my years at the CBOE in the OEX pit, where the practice of hiring MBAs was discouraged – even derided. Why? It was believed that you couldn’t teach a business major anything. And that might have been true: they weren’t pliable enough to mentor. Floor traders needed to have an intuitive sense of risk management and quick reflexes to maneuver around short term market moves. With an eye toward disaster, they frequently owned out-of-the-money puts. Countless arguments erupted between the quants, who understood the mathematical impossibility of a 23 standard deviation move during the Crash of 1987 and the floor traders who had no idea what a standard deviation was, but who did know that they would lose their homes if the market dropped substantially.

And they figured – without the aid of a calculator – that their wives would be really, really mad.

Lowenstein cites how Nobel Prize winners Fisher Black, Myron Scholes, and Robert Merton, who created the famous option pricing model known as Black-Scholes, disagreed with the fat tails or steepness of volatility skew that floor traders priced into out-of-the-money put options. To the creators of the Black-Scholes option pricing model, volatility was a constant, log-normal distribution.

“Merton carried the assumption a step further,” Lowenstein says. “He assumed volatility was so constant that prices would trade in continuous time, without any jumps.”

Today’s options traders need a firm grasp on the nuances of volatility skew, kurtosis, dollar-weighted deltas, and Vega. Yes, we have high speed computers that process tens of thousands of theoretical values in hundredths of milliseconds and seven billion stock and option quotes per day sent from exchanges.

But can the emotional and often volatile pit trader offer anything to the structured, well educated financial planner? The answer is yes. The truth is that you don’t need anything other than a simple calculator, the right kind of experience, and often, a little out-of-the-box thinking to achieve a terrific rate of return. After all, it is said that some of the best inspirations come from outside the box.

And who is more outside the box than an options trader?

I was struck by a comment made by CFA Adrian Cronje, who was quoted in the Journal of Financial Planning, January, 2009 issue, as saying, “The good news is that for the first time in many years, investors are now being paid to take risks.”2

Investors are being paid to take risks. Imagine that.

Nowhere is that statement truer than in the current environment of options trading and covered call writing. To be more accurate, investors are getting paid handsomely to take less risk. Recent market volatility has created a once-in-a-generation perfect storm, a history making blizzard favoring the individual investor and featuring:

1. Unprecedentedly high option volatility levels due to the credit crisis

2. The inability of investment banks to participate in trading due to their de-leveraging

3. Clearing firms uniformly reducing risk across all market participant

4. Continued fear of the downside

Cronje, Adrian, Journal of Financial Planning, “Is Markowitz Wrong?” ;(Jan 2009)

5. Massive de-leveraging of hedge funds and 130/30 strategies

6. Generational low interest rates

7. Pensions and endowments rumored to be selling assets to meet cash obligations rather than rebalancing strategic allocations

Financial Planners and investors may want to brush up on basic option theory especially covered call writing tactics and read the academic white papers on the higher risk adjusted returns covered call writing provides as the nations 76 million baby boomers will be looking to planners and advisors for help in rebuilding their portfolios and simultaneously converting their “buy and hold” portfolios of growth stocks to a vehicle that delivers substantial retirement income.

Retirees are tired of hearing the endless droning from pundits discussing the benefits of greater asset allocation, cutting monthly expenses or promoting the benefits of being a Wal-Mart greeter.

Endnotes:

Lowenstein, Roger, When Genius Failed: The Rise and Fall of Long Term Capital Management (New York: Random House, 2001), 67-68, 76-77.

10 Days to Successful Options Trading: An Interactive Home Study Course in Basic and Advanced Options Trading Techniques for All Levels of Investors

Option Trading No Responses »

Dec 132009

Clamshell Case Includes-VHS Tape: Introduction to Expectational Analysis. Book(Spiral-bound): 10 Days to Successful Options Trading.

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Are Futures Riskier Than Options

Option Trading No Responses »

Dec 132009

Let’s face it, derivative trading is risky. Period.
Derivatives such as futures and options are leverage instruments and by virtue of being leverage instruments, derivatives inherently carry more risk and exposure than pure and simple stock trading. Leverage instruments are risky because leverage allows you to do more with the same amount of money than you would normally be able to. Yes, leverage instruments such as futures and options have the potential to generate over 10 times more profit on the same move on the price of a stock than just buying the stock itself.
What most beginners to derivatives trading do not take into consideration is the fact that leverage is a double edged sword. Just as it could help you generate over 10 times more profits on the same move, it could also incur as much losses should the stock move against your favor. This is also why many beginners to futures or options trading lose their shirts so quickly and go broke.
So, why is futures and options trading still so popular then?
Very simply, most beginners with only a small fund and wants to build up a significant fund quickly could not depend on simple stock trading for a start. They need more leverage and they can afford to take more risk since the amount at stake is usually pretty small. With this in mind, the only question that remains is, which is safer for beginners? Futures or Options?
To determine which is riskier, we need to ascertain certain the qualities that constitutes “Risk”. For derivative instruments, the main qualities that constitute trading risk are: Leverage, Liability, Liquidity and Versatility (fulfillment obligation is usually not a concern in trading as traders rarely hold till expiration).
Liquidity in the stock futures and stock options market is definitely lower than the stocks themselves but is enough for the trading purpose of retail beginners and shall be excluded in this discussion.
Leverage
Leverage of futures and options is the multiplication effect on your money versus buying the underlying stock itself. We shall not go into detailed discussion on how leverage is being calculated for futures and options here. It suffices to know that the higher the leverage, the higher your potential profits and losses becomes. Leverage in futures is a lot higher than the leverage in stock options due to the much higher lot size and low margin requirement. This makes futures trading riskier than options trading in terms of potential losses due to leverage.
Find out how leverage is calculated in options trading at http://www.optiontradingpedia.com/options_leverage.htm .
Liability
Liability here means the maximum amount of loss you bear when things go wrong. Yes, we all make wrong investment decisions all the time and derivative trading is no exception. When you buy stock options, the maximum loss you can sustain is the amount of money you used in purchasing those stock options. When things go wrong, those stock options become worthless and you can lose no more than that. However, in futures trading, you are exposed to unlimited liability and will be made to top up your trading account with the daily loss amount in what is called a “Margin Call”. As long as your position continues to go south, you continue to top up your losses until you go broke or the stock gets to the bottom. Either way, you could have lost all your fortune in one go. That risk along with the fact that you have higher leverage in futures trading makes futures trading a lot riskier than options trading.
Versatility
Versatility here refers to the ability to profit in more than one direction. Logic says that if you can profit in more than one direction, risk is much lower than when you can only profit in one direction, right? Yes, stock options trading is highly versatile as there are options strategies that can be created to profit from 2 or more directions! Futures trading is basically single directional. You are either the short or the long. Never both, unless used in combination with the underlying stock, which increases capital requirement and defeats the purpose of leverage.
Get a full list of Options Strategies at http://www.optiontradingpedia.com/options_strategy_library.htm .
In conclusion, futures trading is riskier than options trading for the retail beginner to derivatives trading because of higher leverage, unlimited liability and lower versatility. This is also why options trading is slowly taking over as the derivative instrument of choice for the beginner derivatives trader. To learn all about options trading, please visit http://www.optiontradingpedia.com .

Understanding Options and How to Trade Them

Option Trading No Responses »

Dec 112009

In this article I want to describe the basics of options: what they are and how one can trade them.
Options trading is extremely popular and provides far greater possible returns than does trading in the underlying stocks. But it also carries more risk.
So it is extremely important to understand how options work as financial instruments and be clear on what your potential risk and rewards are in trading them.
Options are contracts on some underlying trading instrument – shares of stock, bonds, a commodity, even a mortgage loan! Stock options are the ones most people are familiar with and are the most traded by individual investors.
But regardless of what the option is on, there are common features. One of the most basic is the contract feature specifying what the option owner has actually contracted for.
There are two types of Option Contracts: CALLs and PUTs.
CALLs
A ‘call’ confers on the (option) contract holder the right to buy an asset at a stated price on or before a specified expiration date. An option to buy, but not an obligation. That’s why it’s called an option!
The owner also has the option to let his contract expire. But then he loses everything he invested in buying that contract.
Essentially, when buying a Call option, you are betting that the underlying asset will increase in price before the expiration date. And, not only rise, but rise enough to make a profit.
But whether you make a profit is determined by the price you paid for the option, and the increase in price of the underlying asset. Clearly the price must rise enough to cover the difference between the market price and the price at which you can buy the security (the strike price of the option contract). And, since the option itself has a cost, the price has to rise enough to cover that additional amount. That cost is called ‘the premium’.
The cost of the option fluctuates with the supply and demand for that contract on the open market. Several factors determine the premium, including the price of the underlying asset, the strike price of the option, the time remaining on the option, and others.
The time remaining is particularly important. Naturally as the option contract nears its expiry date the price of the underlying asset (the stock for example) is less likely to change dramatically from its current price. Therefore the result of excersizing the option is known with more certainty and the cost of the option reflects that outcome. For example, if a Call option is nearing its expiry date and the value of the underlying asset is lower than the strike price of the option the option is practically worthless, and so its cost will be very low.
Suppose it’s June 1, for example, and Intel (INTC) has a market price of $27. Call options for Sept 30 are selling for $3 with a strike price of $30. You buy one contract for 100 shares.
So, if you held until expiration you either lose $300 ($3 x 100, the initial price of the contract not including commission), or buy the underlying stock at $30. If the current market price were $35 you’ve made $200. ($35 – ($30+$3) = $2 per share x 100 shares, ignoring commissions.)
When the market price of a share is above the strike price, the option holder is ‘in the money’. If the market price is lower, he’s ‘out of the money’.
PUTs
A ‘put’, by contrast, gives the option buyer the option to sell an asset at a certain price by a stated date. The option, not the obligation.
Puts are similar to ‘shorting stock’, in this sense. Put buyers are betting the stock price will fall before the option expires. In this case the market price must fall below the strike price in order to garner a profit from exercising the option. (Ignoring the cost of the put, for simplicity.) Under those circumstances, the option holder is ‘in the money’.
For example, take the same situation as above but let the option be a put. If the market price falls to, say $25, your profit would be:
First, $3 x 100 = $300 = Cost of put, excluding commissions.
Then, buy 100 shares at $25 per share = $2,500 to repay broker ‘loan’ (since shorting stock involves borrowing shares you don’t own, then repaying later).
Finally, sell 100 shares at Strike price = $30, 100 x $30 = $3,000
Therefore, your profit = ($3000 – $2500) – ($300) = $200.
(Actually, the broker takes care of all the underlying mechanics. The investor merely orders the trades at a given time and date.)
Whether investing in calls or puts, wise investors do need to do their needed homework. Options trading is risky and somewhat more complicated than simple stock trading.
But it can be extremely lucrative!

Older Entries Newer Entries

Options as a Strategic Investment

Facts and Fallacies About Risk/Reward Ratios

Squeezing Additional Income From Your Stocks

The Volatility Edge in Options Trading: New Technical Strategies for Investing in Unstable Markets (Kindle Edition)

Stocks Bonds Options Futures: Investments and Their Markets (Hardcover)

Credit Option Spreads

Getting Started in Options (Kindle Edition)

Getting Paid to Take Risk

10 Days to Successful Options Trading: An Interactive Home Study Course in Basic and Advanced Options Trading Techniques for All Levels of Investors

Are Futures Riskier Than Options

Understanding Options and How to Trade Them

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