Trading Options for Dummies

by Duarte, Joe

• ISBN13: 9781119363705
• ISBN10: 1119363705
• Edition: 3rd
• Format: Paperback
• Copyright: 2017-08-28
• Publisher: For Dummies

Summary

A new edition of the trusted trading resource

Updated with new facts, charts, and strategies to help investors beat today’s tough markets, Trading Options For Dummies helps you choose the right options based on your investing needs. It will show you how to weigh the costs and benefits, build a strategy to gain no matter the market conditions, and broaden your retirement portfolio with index, equity, and ETF options.

Because options cost less than stocks, they’re a versatile trading instrument. If you’re an investor with some general knowledge of trading but want a better understanding of risk factors, new techniques, and an overall improved profit outcome, Trading Options For Dummies is the book for you.

• Protect your investments against a decline in market prices
• Increase your income on current or new investments
• Buy an equity at a lower price
• Benefit from an equity price's rise or fall without owning it or selling it outright

Trading options can be a great way to manage your risk, and this detailed reference gives you the expert help you need to succeed.

Author Biography

Joe Duarte, MD is a financial writer, private investor and trader, and former money manager/president of River Willow Capital Management. His work has been quoted in Barron's, Marketwatch.com, and The Wall Street Journal. He is the author of Trading Futures For Dummies and Market Timing For Dummies.

Table of Contents

Introduction 1

About This Book 1

Foolish Assumptions 2

Icons Used in This Book 4

Beyond the Book 4

Where to Go from Here 4

Part 1: Getting Started 7

Chapter 1: Options Trading and the Individual Investor 9

Giving Yourself a Financial and Strategic Checkup 10

Understanding Options 11

Knowing option essentials 12

Trying different strategies before deploying them in real time 14

Putting options in their place 15

Differentiating Between Option Styles 16

Using options to limit your risk 17

Applying options to sector investing 17

Using Options in Challenging Markets 18

Reducing your directional bias and making money in flat markets 18

Controlling your emotions 19

Chapter 2: Introducing Options 21

Understanding Option Contracts 21

Tuning in to option basics 22

Comparing options to other securities 23

Valuing Options 25

Knowing your rights and obligations as an options trader 25

Terms of endearment and importance 26

Making Sense of Options Mechanics 27

Identifying options 27

Rotating with the expiration cycle 28

Options expiration is decision time 29

Detailing your rights 30

Creating Option Contracts out of Thin Air 30

Opening and closing positions 31

Selling an option you don’t own 31

Keeping Some Tips in Mind 33

Chapter 3: Trading Places: Where the Action Happens 35

The U.S Options Exchanges 36

Navigating the Markets 36

Trade execution 36

Option market participants 37

Transactions unique to options 38

Trading rules you should know 39

Weighing Option Costs and Benefits 42

Identifying costs unique to options 43

Valuing options benefits 44

Grasping Key Option Pricing Factors 47

Introducing option Greeks 48

Connecting past movement to the future 49

Chapter 4: Option Risks and Rewards 53

Understanding Your Trading Risks 54

Risking money with stocks 54

Calculating option risks 57

Reaping Your Rewards 58

Benefiting from stocks 58

Breaking even with options 59

Profiling Risk and Reward 61

Profiling stock trades with risk graphs 61

Profiling option trades with risk graphs 63

Combining option positions 65

Considering the worst-case scenario 67

Part 2: Evaluating Markets, Sectors, and Strategies 69

Chapter 5: Analyzing Mood Swings in the Market 71

A Few Words About Select Macro Factors 72

Assessing the Market’s Bias 73

Judging the strength of a move 73

(Psycho)-analyzing the market 79

Watching Call and Put Activity 81

Understanding put-to-call ratios 81

Using the put volume indicator 84

Using Volatility to Measure Fear 85

Measuring volatility 85

Recognizing impact from changing volatility 86

Spelling fear the Wall Street way: V-I-X 86

Applying Breadth and Sentiment Tools 88

Locating neutral areas for indicators 88

Identifying indicator extremes 89

Chapter 6: Sector Analysis: Technical and Fundamental 91

Getting Technical with Charts 92

Chart basics 92

Adjusting your time horizon for the best view 93

Visualizing supply and demand 94

Identifying Relatively Strong Sectors 97

Relative ratios 97

Rate of change indicator 99

Using Sector Volatility Tools 101

Displaying volatility with indicators 102

Analyzing volatility with Bollinger bands 106

Projecting Prices for Trading 107

Support and resistance 108

Trends 110

Channels 111

Price retracements and extensions 114

Projections and probabilities 116

Chapter 7: Practicing Before You Swing 119

Monitoring Option Greek Changes 120

Tracking premium measures 120

Changing volatility and option prices 121

Paper Trading a Trading Strategy 123

Trading on paper: Pluses and minuses 124

Implementing electronic paper trades 124

Using Trading Systems 125

Knowing what you’re getting 126

Performing a backtest 126

Adding risk management to a backtest 130

Shifting from Knowledge to Mastery 132

Setting the right pace 133

Achieving mastery through longevity 135

Chapter 8: Designing a Killer Trading Plan 137

Developing a Reliable Plan 138

Managing Your Costs 139

Optimizing Order Execution 141

Understanding option orders 141

Entering a new position 146

Executing a quality trade 148

Exiting an existing position 150

Part 3: What Every Trader Needs to Know about Options 153

Chapter 9: Getting to Know Different Option Styles 155

Nailing Down Index Options 155

Getting to the nitty-gritty of indexes 156

Capitalizing on an index with options 158

Watching Out for Style Risk 160

American-style options 161

European-style options 162

Exercising Your Options, American Style 164

Knowing the nuts and bolts 165

What you see is what you get 165

To exercise or not, that is the question 166

Exercising Your Options the Euro Way 167

Tracking index settlement (the SET) 167

Cashing in with exercise 167

Satisfying Option Obligations 168

American-style stock options 168

Expiring options 170

European-style options 173

Breaking It Down: American-Style Index Options 174

Exercising rights 174

Meeting obligations 175

Chapter 10: Protecting Your Portfolio with Options 177

Putting Protection on Long Stock 178

Combining puts with long stock 178

Weighing protection cost versus time 183

Limiting Short Stock Risk with Calls 185

Protecting a short stock position 185

Further reducing short stock risk 186

Hedging Your Bets with Options 187

Protecting a portfolio partially 188

Protecting a portfolio completely 191

Avoiding Adjusted Option Risk 194

Justifying option adjustments 194

Adjusting from adjustments 196

Chapter 11: Increasing Profit Potential and Decreasing Risk 199

Leveraging Assets to Reduce Risk 200

Determining your total dollars at risk 200

Relying on market timing 205

Combining Options to Reduce Risk 207

Spreading the risk with a debit trade 208

Spreading the risk with a credit trade 215

Chapter 12: Combination Strategies: Spreads and Other Wild Things 221

Combining Options with Stocks 222

Creating “covered” positions 222

Covering the covered call position 223

Reducing protected stock costs 226

Varying Vertical Spreads 228

Changing your vertical spread risk profile 229

Spreading time with calendars 230

Defining diagonal spreads 233

Chapter 13: ETFs, Options, and Other Useful Tricks 237

Exploring the Exchange-Traded Fund 237

Comparing ETFs to indexes 238

Distinguishing ETF and index options 241

Reducing Portfolio Volatility with ETFs 244

Revisiting volatility 244

Investing with ETFs 249

Tilting Your Portfolio with Sector ETFs 256

Adding sector ETFs to tilt your portfolio 256

Selecting the right strategy 260

Part 4: Advanced Strategies for Options Traders 263

Chapter 14: Making Money without Worrying About the Market’s Direction 265

Limiting Directional Risk 266

Capitalizing on a big move 266

Reducing straddle risk and reward 272

Neutral View versus Neutral Position 275

Identifying neutral positions 276

Calculating delta for combination positions 276

Trading with Delta 277

Monitoring two key Greeks 278

Creating a delta neutral straddle 279

Understanding Trade Adjustments 282

Deciding when to adjust a trade 283

Deciding how to adjust a trade 284

Chapter 15: Letting Volatility Show You the Way to Trading Opportunities 285

Analyzing Implied Volatility Levels 286

It’s all relative but not overly scientific 286

When options are skewed 293

Understanding Ratio Spreads 296

Reviewing ratio spread risk profiles 296

Identifying best conditions for ratio spreads 300

Deciding your strategy 301

Using Ratio Backspreads 303

Defining ratio backspreads 303

Spotting best conditions for ratio backspreads 312

Chapter 16: Trading Profitably When Markets Move Sideways 315

Winning Positions in Sideways Markets 316

Managing existing positions 316

Option strategies for sideways moves 321

Understanding Butterfly Positions 323

Defining the butterfly 324

Digging deeper into butterfly risk 332

Creating an iron butterfly 334

Understanding Condor Positions 338

Defining a condor spread 338

Recognizing condor risks 340

Part 5: The Part of Tens 343

Chapter 17: Ten Top Option Strategies 345

Married Put 346

Collar 347

Long Put Trader 348

LEAPS Call Investor 349

Diagonal Spread 351

Bear Call Credit Spread 352

Straddle 353

Call Ratio Backspread 355

Put Ratio Backspread 356

Long Put Butterfly 357

Chapter 18: Ten Do’s and Don’ts in Options Trading 359

Do Focus on Managing Risk 360

Don’t Avoid Losses 361

Do Trade with Discipline 361

Don’t Expect to Remove Your Emotions 362

Do Have a Plan 363

Do Be Patient 364

Don’t Suffer from Analysis Paralysis 365

Do Take Responsibility for Your Results 365

Don’t Stop Learning 366

Do Love the Game 367

Index 369