 |
Understanding Options
www.MarkJessing.com
|  |
| Home Trading Checklist Trend Trading Rules Understanding Options |
OK, so what is an option? For that matter, what's a stock; I mean, what is a stock 'to us'? Because what we want to do here is make money, so who really cares what it "really" is. All we need to know is how can we make money buying and (more importantly) selling them?
As far as we are concerned, a stock is the price we pay for a tiny percentage of the company. And because the world is changing a little bit every day, so does the value of any company. For example, when vacuum tubes were invented, the value of the company RCA increased over time, along with their stock. In fact, in the 1920s RCA stock went up 936% in 5 years but they are gone today; bought and dumped by GE in 1986. The point here is that prices go up and prices go down. So we want to buy when the price is low and sell when it is high (buy and hold is a losers game and so is dollar cost averaging; we'll get to that later).
What is an option? A stock option is an agreement to buy (or sell) a stock, at a particular price, within an agreed upon time. That's all there is to it; Stock, Price, Time. So what is the point in owning an option? Well, let's say that the price of DELL is $50 on Monday, but you can't get to the bank to cash your tax return check until Friday. You want to buy 100 shares, but you only have $19 today. Wouldn't it be cool if you could pay your broker $19 today to find 'someone' to guarantee today's $50 price until you cash your check on Friday? You can do exactly that! And it is named a "call option".
So why does everyone say "Oooohhh, that's so r.i.s.k.y."? It got that reputation because stupid people who don't want to invest the $5,000 to buy it go out on Monday and buy the option for $19, and then run out and try to sell it for $20 the next few days. Why would it go to $20? Well, hey, aint' that the reason you paid your broker to guarantee the price; because you expected it to go up? Well, just maybe you were right...and DELL really IS going up. So if the price goes to $51, or $52, or higher, doesn't it make sense that the option to buy it as $50 will go up as well? Sure! In fact, at $53 it is worth at least $3, even the day that the option expires, right? We agreed to trade it at $50, so somebody is making $3 and someone is losing $3. Remember, there is a person on both ends of this deal.
So that's all there is to a call option; The underlying stock (DELL), the strike price ($50), and expiration (Friday). Of course, there is also the person who buys the call (you) and the person who writes the call, the 'someone' that your broker found for you.
For what its worth, here is some 'cut n paste from my Facebook Emails. I'll work on making it 'pretty' later:
You ask excellent questions, Dale and you have the same problems that I did, and some of them I still do have. Link the stops problem. Yes, you WILL get stopped out. And Ed Seycota, one of the best traders alive, said that 'It is simple to eliminate whipsaws; just quit trading'. So true. None of us know what the market is going to do, so we place stop orders to get out at certain places to protect capital. The bummer is that human behavior is unpredictable, so sometimes the market takes us out and then reverses. But when we are stopped out, we have more data than before we were stopped. The market told us that it wanted to go that direction; and we decided ahead of time that we weren't going in that direction. Wonderful, until it turns around on us. So since you have more information (what it did, how fast, & what other stocks did at the same moment) we can make a better decision about IF we still want to own that particular option. Maybe we want a different strike price. Maybe a little more time, or maybe they just "took out all the stops" and the darn thing is ready to run - WITHOUT US if we don't have the balls to get right back in AFTER a reversal.
I started trading in 2001, but it took years for me to scrape together enough money to fund an account. I've been following Better Trades since they started in 2003 and have been to every Trader's Summit, except last year. They used to call it, "Meet our Experts". That is where I learned the most from them, but I took every free class that they offered over and over and over until I was sick of hearing it. Then I took Darlene's class on LEAPS in 2004, I think? I struggled to build my account up and used my tax returns each year to get it going. In 2006 I took Markay's Trend Trading Class, but had limited success. I kept getting stopped out! So I started doing Iron Condors and did about 20% monthly on my tiny account.
In 2007 I changed jobs and rolled the $15,000 in the 401k to OptionsXpress and did Trend Trades. 90 days later I hit $80,000 and have never wanted to do any other kind of trades. Gee, I wonder why!! Needless to say I'm A BELIEVER in trend trading! Now the bad news - I blew the account. Oh ya! ALL of it. Every last dime! F#$%^k! Well, I went back to "cry in my beer" at a Better Trades Summit in Dallas and asked for advise. Darlene gave me the best advise when she said, "We have all pretty much done the same thing. That's why we came up with the rules. Go look at your trading logbook and figure out what you were doing wrong and fix it." So I did. My 2 biggest errors: I was buying front month out of the money and my logbook sucked. Ryan mentioned that the most successful people commit to everyone exactly what they plan to do and that makes them accountable, because they know people will say, hey! You said that you were going to xyz and you didn't! Well those are the reasons that I have such detail in my logbook and why I post it to the internet and Facebook.
So after 2 long years putting money in my 401k (again! @#$%@#!) I am ready to go back into the market and give it another go. But this time I not only have the stuff that I mentioned above, but I KNOW that I WILL do it, because I did it in 2008.
I hope to see you in Orlando in June!
========================
Hi Mark,
I was in a mentor class with Ryan last night and we discussed open interest requirements. Ryan said he doesn't care how many open interests there are on options when he buys. The reason he doesn't care is because the liquidity of options is not the same as for stock, the market maker will buy your options at market or your limit to keep the option market moving, the need to find someone willing to buy or sell is not the same when dealing with options.
Just thought I'd pass that along to you so that you don't let that play into wether you play a certain option or not. I can relate to not wanting to buy into unreasonable spreads.
Great input! Thanks. Ryan is the master.
I never saw it like that, but it makes sense. I guess that I've always seen the low OI go along with wide spread, but hey, that's easy enough to check. I'll relax a bit on the OI demands that I had; I like to see several hundred.
Maybe I'll pick Ryan's brain a bit in FL next month as well!
Cheers!
==========================
You must be devoted enough to really pursue the payoff that comes as a result of paying attention and putting in the time.
I've even heard wealthy people say it this way: "If you will do what others will not do, you can spend the rest of your life doing what others cannot do."
==========================
One Triggers Other (OTO) allows you to enter an initial order and place a second order contingent upon the fill of the first order. This type of order entry can be utilized when trading stocks or options. There are numerous ways to make the most of this feature, but to demonstrate how OTO works let's discuss one of the more popular uses.
==========================
Hey Mark, I like the roll strategy, I had never thought to use that strategy except to change out of front month options. Was this technique something that you developed on your own?
Yes...and when I told Darlene and Markay, they said, 'oh, ya, we do that'" - - gee, thanks for tellin' me! - Not!
Here is how I came to that conclusion: If I don't buy 3 strikes ITM (in the $) that why would I hold 3 strikes ITM? Ekhart Tolle says, "The present moment is all you ever have. It is insanity to resist whatever the present moment holds". And in the market there is only 2 things that it does; go up or go down. So all I need are 2 orders:
1) If it goes against me, get me out when it hits X dollars.
2) Or if it goes in my favor, and runs deep in the money, I say to myself, 'I don't want to be in the money that deep. I want a delta of 0.65. So I'll roll when it goes 2 strikes ITM' and then I place an order to roll it at the market anytime, even on the open, that it hits that level.
3) A trend trader never says, 'I'm up by 9,000% so I'll sell it now.'
We just move up the stop and follow the thing up or down. We won't sell the top or buy the bottom, but we make a lot of money in the middle.
Michael Covel's 2 books are great on that subject:
http://www.amazon.com/Complete-TurtleTrader-Legend-Lessons-Results/dp/0061241709/ref=pd_bbs_sr_1?ie=UTF8&s=books&qid=1214234056&sr=1-1
http://www.amazon.com/Trend-Following-Updated-Millions-Markets/dp/013702018X/ref=pd_bxgy_b_img_b
www.amazon.com
We read constantly about the men and
women who make nine- and ten-figure fortunes in the markets-the Warren
Buffetts, Paul Tudor Joneses, and Michael Milkens of the world. Do they
have some incredible gift the rest of us lack, an ability to make cool
decisions under fire when we let emotion get in t...
============================
Mark, if you don't mind me asking, you mentioned that you lost your entire 80K account after you had built it up from 15K, what went wrong. You must have a very supportive wife to continue with trading after a losing streak like that must have been. I know that there are winners and losers when trading but my wife thinks that if there was any method to this madness, I should always win, talk about pressure!
Problem #1 ==> I was buying front month Out of the money options (with tight stops, but that doesn't matter...I learned).
Problem #2 ==? I put my entire account into the same trade (ya, dumb I know, but I said 'its ok. I have a stop on it'....lost $20,000 overnight when the stop hit! NOT ok).
Darlene told me, 'Hey, we all did it. That's why we have all the rules. Go figure out what you did and fix it with new rules; and now you know not to break them' She was right so I did. Now I buy next month out (but sometimes 3 weeks out) and ALWAYS one strike In the Money (at delta of 0.65 or so).
After 2 years of saving money in a 401k, I quit the job and rolled the $17,050 to OptionsXpress on April 15th and I'm back. I made 19.4% between Monday and Friday of last week! I'm well on the way to pushing it up....way up..again. But this time I'm keeping a better log and I have good folks like yourself to tell me if I'm doing anything stupid! Ya, history could repeat itself IF I let it.
Karen has confidence in me and knows that it takes a lot of effort to 'walk on water' when the rest of the world is 'dollar cost averaging'. But she vividly remembers when I came home at lunch having made $5,000 in 3 hours. She started looking for franchise businesses to buy. Right on! That is the kind of woman that a man needs!
Here are the things about losing the money that Karen and I both understood:
1) ALL millionaires that have lost their fortune will say 'as long as I have my health I can have it back in 5 years'.
2) What is the alternative? Can a man retire on just $80,000? Hell no. So what good is the money if I can't use it to buy my freedom? I have no pension on my job. Social Security will go bankrupt by the time I get to age 65 (I'm 45 now).
3) I only put $15,000 into it; the rest was 'house money' from playing the game. And $15,000 wouldn't pay off the car that I'm driving. So why should I lament over that? The only choice is to figure out what I did wrong and fix it. We all have heard that 9 out of 10 businesses fail, but that matters not to the man who starts 10 or more! And that 10th one pays big bucks. The problem is that people give up on business number 9...just before they make it. So with that in mind, I make statements like this:
"I will make good profits from my stock trades and business or I will die in the process".
There simply is no other rational choice.
You said it well - Passion!
================================
One of Darlene's students took $20,000 to over $5,000,000 in 18 months or so just trading the Qs. So don't quit just because I say that I don't trad them.
I made 19.4% on my account between Monday and Friday of last week! Oh ya! I'm excited, but I gotta' keep my head on straight or 'they' will take it back! I've learned that the market will let you hold the money for a little while, but will snatch is back if I take risks! So, just like the turtle, 'slow and steady wins the race'.
Specifically, I will do 2 things:
1) No more that 15% on my money in each trade.
2) Keep real stops in logical places.
================================
Glad to help. It helps me too, because it forces me to evaluate why I am doing what I'm doing. I also may 'cut-n-paste' some of this stuff for my web page. I may even use all of that web stuff to publish a book, or something, but the real money is in trading, not books.
===============================
Mark, how do you determine where to set your stops when you initially enter a trade? Is it purely a risk tolerance thing or have you got a formula for doing just that? This is the biggest issue that I need to conquer in my trading system. I do pretty good when I day trade and I'm able to watch for pattern formations, but I really don't have a tried and true method for longer term trades. I know there is no magic bullet out there, but I'm hoping to be able to hang with the trade longer because some of the best moves seem to come after I get stopped out and then I'm too gun shy to jump back in after the pain of a stop.
Well, the market is Fractal:
http://en.wikipedia.org/wiki/Fractal
What I mean by that is that it does not matter what time frame that you are in. It will always behave the same as it does in any other time frame. So when I enter a trade, I look at the 1 min. 2 day chart. The most important prices are the open & close, as well as the high & low of each day. Then I place my stops just past those.
If I get stopped out AND it reverses far enough that I want back in (like NEM today) then I buy back in AT WHATEVER STRIKE PRICE gives me the 0.65 delta. That strike price is usually different after a move that stops me out, and I therefore don't feel gun shy about getting back in. It did what I wanted it to do; protect my capital and give me the CHOICE if I want to get in...or not.
Again I say, its not what the stock does that is important.
It is what I do that matters.
http://en.wikipedia.org/wiki/Fractal
What I mean by that is that it does not matter what time frame that you are in. It will always behave the same as it does in any other time frame. So when I enter a trade, I look at the 1 min. 2 day chart. The most important prices are the open & close, as well as the high & low of each day. Then I place my stops just past those.
If I get stopped out AND it reverses far enough that I want back in (like NEM today) then I buy back in AT WHATEVER STRIKE PRICE gives me the 0.65 delta. That strike price is usually different after a move that stops me out, and I therefore don't feel gun shy about getting back in. It did what I wanted it to do; protect my capital and give me the CHOICE if I want to get in...or not.
Again I say, its not what the stock does that is important.
It is what I do that matters.
en.wikipedia.org
A fractal is "a rough or fragmented
geometric shape that can be split into parts, each of which is (at least
approximately) a reduced-size copy of the whole,"[1] a property called
self-similarity. Roots ...
===================================
Awesome trading record, I really hate it when I miss the freight train moves. It seems like every time there is a big move, I'm tied up in something to do with family and I don't pay attention to my charting. I really don't want to enter trades if I can't spend the time to manage them. Congrats again, it looks like you are on the right track this time around.
The train stops every day.
The trick is to just forget the past and do what the chart tells you to do today. I'm going to buy NEM calls AGAIN today. It matters not that I got out twice. The market doesn't care. I only want it if it goes up.
I have the same problem. I use contingent orders, that way I don't have to watch it. No, its not perfect, but who wants to live in front of a computer terminal? Family is more important. Isn't that why we want to trade in the first place?
Its all about balance. Owwwwwwmmmmm.
====================================
Mark. I read on your web page " I tool $80000 to nothing in 60 days. You can too !! ". What do you mean by this ?
Oh yes! I admit the guilt! I got cocky and started buying Out of the money, front month GOOG calls. Yep. I gave it all back! And I can tell you, I will NEVER, NEVER,NEVER,NEVER buy front month out of the money again. Everything I do now is in the money and I roll out before I enter the last 2 weeks.
I just thought that since I have made 40... See More% on my account in the last 3 weeks, I owe it to everyone to tell the ENTIRE truth. Darlene told me that they ALL did that. Freddie Rick (Better Trades founder) went through $360,000 of his wife's retirement on DELL. Ask him! He really did.
Now he is a millionaire. So, I'd say that I'm in good company.
It aint' how many times that you lose, its how many times you get up off the ground, learn from the mistake, and run back into the burning building!
Passion and persistence never lose.
...(now I wonder why they don't put THAT on an infomercial...)
I guess it would scare the living daylights out of people.
But remember, Only $15,000 of that was "really" mine, since that's what I started with.
This info leaves a few questions on the table:
* Since I took $15k to $80k in 90 days, was it just 'luck'?
* What's different this time?
(trade log & feedback from Facebook friends; thank you!)... See More
* Can I do it again? -Without the nose dive at the end-
* What is the alternative? Buy and hold? - there is none
"Damn the torpedoes! Full speed ahead!"
or if you prefer:
"OK men! Burn the boats!"
or
"Give me liberty or give me death!"
(I'm not alone here in this line of thinking)
==================================
Hey Mark, what is it you are looking for when you watch the 6 and 10 minute turns in the morning?
Uh, I'm looking for it to turn at 6 min and then the other way at 10 min....LOL.
It is just the normal swing to screw all the idiots who placed market orders or tight stops the night before. If they find volume, they keep going that direction. If not, they swing the market the other way, again looking for volume.
Remember, the "market maker" gets paid when buyers and sellers exchange shares. He makes a few cents on each share. Makes no difference which direction it moves to him. He just wants folks to swap shares. So naturally, he moves the price to capture the most number of traders.
Fear and greed encourage people to swap shares and that causes the market to move.
=================================