OPTIONS TRADING

FOR BEGINNERS
2022

3 BOOKS IN 1

BOOK 1
OPTIONS TRADING CRASH COURSE FOR BEGINNERS
HOW TO TRADE USING OPTION GREEKS DELTA, GAMMA,
THETA & VEGA

BOOK 2
OPTIONS: 17 TRADING STRATEGIES FOR BEGINNERS
COVERED CALLS, NAKED PUTS, OPTION STRADDLES AND
SPREAD OPTIONS TRADING TECHNIQUES

BOOK 3
OPTIONS TRADING CRASH COURSE: NOVICE TO EXPERT
BEGINNERS GUIDE TO TRADE COVERED CALLS, CREDIT
SPREADS & IRON CONDORS

CRASH COURSE ON DAY

TRADING, SWING TRADING
AND SHORT SELLING
OPTIONS

WILL WEISER
OceanofPDF.com
 Copyright
All rights reserved.
No part of this book may be reproduced in
any form or by any electronic, print or
mechanical means, including information
storage and retrieval systems, without
permission in writing from the publisher.
Copyright © 2022 Will Weiser
OceanofPDF.com
 Disclaimer

Every effort was made to produce this

book as truthful as possible, but no
warranty is implied. The author shall have
neither liability nor responsibility to any
person or entity concerning any loss or
damages ascending from the information
contained in this book. The information in
the following pages are broadly
considered to be truthful and accurate of
facts, and such any negligence, use or
misuse of the information in question by
the reader will render any resulting
actions solely under their purview.

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 Table of Contents – Book 1
Introduction
Chapter 1 Small Account Options Trading Tips &
Considerations
Chapter 2 Option Trading Using Option Greeks Delta
Chapter 3 Options Trading Using Option Greeks
Gamma
Chapter 4 Options Trading Using Option Greeks Theta &
Time Decay
Chapter 5 Option Trading Using Options Greek Vega +
Volatility
Chapter 6 Option Moneyness for Beginners
Chapter 7 Top Options Trading Mistakes New Traders
Make
Chapter 8 Options Trading Checklist You Must Follow
Chapter 9 Options Trading with Time Changes & Option
Deltas
Chapter 10 Best Practices on How to Get Filled on Option
Trades
Chapter 11 Options Trading Tips for Beginners

Table of Contents – Book 2

Introduction
Chapter 1 When To Use Options Trading Strategies
Chapter 2 Low Risk Options Trading Strategy for Covered
Calls and Naked Puts
Chapter 3 Protective Put VS Covered Call Strategies
Chapter 4 Bull, Bear & Calendar Spread Option
strategies
Chapter 5 Option Straddles VS Options Collars
Strategies
Chapter 6 How to Trade Covered Calls the Right Way
Chapter 7 Options Trading Using Expected Value
Dynamics
Chapter 8 How to Trade Options Using Volatility
Chapter 9 Why you should trade Vertical Options
Spreads
Chapter 10 Bull Call Spread Options Trading Strategy
Chapter 11 Bull Put Spread Options Trading Strategy
Chapter 12 Bear Call Spread Options Trading
Strategy
Chapter 13 Bear Put Spread Options Trading
Strategy
Chapter 14 Vertical Spread Profitability VS Time Left Until
Expiration
Chapter 15 Vertical Spread Profitability VS Implied
Volatility
Chapter 16 How to Select the Right Options Strategy
Chapter 17 What Happens at Expiration to a Vertical
Spread

Table of Contents – Book 3

Introduction
Chapter 1 How to Trade Options Using Covered Calls
Chapter 2 Options Strategy on How to Buy Long
Calls
Chapter 3 How to Trade Bull Put Options Spreads / Short
Put Verticals
Chapter 4 How To Trade Option Calls and Puts
Chapter 5 Call VS Put Options Trading Basics
Chapter 6 Options Trading Strategies for Higher Returns &
Lower Risk
Chapter 7 Trading Psychology & How to Handle
FOMO
Chapter 8 Option Greeks for Beginners
Chapter 9 How to Trade Options in a Bear Market
Chapter 10 Vertical Spread Concepts Options Traders Must
Know
Chapter 11 Buying VS Options Risk/Reward
Probabilities
Chapter 12 Options Trading Using Time
Chapter 13 How to Get the Breakeven Price for Any
Options Strategy
Chapter 14 What Are LEAPS in Options Trading
Chapter 15 Credit Spread Options Trading Strategies
Chapter 16 Why Options Are Rarely Exercised
Chapter 17 How to Buy Options with Less Decay
Conclusion
About The Author

OceanofPDF.com
 BOOK 1
OPTIONS TRADING
CRASH COURSE FOR
BEGINNERS

HOW TO TRADE USING

OPTION GREEKS DELTA,
GAMMA, THETA & VEGA

WILL WEISER
OceanofPDF.com
Introduction

Let me ask you something! Do you watch

online poker? If you do, you'll know there's
one must-have skill that every pro has or
they wouldn't stand the chance at the
tables. With trading being so similar to
poker, you would think that every aspiring
trader would have this skill too, right? But,
surprisingly most don't. Options trading
can seem like gambling with the potential
to make loads of money magically appear
or disappear in an instant, but
understanding how to trade Options can
help you both lower your risk and make
more money in your investments. Options
can be used to generate enormous profits
or they can be used to hedge current
positions, so they're a very versatile tool
that every investor should at least know
how to use. But what are Options you
might ask? Well, there are two types of
Options; calls and puts. A call gives the
buyer the right but not the obligation to
buy a stock to call it away from the
Options seller and they can do so at a
certain price by a certain date. In the
meanwhile, the seller of the call has the
obligation to deliver that stock if the buyer
demands it. Pretty simple right? Well, if it’s
that simple, how comes not everyone can
become a successful options trader?
Despite its many benefits, options trading
carries substantial risk of loss, but like any
other business, becoming a effective
options trader requires a certain skill set,
personality type and attitude. Ok, but how
much do the best options traders make in
a year? Well, the salaries of Options
Traders in the US range from $29K to
$791K, with a median salary of $142K.
The middle 57% of Options Traders make
between $142K and $356K, with the top
86% making $791K. The question remains
– do you want to be in the top tier? I
though you do, but let's admit it, most
beginner options traders are no
professionals. In fact you must master the
lack of robust trading mentality and follow
proven systematic approach. But worry no
more! This book will take you to the next
level! In fact, if you want to discover how
to become a thriving Options trader, then
let me share with you the agenda of this
book. First you will discover a few small
account Options Trading tips and
considerations so you have an idea what
you can expect before you get started.
Next, we dive deep so you get the
fundamentals – in fact the very core of
Options trading – the Options Greeks.
Specifically, you will discover how to read
and benefit from Options Delta, Gamma,
Theta and Vega. After that, you will
discover how to use Time Decay and
Volatility for better profitability. Next, you
will discover what is Option Moneyness
and all it’s glory so that you can profit
from options either being in the money, at
the money or out of the money. After that,
you will discover the Top Options Trading
Mistakes New Traders Make and what is
the most sufficient Options Trading
Checklist that You Must Follow at all times.
Next, you will discover several Options
Trading strategies as well as Best Practices
on How to Get Filled on Option Trades
most efficiently. As you can see, this book
is a comprehensive guide on Options
trading and will reveal the must-have
trading skill that every pro has. By
finishing this book, you will become a
consistently profitable trader,
nevertheless, it is suggested to read the
book or listen the audiobook several times
to follow the provided guide. The
audiobook listeners will receive a
complementary PDF, containing over 60
colored images of charts and proven
trades on several platforms, hence it’s
also advantageous to highlight critical
subjects to review them later using a
paperback or hardcover book, or the
accompanied PDF once printed out for
your reference. If you are a complete
beginner, having limited knowledge or no
experience and want to speed up your
trading skills, this book will provide a
tremendous amount of value to you! If you
already a trader but you want to learn the
latest tricks and tips, this book will be
extremely useful to you. If you are ready
to change your life, let’s dive deep
together, covering all the ins and outs so
that you can have the best chance
possible to become a consistently
profitable trader!

OceanofPDF.com
Chapter 1 Small Account Options Trading Tips &
Considerations

In this chapter I’m going to be talking about trading Options

and smaller Options trading accounts and when I say
smaller Options trading accounts, typically I’m going to be
referring to an account with 2500 to 5000 dollars in the
account. Keep in mind that you'll need at least 2000 dollars
at any brokerage firm to open a margin account and if you
don't have a margin account you're going to be severely
limited with the Option strategies that you can trade in the
first place and since we are limited in a small Options
trading account as it is, it's going to be even more difficult
without a margin account so I would recommend having at
least 2 000 dollars in a margin account so that you can have
full access to Options trading privileges. I trade with tasty
works and with a two thousand dollar deposit you can apply
for a margin account with full Options trading privileges but
at other brokerage firms you may have tiered access -
meaning that depending on the tier of privileges that you
have, you'll have access to a small basket of Option
strategies and once you unlock the next tier you'll unlock
more Option strategies and finally with the highest tier you'll
have the ability to trade basically any Option strategy that
you want so long as you have the appropriate amount of
money in your account to cover the margin requirement.
Trading Options in a small trading account is very difficult
because since you have a limited amount of money it's very
difficult to trade a small portion of your account since you
can only really get so small with the Option strategies that
you're trading. For example if you have twenty five hundred
dollars in a margin account if you put on a position with five
hundred dollars of lost potential, that represents twenty
percent of your account in risk and obviously that's a very
large position, given that you could potentially lose twenty
percent of your account if that trade were to realize the
maximum loss potential of five hundred dollars.
Unfortunately it's very difficult to risk just five to ten percent
of a small Options trading account because if you do have
let's say twenty five hundred dollars in an account and you
wanted to risk five percent of that Option trading account,
that would be risking one hundred and twenty five dollars.
Entering an Option strategy with just a hundred and twenty
five dollars of risk is going to be very difficult because you're
going to trade very low price stocks and or you're going to
have to trade Option spreads with very narrow spreads and
in that case, the maximum profit potential is going to be
very low and in most cases the Commission's require to
enter those positions is going to eat into a decent chunk of
your maximum profit potential. We all want that homerun
trade that can earn us a significant amount of money or
earn us a significant return on our total account in a very
short period of time and that urge is even stronger in a
small Options trading account because you thinking if you
could just have one big win, then you'll have much more
money to work with and everything will be easier, but
unfortunately it's not that easy. Before getting to these
small account Options strategies and back tests and my
other tips and tricks I need to talk about the difficulties of
trading in a small Options trading account so that when we
move forward, we can understand these difficulties and try
to figure out ways to work with them. The first problem with
trading in a small Options trading account is the risk
problem. When you're trading Options you can only really
get so small and when you have a small Options trading
account, that means you're going to be risking a high
percentage of your account in every trade or at least you're
going to be tying up a significant amount of margin in one
position, because with a small Options trading account if
you put on a trade with only two or three hundred dollars of
risk, that could represent a high percentage of your account.
The first thing that you need to be comfortable with when
trading in a small Options trading account is putting on a
position that is going to require a significant amount of
margin requirement relative to your account size. Because
your maximum loss potential is equal to 10 or 20 percent of
your small Options trading account, it doesn't necessarily
mean that you're going to be risking that amount because in
this chapter I’m going to recommend that you manage
trades before expiration and when you're strict with your
trade management and you do not hold trades until
expiration, the likelihood of realizing the maximum loss
potential on any trade is very low, so in the worst case
scenarios I would say that you are not actually going to be
losing the amount of your max loss potential in a trade that
goes against you. The second problem I need to talk about
before getting to the small account Options trading
strategies is the number of positions that you can trade in a
small trading account. If you have a $5000 account and
you're putting on a position with $500 in margin, that is
going to represent a maximum loss of 10 percent of your
account in the worst-case scenario. A lot of people will think
that it's better to trade more positions in an Options trading
account because with more positions you are technically
diversified but in my opinion you are not and if you are
adding more positions to your portfolio, more than likely
they are going to be correlated, especially if you're putting
on say two different iron condors and two different stocks
and if the market plummets, more than likely you're going
to lose a lot of money on both of those trades, so trading
two positions is not actually helping you in this case - it's
just actually increasing your risk overall and in your portfolio
and in a small Options trading account, I would not
recommend trading more than two positions at a time and
for the most part it would be best to start with just one
position at a time because if you are trading in a small
Options trading account, it's likely that you are a beginner
and by focusing on just one Options trading strategy, you
can focus on watching that particular position and learning
about Options by watching that particular positions changes
on a day to day basis.
Moving on to topic number three is trade management. If
you're putting on a trade that represents a loss potential of
10 to 20 percent of your small Options trading account, you
need to have a system in place where you know exactly
when you are going to exit that trade for a profit and for a
loss. The loss management is far more important than
knowing when you are going to close a trade for a profit so
when you're trading in a small Options trading account
before you even put on a trade you need to know exactly
when you're going to exit the trade for a profit and when
you are going to exit it for a loss. Before getting to the
strategies that you can potentially employ in a small
Options trading account, let's talk about the products you
are going to trade. In my opinion the safer stocks and
products to trade when you're trading in a small Options
trading account would be to stick with broad stock market
ETF such as SPY or IWM or even QQQ which is the Nasdaq-
100 ETF. It is enticing to trade penny stocks with a smaller
Options trading account because the Options are cheaper
and therefore you will have more access to different Options
trading strategies on those penny stocks, but you have to
keep in mind that when you are trading Options, you are
trading outlooks on a company's stock price and because of
that, I would not trade any obscure stocks. I would stick to
broad stock market ETFs or very well-known stocks such as
Apple or potentially even something like NETFLIX if you
have a higher risk tolerance. Let's go ahead and hop over to
the tasty works trading platform and also the Option that
explore Options trading analysis software so that I can show
you potential trade setups that you can use in small Options
trading accounts. I can show you the difference between
margin and risk when using the same exact Option strategy
but on two different products that have different stock
prices and also I’m going to simulate and backtest some of
these strategies to show you how we can expect the trade
to perform and how they can potentially be managed before
expiration to avoid any blowout trades. I hope those
explanations helped and you are more comfortable with how
you can potentially set up and execute a trade and a small
Options trading account and that you understand how those
positions could work out based on the passage of time,
changes in implied volatility and changes in the stock price.

I have the Option chain open for SPY which is the S&P500
ETF. SPY has a lot of liquidity and as we can see here today
SPY traded 113 million shares and if I go ahead and open up
an Option chain we can see how much activity is actually in
the Options as well. If we look at the open interest columns
for the call Options and the put Options we can see that the
call Options have thousands and thousands of open interest
and the same for the put Options as well.
The specific strategy that I’m going to start with is called
the short Iron Butterfly and I like this strategy because it is a
directionally neutral strategy and it has limited lost
potential. An Iron Butterfly strategy is when you sell the at
the money straddle and then you buy a put Option below
the strike price and then buy another call Option above the
strike price. Another way to interpret it is selling a call
spread and selling a put spread with the same exact short
strike. SPY lows today at 333,48 so that means we can
pretty much choose the 333 or the 334 strike price as the
short strike for this position. I’m going to go ahead and use
the 333 strike and to queue up in order to sell it I’m going to
click on the bid for the 333 call and then I’m going to click
on the bid for the 333 put and then to complete this iron
butterfly position, I need to purchase another Option above
the market or above this strike price and then purchase a
put Option at a strike price lower than 333.
What I’m going to do is purchase the call Option with a
Delta near 15. I’m going to do that for demonstrational
purposes and if there's no real specific reason I’m doing that
but it is a methodical way you can use to choose strike
prices for any strategy that you're using. I can see that the
344 call Option has a Delta of 0.14 and that is the closest
strike to the Delta of 0.15. I’m going to click on the asking
price for the 344 call and then I’m going to do the same
thing on the put side. Right away I can see the 314 put has
a Delta of 0.15 so I click on the asking price for the 314 put.
Now we can see that I have a short iron butterfly position
and the current credit is nine dollars and 9 cents. This
means that the one iron butterfly maximum profit potential
will be nine hundred and nine dollars and the maximum loss
potential in this case is nine hundred and ninety one dollars,
which would give us a buying power effect or margin
requirement of just about a thousand dollars for this
position. If you were trading a twenty five hundred dollar
account, this is a limited risk strategy that you could put on
but obviously this is a lot of risk relative to $2 500. One of
the things that you could do to reduce this would be to trade
an Iron Butterfly with narrower strike prices, particularly the
Options that you're buying. I could move this in two points
to the 342 call and then I could move up the put to the 316
put as opposed to the 314 put and now this has a margin
requirement of 865 dollars, as opposed to $1 000. But as I
move the strike prices that I’m purchasing closer to the
short straddle, I will actually collect less of a credit and
therefore my maximum profit will also decrease. If you need
to decrease the risk, one way you could do that is by
moving the strike prices closer to the short straddle. Before
going ahead and actually visualizing this position and doing
a simple back test, I want to look at this exact same trade
structure but on IWM. I’m going to switch over to IWM and
IWM is the Russell 2000 ETF.

I’m going to open up the March 2020 Options and those

have 28 days to go and really quickly I’m going to do the
same exact thing as I did before. I’m going to sell the at the
money straddle and buy the 15 Delta call Option and put
Option. IWM was at 167,10 when it closed so I’m going to
click on the bid price of both the put and the call at the 167
strike and that cues up the short straddle and then I’m
going to click on the asking price for the 174 call because I
can see that the Delta of 0.14 and that is closer to 0.15,
then the 0.19 and point 1 1 Delta call Options that are
available at the adjacent strike prices.

I’m going to go to the put side and do the same thing and
right away I can see the 157 foot has a Delta of 0.15 so I’m
going to click on the asking price for the 157 put. This is the
same exact trade structure that I queued up in SPY but since
i WM is half the price of SPY I’m expecting that this position
will be smaller altogether so we can see that the credit is
$4.95 and we can see that the maximum loss potential is
$505, giving us a buying power effect or margin
requirement of 505 dollars.
This is the same exact trade structure as I just queued up in
SPY, but since IWM is a much lower price stock I can put this
same exact position on but is it is essentially going to have
half of the size as the one in SPY because SPY is twice as
large. I will mention that IWM and SPY will not move the
same because IWM is the small-cap index whereas SPY is
the S&P500 large-cap index and they do not have the same
exact movements but they are both highly active products
with great Option markets, so for this example I’m just
showing you that if you have two different priced stocks,
you can set up the similar trade structure and it will be
cheaper and require less margin requirement in the lower
priced underline. Now that I’ve gone through this trade
structure let's go to Option that explore and then actually do
some simple back tests so that we can understand what this
position looks like in terms of the payoff graph and then also
do a simple back test to see a profitable and unprofitable
scenario. I’ve opened up Option net Explorer which is
Options trading analysis software and I can use this to back
test certain strategies and also model different trade
adjustments to see exactly how it will change my expected
profit and loss curves and it's cool because I can look at the
expected loss curves at different intervals and time in the
future.

Right now I have January 15th 2020 opened up about 30

minutes before the market closes and we can see that the
last price for IWM was 166,53. I’m going to queue up the
exact same trade structure that I looked at on tasty works
and that means I’ll be looking at a short iron butterfly and to
start that position, we know that the at-the-money strike
price is 166 or 167, since IWM is at 166,53. For this example
I’ll use the 167 strike price to start off our Shore straddle.
The way I’ll models this trade first of all I’m looking at the 37
day Option cycle which has a little bit more than a month to
go and to start this off I will selling one of the 167 calls by
typing negative one into the model box and then I’ll do the
same thing for the 167 put. I’ve gone to the 167 put I typed
negative one in the model box and on the right hand side
here we can see it updating with all the model trades that I
enter.
Currently I have a short straddle queued up and to finish
this off I need to purchase the call Option with the Delta
closest to 15, so that's the 173 call in this example and I’m
going to take positive 1 into the model box to simulate
buying one of these contracts and then I’m going to do the
same thing on the put side by going to the 158 put, typing
positive 1 and now I have a modeled trade of this iron
butterfly's structure that I was telling you about on tasty
works.
To actually commit this simulated trade and therefore
execute it and see how it performs going forward, I can click
commit trade up here and this will bring up a window with
the price and let's say I sold this for $4 and 20 cents, I hit
save and this trade is now committed. On the bottom left I
can see the cost of the trade and the margin requirement as
well as the Greeks and the P&L information as I go forward.
We can see that the Delta is pretty close to zero and we can
also visualize that by looking at this curve right here.

Right here the curve is relatively flat and that is a visual

representation of a Delta that is close to zero. As we go
further to the left and as the stock price Falls we can see
that the Delta will get positive because if the stock price fell
to 164, then an increase would help the P&L and a decrease
would lead to more losses. On the other side if IWM to 170
we can see that at this point in the graph the P&L gets
better if the stock price falls and the P&L gets worse as the
stock price increases which is representative of negative
Delta. Now that I’ve had this position queued up we can go
ahead and look at intervals in the future to see how the
trade is expected to perform. This curve is the profit and
loss expectation of this position for IWM stock price changes
today but if we move forward in times that this next curve
this curve is actually T plus 12. T plus 12 means today plus
12 days. These are the expected profits and losses for this
position in 12 days if IWM is at these specific prices. The
next curve up is T plus 24 so in 24 days time if IWM is right
here and there are no changes in implied volatility this is the
expected profit and loss curve for this position in 24 days at
various IWM prices. To simulate the trades performance
going forward, I can click on the next trading day button and
we're going to jump forward in time and see what happens
and talk about this position as time passes. The first day
IWM gapped higher and we can see that IWM is still in this
profitability area but it is not yet profitable.
At this point IWM has fallen to 160 dollars. If you look at the
profitability range we can see that the break evens are
around 171 and 163, so IWM needs to be within this range
for this position to be profitable at expiration. But I like this
example because we can see what happens when the stock
price falls significantly. When I put the trade on IWM was
around 167 and now at this point in time IWM is at 160
dollars. This position is not doing well but fortunately we can
see that the loss is only a hundred and fifteen dollars which
represents 25 percent of the maximum loss potential of
around five hundred dollars. The maximum loss is just less
than five hundred dollars and because the loss is only a
hundred and fifteen dollars it is still not a bad loss relative to
what it could be. Earlier when I mentioned closing trades
before expiration to avoid the worst case scenario, this is
exactly what I meant. If I was uncomfortable with this
position at this point in time which I probably would be if I
was holding it, I would probably close this position and take
the loss of a hundred and fifteen dollars because at this
point if IWM stayed and at expiration was still at this price a
loss would be more than double that at around two hundred
and seventy dollars which I can see on the chart. As long as
you manage a position before expiration you will not realize
the maximum loss potential and this is a perfect example of
an opportunity that you might have to close the position,
take your small loss and then potentially redo this position
and reset your strike price to the current price. We can see a
small change in IWM stock price will drastically change the
expected profitability of this position. If I click one day
forward or two days forward we'll notice that these lines get
even steeper on each side. At this point depending on how
I’m managing this trade I would likely have a profit target
and I would have had a loss limit but I would probably take
this trade off because these Options only have eight days
left to go until expiration and as the expected P&L curve
lines are getting very steep on either side and that means if
IWM has one big movement day, this position could easily
go from a nice profit to a decent loss and I do not want to let
that happen, so in this instance I probably would close this
trade. The last thing I want to do is talk about things you
should never do when trading a small Options trading
account. The first thing you should never do when trading a
small Options trading account is selling naked Options.
Selling naked Options means you are selling a call Option or
selling a put Option without any protection against the
movements, against those positions. For example if you're
selling a call Option and that's the only trade that you're
doing, you have theoretically unlimited upside loss potential
and if you are selling a put Option without any protection
below that put Option in the form of another put Option that
you've purchased, then you are going to have significant
loss potential on the downside. The reason I would not
recommend selling naked Options in a small Options trading
account is first of all you are probably going to run into
margin issues because selling naked Options requires a
significant amount of margin because the loss potential is so
great. Another reason that selling naked Options is a
problem and the bigger reason it's a problem is because you
have theoretically unlimited loss potential, particularly in
the case of selling a naked call Option. But when you're
selling a naked put Option you have significant loss
potential to the downside and if you're selling a call Option
you have theoretically unlimited loss potential to the upside
so that means all it takes is one bad move against you and
your small Options trading account could turn into a $0
Options trading account with just one bad trade, so I would
recommend sticking to limited risk strategies such as
trading credit spreads or debit spreads or combining credit
spreads into something like an iron Condor or a short iron
butterfly. All of those trades have limited lost potential. The
second thing I would never do in a small Options trading
account is trade too many positions. Doesn't matter how
many positions you trade if the stock market moves big in
either direction it's very likely that your positions are going
to become one larger position and what I mean by that is for
example if you sold four different iron condors in four
different stocks and the market drops 5% in the week, it's
very likely that all four of your iron Condor positions are
going to be losing trades and they could potentially be very
big losing trades and if you have four of those trades on at
the same time, not only is it going to be difficult to manage
and exit four different positions, but you could potentially
experience a huge loss relative to your overall account. So if
you had a $5000 trading account and you put on four
different iron condors with $500 in risk, your overall margin
requirement for those four iron condors would be $2 000
and that means your maximum loss potential should all four
of those iron condors not work out is also going to be $2 000
and that represents a 40% loss on your overall $5 000
account. If you're in a small Options trading account I would
stick to focusing on one position at a time. The third thing to
never do in a small Options trading account is trading
obscure penny stocks. Because penny stocks are very low
priced stocks their Options are also going to be cheap and
that's going to allow you to have more flexibility and the
strategies that you can trade in a small Options trading
account, but since you are trading a company when you are
trading Options and since your Option position is going to
make or lose money - depending on what that stock price
does, I would not recommend trading obscure penny stocks
and I would recommend sticking to broad stock market
index ETFs such as SPY, IWM or QQQ.

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Chapter 2 Option Trading Using Option Greeks
Delta

In this chapter I’m going to be explaining to you Option

Delta and if you're not familiar with Delta, Delta is one of
the four Option Greeks and the Option Greeks help us
understand how our Option positions are expected to
perform relative to changes in specific things in the
environment. The Option Greek Delta is the directional risk
measurement of an Option and all that means is that Delta
tells us how much an Options price is expected to change
relative to a change in the stock price. More specifically, an
Options Delta tells us the expected price change of that
Option relative to a one dollar movement in the stock price.
Let's say we have a call Option with a price of $5 and the
Delta of that call Option is a positive 0.75. What that means
is that if the stock price increases by one dollar that Option
is expected to increase by 75 cents to five dollars and 75
cents. On the other hand if the stock price decreases by one
dollar, that five dollar call Option is expected to lose 75
cents of value based on the Delta of 0.75 and with a one
dollar decrease in the stock price, the Option is expected to
lose 75 cents and be worth four dollars and twenty-five
cents after that one dollar decrease in the stock price. Let's
say we have a put Option with a price of three dollars and
the Delta of that put Option is negative 0.25. What that
means is that if the stock price increases by one dollar that
three dollar put Option is expected to be worth twenty-five
cents less at two dollars and seventy five cents an Option
after that one dollar increase in the stock price. On the other
hand if the stock price falls by one dollar, that three dollar
put Option with a Delta of negative 0.25 is expected to be
worth three dollars and 25 cents after that one dollar
decrease in the stock price. From these examples we can
learn that an Options estimated value after a one dollar
increase in the stock price is the current Option price, plus
the Options Delta. So in the example where I had a five
dollar call Option with a positive point seven five Delta, a
one dollar increase in the stock price suggest that the
Option is expected to be worth five dollars and 75 cents.
Since the put Options Delta is negative, that three dollar put
Option with a negative 0.25 Delta is expected to be worth
three dollars plus a negative 0.25, which gives us three
dollars minus 0.25 and that gives us an estimated put
Option value of $2.75. To estimate an Options expected
price after a one dollar decrease in the stock price, we take
the current Option value and subtract the Options Delta
from that price. So in the case of the five dollar call Option
with a positive 0.75 Delta, the estimated Option price after a
one dollar decrease in the stock price is five dollars, minus
the Options Delta of 0.75, which gives us an estimated call
price of four dollars and twenty five cents after that one
dollar decrease in the stock price. For put Options, since a
put Option has negative Delta if we subtract a negative
number, we actually are adding that number. So in the case
of having a three dollar put Option with a Delta of negative
0.25, if we take three dollars minus negative 0.25, we are
actually doing the calculation of three dollars plus 0.25 and
that means after a one dollar decrease in the stock price, a
put Option is going to be worth more because it's Option
Delta is negative. Hence call Options are expected to
increase in value as the stock price increases and lose value
as the stock price decreases and on the other hand put
Options since they have negative Deltas, we expect put
Options to decrease in value as the stock price increases
and we expect put Options to increase in value as the stock
price falls. On the Tastyworks trading platform you can
select Delta or any of the Option Greeks as a metric to view
on the trade tab and when you do that you can see the
Delta of every single Option. call Option Deltas are positive
while put Option Deltas are negative and at each respective
strike price we can see the different levels of Delta's for
each of those Options. But let's look at some example of
Option price changes relative to changes in the stock price
to better understand what Delta is trying to help us
accomplish.

In this illustration we can see that the price of the call

Option increases and decreases in tandem with the stock
price and the church look almost the same, but keep in
mind that the Option is not changing by the same amount
as the stock price movements and that is exactly what Delta
is trying to help us do. The Delta of a call Option helps us
understand how the calls price is expected to change with a
one dollar change in the stock price. On the other hand, put
Options gain value as the stock price Falls and lose value as
the stock price increases.
In this illustration we can see the opposite relationship
between the put price and the stock price and again the
charts look opposite as the put gains value when the stock
price Falls and loses value when the stock price increases
but keep in mind again that the Option price is not changing
by the same magnitude as the change in the stock price and
that's exactly what the puts Delta is going to try and tell us.
The Delta of a put Option helps us understand how the puts
price is expected to change with a one dollar change in the
stock price. Understandably then, Options with larger Delta
values will experience larger price changes relative to the
same stock price movement as compared to Options with
smaller Delta values so for instance if I have a call Option
with a Delta a positive 0.8, that Option is expected to
change by 80 cents with a $1 change in the stock price,
whereas if I look at an Option or a call Option with a Delta of
0.2, that call Option is expected to change by 20 cents for a
$1 change in the stock price. Options with larger Delta
values or Delta's closer to 1 will experience greater price
changes as the stock price is changing.

In this illustration we can see the cumulative price changes

of the call Options starting at various Delta levels. In the
shaded region in the beginning of this chart the stock price
increased by 4 dollars. The original 0.75 Delta call increased
by 3 dollars, the original point 5 Delta call increased by $2
and the original 0.25 Delta call increased by $1. These
Option price changes are exactly what Delta predicted
because if we take a point five Delta call Option and
multiply it by a four dollar stock price increase, we would
expect that call Option to increase by about fifty cents for
each dollar increase in the stock price. Based on that, a four
dollar increase in the stock price should give us about a two
dollar increase in the Option price which is exactly what we
observed in this chart. In this example the Option changes
we're exactly what Delta would have predicted but keep in
mind that it's not always going to work out this perfectly
because Delta is an estimation of a change in an Option
price, based on a one dollar change in the stock price. Delta
is going to be less and less accurate for larger and larger
stock price movements and that's because Delta itself will
actually change as the stock price changes as time passes
and as implied volatility changes, but those are completely
separate topics.

In this illustration we can see the price changes of put

Options at varying starting Delta levels and in this example
the stock price also increased by four dollars, but the put
Options experienced slightly larger price changes than the
Delta would have suggested. It's not perfect because Delta
is more accurate for small stock price changes, not larger
changes like four dollars. Additionally, Option Deltas will
change as the stock price changes as time passes and as
implied volatility changes. Option Deltas are fairly accurate
and can be used to estimate Option price changes, relative
to small changes in the stock price. Moving on let's talk
about call Option Deltas and put Option Deltas as they
relate to where the strike price is relative to the current
stock price.

In this illustration we can clearly visualize the relationship

between put Option and call Option Deltas relative to their
strike prices versus the stock price. In general, put Options
and call Options with strike prices near the stock price will
have Delta's near point five zero and four call Options that
means the calls with strike prices near the stock price will
have Delta's near positive 0.5 zero and four put Options, the
put Options with strike prices near the stock price will have
Delta's near negative 0.50. If we look at the strike price is
lower than the stock price we can see that the call Deltas
are higher than 0.50 and increase towards 1.0 at lower and
lower strike prices. For put Options, the Delta of these
Options with strike prices less than the stock price are
higher than negative 0.50 and move closer to 0 as we move
to lower and lower put strike prices. If we look at strike
prices higher than the stock price, we can see that the call
Deltas are less than positive 0.50 and decrease towards 0 at
higher and higher strike prices. For the put Options, the
Deltas of these Options with strike prices higher than the
stock price are less than negative 0.50 and move closer
towards negative 1.0 as we move to higher and higher
strike prices. In addition to being an estimator of an Options
price change relative to a one dollar movement in the stock
price, an Options Delta is also frequently used as an
estimation of the probability of that Option expiring in-the-
money. Based on that we can actually make more sense of
these Delta values by looking at call Options and put
Options at various strike prices and looking at their Deltas
and converting them into probabilities of those specific
Options expiring in-the-money.
If we look at this chart it makes complete sense then that
the call Options at lower strike prices have higher Delta
values as calls at lower strike prices have a higher
probability of expiring in-the-money, than call Options at
higher strike prices. Conversely, put Options with higher
strike prices have Delta's closer to negative 1.0 and put
Options at lower strike prices have Delta's closer to 0,
suggesting that put Options at higher strike prices have a
higher probability of expiring in-the-money then put Options
at lower strike prices. We can estimate the probability of an
Option expiring in-the-money by converting the Options
Delta into a percentage. For example if I have a call Option
with a Delta of 0.75, that call Option has a 75% chance of
being in the money at expiration, or at least an estimated
probability of 75%. If I look at a put Option with a Delta of
negative 0.30, that put Option has an estimated 30%
chance of expiring in-the-money. To convert an Options into
the probability of that Option expiring in-the-money, all we
have to do is convert the Delta to an integer or a whole
number and ignore the sign and that will give us the
percentage. For instance if I have a call Option with a Delta
of 0.60 that Option has a 60% chance of expiring in-the-
money and if I have a put Option with a Delta of negative
0.85, that put Option has an 85 percent chance of expiring
in-the-money. This helps explain why Options with strike
prices near the stock price have Delta's around 0.5,
suggesting they have around 50% probabilities of expiring
in-the-money. Since stock prices are said to be random,
there's theoretically a 50% chance that the stock price will
be above or below its current price in the future, which is
why at the money Options or Options with strike prices very
close to the current stock price will often have Deltas right
around positive or negative 0.50. If we look at call Options
at higher strike prices than the stock price, the call Deltas
will get closer and closer to 0 as the probability of a huge
stock price increase is less than the probability of a small
stock price increase. On the other hand if we look at put
Options at strike prices lower and lower than the stock price,
the put Deltas will get closer and closer to 0 as the
probability of a huge stock price decrease is less than the
probability of a small stock price decrease. In other words,
the probability of a put Option expiring in-the-money will be
higher if the Options strike price is close to the stock price
or above the stock price, relative to a put Option with a
strike price way below the stock price. Traders will often
omit the decimal when referring to an Options Delta and all I
mean by that is if I say I’m going to sell a 30 Delta put
Option, I really mean I’m going to sell the put Option with a
Delta of negative 0.30. But instead of me saying I am going
to sell the negative 0.30, traders often will say I’m going to
sell the 30 Delta put Option. That's just to make things
quicker and it's much easier to say then 0.75 or negative
0.35 but to help you not get confused, if you ever hear
someone say they are going to trade an Option and they
refer to the Delta as a whole number such as a 50 Delta call
Option or a 75 Delta put Option, they are referring to the
Option at that same Delta level but in decimal form. In other
words a 75 Delta put Option means the Options Delta is
negative 0.75 but to make things easier, they just say 75
Delta Option.

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Chapter 3 Options Trading Using Option Greeks
Gamma

In this chapter we're going to be talking about Gamma which

is one of the four primary Option Greeks. The Option Greeks
help us understand how our Option positions are expected to
change or perform based on changes in specific
environmental factors such as changes in the stock price,
passage of time and changes in implied volatility. In today's
chapter we're going to be focusing on Gamma and Gamma is
an Option Greek that tells us how an Options Delta is
expected to change as the stock price moves. While an
Options Delta tells us how much the Options price is
expected to change based on a one dollar change in the
stock price, the Option Greek Gamma actually tells us how
much the Options Delta is expected to change with that
same $1 change in the stock price. I know this is confusing
so let's go through a bunch of examples and by the end of
this chapter you're going to be very comfortable with what
Gamma represents as I’m going to walk through numerous
examples to demonstrate each of the concepts that I’m
about to discuss.

In this table we're looking at different Options with different

Delta and Gamma values. On the right hand most column we
can see the expected Option Deltas with a one dollar
increase in the stock price as well as a one dollar decrease in
the stock price. For example if we're looking at a call Option
with an initial Delta of 0.50 and a Gamma of 0.05 we can see
that if the stock price increases by one dollar that call
Options Delta is expected to be 0.55 and with a one dollar
decrease in the stock price that Options Delta is expected to
be 0.45. The Options Delta is expected to change by the
amount of Gamma and in this case the Gamma when this
Option starting out is point zero five which means with a one
dollar change up or down and stock price the Options Delta
is expected to change by the amount of Gamma which is
0.05 in this scenario. If we're looking at a put Option with an
initial Delta value of negative 0.35 and a Gamma value of
0.03 then if the stock price increases by $1 then that put
Options Delta is expected to change to negative 0.32. On the
other hand if the stock price decreases by $1, that put
Options Delta is expected to change to negative 0.38, so in
this scenario the put Options Delta is expected to change
again by the amount of its Gamma which is 0.03 in this
scenario. From this table we can learn that an Options
expected Delta value after a $1 increase in the stock price is
equal to the starting Option Delta, plus the Option Gamma.
On the other hand to calculate an Options expected Delta
after a $1 decrease in the stock price, we take the starting
Option Delta and we subtract the Options Gamma from that
value to get the Options expected Delta value after a $1
decrease in the stock price. Because call Options have
positive Deltas and positive Gamma, call Option Delta's will
increase and get closer to positive 1 as the stock price
increases and they will get closer to 0 - meaning they will fall
as the stock price decreases. Since put Options have
negative Deltas and positive Gamma, the opposite is true for
put Options. As the stock price increases, a put Options Delta
is actually going to get less negative meaning the Options
Delta is going to get closer to 0, and as the stock price Falls
the put Options Delta is going to get more and more
negative approaching negative 1 and that means that as the
stock price Falls put Option Delta's will fall to more negative
values and get closer to negative 1. Later on I’m going to
explain how we can understand this intuitively because it
does make sense from a probabilistic standpoint but for now
just keep these formulas in mind. Here is a diagram that
helps illustrate this fact about the changes in Option Deltas
as the stock price increases and decreases.

All Option Delta's increase after an increase in the stock

price and decrease after 8 decrease in the stock race but
since put Options have negative Delta's, adding Gamma to
the negative put Delta's means the put Deltas actually get
closer to zero - meaning their prices get less sensitive future
stock price movements as the stock price increases. The
opposite is true for call Options. Call Option Deltas grow it
towards 1.0 as the stock price increases, which means their
prices get more and more sensitive to future stock price
movements as the share price rises. Let's go ahead and look
at some historical examples of put Option Deltas and call
Option Deltas as the stock price is changing over time so
that you can visually see what I’ve just described in this past
section. In this first example we will look at changes in a call
Option and a put Option at the exact same stock price on
Apple as Apple's stock price is changing over time.
The top half of the chart shows the change in the stock price
and the strike price of the Options in this example and the
strike price of the call input in this example is a hundred and
twenty dollars. The bottom half of this chart shows the
change in the Deltas of the 120 call and 120-put as Apple's
share price fluctuates over time. Apple share price is falling
throughout the entire period but at the beginning of the
period Apple was at a hundred and thirty dollars and fell to
one hundred and five dollars by the end of the period which
means the 120 calls started in the money and ended out of
the money by the time it expired. The 120-put started out of
the money and ended in the money by the time of the end of
the period, which means the Option expired in the money. A
decrease in the stock price will lead to a decrease in the call
Delta and put Deltas which means the call Delta will move
towards zero and the put Delta will move towards negative
1.0.
What this means is that in this example the call Options price
got less sensitive to changes in the stock price over time
because the calls Delta were shrinking - meaning it was
getting closer and closer to zero while the put Options price
got more sensitive to changes in the stock price because the
put Delta was becoming more significantly negative as the
stock price fell. But how can we understand these changes in
an Options Delta intuitively? An Options Delta is used as an
estimation for the probability of that Option expiring in-the-
money. For example if we're looking at a call Option with a
Delta of 0.55, that call Option has an estimated probability of
55% of expiring in-the-money. On the other hand if we're
looking at a put Option with a Delta of negative 0.35, that
put Option has an estimated 35% chance of expiring in-the-
money. Since Gamma estimates how much on Options Delta
is expected to change with a one dollar movement in the
stock price, Gamma essentially tells us the change and the
Options probability of expiring in-the-money as the stock
price changes. Let's look at the previous Apple example from
before and understand what I’ve just said by visualizing the
changes in the call Delta and the put Delta as Apple stock
price changes over time.

At first Apple is at one hundred and thirty dollars and we are

looking at a call input with a strike price of one hundred and
twenty dollars. Since the call Option is ten dollars in the
money at the beginning of the period it makes sense that the
Delta of the Option is 0.75, indicating a 75% probability of
being in the money at expiration. The stock price can fall ten
dollars and the 120 call will still be in the money at
expiration. On the other hand the 120-put is ten dollars out
of the money at the beginning of the period - meaning the
stock price needs to fall more than ten dollars for the 120
put to be in the money at expiration. It makes sense then
that the put Options Delta is negative 0.25, indicating a 25%
estimated probability of being in the money at expiration. As
the stock price Falls we can see that the calls Delta falls from
0.75 and moves closer to zero, indicating a lower probability
of expiring in-the-money at expiration, while the put Options
Delta follows from negative 0.25 to a value closer to
negative 1 indicating a higher probability of expiring in-the-
money. In the final days of the chart the calls Delta is right
around zero, while puts Delta is right around negative 1.0
which indicates an estimated 0% probability of the call
expiring in-the-money and an estimated 100% probability of
the put expiring in-the-money. These values should make
sense because with one or two days left until expiration, the
call is 10 to 15 dollars out of the money and the put is 10 to
$15 in the money, which means the stock price would need
to experience a very large increase in a short period of time
for the call Option to become in the money and for the put
Option to become out of the money. Probabilistically
speaking these changes are not likely and therefore these
Options have a very high probability of expiring out of the
money and in the money respectively. These changes make
sense because as a stock price increases, call Options at
every single strike price have a higher probability of expiring
in-the-money, while put Options at every single strike price
have a lower probability of expiring in-the-money. The
opposite is true when the stock price Falls. When the stock
price Falls call Options at every single strike price have a
lower probability of expiring in-the-money, while put Options
at every single strike price have a higher probability of
expiring in-the-money, which explains why as a stock price
Falls, call Option Deltas will get closer to zero, while put
Option Deltas will get closer to negative one. Moving on let's
talk about Gamma risk. You may have heard Options traders
sometimes refer to Gamma risk and Gamma risk essentially
refers to the increase and an Option positions sensitivity
relative to changes in the stock price as the stock price
changes and as time passes. If you own a call Option with a
Delta of 0.50 and the stock price falls by $1 your call Option
is expected to lose 50 cent's of value which actually means
that your position is expected to lose $50 in value when
accounting for the Option contract multiplier of 100. Later on
in the trade if your call Options Delta has increased to 0.85,
if the stock price falls by $1, now your call Option is expected
to lose 85 cents of value, which means that you are
expected to lose $85 in your position if you own that call
Option because you have to account for the Option contract
multiplier of 100. Gamma risk refers to the increase in an
Option or an Option positions Delta value or sensitivity to
changes in the stock price as the stock price changes or as
time passes. A larger and larger Delta value of your Option
position means that as the stock price changes, your position
is going to experience larger and larger price fluctuations or
P&L fluctuations and generally speaking as an Options trader
or especially as someone who sells an Option, you typically
do not want wild swings in the profitability of your position.
The Options with the highest amount of Gamma are Options
with strike prices near the stock price and Options with very
little time until expiration, while also having strike prices
near the stock price.
In this chart we are looking at the Gamma values of call and
put Options at various strike prices but with the same
amount of time until expiration. The Options with strike
prices close to the stock price have the highest Gamma
values, meaning they have the most Delta sensitivity relative
to changes in the stock price.
In this chart we're looking at Options at various strike prices
and also with various amounts of time until expiration.
Options with less time until expiration have more significant
Gamma values, particularly the Options with strike prices
close to the stock price. What this means is that if you are
trading Options with strike prices near the stock price, the
Delta values will change more rapidly than in the money or
out of the money Options when the stock price does change.
Those Delta changes will be more significant if the Options
have less time until expiration. What this means is that if
you're trading Options with less and less time until expiration
and especially if those Options have strike prices near the
stock price, the Gamma of those positions is going to
increase rapidly as expiration approaches and that means
that if the stock price changes, your Option position is going
to experience more and more significant swings in its value
as the stock price fluctuates. In short, positions with larger
and larger Gamma values are susceptible to wild swings in
the P&L and most of the time you do not want to see violent
swings in the PNL of your positions. We can visualize this
concept by looking at the following chart.

In this chart we are looking at changes in the NETFlIX stock

price relative to changes and the 120 puts Delta and Gamma
as time passes. In the shaded region at the end of the period
we can see that the 120 put is at the money because
NETFlIX is share price is around 120 dollars. The Gamma of
the 120 put is growing more and more as the Option
approaches expiration and we can see wild swings in the
puts Delta in those final days before expiration. Do you really
need to worry about Gamma risk or is it somewhat of a topic
that is a little bit exaggerated? In my opinion if you are
trading short-term Options then Gamma risk is going to be a
real threat to you, and as I’ve just described that if you are
trading Options with very little time until expiration and
those Options have strike prices near the stock price then as
the stock price changes the value of your Option position is
going to experience significant changes and if the stock price
moves against you, obviously that's not going to be a good
thing because the losses can stack up fairly quickly. But if
you're someone who closes your Option positions with a few
weeks left before they expire, and you're never holding
Options close to expiration, then you really don't have to
worry about the Gamma risk of that Options traders are
talking about. But at the end of the day if the stock price
moves against you, you are going to experience changes in
the P&L of your position but not as much as you would if you
were trading short-term Options and those Options had
strike prices near the stock price. I hope you found this
chapter to be helpful and now you are more confident with
your understanding of an Options Gamma which is one of
the four primary Option Greeks.

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Chapter 4 Options Trading Using Option Greeks
Theta & Time Decay

In this chapter I’m going to be sharing with you one of the

primary Option Greeks and that means we're focusing on
Theta. The Option Greeks help us understand how our
Option positions are expected to perform based on various
changes in environmental factors such as changes in the
stock price the passage of time or changes in implied
volatility. Theta is the Option Greek that helps us estimate
how much our Options are going to decrease in extrinsic
value with each passing day. Options are a decaying asset
which means as time passes and as their expiration dates
approach, they lose their extrinsic value slowly but surely
and Theta is the Option Greek that helps us understand how
much our Options are expected to lose their extrinsic value
on each day. All Option prices have to price components.
One being intrinsic value and the other being extrinsic value
which is sometimes referred to as time value. One fact we
know about Options is that as time passes an Option will
lose its extrinsic value until it reaches its expiration date at
which point the Option will have no more extrinsic value
remaining. Theta is the Option Greek that helps us
understand how much extrinsic value our Options are
expected to lose with each passing day. All Options that you
look at on an Option chain will have negative Theta because
all Options lose their extrinsic value as time passes and as
they approach their respective expiration dates. When you
look at an Options Theta it will always be negative when you
are looking at it on the Option chain.
As an example of what an Options Theta represents let's say
we have a $10 Option and the Options Theta is stated to be
negative 0.25. What this means is that with the passage of
one day this Option is expected to lose 25 cents of value
and more specifically 25 cents of extrinsic value because
intrinsic value to not decay - only extrinsic value decays as
time passes. All else being held equal, if one day passes this
$10 Option is expected to be worth 25 cents less or 9.75
cents after the passing of one day and that is assuming that
there is no change in the stock price and implied volatility
also remains the same and the only thing that is changing is
the passage of one day. But why do Option prices decay and
decrease over time? Well an Options extrinsic value is the
only price component that decreases and decays away as
time passes. Extrinsic value is sometimes referred to as
time value and that's because if you look at Options with
more and more time until expiration, those Options will be
trading with more and more extrinsic value or time value
and extrinsic value or time value can be interpreted as the
portion of the Options price that is associated with the
Options potential to become more valuable, specifically
intrinsically valuable before that Option expires. If you look
at an Option with 30 minutes to expiration, that Option is
going to be trading with very little extrinsic value - almost
no extrinsic value because stock prices themselves do not
change much over typical 30-minute periods and because of
that, in 30 minutes the Option is very likely to be worth
exactly what it's worth now because stock prices do not
change much in 30 minutes and therefore that Option is not
going to be trading with a lot of extrinsic value because with
30 minutes left until expiration, there is not much time left
for the Option to become more valuable through significant
changes in the stock price. However if you look at an Option
with 365 days to expiration, this Option is going to be
trading with a significant amount of extrinsic value or time
value because with 365 days left before this Option expires,
there are 365 days left for the stock price to move in favor
of that Option and because of that, there is a chance that
this Option becomes significantly more valuable because
stock prices can tend to move significant amounts in a
year's time. But as time passed and as the Option
approaches its expiration date, the value of that Option at
expiration becomes more and more certain. For example if
we're looking at a call Option with $10 of intrinsic value -
meaning the stock price is $10 above the call Options strike
price, and this call Option expires in 30 minutes, well it's
very likely that in 30 minutes this call Option is going to be
worth somewhere around $10 because in a typical 30
minute window stock prices do not change significantly and
because of that, in 30 minutes of this call Option with $10 of
intrinsic value is going to be somewhere around $10 in
value because over a typical 30 minute period, stock prices
do not change much which means we can expect that this
Option is going to be worth somewhere around $10 when it
expires in 30 minutes. However if you look at that same
Option that has $10 of intrinsic value but a year until
expiration this Option is going to be worth significantly more
than $10 because it has the $10 of intrinsic value but it also
has a year before it expires, which means there's the
potential for the stock price to increase significantly and
maybe that $10 Option goes to a value of $30 and because
of that, this Option is going to be trading with a lot of
extrinsic value. As time passes and as the Option
approaches its expiration date, the extrinsic value will
slowly approach zero and Theta is the Option Greek that
helps us understand how much the Option is expected to
lose with the passing of one day. Let's go ahead and look at
some examples so you can see exactly how time decay or
extrinsic value decay actually works in practice and to do
this we're going to look at numerous trade examples from
history so that you can see exactly how this concept plays
out in the real world.
In this example we are looking at a call Option with a strike
price of 105 dollars. On the bottom portion of the chart we
are looking at the price of the call Option as time passes. As
we can see here Apple never gets above 105 dollars which
means this call Options price is 100% extrinsic and extrinsic
value decays away as time passes. The value of the call
Option changes over the course of the period because
Apple's stock price fluctuates getting closer to and further
away from the call of strike price at various points in this
trade. However we can see that as expiration gets closer,
the Options value which is 100% extrinsic eventually gets to
zero dollars. As time passed and as Apple remained below
the strike price of 105 dollars, even moving further away
from it, it became less probabilistic that the Option would
become intrinsically valuable before expiration and that is
why we saw a steady decrease in the Options price and at
the very end of this trade we saw a dramatic decrease in
the Option price because as expiration approached and with
Apple well below the strike price of 105 dollars, the
probability that this Option expired worthless increased
dramatically. At the very end of the period we can see that
all of the extrinsic value came out of the Option over time
and with the Option having no intrinsic value, the Option
expired worthless.

In this next example we are looking at a call Option on

NETFlIX with a strike price of $90 as we can see NETFlIX was
above the caused strike price the entire time which means
the call always had intrinsic value. Only in Options extrinsic
or time value melts away as time passes and on the bottom
of the chart we can see that the Options total price in
relation to its intrinsic value with the shaded region in
between the actual price and the intrinsic value,
representing the Options extrinsic value. We can see that
over time and as the Option approached its expiration date
the difference between the intrinsic value and the total price
of the Option converged, which means the Options price lost
the extrinsic value over time, bringing the intrinsic value
and the total Option price closer to the same value as
expiration got closer and closer.

In this next example we are looking at a straddle on

Facebook with a strike price of 105 dollars and Facebook
hovered around the 105 price level the entire time and we
can see how the extrinsic value in the straddle gradually
melted away as time passed. I did not plot this trade all the
way to expiration so there's still extrinsic value at the end of
the period, but we can clearly see how an Option positions
extrinsic value will melt away as time passes if the stock
price does not change significantly. This is perhaps the best
example of time decay or extrinsic value decay in action
because the stock price remained right around the straddle
stretch price, virtually the entire period and we see a very
gradual decrease in the value of those Options as time
passed. Hopefully these examples helped you understand
exactly why and how Option prices decrease over time and
as they approach their respective expiration dates. But now
that we know why and how Options decay, what Options are
expected to lose the most extrinsic value as time passes
and in other words which Options have the highest levels of
negative Theta? In general the Options with the most
extrinsic value in their prices will have the most significant
negative Theta values and that's because they have the
most extrinsic value to lose before they expire, compared to
a different Option with less extrinsic value but the same
amount of time until expiration. If one Option has $1 of
extrinsic value and 30 days to expiration, while another
Option has $10 of extrinsic value and 30 days to expiration,
obviously the $10.00 Option has $10 of extrinsic value to
lose in 30 days, while the $1 Option has $1.00 of extrinsic
value to lose over 30 days. If we use very simple math we
can calculate that the $10 Option is expected to decay in
value much faster than the $1 Option because it has more
extrinsic value but the same amount of time until expiration.
The Options with the most extrinsic value are going to be
the ones that are at the money, meaning their strike prices
are near the stock price and they have lots of time until
expiration as they will have more extrinsic value or time
value since there is more time for the stock price to move
and therefore there's more time for those Options to
become significantly more valuable. But not all Options are
observed to decay at the same velocity. It has been said
before that at the money Options actually decay faster and
faster in the final weeks before they expire. A few years ago
I ran a study to test this assertion of at the money Options
decaying faster and faster as they approach their expiration
dates and the way I did this was I looked at the at the
money straddle price on SPY which is the S&P 500 ETF and I
started with 90 days to expiration and then I recorded the at
the money straddle price every single trading day until that
expiration reached 0 days to expiration - in other words until
those Options expired. Then I grouped all of the straddles
that I recorded by the number of days they had left until
expiration and I calculated the remaining straddle price
relative to the very first recorded date where I recorded
their prices and I plotted the percentage of the remaining
price over time until all of those straddles reached
expiration.

In this chart we have the percentage of remaining extrinsic

value on the y axis and the days to expiration on the x axis.
From ninety days to expiration to sixty days to expiration
the at the money straddle were worth about 80% of the 90
days straddle value or starting value on average. At 30 days
to expiration of the at the money straddle still held on to
about 60% of their starting 90 day values on average. In the
final 30 days the straddles lost all of their extrinsic value
because all Options must lose all of their extrinsic value by
the time they reach expiration. We can see the decay rate
accelerate as the expiration date approaches. This is not a
perfect study but it does show how at the money Options
hold on to a lot of extrinsic value until the final weeks before
expiration. This does not mean they do not decay when they
have more time until expiration, just that the decay gets
faster and faster as the final days before expiration pass.
The exact fate a number of an Option is not the final stop on
our discussion of Theta because what's more important is
understanding your position Theta. Position Theta is actually
just Theta but it is converted into a dollar amount and what
position Theta tells you is how much money you are
expected to make or lose, based on the passage of one day
with all else being held equal. If you look at your position
tab on your trading platform you will see a position Theta
number and this number is going to be a little bit larger
than the Option Theta you see on the Option chain. If you
sell a call Option and the Theta on the Option chain says
negative 0.25, on your actual position Theta the Theta will
show up as positive 25 because if your Option decreases by
25 cents and you are short that Option, that means you are
going to experience a profit of $25 because that 25 cent
decrease in the Option multiplied by the 100 Option
contract multiplier gives you a profit of $25 for every call
Option that you sold and saw decrease by 25 cents. If you
buy an Option your position Theta is going to be negative,
which is telling you that as time passes you are expected to
lose a certain amount of money with each passing day and
if you sell Options, your position Theta is going to be
positive - meaning that with each passing day you are
expected to make money because as your Option position
decreases in value, as someone who sold the Option
initially, you want the Option price to decrease and position
Theta being positive tells you that with each passing day
you are expected to profit with all else being held equal. All
else being held equal meaning no change in the stock price
and no change in implied volatility.

On the tastyworks trading platform you can see this on the

open positions tab which is where your open Option
positions and stock positions will show up. As we can see
here I have an open Option position in SPX and the position
Theta says positive 55.738. The positive position Theta is
telling me that my position is expected to profit from the
passage of time with all else being held equal. More
specifically if the stock price and implied volatility remain
the same, I’m expected to make about 56 dollars from the
passage of one day. This position Theta number will change
as time passes as the stock price changes and as implied
volatility changes so it is not a linear estimation. But in this
specific situation the current expected profit from one day of
extrinsic value decay in my Option position is 55 dollars and
74 cents which is obviously a very good thing for me
because if the stock price does not and implied volatility
remains the same, my position is expected to profit so long
as the stock price does not move significantly, implied
volatility does not increase significantly and time simply
passes. But with this in mind, you should not go out there
and sell Options with the intention of increasing your
position Theta number, because you have to keep in mind
that a direction of movement in the stock price against your
position can easily overwhelm any profits that you would
have had from the passage of time, so when you're trading
Options you always have to keep in mind that more often
than not, you are making a directional bet and even if your
position doesn't really have any directional exposure or
Delta exposure at the start, it can become very directional
very quickly if the stock price moves against your position
so when you're trading Options, you can't just look at the
position Theta number and try to jack it up as high as
possible because that's more than likely not going to be a
winning strategy in the long term. You have to keep
everything in mind when you're trading Options.

OceanofPDF.com
Chapter 5 Option Trading Using Options Greek
Vega + Volatility

In this chapter I’m going to explain to you one of the four

primary Option Greeks and in this chapter we are focusing
on Vega. The Option Greek Vega estimates how much your
Option is expected to change in value in relation to a one
percent move in implied volatility. As the demand for a
stocks Options change, the Option prices themselves will
actually change in value and with these changes in value
over time, the implied volatility or the expected amount of
stock price fluctuation from the market will actually change
over time and we can determine that based on changes in
these stocks Option prices. Vega as an Option Greek is a
little bit tricky to explain because implied volatility does not
change on its own. It is not something that magically just
changes. Implied volatility as it measures Option prices
actually changes when the Option prices change, so for
implied volatility to change, the stocks Option prices have to
change first and for that to happen buying and selling
pressure in the market has to shift so that the Option prices
become more expensive or become cheaper. Based on how
much time those Options have until expiration, a change in
their prices will alter the level of implied volatility that is
currently observed in that stock. As an example of what
implied volatility actually measures, if we have two $100
stocks and we look at their 30-day Option prices, the
Options with more extrinsic value will give that stock a
higher implied volatility reading because on two $100 stocks
with 30 days until expiration, the Options that are more
expensive are going to tell you which stock has more
expected volatility in the future, because Option prices are
an indication of how much volatility is expected from that
stock going into the future. Theoretically speaking, if the
stock with cheaper Options were to experience a shift in
supply and demand and those Option prices actually
increased to match the more expensive stocks Options, than
the implied volatility of that stock with initially cheaper
Options would see an increase in implied volatility if those
Option prices in to match the stock that initially had more
expensive Options. In other words, if you look at his stocks
Options and in one single trading day those Options get
more expensive and take on more extrinsic value due to
more demand for purchasing those Options, then you will
see an increase in implied volatility in that stock because
with more expensive Options relative to the time until they
expire, that means that traders are expecting more and
more stock price volatility and because of that, the Option
prices will increase in value based on that increased
demand and with it implied volatility will also increase.
Vega, one of the primary Option Greeks estimates how
much an Options value is expected to change with a 1%
change in implied volatility. Let's look at a table so I can
demonstrate exactly.

If we look at the $10 Option with 0.25 Vega, the Option is

expected to be worth ten dollars and 25 cents if Implied
volatility increases by one percent. That same $10 Option
with 0.25 Vega is expected to be worth about $9.25 if
Implied volatility were to fall by 3%, but implied volatility
does not magically change. Implied volatility changes when
a stocks Option prices experienced a broad change due to a
shift in supply and demand, which means that the market
believes the stock will be more or less volatile in the future
than it currently is now based on those Option prices. The
reason this makes explaining Vega tricky is because Vega is
typically described as if Implied volatility increases by one
percent, then the Option price will increase by its amount of
Vega and if Implied volatility follows by one percent, then
the Option price will decrease by the amount of its Vega.
Implied volatility does not just magically change and Option
prices have to change first before implied volatility changes.
If an Option price changes by the amount of its Vega then
implied volatility will shift by about one percent. For
instance if we have a ten dollar Option with a baker of 0.25
and the stock price does not change and within a five
minute period the Option price goes from ten dollars to ten
dollars and twenty five cents, then I would expect implied
volatility to have increased by about one percent. In a more
extreme example let's say we have Option A and Option B.
Option A is worth seventy five cents and Option B is worth
twenty five cents and implied volatility is 1%. If Implied
volatility goes to zero percent, that means the Options have
no extrinsic value whatsoever so if that Option A went from
seventy five cents to zero dollars, that means implied
volatility would go from one percent to zero percent and
Option B would go from twenty five cents to zero dollars
because it has to lose all of its extrinsic value for implied
volatility to go to zero and because of that, we would say
Option A has a Vega of 0.75 and Option B has a Vega of
0.25. But which Options have the most exposure to Vega or
changes in implied volatility? Well, generally speaking the
Options with the most extrinsic value such as the anthem
any Options or Options with more time until expiration will
have higher levels of Vega.
In this chart we can see the Options with the highest Vega
exposure are the at the money Options with less and less
Vega exposure as we move to strike prices further away
from the stock price. Going one step further, the Options
with even more extrinsic value will be the at the money
Options at further expiration dates.
In this chart we're looking at Options across strike prices but
also across various expiration dates. The Options with 225
days until expiration have more Vega exposure than the
Options at the same strike prices but with 15 days to
expiration. To intuitively explain why this is, we need to
understand that volatility scales with time. Implied volatility
is always presented as an annual number, but we can use
the annualized implied volatility number to calculate implied
stock price ranges over specific time periods. For instance a
$100 stock with 20% implied volatility has a 30-day
expected range of plus or minus five dollars and 73 cents -
meaning the stock price hasn't implied 68% probability of
being within five dollars and 73 cents of 100 dollars in 30
days time. The same stock has a 90-day expected range of
plus or minus nine dollars and 93 cents meaning the stock
price hasn't applied 68% probability of being within nine
dollars and 93 cents of 100 dollars in 90 days. If the stocks
Option price is increased so that implied volatility was 21%,
the 30-day expected range would increase to six dollars and
two cents which is an increase of 29 cents in the expected
range. The 90 day expected range however would increase
to 10 dollars and 43 cents, which is an increase of 50 cents
over the initial expected range with implied volatility at
20%. From this simple calculation we can see that the
increase in implied volatility impacts the longer-term
expected range more so than the shorter term expected
range, because stock prices have larger expected ranges
over longer periods of time as compared to shorter periods
of time. An increase in implied volatility will impact the
longer-term expected range more so than it will the shorter
term expected range, which is why longer-term Options
have larger Vega values than shorter term Options at the
same exact strike prices. But just because longer term
Options have larger Vega values than shorter term Options,
it does not necessarily mean you are going to make or lose
more money from a change and implied volatility if you are
trading longer term Options. The reason for that is that
when implied volatility does change - whether it's from a
stock price increase or a stock price decrease, the shorter
term expiration cycles typically experience much larger
changes in implied volatility as compared to the longer term
expiration cycles. For example if a stock's price falls
significantly and the one month expiration cycle
experiences a five percent increase in implied volatility, the
365 day expiration cycle might only experience a 1%
increase in implied volatility, which is significantly less than
the five percent increase that the one-month Options saw.
In the financial crisis of 2008 I plotted the VIX index which is
calculated from one month SPX Option prices against the
VIX futures contracts expiring in October, November and
December. When implied volatility as measured by the VIX
index increased the October VIX future increased to less and
the December VIX future increased by the lowest margin
and it is interesting because the December VIX future had
the longest time until expiration. If you would have
purchased the VIX call Options at the strike price of 20 in
each of these expiration cycles, here is how each trade
would have performed. The shortest term call Option did the
best while the longest term call Option increased by the
lowest margin. To give another example from real price
history, let's look at a significant stock price decrease in
IWM which is the Russell 2000 ETF in September of 2019.
On September 23rd 2019 IWM was trading for 155 dollars
and the October 2019 Options with 25 days to expiration,
trading with 18.5% implied volatility. The September 20
2003 hundred and 61 days to expiration, trading with 21.4%
implied volatility. The next day September 24 2019 IWM had
fallen to $152.50 and the October 2019 Options with 24
days to expiration, we're now trading with 21.3% implied
volatility. The September 20 2003 hundred and 60 days to
expiration we're trading with 21.8% implied volatility. The
October 2019 Options with about 25 days to expiration
experienced a near 2% increase in implied volatility, while
the September 2020 options 360 days to expiration
experienced 0.4 percent increase implied volatility,
demonstrating that the longer-term implied volatilities are
more stable than shorter-term implied volatilities and this
means that longer-term Options with more Vega exposure
do not necessarily have more volatility risk than shorter
term Options with less Vega exposure. Generally speaking
longer-term implied volatilities do not change as much as
shorter term implied volatilities when the market does
move. In this entire chapter I’ve talked about specific Option
Vega values but what's more important to understand is
your position Vega and position Vega is actually the
expected profit or loss that should occur or is estimated to
occur from a change in implied volatility as it relates to your
Option position. In this image of the tastyworks trading
platform we can see that the position Greeks for the SPX
position I have on.

In the right-hand column and the positions tab it says my

positions Vega is negative eighteen point four six. This
means that if a 1% change in implied volatility occurred in
the expiration cycle that I’m trading, my position is
estimated to experience a P&L change of eighteen dollars
and forty six cents. More specifically, if the implied volatility
increased by one percent I am expected to lose 18 dot 46
cents and if the implied volatility decreased by one percent I
am estimated to make eighteen dollars and 46 cents. While
the position Vega tells you how much you are exposed to
changes in implied volatility, keep in mind that it is very
difficult to predict just how much implied volatility will
change in your specific expiration cycle when the stock
price moves. Generally speaking if you are in a longer term
expiration cycle, the implied volatility of those Options will
be relatively stable compared to much shorter term
expiration cycles.

OceanofPDF.com
Chapter 6 Option Moneyness for Beginners

In this chapter we're going to discuss Option moneyness.

You'll hear traders refer to Options as being in the money, at
the money or out of the money and this chapter is going to
break down what each of those terms mean. What is Option
moneyness? Well Options traders often use moneyness to
describe the relationship between an Option strike price and
the current stock price. Option moneyness refers to three
specific terms with the first being in the money, the second
being at the money and the third being out of money, so
let's go through each of these terms and go through some
examples so you know exactly what each of these terms
actually means. Starting with in the money, and in the
money Option is any Option contract that currently has
intrinsic value. For calls that means the strike price is below
the stock price.

In this table here we have the stock price the calls strike
price and any corresponding intrinsic value that Option has
and then that will tell us if the Option is in the money or out
of money. The first example is a stock price of 100 with a
call strike price of 110. That call has no intrinsic value so
that call would actually be out of the money. If the stock
price is 125 dollars and the calls strike price we're looking at
is a hundred, that call actually has twenty-five dollars of
intrinsic value because that strike price is 25 dollars below
the current stock price. That Option would be in the money.
The same with a third example the stock price is 150 dollars
and the calls strike price we're looking at is 145 dollars, that
call Option has five dollars of intrinsic value and therefore
the Option is in the money.

The opposite is true for put Options as in the money put

Options have strike prices above the current stock price, so
if we have a stock price of 100 dollars and we're looking at a
put with a strike price of 110 dollars, that put has ten dollars
of intrinsic value because the strike price is ten dollars
above the stock price, and therefore that put would be in
the money. If we're looking at a hundred and twenty-five
dollar stock and we're looking at a put Option with a strike
price of one hundred dollars, that put Option has zero
dollars of intrinsic value because the put strike price is
below the current stock price, and therefore that Option
would not be in the money. Lastly if we have a hundred and
fifty dollar stock and we're looking at a put Option with a
strike price of one hundred and fifty five dollars, the intrinsic
value of that put would be five dollars and therefore the
Option would be in the money. Now that we've walked
through in the money calls and in the money puts, let's look
at a real Option chain and identify the in the money Options.
In this particular image we're looking at the Russell 2000
ETF with the ticker symbol IWM. As we can see in the top
left, the current stock price in this image is a hundred and
thirty seven dollars and 21 cents. If we look down to the
Option chain, we're looking at the May Options. On the left
hand side we have two call Options and on the right hand
side we have the put Options and right in the middle we
have the strike prices. The strike prices of the calls that are
below $137 are in the money and this software actually
highlights those Options to indicate that they are in the
money. The put Options with strike prices above 137 dollars
are also in the money so as we can see on the bottom right
the strike price is 138 through 142 in this image are the in
the money puts and as we can see the software also
highlights those Options as being in the money. Moving on,
now we're going to talk about at the money Options and at
the money Options are really easy because at the money
Options just indicate Options with strength prices equal to
or near the current stock price and that applies to calls and
puts.
For example if we're looking at a hundred dollar stock and
the strike price of the call and put we're looking at is a
hundred and ten dollars, those Options would not be at the
money because that strike price is not near the stock price.
If we're looking at a hundred and twenty five dollar stock
and we're looking at a call input with a strike price of one
hundred and twenty five dollars, those Options would be at
the money because the strike price is equal to with the
stock price. Lastly if we're looking at a hundred fifty dollar
stock and we're looking at Options with strike prices of one
hundred and sixty dollars, those Options would not be at the
money because those strike prices are not near the stock
price. Now let's go ahead and look at a real Option chain
and identify the at the money Options.

We're looking at the same image that we were before and

it's of IWM when it's trading for one hundred and thirty
seven dollars and twenty one cents. In this particular Option
chain we can see that there's a strike price of one hundred
and thirty seven dollars for the calls and the puts and that
would be the anthem any Options in this case. Since the
stock price is trading closest to one hundred thirty seven
dollars, that one thirty seven call and the one thirty seven
put would technically be the at the money Options.
Let's finish up with out of the money Options. Out of the
money Options are Options with no intrinsic value and that
means calls are out of the money when the strike price is
above the stock price. If we're looking at a stock that's a
hundred dollars and we're looking at a call Option with a
strike price of one hundred and ten dollars, that call has no
intrinsic value and is therefore out of the money. If we're
looking at a one hundred twenty-five dollar stock and we're
looking at a call Option with a strike price of one hundred
dollars, that call has twenty-five dollars of intrinsic value
and is therefore not out of the money because it is in the
money. Lastly if we have a one hundred and fifty dollar stock
and we're looking at a call with a strike price of one hundred
and fifty five dollars that call has no intrinsic value and is
therefore out of the money.

The opposite is true for put Options as out of the money

puts have strike prices below the current stock price. We're
looking at a hundred dollar stock and we see a put with a
strike price of one hundred and ten dollars, that put Option
has ten dollars of intrinsic value and is therefore not out of
the money. If we're looking at one hundred and twenty five
dollar stock and we look at a put Option with a strike price
of one hundred dollars, that put has no intrinsic value and is
therefore out of the money. Let's go ahead and look at a real
Option chain and identify all of the out of the money calls
and out of money puts.

To finish up we can see that we have IWM and it's trading for
one hundred and thirty seven dollars and twenty one cents.
To identify the out of the money calls we're going to look at
the calls with strike prices above one hundred and thirty
seven dollars and twenty one cents. In this image that's
going to be every call Option with the strike price between
138 and 142 and in regards to puts, the out of the money
puts are any puts with strike prices below one hundred and
thirty seven dollars and twenty one cents. In this image
that's going to be the puts with strike prices between one
hundred and thirty three dollars and one hundred and thirty
seven dollars. While that one thirty seven put is technically
out of the money, since its strike price is so close to the
stock price, it could also be considered at the money. That
pretty much sums up everything you need to know about
Option moneyness so let's quickly recap everything that
you've learned in this chapter. First and foremost
moneyness refers to the relationship between an Option
strike price and the current stock price. In the money refers
to Options with intrinsic value, which means calls with strike
prices below the current stock price and puts with strike
prices above the current stock price. At the money refers to
Options with strike prices near or equal to the stock price,
which applies to calls and puts. Lastly out-of-the-money
refers to Options with no intrinsic value and that means call
Options with strike prices above the current stock price and
put Options with strike prices below the current stock price

OceanofPDF.com
Chapter 7 Top Options Trading Mistakes New
Traders Make

In this chapter we're going to cover the top 9 most costly

Options trading mistakes so that you can avoid these
mistakes and ultimately save money in your trading
account. Options trading mistake number one is not having
an exit plan. It's very crucial to know when you will get out
of a trade whether it's profitable or not, otherwise you'll be
scrambling to make a rational decision when things go
wrong which is not likely to happen because in the heat of
the moment your emotions are firing off and that's when the
traders typically make bad decisions. If you know when you
will get out of that trade or what will cause you to get out of
that trade, that's going to make managing that position
much easier and it's going to help you avoid making
emotional decisions. I can't tell you when you should get out
of profitable trades or losing trades, so you're going to have
to come up with a system that makes sense to you. Maybe
it's some sort of technical indicator that reaches some
certain level or maybe it's a price point for your strategy,
but overall having an exit plan is one of the most important
things when it comes to trading Options.
Options trading mistake number two is trading too many
positions. This might be a bit of a controversial mistake
because a lot of people believe that you should have lots of
positions on because that will help you diversify your
portfolio. However when you have a lot of positions on it's
going to be very difficult to keep track of all of those
positions and your risk is most likely overlapped. Lastly and
perhaps most importantly, when markets get extremely
volatile it's very difficult to get filled on your positions
because the bid-ask spreads widen significantly as a result
of increased stock volatility. If you have on 10 or 15
positions that go south and you need to manage those
positions, how are you going to manage all those positions if
you can't even get filled on one adjustment because the
bid-ask spreads are so wild. At the end of the day if you
want to trade a lot of positions and that's your trading style,
that's completely fine - just keep these three points in mind.
Options trading mistake number three is trading illiquid
Options and here's why. When you trade illiquid Options
you'll likely only be able to exit that position at a very
unfavorable price to you and that's because the bid-ask
spreads are typically wide for illiquid Options. That means
you need to target Options with volume and the hundreds
and open interest in the thousands at a minimum. Keep in
mind that early in the trading session volume will be low
because volume tracks how many contracts have traded
during that particular day, so you can always just look at
open interest to gauge liquidity. The bottom line is that you
don't want to enter into an Option position where there
aren't any other market participants because when you try
to get out of that position chances are you're going to lose a
lot of money to the bid-ask spread.
Options trading mistake number four is trying to fix entirely
broken trades. A lot of the times new traders just hold on to
their losing trades because they cannot admit defeat. That's
completely understandable because it's human nature to
not like to lose but when it comes to trading Options you
have to learn how to take a losing trade. At some point a
losing trade has a very low probability of coming back and
ending profitable which means trying to fix that trade is a
waste of commissions and margin, and by margin I mean
the amount of money that you have to put up to hold that
position. The bottom line is to know when and losing trade is
a lost cause, take that loss and just move on.
Options trading mistake number five is taking profits too
soon and here is why. Taking profits sooner will boost your
percentage of profitable trades but that doesn't actually
mean anything because when you take small profits and
have the same size losses you're required winrate to
actually break even on that strategy is significantly high. For
example if your average profit on a trade is $10 in your
average loss on a trade is $100 then you need a success
rate that's over 90% just to break even with those average
profits and losses over time. Lastly, Commission's will eat
into your return substantially when you take really small
profits which is going to make it even harder to profit over
the long run, so try to be a little more patient with your
winning trades and set higher profit targets for your
positions because at the end of the day that's going to lead
to a lower required win rate which means that you won't
have to have so many winning trades to break even or make
money overtime, but secondly, the Commission's for trading
will account for a lower portion of your overall profitability.
Options trading mistake number six is of course trading too
big. If you have one massive losing trade, that's going to
make it very difficult to recover from and you could
potentially just get taken out completely if you use improper
sizing. Focus on not blowing up and portfolio growth
becomes more probable because if you avoid the
catastrophic draw downs, that's going to make it easier to
grow your portfolio over time. Options trading mistake
number seven is not analyzing implied volatility before
entering a trade. Your strategy that you are going to use
should fit the current volatility environment, otherwise your
profits may be hard to come by even if your stock price
outlook is correct.
Options trading mistake number eight is not checking for
market catalysts. When new information is released that
causes markets and stocks to move and sometimes in a
substantial way up or down, so be sure you're aware of
upcoming market catalysts so that you're prepared for
potentially negative outcomes. When I say market catalysts
the most common are earnings reports for individual
equities and in the context of the broader market such as
the S&P 500, potential market catalysts are unemployment
reports which happen on the first Friday of every single
month and interest rate decisions by the Federal Reserve
which happens multiple times a year.
Options trading mistake number nine is trading complex
products without researching them first. There are many
complex products out there primarily in the leveraged ETFs
pace or the volatility product space. Entering a trade and a
product without understanding what drives its movement
can be costly because if you don't know what drives a
particular product then you can't make an informed decision
in regards to forecasting the direction of that particular
product. So before trading any product that includes the
phrases 2X, 3X or inverse just be sure to do some research
on those products and try to figure out how those products
are likely to move especially over the time frame of your
particular trading strategy.

OceanofPDF.com
Chapter 8 Options Trading Checklist You Must
Follow

In this chapter we're going to run through our seven-point

pre-trade checklist that we use before trading any new
positions. By going through each of these seven points we'll
have a better understanding of what we're actually trading,
how it fits into our portfolio, how we're going to manage the
position and things you need to look forward before entering
any new position. Item number one on our pre trade
checklist is does the new position fit your portfolio? These
days it's extremely easy to enter new positions with the
advancement in technology and cheaper Commission costs
but you need to think about does that new position that
you're trying to add actually add any value to your portfolio
or does it add unnecessary risk. For example let's say you
have on three different short put spreads on three different
stocks. A short put spread is a bullish strategy and let's say
you're looking at selling another put spread in a different
stock because you think that stock is right for an increase.
Well, what you need to consider is what's your portfolio
drawdown going to be if all four of those short put spread
positions become losers which is likely going to be the case
if the stock market corrects. With that said maybe you'd like
to have a 10% allocation to short put spread positions in
your portfolio at all times and those three short put spreads
you have on currently are only taking up seven and a half
percent. In that case then your strategy would be to add the
fourth short put spread which would be in line with your
overall portfolio management style. There aren't any hard
and fast rules but just consider does this new position that
I’m putting on actually makes sense in the context of my
overall portfolio.
Item number two on the pre trade checklist is have you
selected a time frame that suits your strategy and outlook
for the particular stock in question? Let's say you have a
one year bullish outlook for us and you want to put on an
Option strategy that benefits from the increase in the stock
price. If you're primarily a short premium trader which
means you sell Options, then maybe you don't want to go
into that one year expiration cycle and sell a put spread
because as a short premium trader, time decay is one of
your best friends and in longer term Options time decay is
not as present. Even though you have a one-year outlook for
the stock maybe you use the thirty to sixty day expiration
cycles to fit your short premium strategies. On the other
hand, if you're a trader that prefers to buy Options then
maybe you go into that one year expiration cycle and since
you're bullish you go ahead and buy a call Option. It would
probably be better to buy a longer-term call Option as
opposed to a shorter term call Option because when you
buy an Option you fight against time decay, so you fight
against that negative Theta exposure. If you were to buy a
longer-term Option then you're actually going to fight
against time less because longer-term Options do not decay
as rapidly. The bottom line is that you need to consider how
your time frame, stock price outlook and typical strategies
that you use all pair together.
Item number three on our pre trade checklist is there
enough liquidity in the Options that match your strategy and
outlook timeframe? Per the last slide let's say you have a
one-year outlook for the stock price and you want to go
ahead and buy a long-term call Option to get bullish
exposure with some leverage over that one-year time
period. Let's say you open up the Option chain in that 365
day expiration cycle and there is literally no volume and no
open interest. That would be a huge red flag because you
don't want to get into an Option position where there's no
other market participants that are trading that particular
Option. The reason for that is when you want to go ahead
and close that Option or even open that Option, you are
probably not going to get filled at the mid price and that
means you're probably going to have to buy near the asking
price if you're buying or selling your the bid price if you're
selling and as you get in and out that position you're going
to pay that wide bid-ask spread, which means simply
getting in and out of the position is going to be very costly.
So be sure that the Options you're looking to trade have
open interest in the thousands and volume in the hundreds
at a minimum. Keep in mind that early in the trading day
volume will be very low because volume tracks how many
contracts have traded on that particular day. If you're
looking at an Option contract at 8:35 Central Time right
after the opening bell, and the volume is at ten contracts
but the open interest is at a thousand or two thousand, then
that's okay because that open interest indicates that there
are a lot of open contracts which means there's a good
chance there will be value in the future.
Item number four on our pre trade checklist is does the
current level of implied volatility make sense for your
strategy? Implied volatility indicates the current level of
Option prices on a particular stock so when we say the
current level of implied volatility we're really saying the
current level of the Option prices on that stock. In particular,
are you about to battle implied volatility with your proposed
strategy? For example let's say a stock is down 10% in a
couple days and you think it's going to rebound strong, so
you go ahead and you look at some out of the money call
Options that you want to buy because you want to take a
little bit of risk but you want to have a lot of upside
potential, should the stock rebound. Well the problem with
that strategy is that after a stock declined substantially, it's
Option prices are more than likely going to be pumped up
which means purchasing that call Option might not be such
a good idea because as that stock price increases, implied
volatility is likely to come back down which just means that
the Option prices are going to contract in value. What that
means for your long call strategy is that even if the stock
price increases if It does not increase enough to offset the
losses from the decrease in Option prices or implied
volatility, then overall that long call strategy will be a losing
trade, even if you were right about the stock price
increasing. Does the same concept apply two selling
Options when implied volatility is low? That depends on your
particular trading philosophy but I personally do not think
so. You can sell Options with implied volatility being low you
just have to be aware that if there's a transition back to a
higher implied volatility environment, you have to be
prepared to make the necessary adjustments to your
positions. The bottom line is that you always need to
consider the current level of implied volatility and how
certain changes in implied volatility might make your trade
harder to profit from.
Item number five on our pre trade checklist is are there any
upcoming stock price or market catalysts such as earnings
reports, product announcements or economic data releases?
New information causes stocks and markets to move and
sometimes significantly so you need to be aware of the
upcoming catalysts that could cause the stock price to soar
or plummet in a hurry. When you're trading individual
stocks, it's a good practice to check whether or not there
are any earnings announcements that will occur before your
particular Option position expires. The reason for that is if
you have on a short premium position, then you need your
Options to decay to continue profiting from that position, so
long as the stock price doesn't move too significantly
against you. As that earnings announcement approaches
Options actually begin to decay more slowly which means
you're going to stop having that time decay work for you if
we have a short premium position on. More importantly, if
you accidentally put on in a position and there's an earnings
announcement and you hold that position through the
earnings announcement, you could potentially lose a lot of
money if that stock price moves significantly against you. So
when trading individual stocks, just be sure that there are
no earnings announcements that we're going to occur
before your position expires. An exception to that would be
if you're planning on trading the earnings announcement in
which case you're aware of it and that's completely fine.
Lastly it's a good practice to be aware of when important
economic data releases come out such as unemployment
reports, GDP numbers or interest rate decisions by the Fed.
Item number six on our pre-trade checklist is do you have
an exit point or exit catalyst for losing trades, and this is
perhaps the most important part of every pre trade routine.
You never want to put on a trade especially a highly risky
trade without knowing what price or what event will cause
you to close that position for a loss. A good example of a
highly risky position that you should always have an exit
plan for is a short strangle, so that's when you sell a call
Option and you sell a put Option and you don't have any
protection against either of those Options. Let's say you put
on that position and you don't have an exit plan, you're just
going to put it on and hope that it goes well. One day an
unexpected news announcement comes out related to that
stock and the stock price falls significantly. Well now you're
going to be extremely flustered because you don't know
what to do and you're staring at that large loss and
therefore you're going to make a decision based on your
current emotions at the time which more than likely are not
going to be good decisions. Knowing when you will exit a
losing trade will help you to avoid making emotional
decisions at the worst possible time and I know it sounds
cheesy but it is absolutely true especially when you're
trading highly risky positions.
Item number seven on our free trade checklist is do you
have an exit point or exit catalyst for profitable trades?
When will you close your profitable trades? Well when you're
actually selling Options the decision becomes very easy as
you have more and more profits on that position because
you have very little left to make and you still have a lot of
risk. In the case of short premium positions, it makes more
and more sense to close those profitable trades the closer
you get to the maximum profit potential. In the context of
long premium trades such as buying puts or buying calls,
the decision to close profitable trades is a little bit more
difficult because you have theoretically unlimited profit
potential, so come up with a trigger or system that helps
you determine when profitable trades will be closed or when
you'll start to hedge the profits on those positions. That
wraps up our seven-step pre-trade checklist. I hope you
learned something from it and found it informative. If you
did, please go ahead and post an honest review – it would
be highly appreciated.

OceanofPDF.com
Chapter 9 Options Trading with Time Changes &
Option Deltas

In this chapter we will be talking about how the Option

Greek Delta actually changes over time. With everything in
Options trading nothing is static and the Option Greeks
actually change as time passes and as a respective Option
gets closer to its expiration date There are multiple levels to
learning about the Option Greeks. The first level is learning
the basic definitions and in the case of Delta and Options
Delta is the estimated Option price change relative to a one
dollar change in the stock price. So if we have a call Option
with a Delta of 0.65 that means that if the stock price
increases by one dollar the Option is expected to gain 65
cents in value and if the stock price falls by one dollar, the
Option is expected to lose 65 cents of value.

But this 65 Delta call Option is actually not going to remain

a 0.65 Delta call Option as time passes. The Delta or the
sensitivity of that Options price relative to changes in the
underlying price is actually going to change over time. First
off to recap what an Options Delta is in Options Delta is the
Option's expected price change relative to a one dollar
change in the stock price. So if we have a call Option with a
Delta of 0.65 that means that the stock price increases by
one dollar that call Option is expected to gain 65 cents of
value. On the other hand if the stock price falls by one dollar
that call Option is expected to lose 65 cents of value. First I
want to introduce three things to keep in mind in regards to
Option Deltas and how they change over time and then we
are going to explore intuitively why that might be and try to
make more sense of it as opposed to just memorizing
things. The first thing I want to introduce to you is that an in
the money Option we'll see its Delta approach positive or
negative 1.0 as time passes assuming that the Option
remains in the money. For example if you buy a call Option
with a Delta of 0.65 and that Option is in the money,
meaning that the stock price is above the call Options strike
price, then as time passes and let's say this call Option has
30 days to expiration when we buy it, over the course of the
next 30 days that 0.65 Delta call Option is going to become
a 1.0 Delta call Option.

What this means is that if It remains in the money through

those 30 days to expiration and at expiration it is still in the
money, then the Delta of that call Option will be a positive
1.0, and that will mean that if the stock price goes up by a
dollar, the Option will gain one dollar in value and if the
stock price falls by one dollar, the Option will lose one dollar
of value. Note that is much more sensitive than the initial
Delta of 0.65 because with an initial Delta of 0.65 if the
stock price goes up by one dollar, the Option gains 65 cents
but now as time has passed and the Option is still in the
money, the Delta has increased to a positive 1.0 and that
means it is now gaining or losing one dollar for each one
dollar change in the stock price. Concept number one is that
in the money Options we'll see their Deltas approach
positive or negative 1.0, depending on if it's a call or put as
expiration approaches. We can simulate this by looking at
Options on the same stock and just comparing the same
exact strike Option in two different expiration cycles so in
these images that I’m going to pull up we are looking at
Options on the e-mini S&P 500 futures so we're looking at
futures Options here doesn't matter what product we're
looking at the concept will hold true no matter what we are
looking at.

In this image we can see that the futures contract price is

42.15 and we are looking at the 4200 calls in two different
expiration cycles. In the 92 day expiration cycle we can see
that the 4200 call has a Delta of 0.53. If we look at the 4200
call that has one data expiration, we can see that that call
Option has a Delta of 0.79 so from the 92 day expiration to
the one day expiration we can see that the same 4200 call
has a much different Delta value. With 92 days to go it has a
Delta of 0.53 and with one day to go it has a Delta of 0.79.
You can imagine a scenario where we buy that 4200 call
with 92 days to go and then 91 days later, if the futures
price is exactly the same that call Options Delta has actually
increased from 0.53 to 0.79 in this particular example, and
at the time of expiration the Delta will be a positive 1.0. But
why is this important to you as an Options trader? Well you
need to know that everything is dynamic and things will
change as time passes. If you own an in the money Option
in your portfolio then you should know that as time passes
and as expiration gets closer and closer, the Delta of that in
the money Option is going to grow - meaning that the
Options price change will be more sensitive to changes in
the stock price and for you as a trader that means that your
P&L is going to have much larger swings as the Delta of that
Option grows assuming it is in the money and it is getting
closer and closer to expiration. But let's go to the second
concept that I want to introduce to you today which is the
complete opposite as the first concept that I just discussed.
This is that out of the money Options will see their Deltas
approach zero as time passes and as expiration approaches.
For example if you short a put Option with 30 days to
expiration and that put Option has an initial Delta value of
negative 0.25 and 29 days later the stock price has not
changed, well now that Delta of that put Option is going to
be much closer to zero. So from 30 days to expiration to one
day to expiration if the stock price has not changed and that
put Option is still out of the money, then we know that that
put Option is going to have a Delta very close to zero as
opposed to the initial Delta value of negative 0.25.
Out of the money Options as time passes and assuming that
they remain out of the money, those Deltas are going to get
less and less sensitive to changes in the stock price as out
of the money Option Deltas approach zero, the closer and
closer they get to expiration. Just like we did for the in the
money call Options, we can actually simulate the decay of
an out of the money Options Delta by looking at two
similarly striked Options in two different expiration cycles.
For these examples we are going to look at Apple.

Here the stock price of Apple is 131.79 and the first Option
we will look at is the 29 day 125 put and we can see that
that 125 put with 29 days to expiration has a Delta of
negative 0.19.
If we fast forward and look at the one day expiration we can
see that the one day 125 put has a Delta of negative 0.02.
This demonstrates that if you have an out of the money
Option as time passes and assuming that the Option
remains out of the money the Delta of that Option will
slowly approach zero until finally we reach expiration and if
the Option is out of the money at expiration, it will have a
Delta of zero and expire worthless. Lastly when we look at
the money Options, at the money Options we'll see their
Deltas remain fairly close to positive or negative 0.5 as time
passes but in the moment immediately before expiration, an
Option is either going to be in the money or out of the
money and therefore the previous rules will apply. If an at
the money Option or an Option that has a strike price very
close to the stock price is in the money leading into the final
moments before expiration, its Delta will slowly approach a
positive or negative 1.0. If the Option is out of the money
going into expiration then its Delta will slowly approach
zero. I just want to clarify that when I say positive I am
referring to call Options and when I say negative I am
referring to put Options as call Options have positive Deltas
and put Options have negative Deltas. Now that we've
talked about how Option Deltas will change over time, let's
go ahead and have a little bit of a thought experiment and
explore why this might be and try to understand this
intuitively. For me the easiest way to understand it is that an
Options Delta is sometimes referred to as the estimated
probability of the Option expiring in the money. For example
if we have a call Option with a Delta of 0.35, that means the
call Option has an estimated 35% probability of expiring in
the money. If we look at a put Option with a Delta of
negative 0.67, then that put Option has an estimated
probability of 67% of expiring in the money. Based on that,
we can start to understand Delta as somewhat of a
probability weighted number of shares at expiration. If we
have an Option that expires in the money it will become a
share position of 100 shares, so if I own a call Option and it
expires in the money it will become 100 shares at the
college strike price. If I own a put Option and it is in the
money and I hold it through expiration then that put Option
is going to convert into a negative 100 share position -
meaning I will short or sell 100 shares of stock at the put
strike price if it is in the money and I hold it through
expiration. So if we combine that concept with the
probability of expiring in the money then we can start to
understand Delta as a probability weighted number of
shares at expiration. If we have a call Option with a Delta of
0.35 and that suggests that the call Option has a 35%
chance of expiring in the money, that means that there's an
estimated 35% chance that the call Option will expire in the
money and become 100 shares so if we take a 35%
probability of becoming 100 shares then that gives us a
probability weighted number of shares of 35 shares and
therefore that Option is going to trade similarly to 35 shares
of stock. What that means is that if the call Options Delta is
0.35 and the stock price goes up by one dollar, then that
Option is going to gain 35 cents but when we actually
account for the Option contract multiplier of 100, that 35
cent increase in the Option price is actually going to result
in a 35 dollar change in the overall Option value. In other
words, if I owned that call Option with a Delta of 0.35 and
the stock price goes up by one dollar, my call Option is
going to increase by 35 cents, but for me that is going to
represent a profit of 35. That's the same thing that I would
experience if I owned 35 shares of stock. So if I own 35
shares of stock and the stock price goes up one dollar I will
make 35 dollars. If I own a call Option with a Delta of 0.35
and the stock price goes up one dollar I’m going to make 35
dollars. How does this new concept that I just introduced
relate to the passage of time and how the Delta of an
Option will change as time passes? Well, for in the money
Options the probability of expiring in the money will
approach 100% if the Option remains in the money and the
Option gets closer and closer to expiration, because if an
Option is in the money with less and less time to expiration,
naturally the probability of that Option actually expiring in
the money will grow towards 100 percent. That will be
represented by an Option Delta closer to positive 1.0 for call
Options and negative 1.0 for put Options. On the other hand
if we look at out of the money Options, as time passes and
as an Option remains out of the money, the likelihood that
the Option expires out of the money is going to increase. If
we invert that the probability that it will expire in the money
will decrease towards zero percent. So we have an Option
that is out of the money and it has 30 days to expiration,
but then we go to one day to expiration and the Option is
still out of the money and let's say it's still out of the money
by the same amount, meaning that the strike price is the
same distance from the stock price, then we understand
that the Option has a much lower probability of expiring in
the money because 29 days have passed, we only have one
day left before the Option expires but the Option is still
pretty decently out of the money. Therefore the likelihood of
it expiring in the money is going to be very close to zero
percent. In both of these cases, whether we're talking about
in the money Options as time passes and the probability of
them expiring in the money approaching 100 percent, or if
we're talking about an out of the money Option where the
probability of it expiring in the money is going to approach
zero percent, it makes sense to think of it as the probability
weighted number of shares that it will become at expiration.
If an Option is getting very close to expiration and it has
pretty much a 100% chance of expiring in the money and
therefore becoming 100 shares of stock, then the Option is
going to start trading like 100 shares of stock, which will be
represented by a Delta close to positive 1.0 for calls and
negative 1.0 for puts.

On the other hand if we're looking at out of the money

Options as expiration gets closer and closer and the Option
is still out of the money, then it becomes very unlikely that
the Option will expire in the money and if It expires out of
the money it will expire worthless and it will not become any
shares of stock, so we could therefore say it will become
zero shares of stock. Therefore with that being the case it
will start to trade like zero shares of stock and not be very
sensitive to changes in the stock price and that will be
represented by a Delta very close to zero.
OceanofPDF.com
Chapter 10 Best Practices on How to Get Filled
on Option Trades

This is a topic that I see beginner traders struggling with all

the time and even people that have experience trading
sometimes they don't understand why a trade is not getting
filled so we're going to walk through a basic strategy and
approach for getting better fills on your Options trades.
We're also going to take a look at a real trade that I made
recently in Tesla and we're going to look at the real time
adjustments that I made to my order because I had to make
a few adjustments to the order to actually get filled on that
particular trade. Before talking about a basic strategy that
you can use to fill your Options trades, we need to first start
with the most basic components of actually trading Options
and getting good fills on our Options trades. The first piece
of advice i have for you is to trade liquid Options and that
means Options that are actively traded with a lot of people
transacting in those Options because if you stick to Options
where there's a lot of trading activity, it's going to be much
easier to enter and exit positions in those Options. A lot of
times when somebody is having trouble getting filled on a
trade a lot of times they are trading stocks with Options that
don't have a lot of trading volume and therefore without a
lot of people transacting in those Options it's obviously
going to be very hard to get filled on any trades that you try
to make in those stocks, so the first thing that you need to
be aware of when trading Options is that to easily fill your
trades you need to make sure that you're in a large
marketplace - meaning that you're trading a stock with
Options that has a lot of trading activity in those Options.
The first step is to stick to stocks that have Options with a
large marketplace meaning that there's a lot of trading
activity in that particular stocks Options and if you follow
that rule you will have a much better time filling your
Options trades going forward. There are a few specific
things that you can look at to quickly determine whether or
not a stocks Options are actively traded. The first thing is
open interest which is the total number of Option contracts
that are currently open between two parties - meaning that
there's existing positions in those particular Option
contracts. If a stock has an Option with an open interest of
50 000 that means that there are 50 000 of those Option
contracts that are currently open - meaning that people
have existing positions in those Options. The next thing you
can look at is the bid ask spread and this is the difference
between the bid price and the ask price for a particular
Option. Typically the more narrow the bid ask spread is, that
means that there is a lot of trading activity that is keeping
those Option prices narrow - meaning that the difference
between the buy price and the sell price is very narrow
because people are very actively trading those Options and
naturally the competition from the buyers and sellers is
driving the bid ask spread to a lower margin. Sometimes the
bid ask spread isn't entirely indicative of a liquid Option
because on higher priced stocks which have more expensive
Options, it's completely normal to see Options with much
wider bid ask spreads. The third thing you can look at is of
course volume which is the total number of Option contracts
that have traded on a particular trading day. I mentioned
volume last because if you're trading Options early in the
trading day, volume resets at zero every single day and a
cruise throughout the trading day as more trades are made.
If you're trading stocks Options early in the morning, volume
will be really low because there hasn't been a lot of time yet
in that trading day and therefore the volume or the amount
of transactions that have happened in those Options could
be low. Volume is really only a good indicator if you're well
into the trading day because then you can actually tell
which Options are trading hands very frequently throughout
that trading day. But if It is early in the trading day or if It is
right at the opening bell, then volume will start at zero and
therefore be very low and that may be a misleading
indicator when trying to figure out whether or not a stocks
Options are liquid. But let's go ahead and take a look at
some real Options using the tastyworks trading platform
and I will walk through the points that I just mentioned and
we will do so by using real Option contracts that are
currently trading in the market. The first stock that we're
going to look at is AMD which is advanced micro devices
and for this example we're going to look at the January 2021
expiration cycle which is the closest standard monthly
expiration cycle that is currently available. If I open up the
January 2021 Options I’m going to close up some strikes and
the first thing I want to look at is open interest.

If we look at the strike prices that we have available, we can

go from 87 and a half to 97 and if we go to the call section
and we look at the open interest we can see that there are
numerous strike prices with open interest in the thousands.
This is a really good indicator that these Options are heavily
traded and are therefore good candidates for trading
Options. If we go over to the put side we can see the exact
same thing as we see multiple strike prices with open
interest in the thousands. Typically the more round number
strike prices will have more trading activity so if we look at
the 95 call and put, we can see that the 95 call has open
interest of 18 000 and volume of 4,300, if we go to the put
side we can see that the open interest is 8 000. If we look at
a more obscure strike like the 90.5 strike if we go to the
calls we can see that the 90.5 call only has open interest of
66 contracts and volume of 100 and the same is true on the
put side as we can see that the open interest is 300 and the
volume is 348.

Typically when you're looking at more round number strikes,

those are going to have more activity in the trading and for
that reason I like to trade round number strikes whenever I
construct Option strategies. If I wanted to trade AMD here, I
would probably not trade the 90.5 strike I would opt for the
90 strike or the 91 whatever makes sense for my strategy
but I will choose the strike prices according to the open
interest and the liquidity metrics that we're talking about.
Hence AMD is a good stock to trade. But let's go to
something a little bit different. Let's go to MSTR which is
Microstrategy. This is a bit of a different stock and if we look
at the Options let's go ahead and open up the January 2021
Options, the open interest for the call Options that every
strike price is less than one thousand.
If we go to the put side we see that the open interest is only
in the hundreds and this is an indication that these Options
are not very actively traded. If we look at the bid ask
spreads, meaning the difference between the bid price and
the ask price, let's go ahead and look at the 420 call Option.

The 420 call Option has a bid price of 25 and an ask price of
28. This is a three dollar difference between the bid price
and the ask price and that is fairly wide, so if I wanted to
trade this Option I have to figure out a price between 25
and 28 to trade which is a $300 range when we're talking
about the actual value of that three dollar price difference.
For that reason I would highly recommend trading stocks
that have a little bit more trading activity and narrower bid
ask spreads because you will have a much better time filling
your trades. In these last two examples we looked at one
stock which was AMD and we saw that AMD's Options were
liquid enough to trade without any problems and the bid-ask
spreads were fairly narrow. We then looked at a stock with
much less liquid Options which was Microstrategy and we
saw that the open interest and volume in Microstrategy’s
Options were far lower than that of AMD's and we also saw
that the bid ask spread in Microstrategy's Options was also
much wider, which makes it much more difficult to get filled
on your trades, particularly at a good price. Now let's move
forward and talk about a basic strategy that you can use to
fill your Options trades. Let's start with buying an Option
position which means you are buying a call or put by
themselves or you are buying a call spread or put spread.
When you are buying an Option strategy, if the bid ask
spread is very narrow say a few pennies then really you
should just try to fill that trade at the mid price and more
than likely you will get filled at the mid price and if the bid
ask spread is a little bit wider that's when things get a little
bit more strategic. When the bid ask spread is wider and
you're trying to buy an Option position then I would
recommend trying to buy that position at a price that is
lower than the mid price which is the midpoint between the
bid and ask and then if you don't get filled there after a few
minutes or however long you're trying to wait before
entering the trade, then you can go ahead and adjust your
fill price higher. If you're buying an Option position and the
spread of the bid ask is pretty wide, then I would start a
little bit lower than the mid price and then I would work up
from there. The opposite is true if you are selling an Option
position. If you are selling an Option position and the bid ask
spread is fairly wide then I would try to sell that position
slightly higher than the mid price, wait it out a little bit and
then if you don't get filled then adjust your fill price lower
and that way you can try to discover if you can get filled
better than the mid price since the bid-ask spread is pretty
narrow and there's a lot of potential prices that you could
get filled at, you're going to try to discover whether or not
you can get filled at a price better than the mid price and if
that doesn't work, then you simply adjust your order price
towards the mid price and if you repeat that process enough
times you will eventually get filled. To demonstrate exactly
what I mean by this process, let's go through a real trade
that I recently made in Tesla, which was rolling up a put
Option that I owned in Tesla. I owned a put Option in Tesla
and I wanted to roll it up to a higher strike which means that
I wanted to close out my existing put position and I wanted
to establish a new put position just changing the strike
price. To do that I sold the old put Option and I purchased a
new put Option at a higher strike price in the same
expiration cycle and I did that in one transaction. We're
going to watch this replay and we're going to look at exactly
how I went about trading this and we're going to look at the
few adjustments that I made before actually getting filled on
this trade. I’m going to open up the Tesla Option position
and the put that I’m going to roll up is the 500 put.
I decided to do this manually through the Option chain as
opposed to doing it with the quick roll feature on tastyworks
and since I own the 500 put, the first thing I have to do is
set up an order to sell it. I clicked on purchasing the 600 put
and then I dragged it down to the 650 because I’m just
trying to figure out which put, I actually want to roll that 500
put up and I decided on the 650 put. The mid price of this
roll is 28.30 and I’m reducing that to 28.25 and it just
changed again so I just reduced it a bit more. I’ve sent this
order and i tried to do this roll for less than the mid price, so
we can see the mid price is 28.15, my limit order is at 28.10
and I’m not getting filled.
I’m going to cancel and replace this order. I’m going to
move it up five pennies and try it again.

As you can see I’m not getting filled, the mid price is now
28.25, my limit order is 28,15 and I am not getting filled. I’ll
replace it again, I’ll move it up another five pennies, send
the order again, mid price is 28,26, my limit order for this
roll is 28.20 and still not getting filled.

But here I’m just waiting to see if the price will come to my
order price and it's not. I’ll replace it again move it up
another five pennies try it again, the mid price is 28,30 my
limit is at 28.25 and still not getting filled. I did get filled
right there so I just had to make a couple adjustments, I
started lower than the mid price and then I moved up my
order price by five penny increments after waiting for 10-15
seconds.
Usually I don't wait too long before trying to adjust my order
because usually I just want to get filled but I do this process
very quickly and instead of just paying a high price and
getting filled instantaneously, I try to get the best price
available to me by starting at more favorable than the mid
price and then going from there. I hope that demonstration
was helpful for you. To recap the basic strategy to get filled
on your Options trades, it is very simple. If you are buying
an Option position, meaning you are paying to enter the
trade, I would recommend that you start lower than the mid
price and then adjust your price higher towards the mid
price if you cannot get filled at those prices, and if you
repeat that process enough times eventually you will
discover the price that you can fill that trade at and you will
successfully fill your trade. The opposite is true if you are
selling an Option position - meaning you are collecting
money to exit that trade or enter it. When you are selling an
Option position you're going to want to try to sell it higher
than the mid price and then if you can't get filled at your set
price, then you slowly lower it through order adjustments
and if you repeat that process enough times you will
eventually discover the price that you can fill your Options
trades at. Once again if you are trading Options that have a
very narrow bid ask spread which is the case on something
like SPY or IWM, then typically you can just go right for the
mid price and you'll get filled pretty much instantaneously
and if not, then you only need to change your order price by
a penny or two and you can repeat the process and more
than likely you will get filled after one adjustment if you
were unable to get filled at that first trade.

OceanofPDF.com
Chapter 11 Options Trading Tips for Beginners

In this chapter I’m going to share with you 11 Options

trading tips that should help you become a better more
consistent Options trader especially if you're a complete
beginner and you have no idea where to start or the things
that you should be considering as a beginner Options trader.
These tips cover a lot of different aspects of trading and
Options trading tip number 11 that I’m going to share with
you is the absolute best piece of advice I can give to any
trader - not even just Options traders. The first four Options
trading tips that I’m going to share with you are related to
setting up and entering trades.
Options trading tip number one is to use Delta to choose
your strike prices and if you're a technical trader you can
use support and resistance levels to also help you choose
strike prices for the Option strategies that you're setting up.
If you believe in trading around support and resistance
levels then using these levels to choose your strike prices or
at least using them as a starting point for choosing your
strike prices can help you come up with a system to setup
your Option strategies. For example if you're trading credit
spreads which means you're selling a call spread or selling a
put spread, using support and resistance levels can be a
good way to choose the short strike price that you use in
your credit spread. Let's look at an example.
In this chart of Facebook we can see that Facebook shares
rallied up to $200 before quickly reversing directions and
falling to about 160 dollars per share. If a trader believed
that $200 resistance level would hold in Facebook over the
next one to two months, they could sell a call spread and
profit from that outlook by placing the short strike of the call
spread at or above that resistance level of $200. If Facebook
shares stay below $200 over the next one to two months
and that resistance level holds then that short call spread
that the traders sold would profit because if they place their
short strike at or above $200 and Facebook shares remain
below that resistance level, they would profit from the
steady decay of that cause bread because those call
Options would be 100% extrinsic value which would decay
to zero dollars over time and when you sell a call spread if
the stock price goes to zero dollars you will keep a hundred
percent of that premium that you received when selling that
call spread. Sometimes you might not be able to use a
technical analysis to help set up your strategies and if
you're a trader who doesn't use any technical analysis in
their trading using Delta to choose your strike prices is a
quantifiable system that makes it much easier and
streamlines the process of choosing strike prices for the
Option strategies that you commonly trade. For example a
trader might have an iron Condor strategy in which they sell
the 25 Delta call input and purchase the 10 Delta call input
to complete their iron Condor position. While Delta is the
estimated change in an Options price given a $1 change in
the stock price, the Delta of an Option is also used as an
estimate for the probability of that Option expiring in-the-
money. For example I mentioned selling a 25 Delta call in a
25 Delta put as part of that iron Condor strategy that I just
mentioned. By selling a 25 Delta call Option you are selling
a call Option that has an estimated 25% probability of
expiring in-the-money at expiration which means it has an
estimated 75% probability of expiring out of the money at
expiration since the Delta of 25 is the estimated probability
of the Option expiring in-the-money. By using Delta to
choose your strike prices you are incorporating probabilities
into the way you're setting up each and every trade and
having a quantifiable system is way better than just winging
it 100% of the time. So if you want to set up your trades and
use probabilities, choosing strike prices with Delta is a great
place to start.
Option trading tip number two is to trade Options at liquid
strike prices or active strike prices. In regards to opening
trades and choosing strike prices it's important to choose
Options at liquid strike prices with lots of trading activity
gauged by high open interest and volume, otherwise you
can have a very hard time getting filled on those trades
which is not ideal and could even be dangerous if you're
trying to close position that you've already entered and you
need to close that position to stop the loss from getting
larger and if you can't close your trade before the loss gets
larger because of liquidity issues, that's something you
could have avoided by first trading liquid strike prices.
Trading active and liquid strike prices should not really be an
issue if you're already trading very active stocks or products
such as Apple stock, SPY which is the S&P 500 ETF or
something like IWM which is the Russell 2000 ETF. Let's take
a look at an example to show you exactly what I mean by
this. In this image of SPX Options we can see that there are
put Options with very little open interest while some of the
put Options have very high open interest.

If I were to make a trade using these SPX Options I would be

sure to use strike prices with high open interest as opposed
to using strike prices with very low open interest because by
trading strike prices with high open interest I know I’m
pulled together with lots of other traders who have positions
in those particular Options, so when I want to open a trade
and later close that trade I know there are lots of other
market participants that have positions in those Options
which is going to make it easier for me to close my position.
Using these Options, selling the 28 75-put and purchasing
the 28 50 put to create a put credit spread would be a trade
that utilizes the most liquid SPX Options in this particular
case. If I move those strike prices by one strike price and
instead sold the 28 70-put and purchased the 28 45-put,
that would be a put credit spread as well just like the one
that I set up before but in this case the Options used have
very low trading activity which is a situation that I always
want to avoid.
Options trading tip number three is to mind your risk. As a
beginner Options trader it can be very easy to focus on the
profitability side of trades such as looking at out-of-the-
money strangle positions or iron Condor positions and
fantasizing to yourself about how much money you could
make by selling those position and watching them expire
worthless, but I would very much encourage you to focus on
the risk side of things and not look at how much you can
make but always consider how much you can lose because
it doesn't matter what strategy you're trading, eventually
you're going to have a losing trade and if you ignore the risk
side of the equation, that's not going to be a fun day for
you. Just because you can make $1000 selling that out of
the money strangle that expires in 30 days it does not mean
that's a trade that you should put on because that same
exact trade over a long period of time will leave you with a
significant loss if you're not focused on the risk side of the
equation and that one significant loss could easily wipe out
all of the profits you experienced up to that point, because
you did not pay attention to the risk and you did not have a
plan around what you would do when the position inevitably
it goes against you at some point. In the same light, just
because a trade has a high probability of making money it
also does not mean that that is a good trade. Options
trading is all about probabilities and the risk and reward
potential of any particular Options trade is going to reflect
the probability of its success. If you have a trade with a very
high probability of making money then that trade has small
profit potential and a lot of risk, and on the other side of the
equation if you look at a trade that has a low probability of
making money, that position is going to have just a little bit
of risk and a lot of profit potential. Profit and loss potential
of any Options trade will reflect the probability of that trade
making money and just because a trade has a high
probability of making money or a low probability of making
money, it does not mean those are good trades so always
pay attention to the risk of a position and don't judge a
position based on the amount of profit it can make or by its
probability of making money.
Options trading tip number four is to try and fill your trades
better than the mid-price and then adjust incrementally. if
you're trading an Option strategy that you have to pay to
enter, try buying the position slightly below the mid price
and then adjust incrementally from there. for instance if the
trade you're trying to put on for a debit meaning you're
paying to enter the position and the mid-price is currently
one dollar and fifty cents, try to buy the position for one
dollar and forty eight cents or $1 of forty five cents and then
adjust upwards towards the mid price from there. on the
other side of the equation if you're trying to enter a trade
that you collect a premium to enter, such as selling a call
spread and the mid price for that call spread is one dollar
and fifty cents, try to sell that call spread for one dollar and
fifty two cents or $1 and 53 cents and see if you can collect
more than the mid price for selling that call spread. If you
can't get filled, adjust the price you try to get filled that
incrementally towards the mid price and if you're selling an
Option that means you will be reducing your price towards
the mid price until you eventually get filled on that trade.
But in general if you try to fill trade better than the mid
price eventually you'll pick up some pennies here some
pennies there and that's going to add up immensely over
time.
Options trading tip number five is to set a GTC order at your
profit target right after you enter a trade. One of the
decisions you have to make when trading any Option
strategy is when you will take the trade off for a profit and
once you enter a trade if you set a GTC or good till cancelled
order at your profit target, you won't have to think about
closing that trade if It reaches your proper target which
means that's one less decision you have to think about
when you're trading Options. The less decisions you have to
make, the better.
Options trading tip number six is to use multiple trade exit
triggers - meaning when you enter a trade there should be
many different things you're looking for to determine when
to close that trade and it could be as simple as using a profit
target, you could use a loss target so if you use a profit
target and a loss target you now know when you will close
profitable trades and you now know when you will close
unprofitable trades which is incredibly important when
you're trading any strategy and not even just Options.
Additional trade exit triggers you can use when trading
Options would be Delta based exits and time-based exits. By
using multiple exit triggers you're adding a little bit more
variety to the things that you're looking for that will
determine when you close a trade and instead of just having
a profit target, adding some additional exit triggers can help
with consistency and potentially smooth out your
performance over time. Many beginner traders struggle to
have consistency with when they close trades and quite
frankly a lot of them don't have any plan whatsoever for
what they're going to do when a trade is on. I am no
exception to this because when I started learning Options
and I was trading I was just throwing trades on with
absolute reckless abandon and I had no idea what I was
going to do with the trades that worked out or the trades
that did not work out which is the more important side of
the equation. I’ve learned through experience that having
multiple trade exit triggers can improve with strategy
consistency and performance and it can also help you
reduce the amount of decisions you have to make, therefore
making it a much more pleasant experience when trading
Options. If you don't know this yet trading should not be
stressful and if It is stressful it's probably because you don't
have a lot of rules in place that you're following for every
single trade that you make and by implementing some
trade exit triggers you won't have to think as much about
what you're going to do with your trades once you've
entered them and that's going to make it a much more
pleasant experience. There are four exit triggers that I
believe can be applied to any Options trading strategy. The
four trade exit triggers are profit based exits, lost based
exits, Delta based exits and time based exits. A profit based
exit is simply closing a trade when it reaches a certain profit
amount and I like to use profit percentages as opposed to
specific dollar amounts. A loss based exit is simply closing a
trade once that trade has reached a certain loss threshold
and I like to use lost percentages meaning that if I sold a call
Option for five dollars and the call Options price increased to
seven dollars and fifty cents, I would consider that a 50%
loss because the Options price increased 50 percent from
my entry premium of five dollars. You can use whatever
metric you want to use when calculating profits or losses
but I like to use profit percentages and loss percentages
when using these two exit triggers. A Delta based exit is
closing a position when one of the Options reaches a certain
Delta level. For example let's say my strategy is to sell iron
condors on SPY and I like to sell the call Option with 0.25
Delta and sell the put Option with a negative 0.25 Delta, in
which case I could use a Delta based exit strategy -
meaning that I would close the iron Condor position
altogether if the short call Delta or the short put Delta
reached a certain level. For example since I started with
Delta's at the 0.25 and negative 0.25 levels one of my exit
strategies could be to close the iron Condor if the short call
Delta increased to 0.35 or if the short put Delta fell to
negative 0.35. In both cases the change in the Options Delta
from 0.25 to 0.35 indicates that the market has moved
against one of my spreads and based on whatever Delta you
choose, my strategy would be to close the entire trade if
that Doulton level was hit and by doing so I could re-enter
the trade using my initial entry criteria, which means I
would be reentering that iron Condor and selling the new
point two-five Deltas and closing the old trade which is now
closer to being in the money since the market moved closer
to one of the spreads as indicated by an increase in the
short Options Delta. When using a Delta based exit trigger,
you close the trade at whatever profit or loss that trade
currently has when that Delta limit is reached - no questions
asked, just take the trade off when that level is hit. The last
trade management trigger that I mentioned is the time-
based exit which is simply closing a position after a certain
amount of time has elapsed. For example if I sell iron
condors on SPY and I sell them with 60 days to expiration or
whatever expiration has closest to 60 days until expiration,
an example of a time based exit would be to close the iron
Condor no matter what after 30 days in the trade. if I’m
selling 60 day iron condors that means my rule is to hold
the trade for a maximum of 30 days - meaning the iron
Condor will have somewhere around 30 days to expiration
at which point if my profit or loss or Delta based exit
triggers are not hit, I will take that trade off because thirty
days have elapsed and with the iron Condor getting closer
and closer to expiration that opens me up to additional risk
so I am going to take that iron Condor off and then sell a
new iron Condor using my initial entry criteria - meaning
that I’ll be selling an iron Condor in the next sixty day
expiration cycle, or closest to sixty days to expiration at the
time of closing the previous iron Condor position. A time-
based exit trigger is somewhat of a safety net because it
gets you out of trades that are not working for you or
against you in a significant manner and that allows you to
reset the position using the initial entry criteria that you use
in your trading plan. The tastyworks trading platform just
added a day's open column so you can see exactly how
many days you've been in each position in your portfolio
and that makes it super easy for me to track how long I’ve
been in each of my trades which makes the time-based exit
trigger very easy to track.

It's worth mentioning that all four of these triggers have one
thing in common and that is that they are quantifiable and
easy to track. With a profit and loss base exit you are
tracking the profit of your position, with a Delta based exit
you're simply looking at the Delta of whatever Option you're
tracking to determine when to exit that trade if that Delta
based exit is hit and with a time-based exit you're simply
looking at how long you've been in a position and basing
your trade exit based on that. Having quantifiable rules to
determine when to exit trades is the name of the game and
you don't have to use these triggers but I encourage you to
come up with trade exit rules of your own that are
quantifiable and easy to track and if you do that I can
almost guarantee you will be happier with your trading
strategy and you will find more and more consistency
because having rules takes the emotion out of the game
and turns you into an Options trading robot which is the
goal.
Options trading tip number seven is log your trades.
Everyone hates the idea of keeping a trade log because I
know from experience it can be an extremely tedious
activity but it's definitely worth it because if you don't track
your trades, you're going to have no idea what strategies
are working for you and what strategies are not working for
you. By tracking your trades and keeping a trade log you
can measure the strategies that you've been trading and
see what's working for you, see what's not working for you
by using a trade log you can determine why a trade may be
working why a strategy might not be working and from
there you can adjust. When you're creating a trade log I
would highly recommend automating or calculating all of
the columns that you can so that once you input your data
certain metrics like the profit target or the lost target
automatically update for you and you don't have to
manually calculate those things each and every time, so
make it as easy as possible for yourself by calculating as
many columns in your trade log as you can because that's
going to make it easier to update and easier to maintain
over time. I know it sucks but I’m confident that if you start
tracking your trades, you will dig up some useful
information related to your strategies that you're trading
and you will be able to tweak those strategies based on the
information you gather from your trade log and hopefully
that will help your strategy become more consistent and
more profitable in the future.
Options trading tip number eight is trim the fat and that
means eliminate what's not working for you and focus more
on what is working for you and as you might gather that's
only possible if you have a trade log because if you're not
logging your trades you have no idea what's working for you
and what's not working for you because you can't quantify
your performance of various strategies. I personally believe
learning active trading is a process of elimination meaning
you start with everything on the table and slowly over time
you experiment with different things and throw out the
things that you don't like and simply throw out the things
that are not working and that leaves you with the things
that are having decent success and it leaves you with things
that are having success and you focus more on those areas
and get rid of the stuff that's not working and that's just
going to help you become a better trader.
Options trading tip number nine is to not be afraid to
experiment with different strategies especially when you're
just starting out. The best way to learn Options trading and
the most effective way to learn Options trading or anything
for that matter is to get real-world experience. By
experimenting with lots of different trading strategies and
approaches you will learn those strategies and approaches
very quickly because you'll have skin in the game and you
will be watching those positions like a hawk and on top of
that I would recommend trying to figure out why those
strategies are profiting or why those strategies are losing
money on a daily basis so that you understand on a deeper
level how Options work in general because there are certain
Options trading concepts that will carry over to every single
strategy you ever trade as an Options trader. With that said
if you have a large trading account to start with and you're
just learning, do not open a trading account with whatever
you have instead start with a small portion of that because
in the introductory phase where you're experimenting and
you're learning, there's a really good chance that you're
going to suffer losses and if you make one big mistake you
could lose a substantial sum of whatever you're starting
with and that's why you do not want to start with a large
account if you have the Option to. If you're just starting out
and you only have a few hundred dollars or a few thousand
dollars, that's fine just understand you need to keep your
position very small. If you're starting out a good way to keep
your risk in check is to stick with low priced stocks and trade
defined risk strategies such as call spreads and put spreads
and by sticking with those types of strategies on lower
priced stocks you'll be able to create positions that have
very little lost potential - meaning that if those trades go
belly-up and you lose a hundred percent of the maximum
loss potential you won't lose a substantial sum of money.
Options trading tip number 10 is to not over complicate
things. I see all the time people trying to over complicate
things and with Options it's already complicated but when
you try to trade 15 to 20 different Option positions in your
portfolio and you're looking at all these crazy metrics and
arbitrary numbers to try to figure out when the optimal time
to sell an Option is or when the optimal time to buy an
Option is, it's just going to get too complicated and it's
going to be very hard to manage that portfolio which is
going to reduce your likelihood of success. Remember that
simple is better because simple is easier to follow. The most
common ways I’ve seen traders over complicate things are
by trading too many positions and by focusing on arbitrary
metrics or trying to find Holy Grail entry or exit points or
even Holy Grail strategies. By trading more and more Option
positions you will inevitably have conflicting outlooks -
meaning that you'll have a bullish strategies, bearish
strategies and neutral strategies all of which will perform
well in different market environments but if you have them
all on at the same time in the same portfolio some of those
positions are going to profit some of those positions are
going to lose money and where does that leave you in terms
of net profitability. I honestly have no idea and I’ve never
been able to figure out a way to successfully trade 15 to 20
different Option positions, not to mention the fact that it is
very stressful to track 15 to 20 different Option positions,
especially if you're implementing some of the trade exit
triggers that I discussed earlier so personally from my
experience I have learned that trading fewer positions and
increasing the size of those positions and using very strict
trading plans around those strategies is a much more viable
approach to successful Options trading, compared to trading
a portfolio of 10 or more Option positions. Personally I only
have one or two positions on at the same time maximum
and most of the time it's just one so I encourage you to just
think about that. I’m not saying one way or is right or one
way is wrong - I’m just saying consider the two approaches
and see what works best for you. For me I like my trading to
be very stress-free and that means I need to focus on only a
couple strategies that are 100% quantifiable and for me
trading a portfolio of fifteen to twenty different Option
positions is just never going to work.
Options trading tip number eleven is to come up with a
trading plan that is 100% quantifiable as discussed earlier.
The ultimate destination when you're learning to trade
Options or getting actively involved in the stock market is to
come up with a trading plan that leaves nothing up to the
imagination, which means you know what stock you're
trading, what strategy you're trading, how you're going to
set up that strategy exactly, how you're going to size that
strategy based on your portfolio size or however you size
your trades consistently, when you're going to enter the
trades and when you're going to exit the trades. By coming
up with those things you're going to reduce the amount of
decisions you make you're going to make it way less
stressful for yourself and most importantly you're probably
going to improve the consistency and profitability of your
Options trading so you have to come up with a 100%
quantifiable trading plan at some point, but if you're just
starting out and you're in the experimentation phase, it's
completely fine to not have a trading plan just know that if
you're serious about doing this and actually making money
consistently over a long period of time you have to have a
trading plan otherwise all bets are off. I hope you learned
something and picked up a couple things that you can apply
to your trading to help you become more consistently
profitable and just become a better trader overall.

OceanofPDF.com
 BOOK 2
OPTIONS
17 TRADING STRATEGIES
FOR BEGINNERS

COVERED CALLS, NAKED

PUTS, OPTION STRADDLES
AND SPREAD OPTIONS
TRADING TECHNIQUES

WILL WEISER
OceanofPDF.com
Introduction

Options trading can seem like gambling

with the potential to make loads of money
magically appear or disappear in an
instant, but understanding how to trade
Options can help you both lower your risk
and make more money in your
investments. Options can be used to
generate enormous profits or they can be
used to hedge current positions, so they're
a very versatile tool that every investor
should at least know how to use. But what
are Options you might ask? Well, there are
two types of Options; calls and puts. A call
gives the buyer the right but not the
obligation to buy a stock to call it away
from the Options seller and they can do so
at a certain price by a certain date. In the
meanwhile, the seller of the call has the
obligation to deliver that stock if the buyer
demands it. Pretty simple right? Well, if it’s
that simple, how comes not everyone can
become a successful options trader?
Despite its many benefits, options trading
carries substantial risk of loss, but like any
other business, becoming a effective
options trader requires a certain skill set,
personality type and attitude. Ok, but how
much do the best options traders make in
a year? Well, the salaries of Options
Traders in the US range from $29K to
$791K, with a median salary of $142K.
The middle 57% of Options Traders make
between $142K and $356K, with the top
86% making $791K. The question remains
– do you want to be in the top tier? I
though you do, but let's admit it, most
beginner options traders are no
professionals. In fact you must master the
lack of robust trading mentality and follow
proven systematic approach. But worry no
more! This book will take you to the next
level! In fact, if you want to discover how
to become a thriving Options trader, then
let me share with you the agenda of this
book. First you will discover what is the
best low risk Options trading strategy for
covered calls and naked puts. Next you
will learn how to implement protective put
covered call strategies, bull, bear and
calendar spread option strategies, option
straddles and options collars strategies.
Moving on, you will discover how to trade
covered calls the right way, how to trade
Options using expected value dynamics,
how to trade options using volatility and
why you should trade vertical options
spreads. After that, you will discover how
to deploy bull call spread options trading
strategies, bull put spread options trading
strategies, bear call spread options
trading strategies and bear put spread
options trading strategies. Lastly, you will
learn how to profit from vertical spreads
versus time left until expiration as well as
vertical spread profitability versus implied
volatility and what happens at expiration
to a vertical spread when it comes to
Options trading. Finally, you will discover
when to use options trading strategies and
how to select the right options strategy for
most efficient profitability. As you can see,
this book is a comprehensive guide on
Options trading and will reveal the must-
have trading skill that every pro has. By
finishing this book, you will become a
consistently profitable trader,
nevertheless, it is suggested to read the
book or listen the audiobook several times
to follow the provided guide. The
audiobook listeners will receive a
complementary PDF, containing over 80
colored images of charts and proven
trades on several platforms, therefore it’s
also advantageous to highlight critical
subjects to review them later using a
paperback or hardcover book, or the
accompanied PDF once printed out for
your reference. If you are a complete
beginner, having limited knowledge or no
experience and want to speed up your
trading skills, this book will provide a
tremendous amount of value to you! If you
already a trader but you want to learn the
latest tricks and tips, this book will be
extremely useful to you. If you are ready
to change your life, let’s dive deep
together, covering all the ins and outs so
that you can have the best chance
possible to become a consistently
profitable trader!
OceanofPDF.com
Chapter 1 When To Use Options Trading
Strategies

Options are getting increasingly popular and they certainly

offer a very accurate way to manage the risk and return of
your portfolio as an investor, but they certainly come with a
bigger overhead in terms of complexity. So in this chapter
we're going to start off with the basics, how Options work
and what they are, but also talk about the environments in
which Options really thrive and where they could benefit
your portfolio. Let's start off by looking at what we mean by
an Option. In fact let's start off with a call Option which is
the right to buy a stock at a fixed price at a fixed time in the
future. That sounds like a pretty simple definition so now
let's compare it alongside what we could do which is simply
to buy a stock. The stock we're going to buy is an S&P
tracker an ETF called SPY. The price of that stock at the
moment is 415 dollars and I’m going to buy a hundred of
those shares and that means I’m going to pay $41,500
today. Alternatively I could buy a call Option on the same
stock. But when you buy a call Option you have to make
more choices. Firstly what's the price at which you want to
buy that's called the strike price and I’m going to choose
$420 so that's a little bit above where we are today about
five dollars higher. The second decision is when our Options
going to expire and in this case I’m going to choose an
expiry date, which is about a month in the future. What's
really different about the Option and critically important is
that it costs a lot less than buying the stock. Instead of
paying four hundred dollars I only pay about four dollars
which is about one percent of the stock price, and normally
an Option will give you the right to buy a hundred stocks at
a time. You can't buy an Option just to buy a single stock so
if in one month's time the price of this stock is very high,
let's say 450, well I’ve got a bargain. I can buy it for just 420
and I’ll exercise my Option - my right to buy it at that low
price and because it's a right to buy a hundred stocks, we
have to multiply that four dollars by a hundred and the total
price I pay for the Option is 402 today. If I’d have gone down
the route of buying the stock, in one month's time I’d make
a profit if the price of SPY was more than the price I paid
which was $415 and the amount of money I make or lose
goes up one for one with the stock price. Whereas if I buy
the Option I’ll make a profit if the price is greater than 424
dollars and two cents. But wait a minute, the strike is 420 -
why does it have to go up to 424 dollars before I make a
profit? Well that's because of the premium I paid which was
four dollars and two cents so my break even price when I
make back my premium and then I get into profit is going to
be $424. But if the price in a month's time is less than $420
then I wouldn’t exercise my Option and it'll expire with no
value and that means I’d have lost my entire premium. As a
proportion of my investment that would be a hundred
percent loss which sounds terrible but remember that I only
paid one percent of what I would have paid if I’d have
bought the stock. But still, a hundred percent loss is a
hundred percent loss and it is actually quite likely that I will
make that loss. That's the typical trade-off when you're
buying Options. You pay a small proportion of the upfront
value of the thing you're buying but unless you pay a huge
amount for the Option there's a fairly high probability that
you'll lose your entire investment. But if the price is above
your strike price plus the premium, then you start to break
even and you make a leveraged profit and that's what we're
coming on to now.
This is called a payoff diagram and here on the x-axis at the
bottom of the graph we've got the price of the stock at
expiry and on the left we have low values of the stock at
around $390 and on the right of the graph we've got high
values of the stock at around $440. This dash red line you
can see the vertical one is the strike that i chose which is
$420 and if at expiry the price of the stock is below that,
then I’ll make a hundred percent loss.

Here's my break even which is 424 dollars and two cents

and if we go beyond that price then I start to make a profit.
Not only do I make a profit but it's a leveraged profit I put
very little money down but the amount of money I make on
the trade becomes extremely large as a percentage of that
investment. The y-axis of this graph was in terms of dollars
and cents. Now let's look at it as a percentage of the
amount I invested. The x-axis of this graph is the same. It's
the price of the stock at expiry but the y-axis is the
percentage profit I make relative to my invested premium.
Let's say that the price of SPY increases by six percent. Well
if I bought the stock I’d just make money one for one so I’d
have made a six percent profit, whereas with the Option I’d
have made a 400% profit and that's because of the leverage
built into the Option, and if the price of the stock had gone
down by six percent well I’d simply lose six percent if I’d
have bought the stock, but with the Option I’d have lost a
hundred percent and that's because the price would be
below the strike and the Option would expire worthless. The
big difference between buying a stock and buying an Option
is the shape of the payoff. Whereas the Option is this
hockey stick shape it's non-linear - for the stock it's just a
straight line it's a linear investment. So a call Option is a
right to buy and an Option to sell at a fixed price at a fixed
time is called a put Option and this is what the payoff looks
like for an Option to sell at $410. Again the premium means
we start off underwater because we had to pay the premium
up front and then we reach our breakeven which is the
strike of the Option minus the premium and then below that
price we make increasingly large amounts of money as the
price of the stock falls. So if you're bearish on a stock you'd
buy a put Option and if you're bullish on a stock you buy a
call Option, and both of those choices would be leveraged
and that means that the percentage gain that we make
would be very significant as a proportion of our very small
initial investment. Some people will have heard of Options
because of the stories about Tesla millionaires. Here's one of
those stories from Nancy Boots Davison who talks about one
of her son's friends. He was 29 years old he bought 40 000
worth of Tesla call Options in spring 2019 and let them ride.
But then he made so much money that he walked into the
boss's office and said he was quitting and that was because
he was a multi-millionaire - thanks to those Options. Is that
really possible? How much would someone have to invest to
become a millionaire with Tesla call Options during the rally
we just saw. Here's the incredible rally that we had in Tesla
stock in 2020 where of the space of just over 200 days it
increased in value by over a thousand percent. If you'd have
simply bought the stock, in order to become a millionaire
you'd have only had to invest around 136,000 and then the
seven-fold increase in the price of the stock would have
pushed that investment up to a million dollars by the end of
2020. But if in April you'd have bought Tesla call Options for
the end of the year struck at 200 you could have invested
much less. In fact just over four thousand dollars would
have got you up to a million dollars in terms of the payoff
and that's because due to the leverage built into the call
Options that have multiplied your money almost 250 times.
So during these periods when we have sustained strong
rallies, call Options provide the leverage to really monetize
those rallies but of course in April no one really knew
whether the rally would be sustained. So just as with buying
a stock there's uncertainty about outcomes, and it's
certainly not true that buying a call Option will give you a
guaranteed profit - far from it. It actually gives you a fairly
high probability of losing your entire investment. But if there
is a rally then at least you can make a leverage gain from
that rally. In February in 2021 that's when the rally fizzled
out for Tesla and many other growth stocks. Another way to
compare stocks and Options is to think about exactly what it
is you're buying. When you buy a stock you're buying
something with unlimited upside. Unfortunately you also get
all of the downside right down to a price of zero, and
certainly when compared to Options you're paying a lot for
all that upside and downside. How about if you didn't want
the downside and how about if you only wanted to buy the
upside of a stock? Well of course you have to pay something
for that and that's the premium that you pay up front. That's
what we're doing with the call Option we're just carving up
the P&L and saying well I don’t want the downside, I want to
cap that but I do want the upside and I’m willing to pay a
certain amount for it and in the case of a put Option I’ve
decided that I don’t like the upside because I don’t think it's
going to happen and if we're bearish on a stock, then how
about if we turn the downside into upside. That's effectively
what we're doing with a put Option - we're monetizing the
downside of a stock. But unlike shorting a stock where we
stand to make unlimited losses if the share price rallies -
with a put Option we've kept our downside if the stock does
rally. But if you can buy Options, maybe you can sell Options
as well right? Yes you can. This is what the payoff looks like
if you sell an Option - it's just the numbers reversed and
whereas buying a call Option was bullish selling a call
Option is bearish and that's because instead of paying the
premium on the first day, you receive the premium and now
the game is you want to hold on to that premium, and that
only happens if the price of the underlying stock doesn't
increase. What you're hoping is that that won't happen. But
if it does happen now you've got this fairly toxic unlimited
downside and this is called a naked call. Selling an Option is
called writing an Option. So if you write a naked call that's a
very dangerous position and you can also sell a put where
the P&L is simply reversed, but now this is like a weekly
bullish position on the stock because you get to keep your
premium if the stock price rallies, but if the stock price falls
below the strike, you start to lose that premium and you
have a very large downside. In this case it's not unlimited
because the lowest price that the stock can go to is zero, so
it is a finite loss but it could potentially still be a very large
loss. So if you sell Options or write Options, then you've got
a capped upside but you take in a premium straight away,
but unfortunately it comes with a very large downside or an
unlimited downside in the case of call Options. Now the
basics are out of the way we can start to do the real fun
stuff which is combining Options. Now we are going to
combine Options to create Option strategies. To start, we're
going to combine two things. We're going to sell a call
Option but that's got an unlimited downside because if the
price of the stock increases we could lose unlimited
amounts of money. So at the same time what we're going to
do is buy the stock as well and this is now called a buy right
- we buy the stock and we write the Option. Why would you
write the Option? Well that's to generate income.
Remember, when we sell an Option, we pocket the premium
and that way we increase the yield we receive by owning
exposure to this stock. This is what the combined payoff
looks like above the strike price the payoff is flat. We don't
gain any more money if the price of the stock rises.
Whereas below the strike price we've still got all of that
downside.

Another way to think about this trade is as a curbed

enthusiasm trade. We don't believe in the upside of a stock
beyond a certain point, so we simply sell it and pocket the
premium and that increases our yield or income from the
stock. Just as before we buy a hundred stocks - that cost us
a total of just over $41 000, but we make a small gain by
selling the Option. So let's say I don’t think the stock is
going to go up by more than 10 over the time between now
and the end of the year. Well in that case I could just sell
that upside to somebody else and pocket the money today.
I’d sell the 460 strike which is about 10% above where the
stock is today and the expiry I’d choose would be for the
end of the year and by selling that Option, I reduce the cost
of buying the stock by 475 dollars. But this is the price I pay.
If the stock does rally above my strike price of 460 by the
end of the year then I will not make any profits. I’ll be
kicking myself because I’d have sold that upside.

However if the stock is below the strike price, the dashed

line here is how much profit and loss I’d make with the stock
itself, whereas my Option strategy my buy right is above
that line and that's because of the premium which I
pocketed on day one. The price of an Option increases when
volatility is higher and that's when stock prices are moving
around a lot. At the moment volatility has actually come
back to fairly low levels, so there's not a massive benefit in
selling the Option. If we do this continually if we roll our
Option position and we're continually selling the upside then
during periods of high volatility - that can actually monetize
that volatility and turn it into an income for us. If you want a
measure of what the volatility is for typical Options on the
S&P 500 and the calculation for this index which is the Vix
index is based on 30 day Options which are deeply out of
the money. It varies hugely over time so during the very big
sell-off in March 2020 Vix spiked to well above 80 percent
and during the big sell-off in 2008 and 2009 again it
touched that 80% mark, and if you'd have been doing buy
rights at that time you'd have made a significant gain by
selling that upside volatility. Of course you'd have lost
money on the downside because remember we've kept the
downside, but the point is that the yield enhancement would
have been significant. Also the volatility remained elevated
for a long period of time even while equity was rallying so
this in fact was a great time for buy rights between March
2020 and the end of 2020. For the stocks which didn't rally
a lot the boring stocks but where the volatility remained
high, these buy rights would have been perfect as a yield
enhancement tool. In fact you don't even have to do it
yourself.

There are many by right ETFs where they take an index,

they sell the upside every month and that way they increase
the yield on the index. Here's a list of seven of those buy
right ETFs. The most popular of which is QYLD and that's a
yield enhanced version of the Nasdaq and if you look at the
dividend yield of that ETF, it's a colossal 11.8 percent and
that's very efficiently turn the volatility of Nasdaq stocks
into a high yield for its investors. Here's a description of that
ETF on Global X's website - they're the creator of the ETF
and as they say; this historically produces high yields in
periods of volatility. As we saw, volatility's certainly been
falling recently so that yield enhancement won't be so
great, but eventually you can bet it'll pick up again, and as
they say buying the fund saves investors the time and
potential expense of writing those call Options themselves.
When will this underperform? Well it's during periods of very
strong rallies because there you've sold the upside so you
won't participate in as much of the upside as other investors
that just bought the index. I have spoken to a lot of people
who say they're scared to invest because they're worried
about a crash, so for those people something like a
protective put might be the way to go.

Firstly we buy the stock notice the payoff is a straight line

one for one with the underlying but at the same time we
buy a put and that protects us beneath the strike price. The
strike price is the point at which we don't lose any more
money, and when we combine the two payoffs we end up
with something that looks very much like a call Option.

As before we pay about forty two thousand dollars for the

stock, but we also have to pay an insurance premium and
that's thirteen dollars and fifty six cents. I’ve chosen a strike
of three hundred and seventy four and that's ten the current
price of SPY and that's the point at which my protection will
kick in. This protection will expire in December and if I want
to carry on the protection I’d have to buy another Option, so
you can see the drawback of this approach which is that
you're continually having to pay premium to protect your
downside. You can make that protection cheaper by
lowering the strike price, but then the drawback is that you
could take a larger loss if the index does fall. This is what
the payoff looks like in practice and again the dashed line is
the payoff if we just own the stock.
Notice that the premium drags down our gains because of
the fact we had to pay up front, but of course if the worst
comes to the worst and the index does tank, then our
insurance policy pays off and because of the put we'll have
capped our downside. But what would you do if you're both
nervous at the downside and you wanted higher income on
an index? Well in that case you could create a caller. This is
a combination of a covered call, so we'd buy the index, we'd
sell the upside beyond a certain point in order to generate
an income and we'd also buy a protective put to protect us
on the downside. Selling the call Option would generate a
premium and buying the put would absorb some premium.
We're still better off if the index increases in value because
we do have some upside but if the stock price increases
above the call strike, we don't make any additional profits.
However if there is a bad outcome and the stock expires
below the put strike then we get our protected downside.
This is actually a fund with the ticker NUSI created by a
company called Nationwide and as ETFdb points out in its
report, look at the expense ratio it's 0.68 which is very
expensive for what is effectively a Nasdaq tracker but as
they say the protection comes at a price NUSI's
management fee is three times that of the Invesco QQQ
trust - a plain vanilla index fund that tracks the tech heavy
Nasdaq 100. While selling the upside calls does reduce the
amount you have to pay for this, it's still a very expensive
way to get exposure to the Nasdaq. This trick of selling the
upside to reduce our costs is used all over the place. Let's
say we're enthusiastic about a stock but we don't want to
pay the full price for a call Option. Well in that case we could
do something called a bull call spread.

First of all we buy a call Option with unlimited upside but if

we don't think that the stock is going to go above a certain
level, we can sell that upside in the form of another call
Option. We have another strike which is the upside we don't
believe in and that way this strategy reduces our overall
premium cost and what we end up with is a payoff that
looks just like that collar that we saw previously.

Below the lowest strike we've capped our downside and

above the upper strike we've kept our upside and between
the two strikes once we cross our break even here, is where
we make our money. So for example we could buy a 370
strike call Option on spy which would cost us 56 dollars but
to make it a little bit cheaper, we could sell some upside
beyond 460. That would gain us about five dollars in
premium and this is what our payoff would look like; our
break even would be 421 so if the value of SPOI exceeds
that, we start making money but then we'll only make it up
to the upper strike price. Beyond that our upside is capped.
Sometimes there's a big event for a stock and we don't
know which way it'll push the price. What we do know is
that the price will move a lot; either up a lot or down a lot.
In that case we could buy a straddle unfortunately this is
quite an expensive strategy because you have to buy two
Options; we'd buy the put Option that's the payoff and we'd
also buy a call Option, and both of them would have the
same strike. When we combine them this is the payoff we
get.

We only lose money with this strategy if the stock price

doesn't move much beyond these two break-evens. When
would this be useful? Let's imagine we've got a drug
company which is about to publish the results of a medical
trial. Either it'll be successful in which case the share price
will rise massively, or it'll be a failure in which case the price
will tank. We don't know which way it's going to go but we
know it'll go one way or the other. Well in that case a
straddle would be perfect. Notice that we're buying both of
these Options with a strike of 417 and we have to pay
roughly equal amounts for both and that's why this is such
an expensive strategy. We'll lose money with this straddle if
the price of the underlying ends up between 369 and 464.
But if it's outside that range, we'll either make money on the
upside or on the downside. We don't really care which it is.
But is there's a way to make this Option strategy cheaper? I
wonder if it involves selling some of the upside and
downside with more Options and that's exactly what we do
with the iron condor. This has made the straddle cheaper in
two ways; firstly I’ve moved this strike of the put and the
call apart from each other so I’m buying a call at 460 which
cost me 4.81 and I’m buying a put struck at 370 which cost
me 12.78. But at the same time I sell a call with a strike of
500 and that gains me 94 cents and I sell a put with a strike
of 330 and that gets me about seven dollars. Unfortunately
the break-evens are further apart than they would be with a
straddle but this strategy is a lot cheaper than a straddle.
This is called the condor because we flatten the upside by
selling those Options; both on the upside and on the
downside, but that's why this is a cheaper strategy because
we've sold those Options. So Options are great fun but
before you rush out and buy them, let me just make you
aware of some of the dangers. The first danger is
complexity. If you don't really understand something, you
shouldn't buy it. It does require a huge investment of time
to understand Options deeply and even then it doesn't
guarantee that you won't screw up and that's why for most
people keeping it as simple as possible is the best way
forward. The other drawback is that for some of these
Option strategies are a lot like gambling and many of the
cognitive biases that make us bad investors are amplified by
Options. For example fear of missing out; when we see a
huge potential payoff from call Options we're very tempted
to over trade or take too much risk. By their nature Options
come with an expiry date and that means you can't just
leave them and ignore them which is a great way to invest
with indices for example. Once you reach the expiry date
you're forced to do something; either to roll over the Option
position or to take out a new one. If you've been investing
for many years and you feel you've got those cognitive
biases under control, then perhaps you should consider
Options. But first you should definitely look deeper into how
they work so you've got a full understanding of their risks.

OceanofPDF.com
Chapter 2 Low Risk Options Trading Strategy
for Covered Calls and Naked Puts

Buying calls and puts in order to make really big profits

comes with big risk. But in this chapter I’m going to show
you a conservative strategy for generating income and
whether your goals are an extra few hundred dollars or a
few thousand dollars a month, these conservative strategies
can help you get there and you can do it without taking on
all that extra risk. We're going to do it by selling Options -
Options that we don't own. One of the cool things about the
market is that we can sell things we don't yet own. You know
the market axiom buy low sell high? Well we're going to sell
high first and then buy low, hopefully at a lower price later
and I’ll show you exactly how it works. Here's how it works
using two conservative strategies; selling covered calls and
selling naked puts. Let's talk coverage calls first. When you
sell a covered call it's like being a bookie. If you own a stock
you can sell call against that stock. The buyer of the call has
the right but not the obligation to call that stock away from
the seller or buy it from them. As the seller of the call, you
have that obligation to sell the stock if the buyer demands
it. For that right the buyer will pay you. Let's say you buy a
hundred shares of Walmart currently trading at 137 dollars
you could sell one call with an expiration the third Friday of
December at a strike price of $150, so that December one
hundred fifty dollar call is trading for four dollars. That
means the buyer of the call is going to pay you four dollars
per share or four hundred dollars because Options contracts
are in 100 share increments. The buyer is betting that
Walmart is going to be higher than $150, as the seller of the
call you're the bookie, as the bookie you're taking that bet
and I’ve never met a broke bookie. For Walmart to pay off
for the buyer that call has to appreciate by nine percent. If
they want a more certain bet - let's say that Walmart will
only be at $140 instead of $150, they're going to have to
pay more for that right just like a bookie is going to charge
you more for betting on the chiefs than they are for betting
on the jets, because the jets are terrible and the chiefs are
very good so the chief's bet is more certain, they will charge
you more for that bet. Your real risk here is opportunity risk.
If Walmart shoots higher to $200, well you have to sell the
stock at $150 and so you miss that upside but remember,
you're getting paid for that opportunity risk and also to
remember you could always buy back the call at a higher
price if Walmart choose higher if you really want to hang on
to the stock. We don't know where Walmart's going to be in
December but you're willing to accept $400 to take on that
risk that it will be higher. If it's not above $150 at expiration
the call expires worthless and you keep the entire $400. As
the call seller you have time on your side. As Options get
closer to expiration their prices start to decay so in
November, if the stock hasn't moved that four dollar call
may only be worth two dollars and at that point you could
even buy it back for two dollars so you'd have a profit of two
hundred dollars and then sell another call a little bit further
out down the road that would be more expensive and you
could make more money that way. The other risk is that the
stock falls and you own Walmart at $137 but remember you
bought Walmart anyway - you own the stock anyway so the
risk is the same as just buying the stock except now you're
getting an extra $400 to cushion that loss if the stock does
go down. If the stock did get called away at $150 so you
have to sell your shares at $150 you still made a $13 profit
plus you kept the four dollars that the call buyer paid you so
that's a $17 profit you've made 12 percent on your money
in just three months. One last thing about covered calls; you
should only sell covered calls on stocks you're okay with
selling because at some point in your career of selling
covered calls, stocks will get called away from you. So only
sell those calls on stocks you're okay with selling and if you
want to own the stocks for years then selling a covered call
is not the right strategy. Now let's move on to naked puts.
Puts are like insurance contracts and people buy puts are
often hedging their positions, making sure that they don't
lose money if the stock craters. Well when you sell a put
you're the insurance company, and what do we know about
insurance companies they make a lot of money. There are
skyscrapers in every major city with the names of insurance
companies on top of them. When you sell a put, you are
giving someone the right to sell you their stock at a certain
price by a certain date. Remember when you sold a covered
call you're selling the right for somebody to buy your stock
and when you're selling a put, you're selling the right for
somebody to sell you their stock. So Walmart's trading at
137 dollars, you could sell the December $125 puts for four
dollars. You don't own the stock and that's why it's called
naked puts. This means that the buyer of the puts can sell
you $100 shares of Walmart for $125 at any time between
now and the third Friday in December. If the buyer chooses
to sell you the shares you have the obligation to buy them
at $125 or $12 500 - again because that's for 100 shares
and remember you also are keeping the 400 dollars. In order
to take on that risk, you are getting paid the four hundred
dollars just like an insurance company gets paid to take on
risk of replacing your house in the event of a disaster. If
Walmart's trading above 125 dollars at expiration, you keep
the 400 dollars just like the insurance company keeps your
premium if your house doesn't burn down. But because
you'd be obligated to pay $125 for Walmart, I only
recommend that you sell naked puts on stocks you'd be
happy to buy at that strike price. Perhaps you think 137
dollars is too much to pay for Walmart today, but you
believe 125 dollars is a fair value. So if you're forced to buy
it at $125 you'd be okay with that, plus don't forget you
receive that additional four dollars per share so it takes your
entry price down to $121. The risk is that the stock
plummets below 125 dollars and you're sitting on a paper
loss, but again this is a stock that you were okay with
buying at 125 dollars at that time. Of course like with
covered calls you always have the ability to buy a put back
before the stock is put to you. But you can see why I say
you should really sell puts on stocks that you are happy to
own at that strike price. Selling covered calls and naked
puts are great conservative strategies for generating
income every month.

OceanofPDF.com
Chapter 3 Protective Put VS Covered Call
Strategies

Our first Option trading strategy is the covered call and I’d
say these accounts for the majority of my Options trading. A
covered call is where you own the shares of a stock and
then sell call Options against them. In our Tesla example if I
owned 100 shares of Tesla I could then sell a call Option
maybe at a 435 dollar strike price and collect that 37.45 per
share and then two things could happen. If shares of Tesla
don't increase to that 435 dollars each by January or above
that amount then I keep my shares and that 37 premium for
the call Option. The investor that bought the call Options off
me isn't going to buy the shares for that 435 dollar strike
price if they can just go into the market and buy the shares
for less. So I keep my shares and about thirty seven
hundred dollars for each call contract. The other scenario on
the other hand is if shares of Tesla do rise to over the 435
dollars each by January, then the investor is going to buy
my shares off me at that price and they're going to use the
call Option that they bought. I keep that 37.45 each the
premium and then i sell my shares for the 435 dollar strike
price. Getting less for your shares than the market price
sounds like a bad deal but there are some very good
reasons why you would want to use this covered call
strategy. Collecting that 37.45 per share premium means
you lower your risk in the shares. If you're worried about
maybe some near-term weakness in Tesla then it's a great
way to make some money on the position even if the share
price falls. Even if the share price rises though and you sell
your shares for 435 dollars in this example, the fact that you
collected that premium means the price you actually got for
your shares is much higher. You're actually getting 435
dollars plus that 37.45 for each share or a total of 472
dollars each. Since these prices are for the January calls
that's a 12 return in just two months from that 422 share
price where the stock is at right now. 12% in two months is
pretty damn good. Another reason why you might use this
covered call strategy is just a cash flow on a non-dividend
paying stock. Dividend investors aren't going to be getting
anything on shares of Tesla for quite a while, but I can go
into these January 2022 Options I can sell the 470 strike
price call Options and collect ninety seven dollars each. That
ninety seven dollars on each share here is about a twenty
three percent cash return - a twenty three percent dividend
and as long as the share price stays under the 470 dollar
strike price when the Options expire next year then I keep
the shares and can sell another call Option for more cash
flow. This is a strategy I’ve used on both Cisco and Teva
recently. I like Cisco as a long-term play on that cloud
computing and the other trends but was worried about that
near-term outlook. I bought shares at 39.50 each and at the
same time sold a call Option at a strike price of 45 dollars
for about 365 each, so you can see even though my shares
are down 51 cents each so far - the value of that call that I
sold is down to three dollars and 37 cents so I’ve actually
made two dollars and 86 cents per share or about a seven
percent return on the investment. As long as the Cisco
shares stay under 45 each over the next two months to that
January 15th expiration, I’ll keep the entire premium that
364 dollars and my shares and it's the same thing with Teva.
I bought the shares at 9.58 each and think they can go a lot
higher after all this opioid litigation gets cleared up but I
didn't think the stock was going to zoom higher in the near
term, so I sold 10 call Option contracts - that's a thousand
shares for a 10 strike price collected that dollar eight each
then i sold another 40 contracts for about four thousand
shares at a thirteen dollar strike for a dollar sixty three
premium. I paid forty seven thousand nine hundred dollars
for that five thousand shares of Teva and I’m up about 418
dollars as the share price has gone up a little bit. I also
collected that thousand and eighty dollars by selling the ten
dollar call Options on the thousand shares. If the share price
stays under ten dollars over the next two months, I’ll keep
that money and the shares. If the share price though goes
over ten dollars I’ll still keep the money but I’ll get ten
dollars each for that thousand shares for a total of about
fifteen point six percent return - that's the ten dollars per
share plus the dollar and eight divided by the price that I
paid. I also collected sixty five hundred dollars by selling the
thirteen dollar call Options on those four thousand shares.
Here if the price stays under thirteen dollars over the next
two months and it looks like it probably will then I’ll keep
that money and the shares. I’ll have made a 17 return and
can sell more call Options or if I just want to hold on to the
shares and let those run. You'll notice though in both of
these call Options that the market price of these Options
has gone down and I’ve made a profit already. Investors are
paying just 16 cents a share for those 13 strike price call
Options so I could actually go back into the market, buy
back those Options that i sold for that price and then keep
almost six thousand dollars that I’ve already made. I keep
that money and wouldn't have to worry about my shares
being called away if they jump over the strike price.
You'll see these profit and loss diagrams a lot with these
Options trading strategies but I wanted to go through the
basics before because they can be a little confusing at first
glance. The diagram here shows this covered call example
of buying a stock at 15.84 and selling the 17 strike calls for
a dollar 44 each. So you've bought the stock and you're
selling another investor the call the Option to buy that stock
from you at $17 each and you're collecting that dollar 44
premium for the each call. The maximum gain on this stock
is 2 dollars and 60 cents per share that's if the stock price
goes to 17 each or higher and you have to sell it for that
price to the call Option buyer so in this scenario you make
the difference between 17 and the price you paid that 15.84
cents per share and you also keep that dollar 44 premium
for the call, so a total profit of two dollars and sixty cents
per share. Your break even point on the shares though is
lower than that price you paid because you keep that call
premium in any case. You paid that fifteen dollars and
eighty four cents per share but then minus the dollar forty
four cents per share that means your cost is really only
fourteen dollars and forty cents each. The shares could fall
nine percent and you'd still be making money on this
investment. Your maximum potential loss in this example is
still going to be that fourteen dollars and forty cents per
share. The covered call strategy doesn't totally limit your
potential loss like we'll see what the protective put strategy
next. This strategy is just going to lower your risk so if the
shares fall below that 14 and 40 cents per share, you're still
going to be losing money. The great thing about that
covered call strategy though is that even if the share price
falls the stock price falls you're going to keep that money
collected on the Options and you keep the stock. That
means you can sell more Options against it in the future
collecting more money or just wait for the stock price to
rebound. The reasons you'd use a covered call strategy
include reducing your risk on an investment or if you're
worried about near-term weakness on that long-term stock
pick. It also allows you to collect cash on an investment
whether it pays a dividend or not. The downside of course is
that it limits your potential return if the share prices zoom
higher. You've sold someone the right to buy those shares
for a certain price and that's the price you lock in even if the
stock price jumps higher. We've already seen how I use this
strategy on shares of Cisco and Teva but I want to show you
how to set it up in real time. Say I want to buy shares of
Tesla but I don’t think the share price is going to do much
over the next couple of months. I can go into the Options
tab to see the different months available and I’ll use these
January 2021 Options but you can see you've got a lot of
different expirations. There are going to be lots of strike
prices available and maybe the price can go as high as 440
or so by January but I want to reduce my downside just in
case, so I go to the four hundred forty dollar strike price call
Options and I see the last price here was thirty two dollars
each.
Some stock platforms are going to have a covered call order
screen or you might just click something like add a stock leg
and that's going to give you the Option to buy the stock and
sell the call Options at the same time. If I do that I can buy a
hundred shares of Tesla for around 413.86 and so one
contract call Option that's 100 shares expiring January 15
2021 at a 440 strike price.
For that call Option there's an investor willing to pay 31.95
and another investor asking 32 dollars and 25 cents to sell
those Options and that's the bid ask spread. That 30 cent
spread isn't really very much here on some Options it's
going to be much larger so I always try to do a net debit
limit order when I’m doing these covered calls. This means
you're going to put in the exact price that you want to pay
for this position, the price you're paying for the shares and
the money you collect by selling those call Options. So at
that price of 413.86 for the shares and the spread and the
bid ask price this position is either going to cost me a net
debit of 381.53 or 381.95 or somewhere in between there.
That's to buy a hundred shares of Tesla and simultaneously
sell the call Options against it. That's really not a bad spread
so I’ll just put in my order at the mid point here so I make
sure that I get this traded. It would cost me 38,175 dollars
for this entire trade.

If shares of Tesla stay under that 440 dollar strike price by

January expiration, I’m going to keep the cash collected and
basically get the shares for an eight percent discount by
selling those calls. Even if they move above that price
though I still make a 13 return in just two months so not too
bad either way. The protective put strategy is a way of
completely limiting your risk on a stock by setting a bottom
price for your shares. In this strategy you buy puts against a
stock you own, giving you the right to sell the shares at a
certain price even if they fall. For example if I own those
shares of Tesla but I’m worried about the stock crashing and
want to reduce my risk even further beyond that covered
call strategy, I can go in here and buy put Options for the
405 dollar strike price for just over 36 dollars a share.

This would give me the right to sell those shares at 405

dollars each, no matter how far they drop by that January
expiration. You can also use this strategy to protect your
entire portfolio of stocks with puts on that overall market.
For example if I was worried about the market but didn't
want to risk losing any of my long-term stocks with an
Option strategy, I could go into the Options for the Spyder
S&P 500 ETF that's ticker SPY which is a fun that follows the
overall market, and if I wanted to protect my portfolio
against a stock crash, I could buy puts for that 350 dollar
strike price for about 11.75 each.
If the S&P 500 falls from below that 350 dollar price per
share on the SPY fund, then I’ll profit off that position which
is going to help offset some of those losses on my individual
stocks, and you can use these strategies and you can buy
puts against your stocks or the market at any time when
you buy the stock or even later, so it's really a great
strategy for protecting near-term risks whenever you see
them. If a stock price falls below your put Option price you
locked in that floor price. If the stock price doesn't fall then
you still benefit from the upside and the shares. You're going
to lose out on that premium that you paid for the puts but
that's just the cost of insurance. In fact that's really the best
way to think about this protective put strategy as a classic
insurance play. You're paying a premium a price to buy
those put Options and they protect you against the
possibility of large losses. Like a lot of these Options trading
strategies, your biggest decision in this is going to be at
what strike to buy and what expiration date. Do you want
protection further out so buying the puts that don't expire
for many months or even a year? You'll notice that the cost
of protecting the portfolio against a market crash below that
350 strike price on that SPY fund to January so just for the
next two months it's only going to cost 11.75 cents a share.

But if we want to go further out for protection out to June of

next year, then that same strike price of 350 dollars is going
to cost me 23 dollars per share. Also asking yourself; do you
want that protection very close to the current price or are
you willing to see some losses on the shares for a cheaper
premium price. The price for protecting my portfolio around
the 353 current price on the SPY - those put Options are
about 12.77 each. But if I’m willing to take a little bit more
risk and only protect myself under maybe a 348 dollar strike
price, those Options are much cheaper at just 10.86 per
share. Playing around with these two questions is going to
lower that premium on the insurance so though at a little
higher risk or it's going to increase the premium and give
you less risk in that trade. It just depends on how far out
you want to protect your stocks or your portfolio so when do
you see those major risks in the market and how big of a
risk are you forecasting, so how much downside protection
do you need.
Here's that profit and loss diagram on those protective puts.
This one is an example where you're buying the stock at a
price of 15.84 and then buying a put at that 15 strike price
for a dollar 46 cents each. Starting towards the bottom; you
see how this strategy totally limits your downside. The
maximum loss you're going to see here no matter what is
going to be that 15 floor that you sell the stock for with that
Options minus the money that you paid to buy it or that
dollar 46 cents per share. Let's just say this stock crashes
five dollars a share but you can still sell it for fifteen dollars
a share because you've got that put Option but you've only
lost the 84 cents which is the 15.84 cents that you paid for
the stock originally, minus the 15 strike price on the put
Option and then plus the dollar 46 cents that you paid for
the right to sell it at that price. Your break even price is a
little higher here because you bought that insurance policy.
Instead of the $15,84 cents price that you paid for the
shares it's that plus the insurance premium of a dollar 46
that you paid for the put Option as well. That means your
break-even price for this investment is now going to be
17.30 a share, but see the great thing about protective put
strategies versus the covered call one is that you have
unlimited upside potential. Even though you had to pay for
that premium to buy the put Options you'll continue to
benefit if the stock price moves higher so your return isn't
limited like it is with covered calls.

OceanofPDF.com
Chapter 4 Bull, Bear & Calendar Spread Option
strategies

Spreads are another great Option strategies I’ve used a lot

and helps you cut costs to using these Options. Spreads
come in two types a bowl or a bear spread is where you buy
and sell the Options within the same month. A calendar
spread on the other hand is where you buy and sell Options
from different months and spreads work so well because
they fix one of the biggest problems with Options trading
that cost of the premium. Look at our January Tesla Options.

If you thought the stock might go higher then you'd be

tempted to buy those call Options you could buy the call
Option with a 420 strike price but they're going to cost you
$44 each. At that price the stock would need to rise to sit
464 dollars or about 10 percent just to cover the cost of the
Option premium. But with a bull spread you buy the call at
the lower strike price and then sell the one at the higher
strike price to help offset that. Here if you buy the 420 strike
for that 44 dollars then maybe you sell the 435 dollar strike
Option for 37.15.

You're buying one for 44 dollars and selling another for

37.15 against it for a net cost of six dollars and 85 cents for
each spread and what happens here is you make money on
your 420 dollar call Options at a strike price is above that
point. If the shares rise above 435 then you're going to start
losing money on the call Options that you sold but those are
totally offset on a one-to-one relationship with that other
Option. You've got a space there of $15 where you're
making money on one and not losing anything on the other.
But just some easy math here say your max gain is $15 per
Option and that net cost is 6.85 cents each - that means a
potential $119 return if shares of Tesla reach 435 or higher
by that expiration date. Now let's do a bear spread example
and then we'll look at those calendar spreads. If I thought
Tesla shares were overbought or might fall, I could buy the
puts for 415 strike price for 39.25 each.
Because shares of Tesla are so volatile that's an expensive
bet. Just buying the put Option here means that shares have
to fall to 375 dollars each just to make money on that trade.
The put Option is going to be in the money when the price
falls below that $415 strike price but because I had to pay
the 39 premium for the Option my actual break even price is
about 10 percent lower. But with a bare spread here I can
cut the cost of that trade. I can buy those 415 strike put
Options at a $39.25 premium and then sell the 405 dollar
put Options the strike price at 405 dollars for that $36.35 for
a net cost of $2.90 each. To do the math on these all you
have to do is look at the net cost and the spread between
these stock strike prices. The spread between the 415 put
and the 405 dollar put Option is 10 which is my maximum
gain. So my max return here is ten dollars divided by that
net cost of two dollars and ninety cents each or a two
hundred and forty four percent return. Using spreads like
this enable you to cut those costs of trading Options and
still potentially get a great return if the stock price goes
your way. The downside to all this is you limit your return. If
you had simply bought that 420 call Option on Tesla and
shares had jumped 30% to $550 each, your Option would
then be worth $130 or 195% return on the premium that
you paid but that's a long way to go and a very expensive
Option to buy. This is actually one of the bull spreads that I
bought. Buying the 170 dollar call on shares of Boeing for
about twenty one dollars and five cents and then selling the
hundred and eighty dollar strike for seventeen dollars and
eighty five cents or a net cost of three dollars and twenty
cents each. The idea here is that with the potential for a
vaCCIne or just some talk out of Washington for a stimulus
deal there are a lot of ways that Boeing can jump back over
that hundred and eighty dollar share and you see here it did
just that in early November. I made over five thousand
dollars on a single day and could make as much as 6 800 on
the trade.

Here's the profit and loss diagram on a bull spread and with
the example of buying a call at a 15 strike for a dollar 64
and then selling the 17 call for 51 cents or a net cost of a
dollar 13 each. The max loss you can have on the spread is
that net cost that dollar 13 that you spent total and that's
where the graph levels out here on the left at any price
under fifteen dollars so under that bottom call and strike
price that you bought, you lose the entire investment.
Anything between that fifteen dollars to the seventeen
dollars though is where you start making money. You're
going to break even if the stock reaches sixteen dollars and
thirteen cents a share because that's the fifteen dollar call
Option - the strike price plus the dollar thirteen net cost that
you spent on the spread. Anything over that and up to
seventeen dollars per share is your profit and max profit
here is 87 cents a share at a price of that 17 per share.
That's where the line flattens out on the right where any
price above 17. You're going to cash out the two dollars per
share for an 87 profit. The calendar spread is the same
concept except you're using it for different months for
example maybe you're long-term bullish on Tesla but you
think the short-term it might not do much and you want to
cover your long-term costs.
You can sell the January 420 strike call Options for 44 dollars
and then you go out to a later month - here you've got the
January 2022 Options you can buy the 420 call Options for
115 each for that net cost of 71 each. If shares of Tesla start
climbing immediately both of these call Options are going to
rise in price. That means you're going to be losing money on
those January 2021 calls that you sold but you'll also be
making money on the 2022 calls that you bought, so a lot of
that is just going to cancel out. The best case scenario here
of course would be if your stock price went nowhere, closed
out under the 420 each in January, so those call Options
that you sold are expire worthless. You would then keep that
44 premium that you made from selling that call Option and
would have still have this 2022 call Option for another year,
waiting for the shares to move higher. These are a little
riskier than the other types of spreads and I don’t use them
often. For example if the shares jumped immediately you
might lose money on that near dated Option that you sold
and then maybe six months down the road if the stock price
falls hard, you could be losing money on that long dated
Option you bought as well. This is why a lot of times
investors are going to keep selling those new call Options on
the position each time earlier when expires. So after that
January 2021 call expires they'll sell another one maybe
March 2021 Option, while they're still holding that 2022
Option.

OceanofPDF.com
Chapter 5 Option Straddles VS Options Collars
Strategies

Option straddles here are really cool because you're not

betting on a direction in the price instead you're betting on
the volatility of the price of the stock. A long straddle is
where you buy a put and a call at the same stock price and
the idea here is that some event or news is going to move
that stock price in a big way.

This is one example where it's actually easier to look at that

profit and loss diagram first to understand this. In this
example you buy a call Option at that fifty dollar strike price
for two dollars and twenty nine cents each. At the same
time you buy the put Option at the same strike at that fifty
dollar strike price for two dollars and twenty eight cents
each, so your net cost for this straddle is what you paid for
each Option - in this case that's the 229 for the call Option
and the 228 for the put for a total of 4.57 each. You're going
to start making money as long as the strike price is above or
below fifty dollars each. Let's say these are shares of
American Airlines and a vaCCIne is approved that sends the
shares up to sixty five dollars each. You would make nothing
on the put Options because the stock price is now above
that fifty dollar strike price but you make fifteen dollars on
the call Options for a net gain of ten dollars and forty three
cents each or a two hundred and twenty eight percent
return on this trade. Conversely let's say hope for a vaCCIne
fades away and the shares tumble to thirty five dollars each.
In this example you make nothing on the call Option
because the shares are now below that fifty dollar strike
price, but you make the difference; that fifty dollar strike
minus the thirty five dollar current price on the put Options
for the same fifteen dollar payoff. You make the same net
gain that 10.43 and that 228 return. With a straddle you're
betting that the share price moves one way or the other in a
big enough move that it's going to cover your total cost. In
this example with the net cost of buying that put and the
call Option for four dollars and fifty seven cents each, the
stock price has to be below forty five dollars and forty three
cents or above fifty four dollars and fifty seven cents before
you start making a profit on the trade. Here you're going to
want to use a straddle when you think some news or event
is going to cause a big swing in the price - you just don't
know which direction it's going to be. For example maybe a
lawsuit decision is expected and it could spark a relief rally
or really hit the shares heart, or a lot of investors are going
to trade Option straddles around those earnings events,
expecting surprise earnings to drive the shares higher or
lower. The problem with the straddles Options strategy is
that everyone is looking at these same events and making
their bets. If a lot of investors think that earnings or some
expected news are going to drive a big change in the
shares, then there's going to be a lot of volatility in that
stock, and that's going to mean really expensive Option
premiums. For example if we look at our January Tesla
Options maybe we think Elon is going to take to twitter
again and move the shares in a big way in January either
higher or lower, so we buy that strike calls for 44 each and
then by the same strike puts for 42.70 each or a net cost of
$86.70 each.

That means shares of Tesla need to rise either above 508.77

or fall below 335 each by January just for us to start making
money on this trade strategy and that's a 20% move either
way so it would have to be a pretty crazy Tweet. In truth
since the price on these Options change as the price does
you can actually make money on these if the price moves
up or down quickly even in say a five or ten percent move.
Just a big move if there's still some time left in these
Options it's going to move the prices and you'll usually
make more on the profitable side than you're going to be
losing on the other side so a slight profit you can collect.
The next Options trading strategy is called collars and then
I’m going to show you how to pick which of these strategies
you want to use. Collars are a great way to protect your
downside but at a lower cost than a protective put strategy.
Here you own the stock and you buy that in the money put
so a put Option above the current price but then sell a call
Option at a higher strike price to offset some of that
insurance cost.

You buy the stock at 422 and are a little worried about the
near term but you really don't want to pay almost 43 dollars
for the put Options with a strike of $420 per share.
Remember this would be the protective put strategy. You
own the shares and buy a put that gives you the right to sell
the stock at that price. You know you'll get at least 420 a
share no matter what the stock price does because you
bought that put but you had to pay that big premium to buy
it well. With a collar you would sell a call Option at a higher
price to offset some of that premium some of that insurance
cost.
Here if you sold the calls with a 435 dollar strike price, you
would collect 37 and 15 cents each to offset that 42.70 that
you paid for the put or a net cost of five dollars and 55 cents
each. Now let's think about what this means for the stock. If
the shares fall we can use that put to sell it for $420 each.
We've locked that in as our lowest price that we'll get from
the shares. At that price the call Options we sold would
expire worthless so we keep that money and we're
protected on our downside. Conversely if the share price
stays above that $420 each our put Option is going to
expire worthless. We wouldn't use the put to sell our shares
for $420 each if we can just take them to the market price
and get more for it. We still have that call Option that we
sold though so if the price rises above 435 dollars each then
that investor is going to buy our shares for that price.
Basically we've locked in a max gain on our shares of 13
each because we bought at 422 dollars and then sold the
call Option at 435 each. In fact our actual cost on the shares
is a little higher because remember we had a net cost of
$5.55 cents we paid for that put protection.
The collar profit and loss diagram here will make it a little bit
clearer. In this example we've bought the stock at $12 each
and bought a put with a $15 strike price for a dollar forty six
cents each and sold the seventeen dollar calls for a dollar
forty four cents. That put and call price almost cancel out
each other exactly. In this scenario if the share price falls
below fifteen dollars each we can use our put Option to sell
it for that price and still make $2.98 profit and that's the
difference between the $15 sell price that put Option strike
price and the $12 that we pay for the stock but then minus
the 2 cents per share that we paid for the puts and the calls.
On the other hand if the share price jumps beyond $17 each
the investor that bought our call Option would get our
shares for that price. In this case we have a profit of 4.98
per share or $17 minus the $12 that we paid and then the 2
cent per dollar cost. Like a lot of these it might take a couple
of times to really understand what's going on with the
strategy. Basically you're locking in a minimum and
maximum profit with your stock, and with any of these you
can experiment with how you're buying and selling different
strike prices to change your profit or loss potential. Now that
we have the Options trading basics and those five strategies
I want to show you a handy little table to help you decide
which strategy you can use depending on your perspective
on a stock. When you go to use an Options trading strategy
you're primarily asking yourself two questions; what
direction do you think the stock price will go higher or lower
and will that direction happen qickly or will it take a while in
other words will the stock price become more or less
volatile. This volatility is important because it affects the
price of those Options. If a stock price is jumping around a
lot Options both higher and lower are going to have a better
chance of making money, so investors have to pay more for
that opportunity.

You see in this table your outlook on the price can be

bearish, meaning you think it's going to go down, it can be
neutral or that stuck in a range or you might be bullish on
the stock and you think the stock price is going to go up. On
the left side of the table is that volatility decision. You might
think the volatility is going to decrease so maybe the share
price doesn't jump towards the price direction but slowly
just builds to it, or conversely maybe you think volatility is
going to increase so the stock price jumps higher or lower
quickly or just whipsaws back and forth a lot. Your answer to
just these two questions is going to tell you which of these
five Options trading strategies to use. For example if you
think shares of a stock are heading lower and volatility will
decrease, you can write call Options on your position with
that covered call strategy. Someone is going to pay you a
premium for those calls and as the stock price drifts lower
and volatility decreases, those call Options are going to
become less valuable. You're going to keep your shares and
the difference in price on that sold call. If on the other hand
you think the share price could fall faster, you might just
buy puts for that protection to lock in the lowest price that
you're going to get on the stock. You could also just buy
puts without even owning the stock if you want to profit
from that crash in prices. If you're not sure where the stock
price is going to go maybe it's going to stay in that range or
there's an equal possibility of it going higher or lower, but
news or events are likely to make the share price volatile,
we're in the middle column or that top or the bottom, then
you'd want to use that straddle Option strategy and if you
think the volatility is going to increase you buy a straddle
and wait for the volatility to make both that put and call
Options more valuable, potentially profiting on both. If on
the other hand you think maybe volatility is going to
decrease in the shares, you can sell a call and a put Option
for what's called a short straddle. As the stock volatility
decreases, both of those Options are going to become less
valuable and you can buy them back for less than you sold
them for - again for a profit on each. You can use the bowl or
bear spreads on either side here really whether you have a
bullish or bearish perspective. The change in volatility
doesn't matter quite as much with this one - you're just
betting on the direction of the stock and lowering your
trading costs. Collars and protective puts are going to work
best when you have that bearish or a neutral outlook on the
shares and want that downside protection. This is not
something you're going to pick up immediately and become
an Options trading professional but give it some time and
you will make money on these. Options tradings can be a
powerful tool if you use them right. It can help you reduce
your risk and increase your returns - all you need to do is
understand which strategies you use and when.

OceanofPDF.com
Chapter 6 How to Trade Covered Calls the Right
Way

Writing covered calls is one of the most popular Option

strategies for retail investors to employ. The problem is that
most people use covered calls the wrong way and then get
themselves into unnecessary problematic situations
because they haven't fully understood the purpose and the
right way of trading covered calls. Hence in chapter we're
going to cover the right way to trade covered calls so that
you avoid all the pitfalls and instead reap all the benefits of
the strategy. Many of you have probably heard of covered
calls which is a technique that many traders and investors
use to create monthly income from stocks that they own.
While you certainly can create monthly income from trading
covered calls, like anything else in life there's a right way to
do something and a wrong way and unfortunately most
traders picked the wrong way and end up getting burned
which is entirely unnecessary if you just follow a few key
principles to effectively utilize this strategy. In order to
understand how covered calls work we'll need to understand
what a call Option is exactly and so a call Option on a stock
entitles the buyer of that Option to buy 100 shares of a
stock at a certain price called the strike price of that call
Option at any time after the call buyer buys that call Option.
The call buyer pays what's called a premium to the seller of
the Option because the seller of the Option is taking the risk
that the stock will go way above the strike price of that call
Option in which case the buyer can exercise his Option and
force the call seller to sell his shares at the calls Options
strike price which is lower than they're worth. A covered call
for monthly income starts out with your owning 100 shares
of a stock and then every month selling a call Option on
those shares that you own usually at a strike price higher
than the stock is trading at. But how exactly do you make
money trading covered calls? Well, the answer lies in the
two possible outcomes of a covered call. The first outcome
is the one that creates monthly income for a trader and
that's when the stock on which you've written the covered
call closes below the strike price of the call. In that case
then the call expires worthless and the premium you
collected for being the seller of that call just becomes
income for you. The Option dies and you have no further
obligation - you get to keep the premium you collected
originally. For that month the trader would receive simply
the premium he sold. But in another month if the stock
closes above the strike price of the call Option on the day it
expires, the call buyer would naturally exercise his right to
buy those shares at the call strike price which is below
where the stock is trading and thereby, making an
immediate profit. In that month the trader shares are sold,
although he did make the income from selling the call in the
first place he gets to keep that cash that he was paid by the
call buyer, but the issue is that in order to continue to get
income the trader would be required to buy the shares back
again at a higher price. This time in order to resume the
covered call program for income. Let's show you an example
to pull all this together for you. Let's head back to March of
this year and as you can see Walmart after initially bouncing
off of its pandemic lows near 100 rallied all the way up to
150 and then sold off to 130 by early March of 2020.
If a trader were to have bought 1 000 shares of Walmart for
the purposes of executing a covered call strategy to bring in
about two thousand dollars a month, he'd most likely start
out by going out about a month to April first and selling 10
of those 133 Walmart calls which expire on April 1st at a
price of two dollars in one cent. But let's drill down to
understand what happened here in the first portion of this
campaign to bring in the two thousand dollars per month
with covered cost so that we can follow along with how the
campaign's going. We spent one hundred thirty thousand
one hundred ten dollars on the shares initially at a hundred
thirty dollars and eleven cents a piece but we sold ten of
those April one 133 strike price calls for 201 a piece, but
remember each Option represents 100 shares of stock so
you multiply that by 100 and we sold 10 of them so the cash
flowing into our account for selling those 10 calls is 2010
dollars which remember, was this trader's goal of making
two thousand dollars a month from his Walmart shares, and
therefore net of that cash flow from the calls that were sold.
The cost of the campaign is one hundred twenty thousand
one hundred dollars. Now let's move to the day that those
Options expire on April 1st and you'll see that Walmart had
actually rallied by then to 135 and so the stock closed
above the 133 strike of the 10 calls we sold so we are
required to sell our shares at 133 to the one who bought
those calls from us.

Now if we want to continue this campaign, we're going to

have to buy those shares again, but this is a crucial point
because this time we have to pay over 135 dollars a share
because Walmart had rallied to that level causing our shares
to be called away at 133.
To make another 2 000 or so dollars we go out another 30
days to April 30th and sell 10 of those 137 calls and this
time for 2.35 cents. Moving to April 30th we see that
Walmart had rallied some more up over 139 and so it's
going to be a repeat of what happened 30 days earlier and
those shares are going to be called away again $437
because the call buyer will want to cash in on his right to
buy them cheaper than they're trading in the open market.
Here is where we are after that happens and as you can see
if you take the cash that we got from selling the first set of
shares at 133 in early April and you subtract out the cash
you paid to get into that first covered call transaction and
then subtract out what it costs to buy those shares again at
$135 and 62 cents and add back the $2250 you got from
selling the second set of calls at the 137 strike, you'll see
that you now have a profit on this campaign so far of
$8,530. Keep in mind that to restart the campaign we
basically are forced to buy the shares of Walmart yet again
but at this time the price is even higher at 139.91 and so
that starts a new cycle of cash outflows starting with the
purchase of those new Walmart shares at the higher price.

Over the next few months Walmart actually didn't move

very much and so the calls expired worthless for the next
two monthly cycles which ended at the end of May and June
where we pocketed two thousand sixty dollars and eighteen
hundred and fifty dollars respectively. We add that in as a
positive cash flow from the calculation and in late June we
sold the July 23rd 139 calls for 1840 but after that Walmart
rallied again, but this time to 142.43 and so again we were
forced to sell our shares lower than that at the 139 strike
price and so we received in $139,000 for those shares. On
July 23rd we again needed to rebuy the shares this time at a
total cost of $142,430 dollars and at the same time selling
the 144 calls for 23.20. On August 20th let's just say we
decided to end the campaign. Well by that point Walmart
had again rally this time up to 150,154 near its all-time high
and so once again we're forced to sell the shares way below
market at 144 and so we received $144,000 for those. When
you add back the profit we had made on the campaign from
April 30th the total profit for this campaign focused on
producing cash flow of about two thousand dollars per
month, netted a final profit of seventeen thousand two
hundred sixty dollars. That sounds like a lot of money but
what if I told you that there actually was a major flaw in that
whole concept. You may have spotted it and others may not
have but once we go through this next example you'll
clearly see what that flaw is. So let's go right back to the
beginning on March 2nd and take another look at this price
chart for a minute.

If you approach this differently and instead make the

supposition that Walmart was likely to bounce and retest its
highs from earlier in the year and we saw this drop to 130
as a buying opportunity, then we could have handled this
covered call program very differently and instead of creating
a goal of making two thousand dollars a month off of our
Walmart shares and having to rebuy them every time the
shares get called away, instead of that we can say to
ourselves let's forget about exactly how much income we're
going to try to generate each month and instead let's
establish a game plan that if the stock gets back to its all-
time highs, we'll take our profits and move on. So instead of
selling any call that gets us two thousand dollars a month
no matter how close is to Walmart's price instead we'll just
keep selling calls at that 150 strike price - our profit target
and if our retest theory holds up we allow the stock to rally
all the way up to 150 without having the shares called away
periodically because in order to sell calls that make us two
thousand dollars each month, we're forced to sell calls that
are so close to the current Walmart price that our shares
keep getting called away and we have to keep rebuying
them at higher prices and starting again. So let's see how
that would play out if we handled things differently focusing
on our price target for Walmart. We again of course start out
the same way buying a thousand shares of Walmart on
March 2nd for a little over 130 thousand dollars, but this
time we sell the 150 calls and we only receive 240 for those
because those calls are so far from the Walmart price of 130
that they represent very little risk to the call sellers of them
being exercised, so the price is lower than the two thousand
dollars we've received each time we sold calls in the
previous campaign. We've listed the premiums we've
received each month through the August calls again but this
time we are strictly only selling the calls at our price target
of 150 and those prices range from as little as a hundred
dollars and as much as eight hundred dollars but in all cases
are lower than the two thousand dollars a month or so that
we were receiving the previous style of covered call
campaign where we are simply focusing on receiving that
income each month. Then we don't sell the shares until
August when Walmart reaches 150 and that's the first time
we actually sell them at the very end of the campaign and
that's because Walmart has exceeded our price target of
150. Now when you net it all down you end up with over
22,000 from this style of covered call campaign where you
focus on the price target of the stock and then collect
income until you hit that price target, as opposed to
focusing on some fixed amount of income and then forcing
yourself in and out of the shares and worse, forcing yourself
to re-buy them at higher prices each time you re-establish
the campaign, causing you to basically skip over some of
the upward price movement - a practice which turns out to
be so expensive that it blows away the supposed advantage
of collecting a steady two thousand dollars each month.
What I’d like you to take away from this chapter is the fact
that a covered call program can be terrific if you handle it
correctly, but it can also be cumbersome and much less
profitable if you don't. Setting a price target on a stock and
then selling calls at that price target is a perfectly sound
way of getting extra income from an investment, because
selling the calls actually enforces a discipline of taking
profits on stocks when you think they're fully valued and
until then, you are letting the stock breathe and not forcing
yourself in and out of the trade, missing price movement
each time and costing yourself a bundle in the process. You
will still make income each month, but less. The bigger
payoff is in the end if and when the stock hits its price
target at which point you've maximized your return on the
trade which is the goal of every trade that professional
traders make.

OceanofPDF.com
Chapter 7 Options Trading Using Expected
Value Dynamics

In this chapter I am going to share with you the expected

value dynamics. This is an advanced topic and one of my
favorite and this is a detail that took me from great to elite
because every single trade incorporates the skill. First to get
into this topic we're going to take a field trip to the poker
table. Poker is amazing because it has so many great
analogies to trading that we're now going to delve into.
Imagine that initially before the flop the one player has a
two-thirds probability of winning but then once the flop
appears those odds change. It's not static odds throughout
the whole poker hand so once the flop changes you need to
recalibrate based on the new info. Once you get the pair of
aces the odds goes to a near lock but it still it’s not over yet.
Then finally on the river there was a total reversal so the
point of this is to show that all throughout that hand as you
can even see by the percentages in poker, players are
constantly adapting to how those odds are unfolding and
while both hands was all in your betting style and your
decision to whether or not to stay in a hand needs to be
constantly assessed throughout. But why do I love poker
analogy so much? The beauty of poker is that it's a
simplified but very similar game to trading and unlike in
trading true odds can be calculated. Everything is also an
extremely finite universe of outcomes. You know how many
outs you have, you know many cards are left in the deck so
it's very easy to calculate this whereas with trading there's a
very broad spectrum often times of what can occur. The
other beauty of poker is that it also has similar psychology
dynamics and betting dynamics. FOMO, tilt all these things
we constantly struggle with as traders much like poker
players and similarly we need to know when should we be
betting more. I’m constantly harping on exponential bet
sizing and that the better hand you get, the more you need
to bet just like in poker. The other thing is that in poker and
in training you're constantly acting under uncertainty and
you need to constantly recalibrate as those odds are
changing. As every hand unfolds, you have the decision to
either bet, fold, check or call and so throughout that like
every single tell is being analyzed by these players. You
need to know what's the other bet size, what are these
players talking about, what are these cards that could help
them and what are their potential hands and so this is really
no different but very few recognize this and are constantly
calibrating like we need to be. In trading every single
second and every single bar that elapses, we need to be
changing with it. Now let's go full trading on this. EV or
expected value is a mix of risk reward and probability - all
three of these variables change for every single detail that
elapses. These nuances include the box the chart pattern
development, the overall market action, the market
environment you're trading in and specifics to your trading
strategy. All of those are influencing those three variables so
your decisions must be updating along this. Now I’m going
to get down into the nitty gritty and remember that this is
an advanced topic this is not for traders that are still getting
the basics down. We're going to dissect a simple breakout
example this was an MSTR on August 3rd of 22 and on the
daily chart there was a $300 breakout and this is the
intraday in which we consolidate up against that resistance
and then we break out on both the intraday and the daily.
For the purposes of this example we're doing a very simple
system. We're going to assume you buy the break of 300
and your stop loss is roughly that prior bar low of 298 and
then we're going to pick an arbitrary target of 325. What I
do now is I break down the expected value in bars A, B and
C. In bar A, if we're buying 300, our reward to our 325 target
is $25, our risk to our 298 dollar stop is two dollars and I
really just made up an approximated a 30% win rate. It’s
not very scientific I’m just doing this for example's sake to
prove my point for now, and so what you get is that in in bar
a there is a 6.10 expected value and I do actually think this
trade is a pretty strong trade and I don’t think these
assumed variables are really too far off. Now we jump to bar
B. It's showing continued strength the breakouts going
great, we had really great volume so I would say as we get
closer to that 325, the probability of us reaching there is
actually increasing. Now I give us roughly a 60% win rate so
you might think wow like our expected value is getting
better but that's not necessarily true because here's the
thing now at 310 our reward versus 325 is only an
incremental 15 bucks but meanwhile our risk if this play fails
is a full 12 dollars down to that that 298 level. So when you
calculate that EV you get four dollars and 20 cents still
strongly positive and worth holding but it's worth noting that
as this play worked in our favour, the expected value
started to decrease. Now we're going to jump to bar C as we
get very close to that target so because we're so close really
just five bucks away now I’m giving it a 75 probability
maybe it's a little bit higher but just ball parking. From 320
the reward is five bucks away but now what happened is our
risk is potentially 20 bucks or actually the numbers and so
now your expected value has actually turned negative.
What is this highlight here? What this example is showing
you is that as this trade is working in your favor and you're
getting closer and closer to your target the trade's actually
getting less and less positively skewed and more negative
as you approach that because your risk increases and the
rewards decreasing. What would that mean for me as a
trader? First of all that would mean if these estimations are
accurate I probably want to get most or all my size at bar A
where the expected value is highest. A lot of traders wait for
confirmation and that confirmation, the win rate might be
higher but that doesn't necessarily mean the expected
value is higher as well and that's such a huge nuance for
many traders. People will buy in bar B where the win rate is
60% because the trades working but they're not recognizing
that they're actually lowering the overall expected value of
the trade and so then by bar C where the expected values
turn negative what that means is you actually don't want
any stock on by then so in practical terms I might be getting
all my size at bar A and then slowly starting to scale out as
we approach bar C and getting less exposure as we get
closer. Intuitively this actually makes a lot of sense as well
but now we're going to complicate things a little bit away
from the simple breakout. What we're going to look at is a
reversion. We're going to do GME on August 8 2022 and this
is an intraday reversal short.
I’m going to simplify this so don't go nuts over my
assumptions. It's just to make this easy. On this opening
drive we go from we go from 41 to a high of 48 and so I use
in this case the moving average as a as a target at roughly
42.50. Why do I do this because if you had the daily chart
you'd see this is really extended overall this is a multi-day
up move at this point it was a huge inflow on this so for this
one the moving average for me would have been pretty
appropriate for my system. The entry for this again for
example sake but pretty similar to what I’d actually do I’m
looking for a break of the prior bar low in this case this
occurs at roughly 45 dollars and what I would be doing is I
would be doing a trailing stop as this play progresses and
the stop is the high of the prior bar. Now let's dive into the
expected values on these.
First let's look at bar A. Here in bar A we haven't yet turned.
We haven't broken prior bar lows. Still to me I would
consider this fighting the trend there's a time and place for
it but just for example sake I’m going to argue this has a
30% win rate that you're going to actually catch the top but
the reward is actually the greatest on this so we might be
seeing as much as five dollars of reward and I even do an
arbitrary three dollars of risk again just using some basic
assumptions to make this work but they are roughly what I
would assume make sense. This would have a negative
expected value of about 60 cents again we're fighting the
trend that makes our win rate pretty poor here which really
dings that expected value a lot. Now in bar B, this is where
we actually break the prior bar lows and so for my system
this would be the true entry there that I would first consider.
But there's one issue. The prior bar highs which is my stop
here is actually really far away because this pattern
unfolded in a very rangey matter so if I were to take my
stop of that prior bar high at 48 bucks, my risk is actually a
full three dollars per share and my reward is only to 42.50,
leaving 2.50 cents of upside. But because I’m now with the
trend I do think this is more probable than not which gives
me just a modest positive expected value of 30 cents. Not
great, not so awful and so maybe I initiate here for a small
size. But what's interesting to highlight now is the way this
pattern unfolds is we now look at bar C. What happens in
bar C is we actually go quite close to that prior bar high and
B and so this allows me a much tighter entry based on my
system again just talking my system that prior bar B was
too rangy compared to a but now I have a beautiful candle
wick that gets me close to those highs that are going to be
my stop so often I’ll initiate or add there because this bar C
wick is actually offering me a better expected value than
any prior place in the trade. When I calculate that based on
my assumptions I’m assuming a little bit lower win rate just
because it is coming back up against that bar which shows
somewhat strength but I do think these are roughly accurate
giving me an expected value of 70 cents. Now we jump to
bar B this also is unfolding in a pretty tight manner and
what we're seeing which is so often the case is we're
starting to stair step lower and so within the bars we're
ranging but we're still holding that trend which tends to
happen on really nice plays. With D I can short pretty close
to those prior bar highs the reward isn't as enticing anymore
and this ends up with an expected value of about 50 cents
so still positive and worth holding. Finally we get to bar E
really at this point we're quite close to that target so very
high win rate but at this point the rewards limited and
there's not that much meat on the bone and the issue
though is in bar E my stop of the prior bar highs is now
really far away. My risk is a buck $50 while the reward is
only 50 cents and this is where I start to think should I be
taking this trade off and if you think about those
probabilities, you come to the conclusion that it's getting
pretty marginal to negative now and in fact this is where I
would be taking off that trade. What are the other
considerations we need to make throughout this? To be
clear I am not actually crunching the exact expected value
calculations when I’m trading. There's no real hardcore
calculations - these prior calculations are just to make a
point. In reality the hardest part of this exercise is so often
handicapping what your probability spectrum is and what
your reward is and where does that come from? A lot of that
needs to come from experience? Yesterday a trader asks me
where do I get these numbers from and is it all from back
testing? I wish it could be but the issue is so many times all
these trades are so nuanced. How do you compare a trade
like HKD or AMDT the past week to some prior comparable
when there is no precedent. every single thing has
differences in volume, the box, the intraday or the daily, so
what we do as traders is it's our job to use our mental
database or an evernote database to really handicap these
the best we can. They're all estimations at the end of the
day but part of being a trader is having the most accurate
estimations versus the market. The other thing is a lot of
traders miss a lot of nuances. We really do want to be
incorporating elements on the tape like a buyer coming in,
or things which might both increase the probability of your
long working and the reward or similarly you could run into
a large seller in front of resistance. That might lead one to
sell under him with the Option of them buying back once
their seller lifts. One needs to be making these decisions
through a rough estimation of what the expected value is
which is dynamically changing on all these factors. Similarly
certain patterns might start off amazing but unfold in a
manner that ruins it. The same way pocket aces can be
awful after the flop. There's always the counter view - some
traders might argue oh let the let the trade work and let it
be binary, and I would argue that this is just stubborn and
not taking advantage of all the information we can have as
a day trader. It's very close-minded and the same as saying
like to a poker player if you get aces just play it just play it
straight through until the end. That would be awful advice.
There's so many times where aces lose and depending on
others betting style and what unfolds on the flop the turn in
the river you really need to be incorporating that
information. The only situations I can think of where that
argument might be valid is if your data supports it if for
whatever reason incorporating these nuances proves to be a
negative expected value for you or if there are certain
trades especially on big picture time frames that require you
to be hands off then I get it but otherwise I would argue you
just simply don't yet have the experience and the skill set
yet to accurately incorporate these different nuances. But
that does not mean that you shouldn't be striving to do so
or that it wouldn't help your trading. But what if none of this
made sense to you? Again this is an advanced topic. Just
read the chapter ,again take time to think about it or just
come back to the idea in the future - it's a hugely important
one and something that I’m going to be focusing a lot of my
advice on in the future. Here's my challenge to you now; I
want you to reflect on your trading and think about what are
some nuances you can begin to incorporate in your trading.
Maybe it's figuring out how can you rate the box on a scale
of negative 10 for being bearish or 10 for being bullish and
start to incorporate that into your trade decisions. If you're
long into a super nice steady strong bullish box maybe you
don't want to sell as aggressively, or if something's looking
bearish despite you being long maybe you start to audible
and start to scale out of it. Beyond the box maybe you're
going to start to further dissect nuances in the intraday
chart or the daily chart perhaps your goal is going to be to
incorporate the strength or weakness of the closing of each
intraday bar. You don't need to go all at once just pick some
small nuance and make sure you're starting to dynamically
incorporate that into your expected value. This is a very
tough skill but this will elevate your training and this is the
objectively optimal mathematically optimal way to be doing
this. It is what will make you better if you take the time to
do this.

OceanofPDF.com
Chapter 8 How to Trade Options Using Volatility

In this chapter we're going to talk about implied volatility

basics. As an Options trader understanding what implied
volatility represents in how to interpret implied volatility and
make trading decisions based on it is extremely important,
so let's go ahead and start talking about implied volatility
basics. What does this fancy term imply volatility means?
Well, implied volatility is just the expected magnitude of its
facts future price changes as implied by the stocks Options.
All you need to know is that implied volatility is synonymous
with Option prices when it pertains to our particular stock.
Implied volatility is just a way to compare one stocks Option
prices to another stocks Option prices. To demonstrate to
you how implied volatility and Option prices are connected
we are looking at two stocks here that are similarly priced
and we're looking at the same Options on each of those
stocks.

Let's start with Pepsi. Pepsi is trading for 102 dollars and
we're looking at Options with 37 days to expiration. The 105
column Pepsi is worth 80 cents, while the 100 put is worth a
dollar 17. Pepsi's implied volatility in this 37 day expiration
cycle is sixteen point four one percent. If we look at UNP,
UNP is pretty much the same price as Pepsi so UMP is worth
one hundred and three dollars and sixty cents. In that same
expiration cycle one's 37 days to go the 105 column is
trading for two dollars and 72 cents in the 100 put is trading
for one dollar 92 cents. UNP's Option prices are significantly
higher than Pepsi's Option prices and UNP has an implied
volatility of thirty point nine four percent in that thirty seven
day expiration cycle. You don't need to know where that
actual implied volatility number comes from and you don't
need to understand the math behind it. All you need to
understand and is that the implied volatility of a stock
represents the overall level of that stocks Option prices.
Right here this was just a basic example to show you that on
two stocks that are similarly priced with the same Options
with the same amount of time to expiration, the stock with
more expensive Options will have a higher implied volatility.
Now that you know the relationship between the stocks
Option prices and the implied volatility, let's go ahead and
talk about why one stock might have a higher implied
volatility than another stock. When people trade Options
they're doing so for one of two reasons. The first is they're
hedging against movements in the stock price or implied
volatility or they're speculating on those movements in the
stock price or implied volatility. The overall level of a stocks
Option prices or implied volatility indicates whether the
market for that stock believes there's going to be large or
small movements in the future. If Option buyers are willing
to pay more an Option sellers demand more, that's going to
lead to an increase in Option prices in higher implied
volatility. Those higher Option prices and implied volatility
indicate that the market is expecting large movements on
that stock price in the future. If Option buyers pay less and
Option sellers demand less premium for taking the risk of
selling Options, Option prices will decrease which leads to
lower levels of implied volatility. Cheaper Option prices and
low implied volatility indicate smaller expected movements
in the stock price in the future. The key point here is that
market sentiment drives Option prices and Option prices
drive implied volatility, and from implied volatility you can
quickly gauge what the market sentiment is for a particular
stock. If a stock's Option prices are expensive, that’s
actually have a high implied volatility which tells you that
the market is expecting significant moves on that stock. On
the other hand if a stock's Option prices are cheap then that
stocks going to have a lower implied volatility which tells
you that the markets expecting smaller movements on that
stock in the future.

Implied volatility and probabilities

Implied volatility actually represents a one standard
deviation change in the stock price. In statistics on one
standard deviation range encompasses about 68% of the
occurrences around the average. In our case the average is
going to be the current stock price, so if you want to
calculate the one year one standard deviation range for any
stock, you can take the stock price and add or subtract the
stock price times implied volatility. Let's go ahead and take
a look at a few examples to demonstrate this formula in
action.

Let's take a look at three different stocks on September 28

2016 - just a random date. NETFLIX had a stock price of
97,50 and an implied volatility of 44 percent. To get the one-
year one standard deviation expected range for NETFLIX, we
take the stock price of 97,50 multiply it by the implied
volatility of 44 percent and then subtract that number and
also add that number to the current stock price of 97,50.
Using that calculation we get a one-year one standard
deviation range for NETFLIX that's between fifty four dollars
and sixty cents and one hundred forty dollars and forty
cents. That means in one year there's a 68 percent
probability that NETFLIX is between fifty four dollars and
sixty cents and one hundred and forty dollars and forty
cents. As you go down the line you can see that GoPro has a
stock price of sixteen fifty with an implied volatility of
eighty-four percent. That means that there's a sixty eight
percent probability based on these current Option prices
that GoPro is between two dollars and 64 cents and thirty
dollars and thirty six cents in one year. That's the market
saying GoPro is either going to be out of business or their
stock price is going to double over the next year. Now let's
go ahead and just visualize one standard deviation ranges.

On this particular graph we're looking at $100 stock with

25% implied volatility. That 25% implied volatility says that
in one year's time there's a 68% chance with the stock
prices plus or minus 25% from its current price. In $100
stock 25% is a $25 move so there's a 68% implied
probability that this stock is between $75 and $125 in one
year. With implied volatility, you can actually easily
calculate the two standard deviation stock price range for a
stock over any time frame but in this case we're going to
use a year because it's easy to comprehend.
To calculate a two standard deviation range you just have to
multiply the stock price times implied volatility times two. In
this case $100 stock with 25% implied volatility would result
in the two standard deviation range of $50, so plus or minus
fifty dollars from the current stock price. A two standard
deviation range encompasses about 95% of the occurrences
around the average. A two standard deviation range says
there's a 95% chance that this stock price is between $50
and $150 in one year's time. This is based on $100 stock
price with 25% implied volatility. Just to visualize the
difference between a high and low IV stock, we looked at
two hundred dollar stocks; one with a 10 percent implied
volatility and one with a 25 percent in volatility and we just
plotted their expected stock price ranges in the future. You
don't have to worry about the exact height of each curve -
we're just trying to demonstrate to you the difference
between a stock with high IV and low IV.
The 10% IV stock has a very narrow price distribution. That's
an expected price distribution. A stock with low IV is
essentially expected to not move too far away from its
current stock price so in this case the current stock price is
100. However when we look at the 25 percent implied
volatility stock, we can see that there's a lower probability
of that stock staying right at the stock price at $100
because the market is expecting wild swings and that stock.
There is a higher probability of larger and larger movements
on the 25 percent IV stock then there is for the 10 percent
IV stock. The 10 percent IV stock is expected to stay fairly
close to its current stock price of $100, while the 25 percent
IV stock is expected to be much more volatile and therefore
has a wider expected price distribution. In all the examples
we've been calculating one-year expected price ranges,
however you can calculate expected ranges over any time
frame.
To do that you just do the stock price times implied volatility
times the square root of the number account number of
calendar days to expiration divided by 365 so for a one-year
expected range the square root of 365 over 365 is 1, which
explains why we were just using the stock price times
implied volatility before. However let's say you wanted to
calculate a 30 day expected range. In that case you would
do the stock price times implied volatility times the square
root of 30 over 365. Let's go ahead and look at some
examples to see how that works. Now let's say we have a
$250 stock with 15% implied volatility.

Over the course of the next year that stock has a one
standard deviation range of plus or minus 15%, however if
we wanted to calculate the 30-day one standard deviation
range we could do so by taking $250 times fifteen percent
times the square root of 30 over 365. That gives us an
expected range of plus or minus ten dollars and seventy-five
cents. So over the next 30 days there's a 68 percent
probability that this $250 stock is plus or minus ten dollars
and seventy-five cents from its current price.

On that same stock if we wanted to calculate the one-day

expected range we would take $250 times fifteen percent
times the square root of 1 over 365. That gives us a one-day
1 standard deviation range of plus or minus $1 and 96
cents. We don't have to just do annual expected ranges. You
can calculate the expected range over any period of time.
Now let's recap the main concepts from this chapter. Implied
volatility is the expected magnitude of a stock's future price
changes as implied by the stocks Option prices. Implied
volatility is represented as an annualized percentage and
represents the 1 standard deviation or 68 percent
probability range for a stock price. If Option buyers are
willing to pay more in Option sellers demand more, then
Option prices will increase which leads to higher levels of
implied volatility. Higher Option prices and higher implied
volatility indicates that the stock is expected to have larger
movements in the future. When Option buyers pay less and
Option sellers to demand less, Option prices decrease and
that leads to lower levels of implied volatility. Cheaper
Option prices and lower implied volatility indicate that there
are smaller expected movements in the stock price in the
future. Lastly, to calculate the expected ring for any
timeframe, take the stock price, multiplied it by implied
volatility and then multiply that by the square root of the
number of days to expiration, divided by 365.

OceanofPDF.com
Chapter 9 Why you should trade Vertical
Options Spreads

There are so many different Options strategies out there

that are available to you as an Options trader but the
following chapters are incredibly important because we will
be focusing on arguably the four most powerful Options
trading strategies that you can trade as an Options trader
and let me just tell you if you can master your
understanding of these four vertical spread strategies, you
will make a massive leap forward in your Options trading
expertise and knowledge and that's because if you
understand these four vertical spread strategies you will
essentially understand eighty percent of the Option
strategies in existence. Specifically I’m going to teach you
these four strategies using numerous examples and trade
performance illustrations so that you can fully understand
how these strategies perform relative to changes in the
stock price and the passage of time. This chapter is all
about vertical spreads, but what exactly is a vertical spread?
A vertical spread is the combination of two Options trades
that are placed simultaneously. The first trade is purchasing
a call or put Option at a strike price and then the second
component of a vertical spread is shorting another caller put
Option at a different strike price. You'll be using either calls
or puts. As a quick example of a vertical spread let's look at
a vertical spread setup in Apple.
In this image we can see a call vertical spread that I’ve
queued up in Apple by purchasing the 140 call Option and
shorting the 150 call Option. This is an example of a vertical
spread because I am purchasing a call Option at one strike
price and shorting another call Option at a higher strike
price. This is called a vertical spread because you're trading
two different Options at different strike prices within the
same expiration and the strike prices are listed vertically on
the Option chain so you're creating a spread vertically when
you're looking at it on the Option chain. But why would
somebody want to trade this vertical spread as opposed to
simply purchasing that 140 call all by itself? Well, let me go
through a real quick demonstration by hopping over to my
brokerage platform. I’m going to look at Apple and right now
Apple is down about seven dollars with the stock price
around $124. But let's go ahead and look at a 120 call
purchase in the October expiration cycle. If I wanted to buy
the 120 call Option in Apple today it's currently listed at a
price of about eleven dollars and sixty cents and with that I
would have to put up one thousand one hundred and sixty
dollars to enter this call Option position.
But what if I didn't want to spend so much money on this
call Option but I still wanted to have a trade that would
make money when the stock price increased. Let's say I
thought Apple might increase to 130 over the next 43 days.
Instead of just purchasing this 120 call Option I could also
short the 130 call Option and by doing so I reduce the cost
of my trade from around eleven hundred dollars to four
hundred and thirty five dollars. This not only reduces my
risk but it reduces my break-even price as well. The break-
even price for this vertical spread here would be 124.35
which essentially means I only need Apple to be at one
124,35 at expiration for this spread to not make or lose any
money. But if I were to just purchase that 120 call Option for
eleven dollars and forty cents, then my break even price
would be one hundred thirty dollars and forty cents. So by
doing a vertical spread trade you can actually reduce your
risk and you can make it a higher probability trade that you
can make money on because your breakeven price will be
much more favorable as opposed to simply buying that call
or put outright.

OceanofPDF.com
Chapter 10 Bull Call Spread Options Trading
Strategy

Now that we've briefly touched on what a vertical spread is

and why somebody would want to trade one as opposed to
simply trading an Option by itself, let's look at the four
vertical spread strategies in depth so that you can fully
understand each of these four strategies and then we'll
move on to the more important and exciting topics. The first
of the four vertical spread strategies we will cover is called
the bull call spread. As the name suggests the bull call
spread is a bullish Options trading strategy that is
constructed using call Options. The bull call spread is
constructed by purchasing a call Option at one strike price
and simultaneously shorting another call Option at a higher
strike price. Sometimes the bull call spread is referred to as
simply buying a call spread or a call debit spread. These
vertical spreads have many different names and it depends
on the trader you're talking to, so you'll just have to
familiarize yourself with the various names of these spreads
with experience. We're going to look at a real historical bull
call spread and we're going to see how the trade performed
over time relative to changes in the stock price. Let's check
out the characteristics of this bull call spread example. The
stock price at entry is and 28 142.28 and to construct this
call spread we're going to buy the 135 call for nine dollars
and 30 cents and we're going to short the 150 call for 1.54
cents.
Both of these call Options are in the 46 day expiration cycle.
The purchase price of this spread is 7.76 which comes from
the fact that I bought the 135 call for 9.30 and shorted the
150 call for 1.54 cents, bringing my net payment for this
spread to $7.76. This means I actually need 7.76 dollars to
purchase this spread because we need to multiply that
spread price by the Option contract multiplier of 100. The
break-even price for this spread at expiration is 142.76 and
that comes from the calls strike price of 135, plus the entry
price of 7.76. Before visualizing the performance of this
trade through time let's actually look at the risk profile for
this position at expiration so we can understand at
expiration what the profits and losses will be for this position
based on various stock price scenarios. The first thing to
know is that this strategy has limited risk and the most the
strategy can lose is the entry price or entry cost of 776
dollars. If I buy this spread for 7.76 and it expires worthless,
my loss will be 776 dollars and that will occur if the stock
price is at or below 135 dollars at expiration, because if the
stock price is at or below 135, the 135 call and the 150 call
will both expire worthless and therefore the spread itself will
be worthless.
The break-even price of this call spread is 142.76 at
expiration and that means if the stock price is at 142.76 at
expiration, the 135 call Option will have intrinsic value of
7.76, but the short 150 call will have zero dollars of intrinsic
value and therefore the net value of the spread would be
$7.76 which is the same as the entry cost and therefore the
position will not have a profit or loss if the stock price is
exactly at $142.76 at the time of expiration. Lastly, the
maximum profit potential of 724 dollars will occur if the
stock price is at or above the upper strike price of 150 at the
time of expiration and that's because the maximum value of
any vertical spread at expiration is the width of the strikes
and in this case the call spread has strikes that are fifteen
dollars apart, which means the maximum value of this call
spread at expiration is fifteen dollars or an actual value of
fifteen hundred dollars. So if I buy this call spread for an
entry cost of seven hundred and seventy six dollars and it
appreciates to its maximum value of fifteen hundred dollars,
my profit on the trade will be seven hundred and twenty
four dollars. The reason that this call spread can only be
worth fifteen $15 at expiration is because if the stock price
is fully above the call spread - meaning the stock price is at
or above $150, if we take the intrinsic value of the call
Option that I own and subtract the intrinsic value of the
Option that I’m short it will always come out to $15 at
expiration. For example if the stock price is at 155 at
expiration the 135 call that I own will have twenty dollars of
intrinsic value but the 150 call that I am short will have five
dollars of intrinsic value and what that means is that if I
want to close that spread at expiration, I could sell the 135
call for twenty dollars - collecting two thousand dollars in
premium and I would have to buy back the short 150 call for
five dollars therefore paying out five hundred dollars in
premium and that would leave me with a net premium
collection of fifteen hundred dollars at expiration. This is the
expiration payoff graph which only really matters at
expiration, but how did this strategy actually perform as the
stock price changed over time? Let's take a look. On the top
portion of this graph we have the changes in the stock price
relative to the strike prices of this call spread and on the
bottom portion of the graph we're looking at the actual
changes in the spreads value as the stock price changed.
In the first few days of the trade the stock price drifted
lower which caused the call spread to lose value. If the
spread price declines from the price you pay for it you'll
have an unrealized loss. Fortunately we can see that the
stock price rocketed higher in the subsequent weeks leading
to an increase in the call spread's value. You'll notice that
there was a moment where the stock price was above the
entire call spread but why wasn't the spreads price $15
because I said that the maximum value of the spread at
expiration would be fifteen dollars if the stock price was
above one hundred and fifty dollars. At around four days to
expiration, the spreads price was very close to its maximum
value of fifteen dollars. It's worth mentioning here that you
can close a vertical spread whenever you want to - you
don't have to hold until expiration. If the maximum potential
value of the spread is fifteen dollars and the spreads price
gets close to fifteen dollars, then it makes sense to close the
trade because you have very little left to gain from holding
it but you have everything to lose. At the very end of the
trade we can see that the stock price did dip lower and the
call spread lost substantial value and that's exactly why a
spread should be closed when it approaches the maximum
potential value. It's really not worth holding. At the time of
expiration the stock price was at 148.06, leaving the trade
with a profit of five hundred and thirty dollars. But where
does this profit come from? If the stock price is at one
hundred and forty eight dollars and six cents at expiration,
the 135 call will have intrinsic value of $13.06, while the 150
call will have no intrinsic value and expire worthless,
therefore the value of the spread at expiration is limited to
the intrinsic value of the 135 call, which is thirteen dollars
and six cents. Meaning that in actual dollar terms the
spreads value would be thirteen hundred and six dollars,
and if I buy a spread for seven hundred and seventy six
dollars, and it expires with a value of one thousand three
hundred and six dollars, my profit is five hundred and thirty
dollars. What we've learned with this example is that when
you buy a call spread or you trade a bull call spread, you
want the stock price to increase and ideally you want the
stock price to be above the upper strike price of the bull call
spread at the time of expiration as that is a scenario that
will result in the spread, having its maximum potential value
which we also learned is the distance between the strike
prices. If I have a twenty dollar wide vertical spread the
most it can be worth is twenty dollars. If I have a one 100
wide vertical spread the most that spread can be worth at
expiration is 100 so keep that in mind. We also saw that as
the stock price goes up and down so does the value of the
call spread, and this is important to understand because
when you enter any Option position, it's not a binary event
where you only get the profit or loss at the time of
expiration - the Option prices or the Options spread in this
example will change every minute of the day as the stock
price is changing and you can get out of that spread or
Option position whenever you want to, so just because it
has an expiration date, it doesn't mean you have to hold
until the expiration date. To close the call spread in this
example since I bought the 135 call as an opening trade and
I shorted the 150 call when I opened the trade to close this
call spread I just have to sell the 135 call that I own and buy
back the 150 call that I am short and you can do this in one
transaction at one spread price and effectively that will
realize whatever profit or loss you have on that spread at
that moment, so you never have to hold a spread until
expiration - you can close it whenever you want, so I could
buy a call spread and sell it five seconds later if I wanted to I
can get out whenever I want to.

OceanofPDF.com
Chapter 11 Bull Put Spread Options Trading
Strategy

Now let's move on to the second bullish vertical spread

which is called the bull put spread. As the name suggests a
bull put spread is a bullish vertical spread, constructed with
put Options as opposed to call Options which we just
discussed. To set up a bull put spread a trader will short a
put Option at one strike price and purchase another put
Option at a lower strike price. This is sometimes just
referred to as selling or shorting a put spread but it is also
referred to as a put credit spread because when you enter
the trade you will collect a net credit - meaning the Option
that you sell is more expensive than the Option you
purchase and therefore you will collect premium when you
enter the trade and that's why it's called a credit spread.
The goal when trading a bull put spread is to see the stock
price increase but at the very least the trade can make
money so long as the stock price remains above the short
put strike price as time passes. It is a high probability
trading strategy meaning that you have a greater than 50
percent chance in theory of making money on that trade.
Just like we did before let's go ahead and look at a real
historical example. In this example the stock price is at
146.92 at the time of entering the trade. To construct this
bull put spread we will short the 145 put and collect six
dollars and sixty cents and simultaneously purchase the 135
put for three dollars and seven cents.
Both Options are in the 46 day expiration cycle. The entry
price for this spread is 3.53 that is received since I shorted
the 145 put and collected 6.60 and paid $3.7 to buy the 135
put so a net premium is collected at entry. The break even
price for this particular position is 141.47 and that means if
the stock price is at $141.47 at the time of expiration then
this put spread will not make or lose any money. The
maximum value of a vertical spread is the distance between
the strike prices and in this case since the put strikes are
$10 apart the maximum value of this put spread at
expiration is $10. So let's look at the expiration payoff
diagram for this particular bull put spread position. As we
can see the best case scenario is that the stock price is
above the entire put spread at expiration. If the stock price
is above 145 dollars at expiration, the 145 put and the 135
put will have no intrinsic value and therefore will expire
worthless, leaving the spread with a value of zero dollars. If I
collect three hundred and fifty three dollars for this
spreaded entry and the spreads price falls to zero I will
effectively make 100% of the profit potential or 353 dollars.
When you short a put spread like this, you want all of the
Options to expire worthless which will happen if the stock
price increases and is above both put spreads, strike prices
at the time of expiration. The expiration break even price of
this position is 141.47 which means if the stock price is at
$141.47 at expiration, the 145 put will be worth its intrinsic
value of $3.53 and the 135 put will be worthless and lastly
the maximum loss potential of this position is 647, which
will occur if the stock price is below both put spread strike
prices at expiration.
If the stock price is below 135 dollars at expiration then the
put spread will be worth its maximum value of 10 dollars,
which again is the distance between the two strike prices.
So if I shorted this spread initially and collected three
hundred and fifty three dollars in premium and the value
increased to one thousand which is its maximum value then
I will lose six hundred and forty dollars. So let's go ahead
and take a look and see exactly what happened to this bull
put spread in real life as the stock price was changing up
and down through the trades duration. The top portion of
this graph features the changes in the stock price relative to
the spreads strike prices. As we can see early on in the
trade the share price was falling which actually caused an
increase in the put spread's value and since the bull put
spread is a bullish strategy it will lose money when the stock
price falls and it will make money when the stock price
rises.
Fortunately the shares regained traction and headed higher
throughout the remainder of the trade and we can see that
the further the stock price increased and as time passed the
spread's value collapsed. At around 17 days to expiration
the spread's value was already very close to zero dollars
which means the trade essentially already had the
maximum profit potential and at that moment a wise trader
would close the put spread to secure the near maximum
profit. Closing the put spread would entail buying back the
short 145 put and selling the long 135 put. The P&L on the
trade would therefore be the difference between the
hundred and fifty three dollars in premium collected at the
time of entering the trade and whatever they paid to close
the spread. If they paid twenty dollars to close the spread
the profit on the trade would be three hundred and thirty
three dollars but as we can see the spread continued losing
value and ended up with the maximum profit at expiration
because with the stock price at 157 dollars and two cents at
expiration the 145 put and the 135 put had no intrinsic
value and therefore the spread's value was zero dollars.
Thus far we've covered both of the bullish vertical spread
trading strategies which are the bull call spread which is
buying a call spread and the bull put spread which is
shorting a put spread. One of those is referred to as a debit
spread meaning you pay to enter it which is buying the call
spread and one of those is referred to as a credit spread
which means you collect premium when you enter the trade
and that is when you sell or short the put spread. You may
be wondering when would you use the bull call spread and
when would you use the bull put spread and we'll talk about
that later but for now we need to move on to the bearish
vertical spread trades which are the bear call spread and
the bear put spread.
Chapter 12 Bear Call Spread Options Trading
Strategy

The first bearish vertical spread trades that we will cover is

called the bear call spread which is basically when you sell a
call spread or short a call spread. The bear call spread is
sometimes referred to as simply selling a call spread or a
call credit spread and a bear call spread is constructed by
shorting a call Option at one strike price and purchasing
another call Option at a higher strike price. It's basically the
bull call spread from earlier except you do the opposite and
instead of buying the call spread you actually short or sell
the call spread as your opening trade. A bear call spread will
make money as long as the stock price remains below the
call spread strike prices so if you sell this call spread and the
stock price, it doesn't matter if the stock price goes up a
little bit as long as the stock price is below the vertical
spreads strike prices the trade will make money as time
passes. In this example the stock price is at $141.46 at the
time of entry and to construct the spread I will short the 142
call for $1.93 and buy the 145 call for 87 cents. Both
Options are in the 32 day expiration cycle, so the entry price
for this spread is 1.06 that is received since the call that I
shorted the 142 call is more expensive than the call that I
purchase and this results in a net premium collection at the
time of entering the trade. Let's look at the expiration payoff
graph for this position.
As we can see the best case scenario is that the stock price
is below 142 at expiration as that would lead to the 142 and
145 calls expiring worthless, which means the call spreads
value is zero dollars. If I short the call spread for one
hundred and six dollars and it expires worthless I’ll make the
full profit of one hundred and six dollars. The break even
price is 143,06 which means if the stock price is right at 143
dollars and six cents at expiration. The 142 call will have
intrinsic value of one dollar and six cents and the 145 call
will expire worthless, leaving the spread with a value of one
dollar and six cents - no profit no loss. If the stock price is at
or above the upper strike of 145 the call spread will be
worth its maximum price of three dollars, because the strike
width is three dollars and again we have to multiply these
figures by 100 to get their actual values so if I short the
spread for 106 dollars and it appreciates to a value of 300 I
will lose 194 dollars. But this is just the expiration payoff
graph and we know that this does not reflect what will
happen before expiration so let's go ahead and look at a
performance visualization for this position to see exactly
how the trade performed relative to changes in the stock
price as time was passing. The first thing to note is the
correlation between the stock price and the spread price
and since this is a bearish call spread trade I want the stock
price to fall and be below 142 at expiration.

About halfway through this trade with 17 days to expiration

we can see that the stock price was approaching the 145
dollar price level and we can see that the spreads value was
at two dollars, representing a unrealized loss of about ninety
four dollars at that time. But as a few more weeks passed
we can see that the stock price declined steadily and with
two days to expiration, the stock price was well below the
call spread strike prices and the spread price itself was
almost zero dollars. With the best case scenario being that
the spread price falls to zero dollars, it would make sense at
that moment to close that spread if the price gets close to
zero dollars. To close a short call spread, meaning a cost per
that you sold as an opening trade you just need to buy back
that same call spread to close it which would consist of
buying back the short call and selling the long call. In this
trade that would mean buying back the short 142 call and
selling the long 145 call and this can be done in one
transaction. If I paid 20 cents to buy back the spread my net
profit would be $86 because i initially shorted the spread for
one dollar and six cents. In terms of this spreads value at
expiration the stock price was at 142.26 which means the
142 call had intrinsic value of 26 cents and the 145 call
expired worthless, therefore the price of the 142, 145 bear
call spread at expiration was 26 cents or a real value of 26
dollars.

If I shorted this spread for 106 dollars and it had value of

$26 at expiration my profit would be eighty dollars. We've
got one vertical spread strategy left and then we will get to
the fun stuff because the next sections are going to be
critical in your understanding of vertical spread profitability
and how you can make more and more money on your
vertical spread positions.

OceanofPDF.com
Chapter 13 Bear Put Spread Options Trading
Strategy

The final of the four vertical spread strategies that we have

to discuss is the bear put spread which is sometimes
referred to as simply buying a put spread or a put debit
spread since you pay to enter the put spread. To enter a
bare put spread position a trader will buy a put spread at
one strike price and short another put Option at a lower
strike price and the goal is to see the stock price fall below
both of the put spread strike prices and that would lead to
the maximum profit at expiration.

Since the put that you purchase will be more expensive than
the put that you short when you enter the trade, this
position will require that you pay to enter the position and
for that reason it is sometimes called a put debit spread.
Let's take a look at an example and then move on to the
more important and fun stuff. At the time of entering this
trade the stock price was at 780.22. To construct this bare
put spread we'll buy the 800 put for 44.88 and short the 750
put for $22.63. Both Options are in the 59 day expiration
cycle. The entry price of this spread is therefore $22.25.
Now let's go ahead and take a look at the expiration profit
and loss diagram for this position and then visualize the
trades actual performance. The best case scenario is that
the stock price falls below $750 and remains there at
expiration because in that scenario the put spread will be
worth the distance between the strike prices which is fifty
dollars. If I buy a put spread for twenty two dollars and
twenty five cents and it appreciates to fifty dollars, I’ll have
a gain of twenty seven dollars and seventy five cents from
the change in the spreads price, but as we know we have to
multiply that by 100 and we get an actual profit of 2775
dollars.
The break-even price at expiration is 777.75 and if the
spread is right at seven hundred and seventy seven dollars
and seventy five cents at expiration, the eight hundred put
that I own will have intrinsic value equal to twenty two
dollars and twenty five cents and the seven fifty put that I’m
short will be worthless, and therefore the spreads price will
be 22 dollars and 25 cents and I’ll have no profit or loss at
the time of expiration. The worst case scenario is that the
stock price is above both put strikes at expiration in which
case both Options will have no intrinsic value and simply
expire worthless. In that scenario I’d end up having a
worthless spread that I paid two thousand two hundred and
twenty five dollars for in the beginning, leaving me with
unfortunately a 100% loss on the position. But this is just
the expiration payoff diagram so let's look at how this trade
actually performed as the stock price changed.
Understanding that this is a bearish trading strategy - it
would make sense that the trade lost money initially as the
stock price was increasing. In the first two weeks or so the
stock price unfortunately went from 778 dollars to almost
850 dollars and we can see that the 750 bear put spread
lost value falling from a price of 22.25 to a low of $10. The
decrease to 10 represents an unrealized loss of one
thousand two hundred and twenty five dollars and that's
because I initially paid two thousand two hundred and
twenty five dollars for the spread and a reduction in its price
to ten dollars means the spread is worth one thousand
dollars. We always have to multiply the spreads price by 100
to get its dollar value.

As luck would have it the stock rally did not last long and
the share price plummeted over the remainder of the trade
and we can see that at 14 days to expiration, the stock price
was just above $750 meaning the 800 750 put spread was
almost fully in the money. The spreads price at that moment
was around thirty four dollars or a value of thirty four
hundred dollars. The stock price fell even further reaching a
low price of seven hundred and twenty dollars when the
spread had around four days left until expiration, and at that
moment the spreads price was around forty seven dollars
and fifty cents or just two dollars and fifty cents shy of its
maximum potential value of fifty dollars. The trader could
have sold the spread at that moment for four thousand
seven hundred and fifty dollars and secured a profit of two
thousand five hundred and twenty five dollars. To close a
put spread that you've purchased you simply sell that put
spread. In this example that would be done by selling the
800 put and buying back the short 750 put. If a trader held
this position all the way to expiration, the P&L would have
been seventeen hundred and sixty dollars but where does
that profit come from?

With the stock price at seven hundred and sixty dollars and
sixteen cents at expiration, the 800 put had intrinsic value
equal to $39.84 and the 750 put had no intrinsic value and
therefore the price of the 800 750 put spread was $39.84 at
expiration or a value of three thousand nine hundred and
eighty four dollars. So if I bought this put spread initially for
two thousand two hundred and twenty five dollars and it
was worth three thousand nine hundred and eighty dollars
at expiration, my profit is $1,759. We've covered the four
vertical spread strategies and we've gone through a lot of
examples and a lot of numbers in these past four examples
but it's important that you understand the basic mechanics
of these vertical spread trades and that's going to set you
up for the next sections that we're going to talk about which
are much more exciting and these next sections are going to
talk about vertical spread profitability versus the time left
until expiration and also with changes in implied volatility.
Then I’m going to talk to you about how to select the right
strategy for your particular situation and stock price outlook
and then we'll close out the book by talking about what
happens at expiration to a vertical spread and lastly do you
have early assignment risk when you trade vertical spread
positions.

OceanofPDF.com
Chapter 14 Vertical Spread Profitability VS
Time Left Until Expiration

This is perhaps one of the most important things to

understand about vertical spread trading as the time left
until expiration has a significant impact on how profitable
your vertical spread will be depending on where the stock
price is. The reason this is so important is that you have to
understand one law about vertical spreads and the law
about vertical spreads is that to achieve the maximum profit
potential on a vertical spread position both of the Options in
your vertical spread must have very little extrinsic value and
more specifically to get to the absolute maximum profit
potential, the extrinsic value in your Options will need to be
zero which will happen at expiration or if the spread is so far
in the money that the Options have very little extrinsic
value or no extrinsic value. Basically the more time your
spread has left until it expires the deeper in the money that
spread will have to be to get close to the maximum profit
potential, but if your spread has very little time left until
expiration or is expiring this day, then the spread can just
be fully in the money and it will be trading with very close to
the maximum profit potential and subsequently expiring
with the maximum profit potential because if the spread is
fully in the money at expiration only intrinsic value will
remain and the spreads value will have 100% of its
maximum potential value which will be the width of the
strike prices. In our earlier bull call spread example I had
mentioned at one point in that example that the stock price
was well above both call spread strike prices - meaning the
call spread was fully in the money, but I had noted that the
spread's price was not 15 dollars which is the width of the
strikes. Instead the spread's price was around 12 or three
dollars shy of its maximum potential value, despite being
fully in the money, and the reason for that is because the
spread was not close to expiration. It still had multiple days
left before expiration and because of that the Options in
that spread had lots of extrinsic value and because of the
extrinsic value in those Options, the spread's price was not
yet at its maximum potential value of $15.

At that example and at around 18 days to expiration we can

see that the stock price is around 150 250 but the 135 150
call spread was not worth its maximum value of $15 and the
reason is because of extrinsic value. If we just strip out the
intrinsic value of these Options we can calculate that at a
stock price of 152,50 the long 135 call has $17.50 of
intrinsic value while the short 150 call has 2 dollars and 50
cents of intrinsic value and therefore the net intrinsic value
of the spread is $15 which is its maximum potential value
and by net intrinsic value I mean the intrinsic value that I
own and subtracting out the intrinsic value that I don’t own
or of the Option that I’m short. Basically if I need to sell that
135 call I can sell the 135 call for its intrinsic value of dollars
and fifty cents and I have to pay two dollars and fifty cents
to buy back the short 150 call assuming that I’m only paying
and receiving intrinsic value and therefore if I collect $17.50
from selling the 135 call at its level of intrinsic value and I
pay $2.50 to buy back the short 150 call at its intrinsic value
of $2.50 then I will collect $15 which is the width of the
strikes or the maximum potential value of that spread. But
why is it important to understand that the more time left
until expiration the more extrinsic value these Options will
have which will prevent the spread from getting to its
maximum potential value? Well the reason it's important is
because if you buy a call spread or if you buy a put spread
and you see a favorable stock price movement that leaves
your spread fully in the money you have to understand that
just because the spread is fully in the money, it doesn't
mean that you will have the maximum profit potential and
that's because if the spread is fully in the money with lots of
time left until expiration, then there's going to be a lot of
extrinsic value in those Options and therefore the spread
will not yet be trading at its maximum potential value or the
width of the strikes. If you have a spread that becomes fully
in the money you have to wait for time to pass for the
extrinsic value to decay out of those Options and therefore
the spreads price will gradually approach its maximum
value or the distance between the strike prices. I can prove
this to you by just looking at various vertical spreads and
changing the expiration date or changing the vertical
spreads expiration cycle so that we can simulate the loss of
extrinsic value or the increase in extrinsic value and see
how that affects the spreads price. Now let's hop over to the
trading platform so I can show you some real examples of
this and we can understand that a fully in the money
vertical spread will be trading much closer to its maximum
value than that same vertical spread with more time until
expiration.
I’m going to queue up a vertical spread that is fully in the
money so for this I’m going to look at it call spread so
Apple's current price is 122.75. I’m going to look at the 100
110 call spread and let's look at a long dated expiration
cycle such as November 2020. If I purchase or queue up an
order to purchase the 100 call and then I’d queue up an
order to short the 110 call, we can see that this call spread
is fully in the money because this is the 100 110 bull call
spread and Apple is currently at 123 dollars so this call
spread is fully in the money.

But we can see that the spreads price itself is 6.95 and the
most that this spread could be worth at expiration is ten
dollars. Now let's go ahead and look at the 100 110 call
Option in a much shorter term expiration cycle and see if
the spread price is higher or lower than seven dollars. We
can still gauge the increase in this spreads price as time
passes by simply looking at the same spread in a shorter
term expiration cycle. If I queue up in order to purchase the
100 call and short the 110 call we can see that the 100 110
call spread with 15 days to expiration as opposed to 78 days
to expiration this shorter term call spread that is fully in the
money is trading for about eight dollars and 85 cents so two
dollars more than the same exact call spread with 60 days
more until expiration and the reason for this is that 15 day
Options have much less extrinsic value than 78 day Options
and for that reason if you look at an in the money vertical
spread that has less time until expiration, its price will be
much closer to the maximum potential value as compared
to that same exact vertical spread with much more time
until expiration.

OceanofPDF.com
Chapter 15 Vertical Spread Profitability VS
Implied Volatility

This which relates directly to the extrinsic value statements

because implied volatility literally measures extrinsic value
in Options, so if implied volatility increases that's an
indication that the Options have become more expensive
extrinsically relative to the amount of time they have until
expiration. On the other hand if you see a decrease in
implied volatility, that means that the Options now have
less extrinsic value than they had before relative to the time
left until expiration. If we hold the stock price constant and
we have no passage of time, a decrease in Option extrinsic
value results in a lower level of implied volatility and on the
other side of things, an increase in extrinsic value holding
the stock price and time constant, will lead to an increase in
implied volatility. Here are two things that you need to keep
in mind and internalize. The first thing is that if you buy a
call spread or you buy a put spread you want the stock price
to move so that that spread becomes in the money, and if
you buy a call spreader put spread and it becomes fully in
the money, you want implied volatility to decrease, meaning
that you want the Options to have less extrinsic value,
relative to the time left until expiration because with less
extrinsic value in those Options through a decrease in
implied volatility means that the spreads price will actually
expand towards the width of the strikes or its maximum
value potential. If you have a 20 wide call spread and the
stock price increases above both call strike prices, you want
implied volatility to decrease because then that means that
these Options have less extrinsic value and because of that
the spreads price that you have which is $20 wide will
appreciate towards $20 or its maximum potential value. The
second thing that you should internalize is that if you short
a call spread or you short a put spread and the spread is out
of the money which is a good thing for you, then you want
implied volatility to decrease because that means that there
is less extrinsic value in your vertical spreads Options and
less extrinsic value means that you will see a contraction in
your out of the money vertical spreads price because with
no intrinsic value if your spread is out of the money and it
loses extrinsic value which is all that it consists of, then that
spreads price will fall closer towards zero which is when you
would realize the maximum profit potential. Let me explain
these things that I’ve just said intuitively. A broad decrease
in the extrinsic value that exists in a stocks Options
meaning a decrease in implied volatility means that the
Option market is expecting less volatility from that stock
price in the future, which means that there is a higher
probability that the stock price will be somewhere around its
current price in the future as compared to before.

If you own a call spread meaning you purchase a call spread

and the stock price is fully above your call spread strike
prices a decrease in implied volatility - meaning less
extrinsic value in those Options means that there is a higher
expected probability that the stock price will be somewhere
around its current price in the future, which means that
there is a higher implied probability that your in the money
vertical spread will be in the money at expiration, and if the
probability or the implied probability of your vertical spread
being in the money at expiration increases, the spreads
price will increase. If your spread is fully in the money and
you own that vertical spread meaning you buy a call spread
and the stock price shoots higher, you want implied
volatility to decrease because a decrease in implied
volatility means that there is a higher implied probability
that the stock price will still be above your call spread strike
price at expiration and because that means your spread has
a higher probability of being fully in the money at
expiration, the spreads price will increase towards its
maximum potential value. The same is true if you are short
a put spread or short a call spread. When you short a put
spread you want the stock price to be above your put
spread strike prices because then that means the puts have
only extrinsic value which if the extrinsic value decreases,
that means the spreads price will fall towards zero dollars.

If you have a put spread that you've shorted and the stock
price is above the put spread strike prices, a decrease in
implied volatility means that the extrinsic value has
decreased in those Options, which will lead to a contraction
in the put spreads price towards zero. But the reason this
makes sense is because if you have a put spread that
you've shorted and the stock price is above your put spread
strike prices, a decrease in implied volatility means that
there is a lower expected range for the stock price and
therefore the probability that your put spread expires out of
the money increases and if there is a higher probability of
your put spread expiring worthless, the price of that put
spread will fall. So if you are short a put spread and it is out
of the money and implied volatility contracts that means
that there is a higher probability that your put spread will
expire out of the money or worthless because there is a
lower expected stock price range than there was before
when implied volatility was higher. You may have heard that
when implied volatility is low it is good for debit spreads -
meaning when implied volatility is low it's better to buy call
spreads and buy put spreads because the increase in
implied volatility will benefit the position somehow because
you are net long Options or you've purchased Options
essentially. That's simply not true because if you buy a call
spread or you buy a put spread, you want the stock price to
move through the strike prices and when that happens and
when your spread becomes in the money you want implied
volatility to decrease because that means there's less
extrinsic value in the Options and that means the spreads
price will increase towards its maximum potential value and
intuitively that's because if your spread that you own is fully
in the money and a decrease in implied volatility occurs,
that means that there is a higher probability or higher
implied probability, that your spread will expire in the
money and if your spread expires in the money, it will expire
with its maximum potential value or the width of the strikes.
A favorable movement with a vertical spread combined with
a decrease in implied volatility is always a good thing. The
only time an increase in implied volatility is good is if the
stock price is not in a favorable situation - meaning if you
buy a call spread and the stock price is below the call
spread - meaning the call spread is out of the money, an
increase in implied volatility is good because it means that
there's a larger potential range for that stock price or
expected range for the stock price and that means that
there is a higher probability that your call spread will expire
in the money and because of that increase in the probability
of the call spread expiring in the money, the call spreads
price will increase. But if the call spread is in the money you
want implied volatility to decrease because you want the
implied probability of the call spread expiring in the money
to increase. It's a little more complicated than the simple
examples that we talked about earlier but it is a critical
thing to understand because it doesn't matter if you are
shorting a vertical spread or if you are purchasing a vertical
spread, if the stock price is moving in favor of your vertical
spread - meaning that your call spread that you purchase is
in the money or the put spread that you've shorted is out of
the money, you want implied volatility to decrease 100% of
the time. The only time an increase in implied volatility is
good is if you own a call or put spread that is out of the
money or if you are short a call spread or put spread that is
in the money.

OceanofPDF.com
Chapter 16 How to Select the Right Options
Strategy

Given that there are four different vertical spread strategies

you can choose from which one should you actually use
depending on your particular scenario or stock price
outlook. It's really a matter of preference but here are some
guidelines to help you out. First if you are expecting a strong
directional movement from the stock then it would be better
to buy a call spread or buy a put spread since that would be
a trade that you could structure in a way to have very
favourable risk reward if you are right about your strong
outlook for that stocks potential movement in the future.

Guideline number two is if you are not expecting a super

strong movement in either direction but you want
directional exposure and you want to place a higher
probability trade to profit if the stock price moves in favor of
whatever direction you want, but also could move against
you slightly then in that scenario it would be better to go
with the credit spread strategies which means you short a
call spread in which case, the strategy will make money so
long as the stock price remains below the call spread, or you
short a put spread which will give you bullish exposure but
the strategy will make money so long as the stock price
remains above the put spread strike prices.
Now let's hop over to the tastyworks trading platform and I
will show you some example trade setups with these four
vertical spread strategies so that you can understand the
differences that you'll get with different strike price
selection methods and the risk reward that you'll get with
those trade structures. Right now I have NETFLIX pulled up
on the trading platform and we can see that NETFLIX is
currently trading for 525 dollars per share.

Let's say that I think NETFLIX is going to experience a very

strong directional movement to the downside and I want to
profit from that assumption. NETFLIX will continue losing
substantial value in the share price. Of my bearish vertical
spread strategies I could either buy a put spread and the
other Option is to short a call spread, so it's between the
bear call spread and the bare put spread. So let's look at
going to the October expiration cycle with 43 days to go and
with NETFLIX at $525 let's look at buying the 525 put and
then look at shorting the 500 put. This would give me a put
spread with a cost of $11.45 and that means my maximum
loss potential is right around that number. So if the price of
the put spread is 11.65 my maximum loss potential is
$1,165 but my maximum profit potential is $1335.

The way I constructed this put spread is to purchase at the

money Option and short a further out of the money Option.
This is just one way that you could set this trade up but the
reason I like this and the reason I would suggest buying a
call spreader put spread with a strategy or structure similar
to this one is because it'll give you favorable risk reward and
that will be beneficial to you if you are correct about your
strong directional outlook for the stock. In this case my
maximum profit potential is slightly higher than the amount
I can lose and because of that, if I’m wrong I will lose less
than I will make if I am actually right. So if I’m right about
my stock price prediction that NETFLIX will fall then my
profit potential is actually $1335 and if I’m wrong then I will
actually lose less than that and my maximum loss potential
is $1165. Let's compare this risk profile with the bear call
spread. With NETFLIX at 526, I could even look at selling the
525 call and then purchasing the 550 call. What we'll notice
here is that if I short the 525 550 call spread which is 25
dollars wide just like the put spread was that I just looked at,
in this case I’ll make money as long as NETFLIX is below 525
at expiration in 43 days.

Since I can sell this spread right now for and $10,95 my
maximum profit is eleven dollars, but if NETFLIX is above
550 at expiration then this spread will be worth 25 dollars
and if I short it for 11 and it goes to $25, I’ll have a $14 loss
which means my maximum loss on this is actually 1,400
dollars. When we compare these two strategies of either
shorting the 525, 550 call spread versus buying the 525,
500 put spread, we can see that this has less favorable risk
reward so I can lose more than I can make if I’m right. But
the benefit of using this call spread strategy over the put
spread strategy is that it has a higher probability of making
money, because as long as NETFLIX is below 536 at
expiration which is this position's break even price, this
position will make money. Whereas if I buy the 525, 500 put
spread for $10 then I actually need NETFLIX to be below 515
at expiration. The reason that I said if you have a strong
directional outlook for a stock then buying the spread is
probably better, that is because you'll have more favorable
risk reward if you set it up in this manner. But call spreads
and put spreads, buying them and selling them are
effectively the exact same strategy just with calls and puts.
So buying a call spread is the same exact thing as shorting
a put spread with the same strike prices. Let me
demonstrate that to you right now. As opposed to shorting
the 525, 550 call spread, if I purchased the 550, 525 put
spread which is essentially fully in the money we will see
that the risk profile is very similar.
So for the 525, 550 short call spread the max profit is
around 10.50 the max loss is around 14.50. If I buy the 550,
525 put spread the max profit is 10.85, the max loss is
14.15. Keep in mind that these prices are changing as the
stock price is changing and it's a pretty volatile day so
they're not going to be exactly the same but if we roughly
compare the risk to reward of shorting a call spread or
buying a put spread using the same strike prices, they will
essentially have the exact same risk profile. But let's look at
a different example. If I short the 500, 475 put spread this
has max profit of 925, maximum loss potential of 15.75, but
to get the same exact position I could look at buying the
475, 500 call spread.
Max profit 965, max loss 1535, so they are very similar in
nature and this gets into the realm of Option synthetics
which is how you can construct the same Option positions in
different ways but the reason that I’m bringing this up is
because it is awkward to purchase an in the money vertical
spread much like it is awkward too short and in the money
vertical spread. So if you want to place a high probability
trade then it is better to and out of the money vertical
spread or if you want a very favorable risk to reward trade
based on a very strong directional outlook, then it is better
to buy and at the money or out of the money vertical spread
as compared to buying a deep in the money vertical spread
because if you buy an in the money vertical spread, the
profit potential will be less than the risk and if you buy an
out of the money vertical spread, the profit potential will be
more than the risk. When you have a very strong directional
outlook for a stock, it is more beneficial to give yourself
better risk reward as compared to putting on a higher
probability trade where if you're right about that strong
directional outlook, you'll make a little bit of money but if
you're wrong you'll lose more than you could have made.
It's really a matter of preference and I would encourage you
to go on the trading platform and play around with different
trade structures and see what the risk and the reward
profile is for those vertical spreads but if you have a very
strong directional outlook for a stock, then it is better to buy
a call spreader put spread, namely one that is at the money
- meaning you buy and at the money strike and short and
out of the money Option or you even purchase an out of the
money vertical spread because those will give you the most
favorable risk to reward profiles.

OceanofPDF.com
Chapter 17 What Happens at Expiration to a
Vertical Spread

Understanding what happens to a vertical spread is fairly

simple because at expiration any Option that is in the
money that is held through expiration will automatically be
exercised. For vertical spreads what this means is that if
your vertical spread is out of the money - meaning the
Options have no intrinsic value, then add expiration those
Options will expire worthless and they will not convert into
any stock positions, so those worthless Options will simply
disappear from your trading account and that'll be it. If your
vertical spread is fully in the money which means both of
the Options in the vertical spread have intrinsic value, and
you hold that position through expiration then both of the
Options will actually automatically be exercised and convert
into the corresponding stock positions, associated with
whether that's a short or long call or a short or long put. For
example if I have a 125, 130 call spread that I’ve purchased
and the stock price is at 135 at expiration and I hold the
spread through expiration the long 125 call that I own will
automatically get exercised and I will buy 100 shares of
stock at 125 dollars per share but the 130 call that I am
short will also automatically be exercised and since I’m
short that Option, that means I will be assigned on the
short, 130 call.
That means I will sell 100 shares of stock at 130 dollars per
share. What will happen if the 125 130 call expires in the
money I’ll buy 100 shares at 125 and I will simultaneously
sell those shares at 130 and I will make $500 on that
difference because I will buy 100 shares at 125 and I will sell
those 100 shares at 130, pocketing the 500 gain on that
transaction. But if I paid two hundred and fifty dollars for the
spread when I entered the trade my net profit would be two
hundred and fifty dollars in that particular example. If the
vertical spread is fully in the money and you allow it to
expire in the money, then the exercise and assignments will
offset and you will not end up with any stock position after
expiration. Regardless of that though, you will pay exercise
and assignment fees based on whatever your brokerage
firm charges and I actually would not recommend holding a
vertical spread through expiration, just because you have
the Option to close it before expiration in which case you
don't have to worry about what's going to happen when
those Options expire in the money. In general it is a good
idea to always close Option positions before expiration,
unless they are extremely deep out of the money and
they're just going to expire worthless anyways. Lastly what
happens if a vertical spread is only partially in the money at
expiration. Let's say I buy the 100 put and I short the 90 put
and the stock price is at 93 at expiration. Well the 100 put is
in the money and the 90 put is out of the money so this
means if I hold the position through expiration the 100 put
that I own will automatically be exercised and I will therefore
short 100 shares of stock at the put strike price of 100, so I
will end up with a stock position which would be shorting
100 shares of stock at the put strike price of 100. But the 90
put that I shorted initially will expire out of the money
because it doesn't have any intrinsic value if the stock price
is at 93 and because of that the 90 put will expire worthless,
but the 100 put that I owned will be exercised automatically
and I will effectively short 100 shares of stock at that put
strike price of 100. If your vertical spread is only partially in
the money - meaning the stock price is in between the strike
prices when it expires, if you hold that spread through
expiration you will end up with a stock position and again it
is a good idea to close vertical spreads before expiration
especially if they are partially in the money because in that
scenario you will end up with a stock position and in most
cases you probably won't want to be taking the stock
position because if you're trading Options especially if
you're trading in a smaller account, that stock position is
going to represent a value that is significantly larger than
whatever Option position you have and for that reason, if
your spread is partially in the money at expiration I would
really recommend closing that spread before it expires so
that you don't end up with a stock position and especially if
you don't want the stock position. Lastly is there assignment
risk when trading vertical spreads and the answer is yes.
Since there is a short Option component of all of the four
vertical spread strategies, when you're trading a vertical
spread, if the vertical spread is in the money meaning that
the short Option is in the money, then theoretically you do
have risk of being assigned on that short Option because
the only time you'll be assigned on a short Option is if it is in
the money. But at the same time there really is not a high
risk of early assignment because if you're short and in the
money Option and it has lots of extrinsic value in its price, it
is very unlikely to be exercised by the person that owns it
because whoever exercises the Option with extrinsic value
will effectively burn the extrinsic value in that Option and
give it up unnecessarily, so for that reason a rational trader
would never exercise an Option that has lots of extrinsic
value and if they did exercise an Option that had lots of
extrinsic value, they would essentially be forfeiting all of
that extrinsic value and if you're short that Option that
means you will actually be benefiting by the amount of that
extrinsic value. In the case of early assignment, there is an
early assignment risk when you're trading vertical spreads
primarily if the short Option is deep in the money with very
little extrinsic value. But in the case of buying a call spread
or buying a put spread if the spread is so deep in the money
that the short Option has very little extrinsic value, that also
means that the long Option that you own also has very little
extrinsic value and for that reason that means the spread is
probably trading for very close to its maximum potential
value, and you should be closing it anyways. If you own a
call spread or you own a put spread there should never be a
scenario where you're worried about early assignment
because in the case where you could be assigned early on
that short Option because it is in the money with very little
extrinsic value, that means your put spreader call spread is
already trading near the maximum profit potential and
therefore you should close that position. On the other hand
if you are short a call spread or you are short a put spread
and it is fully in the money, then your short Option is
actually going to have less extrinsic value than the long
Option and in this scenario you are much more likely to be
assigned before expiration. Since your short spread is
actually fully in the money and that means you have a
losing position, it's a little harder to tell you to close that
spread because it is illogical to close a vertical spread that is
close to the maximum loss potential because you have very
little left to lose but you have everything left to gain. It's a
little trickier when you're short a call spread or put spread
and it is deep in the money with early assignment risk
because in that scenario the spread is probably trading at a
point that leaves you with near the maximum loss potential.
In general if you have already lost almost all you can lose on
a trade it doesn't make sense to close it, but in this case it's
tricky because if you continue holding that position there's a
chance that you'll get assigned early on that short in the
money Option, but keep in mind that that does not hand you
a huge loss, because you still have the long Option that is
also in the money and you could just close the stock
position and close the long Option to unwind that position or
you could exercise the in the money Option that you own
which would effectively close out that stock position that
you were assigned into. Again I would not recommend
exercising an Option if it has lots of extrinsic value. There's
a lot to know there and a lot to think about but in general
you should not worry about early assignment risk with
vertical spreads because if you're buying the spreads so
you're buying a call spread or buying a put spread by the
time you get to any situation where you have early
assignment risk your trade is going to have the max profit
and it should be closed. But if you are shorting call spreads
or shorting put spreads it's a little trickier because by the
time you get to an early assignment risk scenario, then your
position is going to have close to the maximum loss
potential and that means that you've already lost
everything you can lose on the trade and in those situations
it's illogical to close the trade, but if you want to avoid the
early assignment risk, the only Option you have is to close
that vertical spread. In summary I covered not only the
basics but some more advanced material that I would
encourage you to study, namely the vertical spread
profitability versus time to expiration, the vertical spread
profitability versus changes in implied volatility and both of
those things relate to extrinsic value. We not only covered
the basics but we covered some more heavy hitting material
but if you can master your understanding of everything that
I’ve described in this book, you will make a gigantic leap
forward in your Options trading expertise.

OceanofPDF.com
 BOOK 3
OPTIONS TRADING CRASH
COURSE
NOVICE TO EXPERT

BEGINNERS GUIDE TO
TRADE COVERED CALLS,
CREDIT SPREADS & IRON
CONDORS
WILL WEISER

OceanofPDF.com
Introduction

Options can be used to generate

enormous profits or they can be used to
hedge current positions, so they're a very
versatile tool that every investor should at
least know how to use. But what are
Options you might ask? Well, there are
two types of Options; calls and puts. A call
gives the buyer the right but not the
obligation to buy a stock to call it away
from the Options seller and they can do so
at a certain price by a certain date. In the
meanwhile, the seller of the call has the
obligation to deliver that stock if the buyer
demands it. Pretty simple right? But, if it’s
that simple, why only a few becomes a
successful options trader? Despite its
many benefits, options trading carries
substantial risk of loss, but like any other
business, becoming a effective options
trader requires a certain skill set,
personality type and attitude. Ok, but how
much do the best options traders make in
a year? Well, the salaries of Options
Traders in the US range from $29K to
$791K, with a median salary of $142K.
The middle 57% of Options Traders make
between $142K and $356K, with the top
86% making $791K. The question remains
– do you want to be in the top tier? I
though you do, but let's admit it, most
beginner options traders are no
professionals. In fact you must master the
lack of robust trading mentality and follow
proven systematic approach. But worry no
more! This book will take you to the next
level! In fact, if you want to discover how
to become a thriving Options trader, then
let me share with you a brief summary of
this book. First you will discover how to
trade Options using covered calls, how to
buy long calls and how to trade bull put
Options spreads and short put verticals.
Next, you will learn how to trade option
calls and puts and how to trade for higher
returns using lower risk. You will also
discover how to trade Options in a bear
market and how to read the Option Greeks
sufficiently. After that, you will learn about
vertical spread concepts that every
Options traders must know and how to get
the breakeven price for any Options
strategy. Next you will discover how to
implement iron condors effectively and
how to deploy credit spread Options
trading strategies. Moving on, you will
learn the differences between buying and
selling Options as well as their risk and
reward probabilities. Next you will
discover how to trade Options using time
and how to buy Options with less decay.
Lastly, you will discover what are leaps in
Options trading and why Options are
rarely exercised. Finally, you will learn how
to use trading psychology for more
profitability and how to handle FOMO so
you can be a sufficient Options trader. As
you see, this book is a comprehensive
guide on Options trading and will reveal
the must-have trading skills that every pro
deploys daily. By finishing this book, you
will become a consistently lucrative
trader, nevertheless, it is recommended to
read the book or listen the audiobook
several times to follow the provided guide.
The audiobook listeners will receive a
complementary PDF document, containing
over 130 colored images of chart patterns
and proven trades from several platforms,
hence it’s also advantageous to highlight
critical subjects to review them later using
a paperback or hardcover book, or the
accompanied PDF once printed out for
your reference. If you are a complete
beginner, having limited knowledge or no
experience and want to speed up your
trading skills, this book will provide a
tremendous amount of value to you! If you
already a trader but you want to learn the
latest tricks and tips, this book will be
extremely useful to you. If you are ready
to change your life, let’s dive deep
together, covering all the ins and outs so
that you can have the best chance
possible to become a consistently
profitable trader!
OceanofPDF.com
Chapter 1 How to Trade Options Using Covered
Calls

If you're looking to trade Options or even if you're just

curious about what Options are, you've come to the right
place. By the end of this chapter you'll understand how
Options work and know how to place your first Options
trade. We're going to walk you through step-by-step on how
to place your first Options trade. Options aren't for everyone
but for those with the risk tolerance and time to learn
they're a highly customizable and powerful instrument that
can allow you to potentially profit in any market conditions;
up, sideways or down. With Options you can do things like
speculate, hedge or generate income. You can also place
trades with a wide range of risk levels and probability of
success. Here's what we'll cover when it comes to Options.
First we'll dig into what Options are and how they work.
Next, we'll walk through a basic Option trading strategy: the
covered call, and then I’ll show you how to place your first
Options trade on the Thinkorswim paper money platform: a
powerful trading simulation tool that allows you to practice
without the use of real money. We're going to cover some
technical terms and definitions but stick with me. Getting
this foundation will make it clear why Options can be so
powerful. So what is an Option? It's a contract that gives the
owner the right or the Option to buy or sell a specified
number of shares of a stock, ETF or another predetermined
underlying at a certain price on or before a certain date. But
why would you want to do that? Basically it can give you
more ways to potentially profit from stocks whether you own
them or not. An Option is what's called a derivative. That
means the Option derives its value from what's called an
underlying security, like a stock. There are two types of
Options: calls and puts. Calls allow the Option buyer to buy
the underlying at a certain price so buying a call is bullish.
You want the stock to go up. Puts allow the Option buyer to
sell the underlying at a certain price so buying a put is
bearish. You expect the stock to go down. But you can also
sell Options. So selling a call is typically bearish, while
selling a put is typically bullish. Each Option contract usually
represents 100 shares. This is known as the Options
multiplier. That's a lot of information so let's look at an
example of buying a call Option to help show how it actually
works. Let's say a stock XYZ is trading at $49 a share and
trader A is bullish on it. She thinks the price will go up over
the next month. Trader A could just buy some shares of
stock but she could also buy a call Option if she's not
interested in actually owning the stock. So a call Option lets
her speculate on the stock's future movement without
actually having to own the stock. Trader A buys a call from
trader B who doesn't think the stock will go up. Buying this
call earns trader A the right to buy the shares of the stock
from trader A at an agreed upon price called a strike price
by a certain date called expiration. For this example let's
say the strike price is $50 and the expiration is one month
from now. Trader A is hoping the stock will go above $50 in
the next month which would make the right to buy $50
valuable. But we'll talk about potential outcomes in a
minute. In exchange for the right to buy shares at $50
trader A pays trader B what's called a premium. Premium is
just another word for the price of the Options contract. In
this example we'll say it's $2. Because a standard Option
contract controls 100 shares of the underlying asset, the
total premium is $2 times the Option multiplier of 100 or
$200 per contract. This does not include transaction costs -
typically a contract fee paid to the broker. So as the seller of
the call trader B collects $200. But they're obligated to sell
100 shares of XYZ at $50 each if trader A exercises a right
to buy, which could happen at any time in the next month
before expiration. Notice the difference; the buyer of the call
has the right to buy the shares and the seller of the call has
the obligation to sell them. Trader A doesn't have to exercise
her right. If she doesn't, trader B won't have to sell. But if
trader A does exercise her right, trader B must fulfill his end
of the deal and sell the shares at $50 each. The Option
seller having to fulfill their obligation is called assignment.
Looking at different ways this trade could go will help us see
how this all fits together. Let's say the stock price jumps to
$53. This would make the Option be what's called in the
money. That means trader A could exercise her right to buy
the stock at $50 - a $3 discount per share. You can see why
buying a call Option is bullish. If the stock goes up, the call
buyer has the ability to buy the stock for less than it's
worth. Trader B on the other hand would have to sell the
shares though they would keep the $200 of premium. But
what if the stock drops to $48 per share before the contract
expires? In this case the Option would be what's called out
of the money and would expire worthless. Why would trader
A want to buy a stock at $50 if she could buy it for $48 on
the open market? Trader A loses the premium she paid for
the Option. This is the desired outcome for trader B who
sold the call. The seller hopes the contract will expire
worthless, so they can keep the full premium. In this case
$200 and there's a crucial thing to note. The example we
just looked at shows what would have happened if trader A
wanted to exercise a right to buy the stock and waited until
expiration to do so. But many Options traders don't actually
intend to buy or sell the underlying. Options contracts
fluctuate in value and can often be bought or sold before
expiration for a profit or loss. So Option buyers often buy
the Option hoping it will increase in value so they can sell to
close the position for a profit before expiration. Option
sellers often sell the Option hoping they can buy the close at
a much lower price or let it expire worthless and keep the
full premium. The other important thing to understand is
that the price of the underlying stock is a big factor in the
Options value but it isn't the only one. Time to expiration in
the underlying stock's riskiness known as implied volatility
matter too. To help clarify how these factors work we'll look
at put Options and compare them to something you may be
more familiar with: car insurance. With car insurance the
underlying asset is the car. The more valuable the car, the
higher the premium. If you insure a Porsche, you'll have to
pay more than you would with a Honda Civic. Time is also a
factor. Some choose to pay car insurance every month,
while others pay every six months. The longer the time, the
higher the premium. And don't forget about risk. Insurance
companies look at certain characteristics of drivers to
determine how risky they are. For example teenagers are
usually considered riskier than say more mature responsible
drivers - much to parents' dismay and the insurance
contract will likely be more expensive for teenagers. These
factors are very similar for an Options contract. The price of
the underlying asset is the most significant factor. Options
tend to be more expensive when the underlying stock costs
$700, rather than $10. Also time is an important element.
The more time between now and when the Option expires,
the more expensive the contract. Lastly there is implied
volatility. Some stocks and ETFs are riskier than others.
Some stocks like biotechs for example could be considered
the teenagers of the investing world, while blue chips with
healthy dividends are more like mature stable elders of the
market. Now that we've covered the basics of how Options
work and how you could potentially profit from them as a
buyer or a seller let's dive into one strategy in particular:
covered calls.
The covered call is a common starting point for new Options
traders because it combines call Options with stocks you
already own. So what is it? Generally the goal of a covered
call is to generate income by selling out of the money calls
on stock you already own. As the Option seller, you hope
the Option decreases in value so you can buy it back for less
or let it expire worthless so you get to keep the premium
and the shares of the stock. But remember, as the Option
seller there's the possibility of getting assigned and being
obligated to sell the stock. The stock you own can limit risk
and serve as collateral. If you get assigned, the stock will
automatically be sold to fulfill your obligation. Because of
that assignment risk, don't consider this strategy unless
you'd be OK with selling those shares of stock if the trade
doesn't go your way. In fact some traders use covered calls
as a way of exiting a stock position they already plan to sell
because it can earn extra income along the way, thanks to
the Option premium. But for now we're going to focus on
using a covered call as an income generating strategy;
selling contracts we hope expire worthless. Let's look at an
example. Suppose a trader holds 100 shares of stock XYZ
which she bought at $46 a share. Let's say she sold a call
with a strike at $48 that expires in 30 days. She earned
$100 in premium on the trade. Since she bought the shares
at 46 the break-even point is 45; 46 minus $1 for the
premium. The stock falls anywhere from $46 to $45 the
premium will offset the losses and the trade would still be
profitable. But if the stock drops lower than 45, she would
start to lose money. Let's say the stock goes up to $49 a
share at expiration. The Option would be in the money and
there's a good chance it would be exercised. That means
she would be forced to sell those 100 shares. She'd keep all
of the premium; $100 and the profit from the stock sale at
the strike price. Remember she agreed to sell the stock at
$48 which is $2 above where she bought it at 46. That's
another $200 in profit for a total of $300 gain. One thing to
keep in mind is that there is a risk of missing out on further
gains if the stock goes up even further. What if the stock
only goes to 47 at expiration? In this case the Option is out
of the money and would expire worthless. Why would
another trader buy the stock at 48 when they could buy
them at 47 on the open market? In this case, she'd keep the
full $100 of premium plus $100 worth of price appreciation
in the stock she still owns for a total profit of $200 minus
any fees. Now that you've seen how covered calls work let's
break down how you actually trade them. Trading a covered
call comes down to a few key decisions. First, choose an
underlying. Some stocks may be better suited for covered
calls than others. Next, choose an Options contract. This has
two parts; choosing an expiration or how long the Option
will last and choosing a strike price. Once you've chosen a
contract you need to determine your position size. How
many contracts will you sell? This depends on how many
shares you own or how many you would be willing to sell if
you get assigned. To walk through these decisions let's log
onto a trading software Thinkorswim paper money. Here
we're taking a look at the Thinkorswim platform and we'll
notice up at the top left, it says PM for paper money in
simulated trading.

This allows investors to practice a covered call or any type

of strategy in a paper money account. It's not real trading
so it's nice to be allowed to really learn strategies where
there's not the pressure of real money. In this example we're
going to look at the monitor tab which is the first tab and
we're going to go down and we're going to look at what's
called the position statement. The position statement just
simply states the positions that are in this paper money
account. We can see down below we have Boeing, J.P.
Morgan, PayPal and also a company called Zoom ticker ZM.
For our first example we're going to take a look at J.P.
Morgan, ticker JPM. And you'll notice in this paper money
account there's 100 shares of stock. And what you'll notice
is you can click on that little triangle right there collapse or
expand and show what is the position. The position has 100
shares of stock. If you remember to do a covered call the
investor needs 100 shares. The trade price was $98.88 and
the current price known as the mark is at $102.03. You'll
notice if you go over to the right we're going to see in this
column where it says profit loss open this stock is up an
unrealized gain of $314.70. So if the investor has 100 shares
and the stock is above support in an upward trend, that
investor can consider to do a covered call position. Second,
the investor would want to go look at the charts tab where
we can visually see what that trend looks like and if that
stock is above support.
Here we can go to the top left we can type in JPM and if we
do that and press enter we can see the chart of J.P Morgan
Chase. We see down the bottom that this is really a chart
looking in the last couple of months since January. What we
will notice is on the chart we do see support levels. Think of
support like a floor, maybe right around about the $80 level
maybe about another level-- let's say about $90 or so and
then even recently maybe right around 95. It is a bullish
strategy, so the investor needs to see proof that the stock is
actually holding above its support and the stock has actually
even been recently making some higher highs. So if the
investor considers to do a covered call on J.P. Morgan, they
can now go to what we'd call the trade tab. The trade tab is
just found to the right of the monitor tab where we were
before. We can now type in the symbol J.P. Morgan.
We're going to actually take a look at right underneath J.P.
Morgan, the ticker JPM we see underlying. Underlying is just
another word for stock. We can see the stock is trading at
$101.91 today up $0.58 and the up top is really the stock
information. But we're looking at applying a covered call. So
when we talk about doing a covered call we're going to now
go down to what's called the Option chain. The Option chain
is really going to give us a variety of different strike prices
and expirations. First off on the left hand side we're going to
see two different colors; one a goldish color and another
color this white color. The golder yellow color really
represents what we call weekly Options. This is really
reading when this Option expires. If you put your cursor
right on that it will tell you how many days there are to
expiration. This has 100 shares in the contract and like
labeled we can see that these are weekly Options. The ones
that are in this white font we actually see that these are
what's called the monthly Options and we'll start here. But
you'll actually see that these expire on the 18th of
September. It has 14 days left to expiration and again you
can put your cursor on that. The investor could click on that
triangle right there and if we click on that triangle that will
expand it so we can see which strikes this Option expiration
has.

First so we can see what's going on we can see on the left-

hand side is calls and on the right-hand side is puts. And
what you'll notice is the investor can also pick which strikes
they want to see. This is now showing four strikes and the
strikes are right down the middle of the page. We can see
the 101 the 102 the 103 et cetera. What the investor could
do is if they wanted to see a couple more strikes for their
picking of which strike they want to sell they can now
maybe click on the dropdown and maybe even go to six.
Now what you're going to see is when we look at the left-
hand side again we're told about a covered call we're talking
about selling calls, we're going to focus our eyes really on
the left-hand side. Now what you're going to really be
seeing is a little difference here between why are some
Options shaded and then why are some Options not shaded.
Well the ones that are shaded the 99 strike down to the 102
those Options are shaded because those Options are in the
money.

That just means the stock price is above those strike prices.
The strike such as 103 the strike such as 104 those Options
are out of the money. That means in that case the current
stock price is below that strike price. Now that we've looked
at the Option chain, let's actually now take a look at the
decision making process. Number one; looking at the Option
expiration that you want to sell. Number two; which strike is
the investor going to actually sell. So let's first tackle which
expiration month. If the investor decided they wanted to
have less chance of the stock to close above the strike, they
could pick the Option expiration that has the shorter
number of days. If they do that, the investor is actually
wanting the time to be on their side where there is less time
for the stock to get above the strike that they sell. If the
investor were to say I want to actually try to sell more time,
well clearly that would be more time for the stock to go up
and potentially get above the strike that they sell. So if the
investor wants to have a greater chance of keeping the
stock, they probably sell an Option that is closer to
expiration like 14 days. If the investor said I’m OK with
actually having more time for that stock to potentially get
above the strike and I don’t mind if those shares are
assigned to somebody else, they could actually sell an
Option that was farther out. Also remember when the
investor sells an Option that is shorter dated, the premiums
are going to be typically smaller because there's less time
than if someone were to actually sell an Option farther out
in time. When we pick an Option expiration month we
typically look for Options that have 20 to 50 days to
expiration. The rationale behind there is we want to make
sure that there is enough premium but not too much time
for the stock potentially to close above that strike. So it's a
balance between the premium and time. Number two; we
want to now talk about the strike selection. When an
investor really looks at the strike we're going to go up over
on the left-hand side to where it says calls again and right
below where it actually says calls we're going to click on the
dropdown. We're going to drop down to where it says Option
theoreticals and Greeks.
The Option Greeks are really measurements of sensitivity.
The Option Greek Delta can also be used as a proxy or a
way to find out the probability of a stock to close in the
money. What you'll now notice is with each one of these
strikes there is a probability associated with the stock
closing above the strike. Let's stay with the 18th of
September. What you'll notice is if the investor were to sell
the 102 strike, the probability of the stock closing above
that strike by a penny is 52.

If the investor were to sell the 103, 47% chance to close

above the 103. If the investor were to sell the 105 what
you'll notice is it's a 38% chance. What you'll notice is
there's a correlation here. Higher probability of closing
above the strike price and there's also a higher premium.
Lower probability of closing above the strike price, lower
premium. Remember we said in rule number one is taking a
look at the Option expiration month. The investor could start
with looking at Options 20 to 50 days. These Options only
have 14 days. Let's go ahead and close that by clicking on
that triangle and let's go down to the Option expiration that
has 20 to 50 days. The 16th of October has 42 days to
expiration.

Second, when the investor is actually considering which call

strike to sell the investor is typically looking at the strike
that has a Delta - again think probability - the Delta of 30 to
40. What does that mean again? If this Delta says 31 that's
saying the likelihood of the stock closing above the strike
price. So a 31% chance to close above, which means a 69%
chance to close below that. When the investor actually goes
and also looks at the bid and ask, how does the investor
know what to click on? Well, remember if the investor is
buying an Option and as we hover our cursor right there
you're going to see right below that arrow it says buy. Well
we're not buying a covered call we're selling a covered call.
We're selling the call. So we're going to go over to where it
says the 264. Right below that arrow it says sell.
If the investor picked 20 to 50 days to expiration - that's the
expiration month we're in with 42 days to expiration.
Number two, if the investor were to pick an Option strike
with a Delta of 30 to 40 which is in this case the 110 and the
premium in the big column shows $2.61. Remember it's not
just $2.62 - we need to times that $2.61 by 100 because the
investor has 100 shares of stock. This is actually $261. If the
investor wanted to sell the call they click on the big column
on the strike price that they want to sell. If the investor were
to click on that you're going to notice that down below a red
horizontal line appears.
That red horizontal line is an order to sell. It's in red. We
know it's also to sell because it says minus 10. This is not
the number of shares - this is showing the number of
contracts. Remember if the investor had 100 shares of stock
they would not be selling 10 contracts - they would only be
selling one contract. So we could simply just adjust this up
or down and we're just going to change this to where it says
minus one because the paper money account has 100
shares.
If we read across, we're going to sell minus one J.P. Morgan.
The Option expiration is the 16th of October. The strike is
110. Remember what that really means. That means that
this paper money account is obligating itself to sell those
shares from now until expiration at 110. That means the
investor can make from about 102ish up to 110 which is $8
and also get the premium of that $2.61. You'll notice also
where it says order limit. Limit is saying you want that price
or higher, but not lower - could be filled for higher though.
Before we actually send this order let's remind ourselves of
what the paper money account really bought the stock for.
You're going to see that right above that say position. Let's
click on that and it's going to show the position that's in the
paper money account just like we saw before on the monitor
tab.
Where we want to go with this is we want to really be able
to see what is the maximum gain, what's the break-even
and how much can the stock go down? Well in this case
remind ourselves that in this case the trade price was
$98.88. So let's think this through. If the investor owns the
stock at $98.88 and they have an obligation to sell the stock
at 110, that's about $11.12 of stock appreciation. But, the
investor also gets the $2.61. So the investor gets the $11.12
and they also get the $2.61. And so in that case the investor
would get about $13.73 of maximum gain which is actually
pretty good for a stock that's only $98. In this case let's say
the stock were not to close above 110. Well if the stock were
not to close above 110 and let's say the stock stayed
exactly flat from where it is right now, the investor only
would get the premium. Why is that? Remember the
investor agreed to sell the shares at 110. But if the stock
price in the current market is not 110, it is highly unlikely
that someone is going to want to buy the paper money
account shares if the stock is trading below that strike. So if
the stock were not to close above that strike, the investor
gets to keep all of that $261. Lastly, if the stock were to go
down that down move in the stock can be offset by some of
the premium. So if the investor bought the stock at $98.88
and got a premium of $2.61, the break-even on the stock is
at $96.27. What's nice is if the stock goes up quite a bit, the
maximum gain would be $1 373. If the stock were to go
sideways and stay completely flat and nothing happens, the
investor gets $261. Why are they getting paid that $261?
Because of the obligation for selling those shares at 110 and
for their time. Wouldn't that be nice to actually get paid for
that obligation? That's why investors like to consider selling
covered calls. Because sometimes that stock doesn't close
above the strike and that allows the investor to also reduce
their average price in which they own the stock. Lastly if
that stock were to go down, the break-even to the downside
is $96.27. If the investor went down to the bottom right and
said let's confirm and send this and read the order together.

Let's remind ourselves that this is a paper money

demonstration. It's a simulation not a real trade. The one
thing that this does not take into account is that the paper
money account already owns the shares already. This is
thinking that the paper money account is selling not a
covered call, but a naked call which is where the investor
doesn't own the shares. This is a covered call because the
paper money account has the shares. We can now look at
this where it says the credit, the $261 and what is the
commission? The commission is $0.65 per contract and
you're going to see that's debited from the credit leaving a
credit of $260.35. If that's what the investor wants to do,
they can now come down and click on the send button. And
if the investor clicks on the send button it's going to go out
and try to sell that Option Now notice what's happening
below. Remember a covered call is two lines.

The first line is the 100 shares of stock. The second row is
really the call which just filled and it says minus one. Why
does it say minus one? Because it's a sold call 42 days left
to expiration. So we can see that the premium is $2.61 but
remember we need to times that by 100 the Option
multiplier. So that's $261. The mark value right now is
$2.55. What the investor would like to do is sell that call
when it's high and potentially buy it back when it's low. We
can see on the 16th of October we have a position in our
first covered call at the 110 strike.
It says P.O.S. for position. But where do we really see the
position in the entirety? Well what we could do is we can go
up to the monitor tab. The monitor tab monitors the
positions and states the positions in the account. So we can
now see the JPM by simply clicking on the triangle to the left
of the ticker symbol JPM.
We see that we have the stock and the sold call that we just
did. But what about other covered calls that have already
been going on for a while? Let's take a look at another
position where we can see what happens after a while in
some of these positions and let's start with the ticker BA -
also known as Boeing. As we go up to the left-hand side of
Boeing. We can again click on the triangle.

That will expand and we'll be able to see the shares. We'll
also be able to see which call was sold. So again let's really
walk through what this is really showing. Number one; 100
shares of stock. The trade price was $176.22 and the
current stock price - and sometimes this happens - it's lower
than where it was traded. It's at 167 and what you'll notice
is all the way over to the right we can see that the stock
position is down $837. That's not great. How to covered
calls play into this? Well if the investor maybe thought that
the stock might not close above the strike price and they
decided to sell a covered call well in this case that's what
the paper money account did. The investor sold the 11th of
September the 185 call. We know we sold it because it says
minus one. And what you'll notice is here we see that
there's seven days left to expiration. What I want you to
recognize is what is that strike price? It's 185. What is the
current stock price? It's 168. When an investor does a
covered call any time from the time the investor sells the
call until expiration - not just expiration but anytime up to
expiration - someone can buy the shares of the stock even
though it's prior to expiration. So if the stock is at 168 and
the strike or the obligation is at 185, do you think
someone's going to want to buy these shares at 185 if the
stock price is $17 below that strike price? Pretty unlikely
right? What you're going to notice is when the investor sold
that call at 185, the premium that was received was $11.32.
But it wasn't just $11. Times that by 100 again for the
Option multiplier it was $1 132. That's quite a bit of
premium for just 100 shares of stock. What you'll notice is
the mark price or the current value of the Option right now
is $1.31. The Option was $11.32 and now it is $1.31 or
$131. So what causes the value of the call the change in
price? Well in this case if the call Option value declined in
value, that means the stock probably went down and it did.
Number two that would actually cause the Option value to
decline in value is the time decay. Over the right we can see
the profit loss open for this Option: $1 001. When the
investor sells a call they can only get a certain amount of
premium that was received the $11.32 or $1 132. Currently
right now this position is sitting in a profit of 88% of the
premiums. What that really means is if the paper money
account were to exit this Option, it has about 88% or $1 001
of the $1 132. So in this case the investor now could decide,
do they want to stay in this Option? Well what would make
them consider to maybe potentially stay in? Well one
question is; how much Option premium is left? Well how
does the investor get that last $131? The investor would
have to wait the next seven days to see if the stock were to
close below the strike. If that stock were to close below the
strike, the investor would not get some of that $1 132 - they
would get all of the $1132. If they think that there's a good
chance the stock won't close above that 185, they could just
let this Option erode in value and want this stock to close
below that strike of 185. Where's the current stock price
right now? It's at 168. So that stock in the next seven days
would have to go from 168 to 185. If it doesn't do that, the
investor could pick up another $131 and that could be at a
potential full maximum gain of that $1 132. This is an
example of an Option that is out of the money - meaning
the current strike price is above the current stock price.
There's probably a high probability of this stock not closing
above that strike price. But what happens if the stock is
above the strike? Well let's go look at an example together
of the ticker ZM.

First off let's take a look at where did the paper money
count buy the shares? Well the paper money account
bought the shares at $242.56 and the stock price is way
higher than that. You know that in the COVID-19
environment a lot of people have been using Zoom
technology for their conference calls. So the stock has had a
big move to the upside. What you're going to notice is that
stock profit and loss is up $12 169. But what you'll notice is
here when we go take a look at let's say the call that was
sold was the $277.50 strike price. But wait where's the
current stock price? Well the current stock price is at $364.
But what happens in this situation? When the investor sells
a covered call they obligate themselves to sell those shares
at $277.50 and with the stock so much higher than that
strike price, we probably know there's a very high likelihood
that this paper money account is going to be losing these
shares of stock. If for example someone did not care in
selling these shares of stock, they could just let this trade
close above the strike price. If that stock were to close
above the strike price, then the 100 shares that are in their
portfolio would be sold at the strike price of 277. What does
that mean? Well that means that the investor gets from
$242.56 up to $277.50. That's about $33ish or $3 300. But
remember that's not all. The investor also gets the premium
on top. So they get the stock appreciation from $242.50 or
so to $277.50, $35, and the investor also gets seven
additional dollars on top. So the investor gets about $3 500
of appreciation and $710 in premium for a total of about $4
200. So don't feel bad for the paper money - the paper
money account is still going to walk away with about $4 200
or so. Option number one; if the investor was OK with that
the investor does not need to do anything. They could just
let the stock close above the strike price. If that were to
happen, the paper money shares of those 100 shares would
be gone at any time from now until expiration. But wonder if
the investor actually said no, I do not want to sell those
shares at $277.50. Well let's now talk about the Option
premium. The trade price on that Option was $7.10 or $710.
The mark value or the current value of the Option now is
$86.50. This is different than what we saw before. The
Option value appreciates when the stock goes up. So if the
investor were to let this close here and let's say today was
expiration, these shares would be taken. But if the investor
said I don’t want these shares taken they now have the
choice to buy that call back. If they buy the call back,
they're not doing so for a gain because that call is losing $7
940.

But wait did the overall covered call position make or lose
money? The stock position is up $11 800. The call is actually
down $7 940 for a net of $3 887. If the investor decided
they did not want to sell those shares of stock at the strike
price, they could simply right click on that line on the strike
price right click anywhere on that line. They could then go
to create closing order and what this is really doing is it's
buying the call back.
When they buy the call back, they're releasing themselves
of the obligation to sell the shares at 277. Why would an
investor do this? The investor that buys the call back is
thinking that the stock could likely go higher and that way
they don't have to sell those shares at $277.50. If the
investor picked that top line right there, buy that Zoom call
it $277.50, they're buying the Option back at a higher price.
Once that does that it now takes us to the trade page.
The trade page is where the investor can see buying the
Option plus one contract because it was sold initially and
now what you can see in this case is the investor is buying
that call back for a price at $86.20. Now in this case we
would want to go look at what's the mid price? The mid
price is really in between the bid and the ask. If the investor
just wants to hurry and get out of that call, they could
probably have a higher chance of being filled at the higher
price of course. But if the investor said you know what I
don’t want to pay that much for it - I want to try to get a
little bit better price. The mid price again is just between the
bid and ask on the Option price the investor typed in $84.80
and again limit that says that's the most the investor is
willing to pay to buy this Option back. If that's what the
investor wanted to do, remember this is not $84.80 - this is
$8 480. Remember the Option multiplier. The investor might
be shocked by that but you have to remember that the gain
also is coming from the stock. The stock gain is paying for
the loss in that Option for a net of about $4 000. If the
investor is OK with that, they can go down to confirm and
send.
The cost of the trade is what the investor is buying that
Option back for $8 480 and add $0.65 per contract for the
commission. If that's what the investor would like to do,
they can now send this order and when they do that what
it's actually going to do is it's going to try to go out and buy
that Option back. In this example on Zoom some things to
note here.
Is it a good idea that the investor waits until maybe the last
second or the last day to buy the Option back? Not
necessarily. Typically investors would look inside four to 10
days prior to expiration and make the decision if they want
to buy that call back. If they buy the call back, they're really
saying they want to keep the shares of stock because they
think the stock could go up. We looked at an example of J.P.
Morgan about placing a covered call. We looked at the
example of Boeing where that's an example of something
that was out of the money - meaning the stock price was
not above that strike. Lastly we looked at an example of
Zoom where we said this stock has gone up a lot and is
quite far above that strike price and what could the investor
consider? We said two Options. If the investor is OK with
maximum gain, the investor had to do nothing. Just let the
stock close above the strike. If the investor decided no I
want to keep the shares, the investor does add the Option
prior to expiration to buy that call back. If the call has
appreciated in value that tells you the stock has also gone
up as well. Very important to remember those things
whether the Option is out of the money or the Option is in
the money. Those are the basics you need to trade your first
covered call. Keep in mind to trade Options in a real account
you need to have Options trading approval.

OceanofPDF.com
Chapter 2 Options Strategy on How to Buy Long
Calls

Long calls can be some of the riskiest Options trades you

can make. If you're right about the timing and size of a
stock's move buying calls can deliver big profits without
even owning the stock. But if you're wrong about price, time
or volatility you can lose some or all of your investment
really quickly. But not all long call strategies are equal.
Some people swing for the fences every time, making fast
pie-in-the-sky bets with high risk and high potential returns.
That can mean big wins when it works out, but it's also a
strategy that could bring lots of strikeouts and big losses. A
different approach is more about pursuing success through
lots of singles and doubles over time trades that last for a
few days to a few weeks but may move at a more
manageable pace. We'll talk through how long calls work
and discuss a smarter way to trade them that might offer
lower profits per trade, but may increase the likelihood of
success over time. I’ll also show you how to set up and
manage this strategy. For this chapter we'll assume you
have a basic knowledge of Options, the Options Greeks. But
what is a long call? A long call is a bullish speculative trade
where you buy a call Option on an underlying security you
expect to move up ideally in a big way and quickly. Buying a
standard call Option contract gives you the right to buy 100
shares of stock at the strike price on or before its expiration
day - though getting stock isn't the goal of this strategy. You
expect the long call's value to increase when the stock price
goes up so you can sell back the contract for a profit before
expiration. But the move has to be big enough and quick
enough to make up for the effects of time decay which
erodes the contract's value. For example let's say XYZ stock
is currently trading at $81 per share and you think it'll go up
in the next few days. You buy an at-the-money call contract
with an 81 strike price for a premium of $3 or a total of $300
with the expectation that the premium will increase
sufficiently over the next few days for you to sell the Option
for a profit. But how much does the stock need to go up?
And what if it doesn't? Let's take a look at the long call's risk
profile. The maximum gain for a long call strategy is
unlimited because the underlying stock could skyrocket
boosting the premium in the process. Keep in mind that
Options profits aren't linear. The higher the stocks goes the
faster your potential profits can accumulate. This is one
reason long calls are so appealing to traders. The maximum
loss is limited to the premium you've paid. You could lose
100% of your investment in the Option if the underlying
turns bearish or even just goes sideways. The break-even
point for a long call at expiration is the strike price, plus the
premium paid. However we don't plan to hold this Option
until expiration so there are three forces that can determine
the profitability of the trade in the meantime: price, time
and volatility. These forces are measured by the Options
Greeks. The first force is price and is measured by Delta.
Long calls are Delta positive which means call prices rise
along with the stock price. This Greek will give you a sense
of how much the Options contract price may change with a
$1 move in the price of the underlying. The next force is
time. Theta measures the impact of time decay on the long
calls it's negative so it works against our position. The closer
you get to expiration the harder Theta works against you.
An expiration that's further away helps alleviate some of
that risk by reducing the rate of time decay. Our goal is to
plan for a profitable exit before Theta melts away too much
premium. The last force is volatility. Vega tells us how rising
or falling implied volatility could impact our Options trade.
Long calls have positive Vega so ideally we'd like to see
volatility rise. But remember implied volatility often moves
OPPOSITE of the stock's price movement so it's pretty
common to see volatility drop if the stock price moves up.
So volatility is often another force working against a long
call. Now that we've covered how long calls work, let's get
into some common mistakes people make when trading
them. The first is buying calls before a big event like
earnings in hopes of profiting from big moves. The problem
is that the Options can be expensive at this time because of
the high implied volatility. But as soon as the event occurs
and the uncertainty around price movement ends all that
extrinsic value disappears and the price of the Options
collapse. This is called a volatility crush and it can be so
dramatic that even if the stock moves in your direction, you
can still lose money. Take Tesla for example and let’s use a
tool called thinkBack to look at historical data.

Here we are on Oct 21 2020 the day Tesla announced

earnings after the closing bell. The closing stock price
before the announcement was 422.64. By the end of the
next day it was up just over $3 at 425.79.
With the leverage offered by long calls you might typically
expect a profit as a result of a one day move of that size.
But let's see what actually happened with the Options. On
Oct 21 the Oct 30th at-the-money 422.50 call closed at $24.
The next day despite the rise in Tesla's price the same call
closed at only 15.80 suffering about a 34% drop in value.
Some of this drop can be attributed to time decay but the
real culprit was the volatility.

You can see why it's called a volatility crush. The stock
would've needed to rise an extra $14 to overcome that
crush. Up next is what I call the lottery ticket. By that I mean
buying way out-of-the-money strikes because they're cheap
and the potential return is huge These contracts are cheap
for a reason. Far out-of-the-money contracts often expire
worthless because the probability of the stock moving
enough to make them profitable is very low. I’ve got the
December 11th call Options for Chipotle Mexican Grill ticker
CMG pulled up.
It's currently trading around 1323. Toward the bottom of the
Option chain is the 1410 strike which is almost $90 out of
the money. You could buy a contract for just $400 bucks on
the off chance it'll make a big move but check out the
bid/ask spread. It's $1.35 on a $4 contract.
These way out-of-the-money Options tend to be thinly
traded and poorly priced in a way that puts you at a
disadvantage. From the moment the order is filled you'd be
sitting on about a 20% unrealized loss. The stock would
have to make a significant move up just to overcome that
obstacle. Plus if you've based this lotto ticket around an
earnings event, the volatility crush could impact your losses
too. Another common mistake is choosing an expiration
that's way too soon like next week. Some investors do this
because the Options are often cheaper but if it doesn't make
a big move quickly time decay kicks into high gear. The
closer you get to expiration the faster time decay erodes
your position. Let's take a look at an example of the impact
of time decay. A great tool to do this is called theoretical
price or theo price which I’ll pull up. The theo price allows
you to experiment with changes in price time and volatility.
To begin our experiment here's the 126 call on Apple
expiring next week.

The theo price begins with the current mid-price of that

Option which is currently 1.32. Now using the theo price
menu I’ll simulate just one day passing and look at what
happens to the simulated value of the Option even if the
stock price stays the same.

It fell around 10% over night. It'll only get worse the closer
you get to expiration. The last big mistake some traders
make is trading without an exit strategy. Before you ever
enter the trade, it's important to give yourself a point where
you're ready to cut and run. On the upside, that point could
be something as simple as a specific price target of the
underlying stock or a specific gain on the Option. On the
downside, that could mean using stop orders or exiting if
you haven't hit your price target by a certain date. If you
don't stick to your exit rules, you could make gains and
watch them slip away while hoping for more gains. Now that
you know what not to do, let's look at a smarter approach to
trading long calls. It's a smarter approach because it's
based on more informed assumptions about how Options
work. It boils down to choosing at-the-money Options a few
months from expiration on uptrending stocks that you
believe are ready to pop. These factors are all meant to
increase the likelihood that the trade could be profitable.
When you trade stocks, you only need to be right about
price to be successful. With Options especially long calls,
you often need to be right about price, time and volatility.
Make no mistake: Even with this smarter approach we're
talking about, it is still speculative and directional. If you're
looking for something less speculative, consider defined
risk-return strategies like vertical spreads. So how do you
set up a long call? First up you've gotta choose an
underlying. This could be a stock or ETF. Consider highly
liquid assets that are already in an uptrend as opposed to
looking for big event moves. Of course there's no guarantee
that upward trend is going to continue but it could increase
your probability of success. You could set up a watchlist of
stocks to keep an eye on. But for a long call we need more
than just an uptrend we need significant upward movement
in a short amount of time typically 5 to 15 days. That's
where technical analysis can help. A chart pattern like a
close above the high of the low day could be a signal that a
stock is bouncing off support and potentially ready to make
an upward move. This can serve as an entry signal for
timing the trade. Here's a 1Y:1D chart of Disney ticker DIS.
You can see we've got a 50-day simple moving average
added to it which is uptrending.
It also has an average daily volume well above one million
so it's liquid. The stock is trading above its moving average
trendline. If we zoom in we can see it recently bounced off a
previous price ceiling.
And finally it's in position to close above a recent low day. To
a technical trader, all of this may point to a potential near-
term jump. This will be our entry signal. Once you've chosen
an underlying, you've got to select a contract. In short,
we're looking for highly liquid Options with plenty of time to
expiration and without inflated implied volatility. The first
part of that decision is choosing your expiration. Even
though you may only plan to be in the trade for a few days
to a few weeks, consider going much further out for your
expiration think 50 to 100 days. For this example that's the
19th of February expiration which is 80 days out. Remember
that we don't plan on holding the Option all the way to
expiration - we're just trying to take advantage of a
projected price move and get out. I’ve already mentioned
that one of the common mistakes is not buying enough
time. You don't want to be right about the price movement
and still lose money because you didn't buy enough time. If
you buy an Option that expires in 90 days, but the stock hits
your price target in six days, you just get out and sell all
that remaining time. You might also want to make sure there
aren't any earnings or news announcements coming up that
could impact the stock movement. Disney just had earnings
so we don't have to worry about that. Next let's take a look
at the strikes.
The in-the-money strikes are more expensive but you can
see by looking at the Delta they have a higher probability of
expiring in the money. The out-of-the-money Options are
less expensive but like we discussed before their probability
is lower. So you may want to consider something right in the
middle at the money moderate costs with moderate
probability. Remember that we're looking for high liquidity. A
way to gauge that is looking for a low bid/ask spread; one
guideline Options traders often use is that the difference
between the bid and the ask should be no more than 10% of
the ask price.
A tighter spread means you're more likely to get your order
filled at your desired price. For this example we'll use the
150 strike. It's quoting me a buy price of 9.35 which means
I’d pay $935 per contract, plus any commissions and fees to
enter the trade. We'll talk about risk management and exit
considerations shortly, but one thing we can do right off the
bat is to buy our call with a stop order. This can help
manage risk by automatically triggering an order to close
the position if the price of the Option falls to a price we set.
You typically load up a buy order by just left-clicking the ask
price but to buy the contract with a stop I’ll right-click the
Ask price point to Buy Custom and select With Stop.
It'll pull up some trade details at the bottom of the screen.
Let's walk through the order ticket.

The first item is a green row showing we're buying. Below it

is the red stop order. Our next step is to figure out just how
many contracts we want to buy. Position sizing is one of the
main ways you can manage your risk which is crucial to
trading long calls. Even the higher-probability approach
we're discussing here is still very speculative. Even though
the risk is limited to the amount paid in premium, if you
allocate too much going after big returns you can easily
blow up your account. To determine how many contracts to
buy you, need to know two things: your portfolio risk and
your trade risk. Portfolio risk is the total amount of your
portfolio you're willing to lose on a given trade. Consider
setting aside no more than 1% of your active trading
portfolio per trade. Some traders put as little as half a
percent. So for simplicity, let's say I’m trading with a $100
000 portfolio. If I’m willing to lose no more than 1% my
portfolio risk would be $1 000 per trade. Next is trade risk
which is the amount you could lose in a given trade. For a
long call the trade risk is the premium you pay to buy the
contract, plus any commissions and fees. Even though we're
using a stop order there's no guarantee it'll fill, so we'll use
the full premium. For our example the trade risk is $935 per
contract plus the contract fee. Now that we know our
portfolio risk and trade risk, we can figure out how many
contracts to buy. To do this take your portfolio risk and
divide it by your trade risk. So our portfolio risk of a
thousand divided by the premium of $935, equals 1
contract. Once you get more familiar with trading long calls
you can start factoring your stop order into your trade risk
but to start out you'll want your position size based on the
full premium. Let's finish entering the sell-stop order. A
common stop management technique is to place the sell
order at about 50% of the purchase price of the Option. For
our trade that would be about 4.70. So I’ll just update the
price with that. Also we want to make sure the stop order
stays in force for the duration of our trade. So I’ll open the
Time In Force menu and select GTC or Good Til Cancelled.
But before we actually send the trade let's think about how
we might get out of it. Options trades can move really
quickly so you'll want to set some firm exit rules. You
already established one exit rule by setting a stop order at
50% of the Options purchase price. This rule is pure risk
management as it may help prevent your trade from losing
all of its value. If your stop is hit chalk it up as a loss and
move on to the next trade. But just as important as
managing losses is managing profits. If the trade is going
your way you might be tempted to just let it ride and rack
up the returns. But with Options things can change fast and
potential profits can evaporate in the blink of an eye. To
keep greed in check consider setting a firm profit target.
This could be a price target on the underlying stock a
specific dollar amount gained or a specific percentage
gained on the Option. For example let's look at how a trader
might pick a price target on Disney. In recent weeks on two
separate occasions the stock moved up about $12 as
momentum shifted from bearish to bullish. With today's
bounce off an apparent floor at 147 a trader might
anticipate a price target of about 159. Just keep in mind that
past performance is not a guarantee of future performance.
It can be tough to stick to a target and walk away from
potential profits especially when things are going well. But
even if it sometimes means leaving money on the table,
having consistent exit rules can help protect you from losses
over time. Of course there will be times when a trade
doesn't go your way. There's always your stop order, but
what if the trade doesn't move against you enough to
trigger the stop or it goes up but not quickly enough? How
long should you wait around for the underlying stock to go
where you want it to? The last exit rule to consider is exiting
if the stock price hasn't moved at least half as much as you
expected in half the time you anticipated. For the type of
strategy we're discussing a common time frame could by
anywhere from a few days to a couple weeks. For Disney the
previous moves have happened within a week. So we'll say
that if the stock hasn't reached 153 in the first few days it
may be time to think about getting out of it.
If this happens it means you haven't timed the Option
properly and time is of the essence. You'll also want to think
about bailing if the underlying closes below technical
support levels. This is what's known as a counter-indicator
and it may suggest the trend is reversing. Closing the trade
at this point could save some capital. Now that you have
some considerations for when to get out of the trade, let's
go back to the Trade tab and place our order. Let's make
sure everything looks right and then hit Confirm and Send.
Our maximum gain is unlimited like we talked about before.
Our maximum loss shows here as the full premium which is
possible but remember we've set a stop order at 50% of the
Options premium which could help reduce our losses.
If the stop is triggered, it'll send a market order and
compete with other market orders at that time so there's no
guarantee it'll fill at the 50% price. Also note the transaction
fee. If we're ok with this let's go ahead and hit Send. And
there we go. We've just bought a long call. Now let's take a
moment to break down how different factors like stock price,
time and volatility could impact this trade. I’ll open up the
risk profile in the Analyze tab to play around with the
numbers. First I’ll select the position. Now we can see from
the risk profile that our max gain is unlimited, our max loss
is limited to the premium we paid (though that doesn't
account for our stop order) and our break-even point is
about 159.35 at expiration but remember we're planning to
exit long before expiration.

The factor that will affect us the most is the stock price so
let's see what happens when price changes using the price
slice feature. I’ll set some price slices to show the stock
rising or falling $10. The stock is currently trading at 150.54.
If the stock price goes up by $10 you can see a hypothetical
gain of about $630. Of course if the stock price goes down
by $10, we could lose about $445.
But how does time factor into the profit or loss of this trade?
Let's move the date forward a week and assume the price of
the underlying stays the same.

We've got a potential loss of more than $32 in one week

thanks to time decay. But what about Vega? If implied
volatility rises, our Options value could go up and if implied
volatility falls our Options value could go down. Let's take a
look at a fairly big change in implied volatility just to
illustrate the point. First I’ll reset our date. Then I can click
the gear icon to reveal the implied volatility adjustment. I’m
going to give us a little more space here. Now if I increase
implied volatility by 5%, we'll see the projected unrealized
gain of around $155;
If we move it down by 5%, we can see a projected loss of
about $125. Remember placing a trade is just the
beginning.
This is an active strategy so you'll want to monitor closely
with your exit rules in mind. To show you how to do this,
let's head back to the Monitor tab and look at a long call I’ve
already got on our demonstration account. I’m going to look
at some calls we bought on Starbucks. If we click on
quantity we can see on the 24th we bought 4 of the
February 19th 97.50 calls for 5.30 each.

We do have a small profit right now, but lets revisit the

technical logic of the trade. I’ll pull up the chart of
Starbucks. You can see we had an upward trending moving
average price was trading above the moving average and
we had closed above a recent low day.
We can also see that on the two previous bounces the stock
had sizeable upswings in the following week. On the 24th
we were anticipating the stock would move a similar
distance in a similar timeframe, giving us a target around
106. Unfortunately Starbucks has only drifted sideways and
is only slightly above that entry price. One of the potential
exit rules we discussed earlier was exiting if the stock has
not moved half the distance in half the time frame. Here we
can see that over the course of 4 days the stock has only
moved about a dollar. This could mean our timing was off on
this trade and it's time to pull the plug. Again it may be
tempting to try to justify staying in since it's slightly
profitable but a key to success with long calls is to follow
your rules consistently. So I’m going to show you how to
close out of this position. To do that I’ll right click on the
position and click Create Closing Order.
So you can see on the order ticket we're selling our 4
contracts at 5.55 each.

I’m using a limit order and leaving the time in force as day.
I’ll click Confirm and Send but keep in mind that the max
profit and loss don't apply to a closing order. Also note the
transaction fee. Everything looks good so we'll send the
order. Remember that we used a limit order so there's no
guarantee it will fill. That's a smarter way to trade long calls.
Remember that even though the approach we discussed
may be higher probability and less risky than others you'll
see out there - it's still risky. Make sure you practice paper
trading to get a feel for how these trades can move.

OceanofPDF.com
Chapter 3 How to Trade Bull Put Options
Spreads / Short Put Verticals

When you’re trading Options especially if you’re a beginner

you may lean toward single Options strategies like long calls
or short puts because you only have to manage one Option.
But these strategies have some drawbacks. With long calls
you have to correctly predict short-term stock behavior
which isn’t easy. Naked puts carry substantial risk and cash-
secured puts can tie up a lot of cash in your account. These
drawbacks are why some strategies combine multiple
Options contracts. These are called spreads and they’re
popular because they allow you to define your risk and
reward. There are many ways to combine Options into
spreads based on your goals and risk tolerance. We’re going
to focus on one of the most common: the bull put spread or
as we like to call it the short put vertical. This bullish
strategy is known by several different names such as a
credit put spread or short put spread but it is a basic
concept: You sell one put to potentially profit from a stock
going up but also buy another put at a different strike which
provides protection in case it doesn’t. This allows you to
define your risk and your reward. Combining multiple
Options together in one trade can seem complicated but
we’re going to walk through all the ins and outs. We will
break down how the short put vertical works and how to set
it up on a browser-based trading platform.

Short put verticals

This is a bullish strategy that involves simultaneously selling
an out-of-the-money put and buying another put with the
same expiration that is further out of the money. The short
put is the driver of the trade. It benefits from time decay
and when the underlying stock goes up while the long put
hedges your risk. You will have to pay the premium for the
long put but that part of the trade is usually cheaper than
the short put so you’ll wind up with a net credit from the
get-go. Keep in mind you’ll still have to pay transaction
costs. The ideal outcome is for the stock to stay above the
short put so both Options expire out of the money. That way
you keep the premium you received when you entered the
trade. If things don’t go your way and your short put is
assigned you can exercise the long put to deliver on your
obligation to sell the underlying stock at the strike price. It is
also possible the stock could end up between the strikes.
This can be a tricky situation and we’ll walk through ways to
handle it later. But now that you’re familiar with the basic
mechanics of the short put vertical, why should you
consider this strategy? Consider risk versus return. As long
as you play your strikes right, there is a relatively high
probability of being profitable. Lets look at the strategy is
risk profile to see how this works. This is the risk profile of a
short put. This will be your main profit driver. In order for it
to be profitable the underlying needs to stay above the
break-even point which is the strike price minus the
premium.
If it drops below the strike price you run the risk of getting
assigned. Compare that to the risk profile of a long put your
hedge. You can see the risk is defined. Put them together
and you can see both the max loss and max gain are
capped.

This is what I mean when I call this a defined risk and

reward strategy. You’re basically capping your potential
gains in return for defining your maximum loss. This
strategy can offer a higher probability of success than other
bullish strategies like long calls because unlike bullish single
Options Strategies the underlying stock can go up a lot it
can go up a little it can go sideways or it can even go down
a little and the trade can still be profitable. This offers a lot
of flexibility, letting you manage how much profit you’re
willing to trade for what probability of success you want.
There is a trade-off that comes with that higher probability
of success: You limit your potential profit. To get a sense of
how these really work together, let’s look at an example.
Let’s say you’re bullish on stock XYZ and it is currently
trading at $99. You think it is going to hold steady or move
up slightly, so you sell a put 40 days from expiration at the
97 strike for $1.50 premium or $150 for the contract and
you buy another put on the same expiration further out of
the money at the 95 strike for $60 per contract. With these
two Options combined your net credit for the spread is $90
(or $150 minus $60) minus transaction costs. Let’s say
you’re right and the stock does increase slightly up to $101
near expiration. A bullish move is the best-case scenario
here. Both Options would expire out of the money leaving
you with your $90 credit minus commissions and fees. We
will talk about how to manage a trade like this a little later
on. But what if the flipside happens and the stock moves
down instead? Let’s say the stock drops and is trading at
$93 at expiration. If that happens your short put is assigned
meaning you’d have to buy 100 shares of the underlying.
But you bought that long put for exactly this possibility.
Because you bought the long put for a lower strike price,
you will only be out the distance between the two strikes.
Let’s break that down by the numbers. Your short put would
cost you $9 700 to buy the 100 shares but the 95 long put
would let you sell the shares for $9,500 leaving you with a
$200 loss. Remember you sold this spread for a net credit of
$90 so that would offset this a little for a total loss of $110
plus transaction costs. No matter how much the stock drops,
it could drop down to $50 per share or lower and that $110
is the most you will lose on this spread. But what happens if
the stock winds up somewhere in between your two strikes?
You will have an in-the-money short put and an out-of-the-
money long put. Depending on factors like the stock price
and how you decide to exit the trade the trade could
ultimately still be profitable but it might not be. What is
most important is that you’re at risk of being assigned stock
because of the short put. If the stock does end up between
the strikes you have got a couple choices. You could let the
trade expire and get assigned 100 shares of stock. But
because your goal is not to enter a stock position you will
probably want to take some action like closing the trade.
Consider closing both the long and short puts. While the
short put is the one with assignment risk closing the long
put at the same time can lock in any remaining premium in
the long put which could help offset a loss on the short put.
Keep in mind both of these would incur transaction costs.
Now that you’re familiar with potential outcomes of a short
put vertical let’s take a quick look at what forces impact the
value of the Options. These are price time and volatility. The
first force is price and is measured by Delta. Short put
verticals are Delta positive which means premiums fall as
the stock price goes up. As the Option seller you want this
to expire worthless. This Greek will give you a sense of how
much the Options contract price may change with a $1
move in the price of the underlying. The next force is time.
Theta measures the impact of time decay on short put
verticals. Because the driver of this trade is a short put that
you want to expire worthless it is Theta positive. Remember
the max gain for this strategy is the premium you collected
when you first placed the trade. The last force is volatility.
Vega tells you how rising or falling implied volatility could
impact your Options trade. Short put verticals have negative
Vega so ideally you would like to see volatility hold steady or
fall. This makes sense because your ideal outcome is for
both Options to lose value and expire worthless. Now that
you have got the basics let’s make some paper trades. Our
first step is to choose an underlying asset we want to trade.
For this strategy we don’t need to own the stock but we do
want to make sure it is following some entry rules. Because
this is a bullish strategy consider highly liquid assets that
are already in an uptrend. Of course there is no guarantee
that the upward trend will continue but it could increase
your probability of success. You could set up a watchlist of
stocks to keep an eye on. Next we have got to determine
when to actually enter the trade. Technical analysis can
help. A chart pattern like a bounce off a price floor or a
break through a price ceiling could be a signal that a stock
is potentially ready to make an upward move. We will use
Expedia symbol EXPE as an example.

Here is its 6 month daily chart. You can see it is in an

upward trend. You can see there was a recent price ceiling
around 145. So we know what stock we want to trade now
we’ve got to choose our Options contracts. Up first is
selecting an expiration. For a short put vertical the goal is to
hold it to expiration and stay out of the money. There is a
trade-off at play here: We could choose an expiration that is
closer which would mean faster time decay but less
premium overall. Further out could provide more premium
but slower time decay. For a good balance I’ll aim for an
expiration that is 15 to 50 days out. So in this case we will
go with the March 19 expiration expiring in 36 days.

Next up is choosing the strikes for our short and long puts.
Again this is a trade-off. One way you adjust the trade-off
between probability and profit is how far out of the money
you go with that strategy. A common mistake is staying too
close to the at-the-money strike in pursuit of higher
potential profit or going too far out of the money for higher
probability which significantly limits profits. For our short
put, we will look for a Delta between .30 and .40. Ideally this
strike price is at or below support levels which could mean
the stock is less likely to fall below our strike. We can see
the 140 strike has a 32 Delta and is below support.
This will give us a good shot at the Option expiring out of
the money while still providing a decent amount of
premium. It also looks like the difference between the bid
price and the ask price is less than 10% of the ask price
which suggests good liquidity.
So let’s plan to sell that one so I’ll click the bid price. Now
we need to choose the strike for our long put. This strike
should be below our short put. There is another tradeoff
here. The width of the spread determines how much credit
we will receive for selling it. But the wider the spread, the
more risk you open yourself up to because your max loss is
the distance between the strikes. One common rule is to
choose a long put at least $2 below the short put. For us the
next available strike is $5 away at 135. It is allowing us
some breathing room. You will notice our order now says
vertical. So here in the order editor I can see I’m selling the
March 19 140 and buying the March 19 135.
Now you will notice the price of our spread is still moving.
Let’s lock our required credit to a limit of 165. And we will
leave the time in force at day. Now we can figure out how
many spreads to trade. To do this you need to know two
things: your portfolio risk and your trade risk. Portfolio risk is
the total amount of your portfolio you’re willing to lose on a
given trade. Consider setting aside no more than 1% of your
active trading portfolio per trade. For simplicity let’s say I’m
trading with a $100 000 portfolio. If I’m willing to lose no
more than 1%, my portfolio risk would be $1 000 per trade.
Trade risk on the other hand is the amount you could lose in
a given trade. For a short put vertical, the trade risk is the
distance between the two strikes (think short strike minus
long strike) minus the credit you received from the spread.
In other words, the spread width minus the credit. For this
trade that is a $5 wide spread or $500 minus the anticipated
credit of 1.65 or $165 for a trade risk of $335. Now that we
know our portfolio and trade risk we can figure out how
many spreads to sell. To do this, take your portfolio risk and
divide it by your trade risk. So our portfolio risk of a 1 000
divided by the trade risk of $335 equals just about 3
spreads which I’ll enter in the trade ticket.

Now that we have got our trade loaded up, let’s do some
quick analysis using a nifty feature. Below the order ticket
you will see a stock chart and a risk profile chart.

On the stock chart you can see two tabs representing my

strikes and where they fall in relation to the stock is
historical price. You can also hover your mouse over either
chart to get a sense of where a given underlying price would
fall on the other.

In the risk profile the curved dotted line represents how

different prices would impact my profit or loss today while
the green and red boxes represent at expiration. For
example we can see our breakeven for today is
approximately 150.
However at expiration due to the effects of time decay it will
be about 138 and half 138.35 to be precise not accounting
for the transaction costs.
You can see the stock being anywhere above there at
expiration would be profitable, though once we reach 140
both contracts expire worthless and we hit max gain. In the
other direction, anywhere below 135 at expiration both
Options would be in the money and I would hit max loss
Let’s go back up and place the trade. I’ll click review and
confirm the details are correct.

Note the transaction fee in this case 3.90 or .65 per

contract. Now I’ll click send. There is the confirmation saying
our order is been sent. We have placed a short put vertical!
But this isn’t a set it and forget it strategy. We’ve got to
make sure we are keeping up with it. The way you manage
these trades can make or break them so we are going to
walk through managing some other sample short put
verticals that I’ve got in a paperMoney account. But before
we go through them, let’s talk about a simple rule that can
guide how you manage your short put spreads: If you’re
more than five to 10 days from expiration manage your
winners. If you have less time than that, manage your
losers. Let me explain what I mean. Set a profit Target - this
could be something like 80% to 90% of the max gain and
then close your winners when they reach that target even if
it is just a few days after you’ve placed the trade. If you get
to 10 days before expiration start weighing whether you
should exit your losing trades. Let’s open up Nvidia symbol
NVDA.

Both of our strikes are out of the money. Our original credit
was 4.09 which is our maximum gain. Our current
unrealized gain is around $400 leaving us with only about
$9 of remaining profit. We could let it ride and leave it open
for an extra 9 days but that opens us up to the risk of it
turning downward and we could lose out on some gains.
Since we’ve already achieved 98% of our max gain, I’m
going to close this trade to lock in that profit. To close the
position, I’ll click the symbol which opens up more details.
The position is already selected so I can click close selected
to bring up the order entry. So you can see I’m selling the
long put and buying the short put for a debit of 8 cents. I’m
going to nudge that to 9 cents to increase my likelihood of
getting filled.

Now I’m going to click review, where I can see the cost of
the trade which includes $1.30 in fees. Now let’s go back to
our positions and take a look at another one. I’ve got a
spread on Union Pacific UNP and you can see both Options
are in the money. This is looking like a likely max loss
scenario and the risk of early assignment on my short put is
elevated.

But I’ll give it one more day in hopes it’ll turn around and I
can avoid max loss. Remember; if both Options were to
expire in the money my long put would help cap the loss on
the short put. In any event I’ll close it tomorrow whether we
are further from max loss or closer to it in order to salvage
any remaining value before expiration. Let’s look at one
more sample trade to answer the question What happens if
the stock lands between my strikes? On Pepsi you can see I
sold the Feb 12 142 put and bought the Feb 12 137.
I’ve only got 2 days to expiration and the stock is now just
above 137 so the short put is in the money but the long put
hasn’t been hit yet. We are facing a potentially tricky
scenario. I haven’t hit max loss yet but I’m definitely at risk
of assignment on the short put and my long put is still out of
the money. If we hit expiration in this scenario, the short put
will be assigned but the long put would expire worthless,
leaving us on the hook to buy 100 shares that we never
intended to own. So to avoid assignment, I’m going to close
the position for a loss. I’ll follow the same process as my
earlier trade that was a winner: click the symbol and click
close selected. I’m going to leave it at the mid-price and
review the details which show I’m buying the vertical back
at a cost of $350. At expiration it could have cost as much
at $500 so I’m preventing a max loss.
Note the transaction fee of $1.30. Now I’ll click send. There
you go. That’s the nuts and bolts of the short put vertical or
the bull put spread. Remember that even though the
approach we discussed may be higher probability and less
risky than others you’ve seen out there, it is still risky. Make
sure you practice paper trading to get a feel for how these
trades can move.

OceanofPDF.com
Chapter 4 How To Trade Option Calls and Puts

There are two types of Options; calls and puts. A call gives
the buyer the right but not the obligation to buy a stock to
call it away from the Options seller and they can do so at a
certain price by a certain date. The seller of the call has the
obligation to deliver that stock if the buyer demands it. For
example let's look at Qualcomm. If Qualcomm was trading
at $123, a call buyer could buy the November 130 calls for
seven dollars and that means that the buyer of the Option
has the right, but again - not the obligation to buy
Qualcomm at $130 at any time before the third Friday of
November. Options usually expire on the third Friday of the
month. 130 dollars is what's known as the strike price - the
price at which the stock transaction would take place.
Options contracts represent 100 shares, so if you buy one
call, you can buy 100 shares of stock and for that right,
you're paying seven dollars per share or seven hundred
dollars. Wait a second - with Qualcomm trading at $123 why
would you pay seven dollars for the right to buy it at 130
dollars? Well if you bought 100 shares of Qualcomm at 123
dollars, you would have to pay 12,300 dollars buying a call
contract only cost seven hundred dollars. If the stock goes
higher as you expect, your calls will increase in value or you
could pay a hundred thirty dollars for the stock even though
the stock might be trading at $140 or $150 or higher. Most
Options investors don't exercise their Options or make that
stock transaction, rather they're looking for the call to
appreciate and price and profit from trading the call. If by
November Qualcomm was trading at $150, the calls would
be worth at least 20 dollars and likely more so someone who
bought the stock would have made $27 or 22%, but a call
buyer would have nearly tripled their money. The risk is that
the stock does not go up to 130 dollars by expiration. If the
stock goes nowhere and still sitting at 123 dollars, someone
who had bought the stock still owns it, they're flat and
there's an opportunity that the stock could go higher at
some point in the future. A call buyer's Option would expire
worthless and they would lose their entire seven hundred
dollars. Of course they could sell the Option at any time
before expiration - you don't have to hold it to expiration.
Maybe if they sold it in October they'd only lose $350
instead of the entire $700 - that's up to you as the investor
you can sell it at any time. But it's important to understand
that even if the stock rose to exactly 130 dollars at
expiration, that call would have no value. Only above 130
dollars would the call have value, meanwhile if you bought
the stock at $123, you'd have a seven dollar profit if it's
trading at $130. So by purchasing a call, you can participate
in a stocks upside with less upfront capital, you can make
tremendous gains but the risk is higher and you can lose all
of your capital. That's calls - let's now switch to puts. When
you buy a call to bet that the stock is going to go higher. A
put is a bet that the stock is going to go lower and it can
also be used to hedge an existing stock position. Using
Qualcomm as an example again, trading at $123, a put
buyer could buy a put let's say the November 110 puts -
that means that any time by the third Friday November, the
put buyer can put the stock or sell the stock to the put seller
for $110. Obviously if the stock is trading above $110, you
wouldn't do that. But if the stock is trading below $110, you
could force the put seller to buy your stock from you at
$110, or the value of the put would increase and you could
simply take your profits on the put itself. This is important to
understand; you don't have to own a stock to buy a put. You
can buy a put purely as a bet that stock is going to go down.
If Qualcomm drops in price, then the put becomes more
valuable. Let's say that Qualcomm totally blows its third
quarter earnings and it's a disaster and the stock drops to
$90. Well, if you bought the November $110 puts for five
dollars, if the stock is trading at $90 that put becomes worth
at least $20 or a 300% return on your money. Like with the
call you don't have to hold it the entire time - you can sell it
anytime you want to before it becomes worthless, so you
may still lose on the put but it doesn't have to be a hundred
percent of the value of the put, even if the stock does not
trade down to $110. Investors that own the stock can use a
put as a hedge like insurance, so for $500 they can ensure
themselves and protect themselves from downside, worse
than let's say about 10 percent if you're buying the $110
puts. They own the stock at $123 and can sell the stock at
$110, so in the case of a disaster like the stock falling to
ninety dollars, the put becomes worth twenty dollars. So
even though the stock is down thirty three dollars because
you bought it at 123, when you add the profits from the put,
it results in a loss of just $13. You can buy puts at your cost
basis so that you're guaranteed not to lose any money, but
the puts will be more expensive - it's just like insurance. The
larger deductible you have, the larger loss you're willing to
take the cheaper your premiums are. The less loss you're
willing to take the more expensive your insurance will be. So
buying puts and calls is a great way to make big money
without using a lot of capital to invest, as long as you can
handle the higher risks that come with trading Options.

OceanofPDF.com
Chapter 5 Call VS Put Options Trading Basics

In this chapter we are going to be going over the differences

between all and put Options and this important that you
take the time as you're early in your Options trading career
or if you're new to Option trading that you really understand
the differences between these two because these are the
building blocks for everything that we can do as a trader.
There's only two types of Options contracts. We got calls
and puts and everything that you can do in this space
revolves around the use of these two contract types. We're
going to look at just long calls and long puts and we'll talk
later on in the next chapter about buying and selling either
calls and puts and how you can change these risk diagrams.
The first thing we're going to do is we're going to look at an
example of a call Option. Long call Option strategy is the
most basic trading strategy whereby you're going to go out
and buy a call Option with the expectation that the price of
the stock will rise significantly beyond the strike price before
the expiration date.

In this case we're going to look at an example that we have

here is buying a 40 strike call Option so this is where the
payoff diagram pivots and moves higher. Your expectation is
that the stock price is well beyond the 40 price in the future
before expiration date. So if right now the stock price is 30
dollars you're going to hope that it's beyond 40 dollars
because that's your strike price. It's beyond that price point
in the future for you to make money. Compared to buying
the stock shares outright, a call Option buyer uses the
power of leverage, since one contract will control or
leverage 100 shares of stocks so that's the benefit to doing
this. We have power and leverage and we can pick your
points. We assume that maybe the stock is going to go
higher than 40. These are very easy to set up since it's just
a single Option order and that's what we're going to start
with as basics. You simply buy a call Option with the strike
price and expiration period you desire. In this case you
might buy a call Option which is say at the money or you
might buy a call Option that is out of the money if you're
even more bullish. An at the money Option would be if the
stock is trading at 40 dollars you would buy the 40 strike
calls. If the stock was trading at 30 dollars, you might buy
out of the money - meaning it's not quite yet or the stock
price isn't quite at the strike price and you might buy an out
of the money 40 strike call Option. It all determines where
you buy the Options depending on how bullish you are and
how much time you need until expiration. The maximum
loss is limited in call Option strategies. It occurs that the
investor still holds the call Option and that expiration and
the stock is below the strike price. The Option would then
expire worthless and the loss would be the price paid for the
call Option. In our example we're assuming that you're
going to pay 200 dollars for this Options contract. Think
about it logically. If you are assuming that the stock is well
beyond the 40 strike price - meaning the value of the stock
at expiration is beyond 40, that would be a good thing if the
stock is up at 50 because then you can buy the stock at 40
using this call Option and resell the stock immediately in the
market for 50 dollars per share, netting you a 10 dollar
difference for each share. That's only if you assume that the
stock is going to be higher than your strike price. Now let's
say that you come back in and you thought that the stock
would come up to beyond 40 dollars, but now at expiration
the stock is only up to 30 dollars, there'd be no reason for
you to go out and buy the stock at 40 dollars when it's only
worth 30 dollars in the open market. You just wouldn't
exercise your Option contract. You would actually go out and
if you wanted the stock, you would buy it at the current
market price of 30 dollars per share. This is where some of
the reduced risk features of Options trading come in
because now you would be more than happy to lose the 200
dollars that you're going to lose on this contract because
now that's less than what you would have lost if you had
bought the shares outright at 40 dollars and now they're
worth 30 dollars per share. That's the power of using these
Options contracts. With call Options the profit potential is
theoretically unlimited, but the best that can happen is that
the stock price to raise to infinity. We say theoretically
unlimited but Option prices are going to be range bound
within certain parameters. There's no stock that's gone to
infinity. At some point the Option contract does reach parity
though and what that means is that every dollar moved in
the stock, the value of the Option goes up by a dollar as
well. That's on the further edges. As implied volatility
increases, it does have a positive impact on the strategy
everything else being equal. It also really tends to boost the
overall value of long Options because there's a greater
probability of that strike price being passed by expiration.
This just means that if the market is volatile and we have a
stock that's sitting at 40 dollars and there's a good chance
that it could swing between 30 and 50 and 30 and a 50,
then there's a good chance that this Options contract may
be pretty valuable. But if the stock is trading right now at 40
dollars a share and the market's not volatile - meaning that
the stock really doesn't move more than like a couple
pennies per day, maybe down a couple pennies up a couple
pennies, then the value of this Options contract is going to
go down because there's not a good chance that the stock is
going to swing into a potential profit zone. That's the impact
of volatility. As time passes, it has a negative impact on the
strategy. That really goes for all long Options because
Options have a finite life and as they go quicker and quicker
towards expiration the value or the time left for the stock to
move into a favorable zone is going to be less and less.
Once the time value disappears, then all that remains is the
intrinsic value, so the difference between the strike price
and the current price of the market. For in the money
Options that's the difference between strike price and the
current price of the market. For out of the money Options,
they're going to be out of the money so if the stock ends at
30 dollars a share and the strike price is 40 dollars, then in
this case the call Option has no value at 30 dollars and the
Options contract basically expires worthless, the Option
buyer loses their money, the Option seller keeps the entire
$200 premium as a credit. At expiration the strategy breaks
even if the stock price is equal to the strike price, plus the
initial cost of the Option contract. Anything above this level
at expiration would be the additional profit for the Option
buyer. Break even prices at call Options, long strike price
plus the premium that you paid to get into the contract. So
let's look at an example. The strike price in this case like we
talked about is 40 dollars a share. If you bought one 40
strike call Option for 200 dollars, the 200 dollars is the debit
that you paid to get into it. It's your consideration or your
premium. That means your max loss is your 200 dollars or
basically your cost. It doesn't matter where the stock price
is. Anywhere below 40 you can only lose 200 dollars
because you don't have to buy the actual shares. You're not
obligated to buy those shares. Your max profit potential is
theoretically unlimited in this case and your break even
point in this case is 42 dollars. That is the value of the strike
price, plus the Option contract value which is really 2 dollars
is a value not 200 dollars debit. That's the actual value of
the contract, but when you actually see the contract go
across you're going to pay 2 dollars for that contract, so the
actual break even price in this is 42 dollars - meaning that
even though you bought the 40 strike call Options you really
need the stock to move to 42 dollars or higher to be
profitable at expiration. You'll start making money as the
stock goes beyond the 40 strike, but you really won't make
any money net of your cost to get into the trade until the
stock moves beyond 42 dollars. Now let's turn things around
and let's look at put Options.

The long put Option strategy is the second most basic

Options trading strategy whereby you go out and buy put a
put Option with the expectation that the price of the stock
will actually drop significantly beyond the strike price before
the Options expiration date. Compared to shorting the
shares outright, a put Option buyer is using again the power
of leverage since one put contract will control 100 shares of
stock. This is where you can get a bearish position or build-
a-bearish position in a stock for limited risk by using a long
put Option. In this case what you're saying is your strike
price becomes the price at which you guarantee that you're
going to sell shares in the future. With a put Option you're
basically making an agreement with somebody else that
says you will sell shares in the future at 40 dollars per share.
That's your strike price. That's the point at which you're
going to sell the underlined shares. Your goal if you've
already pinned your selling price in the future of 40 dollars
per share your goal now is to buy the shares later on before
you sell them to somebody else for less than that value. You
might go out and buy the shares when they go down to 30
dollars and then you resell them to somebody else that
you've already guaranteed that you're going to sell them to
at 40 dollars a share. Let's say that you're a home builder
and you're building a house for somebody. If you agree to
build that house for them for 100 000 dollars, they agree to
pay 100 000 for that home whenever it's done. You're just
entering into a put contract as a home builder. You've
basically determined what price you're going to sell that
home to them which is 100 000 dollars. Your goal and
mission is to build that house for less than 100 000 –
materials, labor, permits - you want to outlay less money go
out a physically buy the materials and hire the people to
build the house for less than you've already predetermined
to sell the house for to the home buyers which is 100 000
dollars. If you can build the house for 80,000 and you've
already got a person lined up to sell the house to for 100
000 dollars then you make that difference as a profit. It's the
same way with put Option contracts. You're basically going
out and you're pre-selling the stock at some price in the
future and hoping that you can buy the stock at a lower
price in the future. Meaning that the value of the stock goes
down and therefore the profit in the trade goes up
incrementally as well. These are very easy to set up since
it's a single order. You simply buy a put Option with a strike
price and expiration period that you deserve. In our
example we're buying one at the money put Option -
meaning that the stock price could be at 40 dollars. We buy
a 40 strike put. That's where the Option payoff diagram
pivots. If we wanted to buy an out of the money put Option,
let's say that the stock is trading at 50 dollars a share, we
would then be buying an out of the money put Option at 40
if the stock is trading at 50. Our 40 strikes are out of the
money - meaning we need to move down to at least 40
dollars for us to be in the money. The more bearish you are,
the further out of money and the lower that you'll buy those
put Option contracts on whatever you're trading. The
maximum loss with long Options is limited. It occurs if the
trader is still trading the put Option at expiration and the
stock is above the strike price. In this case the Option would
expire worthless and the loss would be the price paid for the
put Option. As opposed to our home builder example, in this
case with an Option contract you are not required to sell the
shares. You might pay a premium to enter into this contract
but you are in no way required to sell shares at 40 dollars.
It's your choice. It's your Option as the Option buyer. The
Option seller does not have that choice but as an Option
buyer you do. So if the value of the stock is now 50 dollars
at expiration, there would be no logical reason for you to sell
the shares at 40 dollars to somebody else when you have to
go out and buy the shares at 50 dollars in the open market.
You just wouldn't exercise that Option. You would let the
contract expire and you'd be happy to just lose your 200
dollar investment which is much less. Profit potential is
theoretically unlimited just to zero. Obviously the stock can
only drop to zero so we have unlimited and you'll see
unlimited in a lot of places but it's really to zero. You can
only make as much money as the current value to zero. At
some point the Options contract does reach parity with the
short stock - meaning that there's no additional value
present in owning the Option. That's usually if the Option
goes very deep into the money and at that point every
dollar move down that the stock makes the Option value
goes up by a dollar as well. All things being equal, an
increase in volatility will generally have a positive impact on
the strategy - just like we looked at with call Options. When
volatility increases and the market is more volatile -
meaning it could swing from 40 all the way down to 30 all
the way back up to 50 back down to 30, there's a bigger
chance that the stock might swing into your profit range.
Versus a market that is not volatile, that stays around 40
maybe swings a couple dollars up or down in either
direction, you really don't have a lot of value. As volatility
increases, it tends to boost the value of these Options
because there's a greater chance of the stock swinging into
your profit zone. The passage of time just like with call
Options with a long put Option a long call Option always
negatively impacts the Options. Options are finite. They
have a definitive date in which they expire, so as time
passes and time erodes then the value of these Options
goes down because there is less time for the stock to swing
into the potential profit zone. At expiration, the strategy
breaks even if the stock price is equal to the strike price,
minus the initial cost of the put Option. Anything below this
level at expiration would be additional profits for the Option
buyers, so the break even price here is the long put strike.
In our case 40 dollars, minus the premium of 200 dollars
and in Options pricing term it's 2 dollars when you actually
enter the order and so that give us a break even price of
about 38 dollars on this particular security. Another
example: the stock price is at 40. You buy a 40 strike put
Option for 200 dollars. In Options pricing terms when you
actually go into your broker platform you're going to enter
an order that's going to say two dollars actually controls or
is valued at 200 dollars. That's the price that you pay. That's
also your max loss. You can't lose anything more than that.
Then again profit potential is unlimited to zero so obviously
the stock can't go below zero. The break even strike price of
40 dollars, minus the value of the Option that you paid
which is two dollars, gives us a break even price of 38
dollars. In this case even if you bought the 40 strike puts,
because of the value in buying those put Options or how
much you had to pay to enter into that contract, your actual
break even price is 38 dollars, so you'd want to see the
stock move down to at least 38 dollars before you start
making money net of the cost to get into the contract. It's
important to remember that calls and puts are the building
blocks for everything.

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Chapter 6 Options Trading Strategies for Higher
Returns & Lower Risk

In this chapter I’m giving you a complete guide on Options

investing - everything you need to make money with these
investments, then I’ll reveal five Options trading strategies
that every investor must know. There is no other investment
that's going to help you lower your risk and make more
money like Options. Every investor needs Options investing
in their toolbox. In the following chapters I’ll explain what
are the basics of Options and a few terms you need to know
like the expiration date, strike price and contracts. I’ll show
you how Options can lower your risk, increase your returns
or both and how to make money using them. Then I’ll
explain step by step those five Options trading strategies;
covered calls, protective puts, spreads, straddles and collars
and exactly when to use each. Options are special types of
investments called derivatives because they derive their
price from another investment. We'll be talking about stock
Options here so these are investments where the price
follows a stock price. Options give you the right to buy or
sell a stock for a specified price on a specified date. For
example buying a call Option gives you the right to buy
shares of a stock, while put Options give you the right to sell
that stock. Now let's look at an example because it's really
not as complicated as it sounds.
Here we see the Options for shares of Apple trading at 119
dollars per share. Across the top here you see these are the
Options for different dates from November 13th all the way
through January 2023. These are called the expiration dates
so how long each set of Options lasts. Most stocks have
Options that expire each month and then longer dated ones
that expire in January of each year. Some of the more
popular stocks and funds even have Options that expire
every week, so these Options with an expiration date of
January 15 2021 give me the right to buy or sell shares of
Apple on that date about two months from now and the
price at which I can buy or sell those shares is called the
strike price. This is seen in the middle of the table. Each of
these rows is a different Option for the shares at that price.
For example in the middle here is $120. The Options here
are going to give me the right to buy or sell shares of Apple
for a hundred and twenty dollars each in January. That's no
matter where the shares are at that point. If Apple is trading
at 150 dollars per share in January, I can still buy it at $120
each if I have this Option investment, so you can already
see how this can be a powerful investment. Options are
going to allow me to buy a stock for less than the market
price sometime in the future or even we could sell it for
more than the market price. Of course you don't just get
that ability to lock in a stock price for nothing. To buy an
Option you pay what's called a premium.

Here on each side of the stock price we see the bid and the
ask columns and then the last price at which the Option was
traded. The bid is just how much someone is willing to pay
for that Option and the ask is how much someone is willing
to sell it for right now in the market. If we look at this
hundred and twenty dollar strike price again that last price
of six dollars and 30 cents on the left is the price that you
would pay per share to be able to buy those shares of Apple
for a hundred and twenty dollars in January no matter where
it's trading at on that date. There are two types of Options;
call Options and put Options and you see them on each side
of the table. Call Options give you the right to buy shares at
that price in the future and for each of these there's a buyer
and a seller of course. One investor buys a call for the right
to buy shares of Apple at 120 dollars per share, they pay
that six dollars and 30 cents per share on the right and
another investor that's going to sell that call Option - they
give the other investor the right to buy those shares from
them at that price and in return, they're going to collect that
six dollar and thirty cents per share of that premium. For
example let's say you did buy these call Options on Apple at
that hundred and twenty dollar strike price. Each Option
contract is for a hundred shares so if you buy two contracts,
you would actually be getting the right to buy two hundred
shares of Apple. If you paid that last price of six dollars and
thirty cents per share that means you paid twelve hundred
and sixty dollars - that's six dollars and thirty cents times
two hundred shares, you pay that right now to buy the call
Option. So if shares of Apple rise to a hundred and fifty
dollars each by January, you can buy those shares for 120
each because you have that call Option so you could
actually pay twenty four thousand dollars that's 120 dollars
each for those 200 shares for the shares that are worth
immediately thirty thousand dollars - that's two hundred
shares at 150 dollars in the market. Most Options traders
they don't actually put up the money to buy or sell those
shares when the Options expire. Since those Options would
be worth about six thousand dollars as they get closer to
expiration, that's because whoever owns the Options can
immediately turn them around for that profit, then the
Options trader is just going to sell the Option before they
expire - they're going to book that profit before even having
to buy the shares of Apple anyway. Put Options on the other
hand give you the right to sell shares at that price in the
future. If you thought shares of Apple were going to fall,
then you could go and buy these put Options at the $120
strike price and be able to sell Apple at that price come
January. You'd pay six dollars and 43 cents per share - this
premium for that right to sell the shares of Apple at 120
each. So if you bought those two contracts of the put
Options so if you paid the 1286 that's 200 for 2 contracts,
200 times that 6.43 each share premium right now to buy
the put Option. If shares of Apple fell to say a hundred
dollars each by January you could then sell them for the
$120 each because you have that put Option so you collect
the difference of twenty dollars for each of those shares
immediately - each of those two hundred shares for a four
thousand dollar profit. That's just two uses of Options
trading though; profiting off the rise and fall in a stock price.
There are a lot more uses though, including synthetic
positions so being able to invest in a stock for a lot less for
example to buy a hundred shares of Apple you'd have to put
up almost twelve thousand dollars at the current price. But
with Options you can invest just six dollars and 30 cents per
share in our example. You pay 630 dollars for that same 100
shares of Apple and get the same investment exposure to
the stock. Other uses for Options trading include lowering
your downside risk in a stock, investing ahead of certain
news events and just profiting as the volatility in a stock
price moves higher or lower. There are just a lot of great
strategies for using these low cost investments to do
everything from lower your risk to making outsized returns.
Options trading and strategies definitely need to be in your
toolbox. I want to go over a few more of those Options
trading basics and then we'll cover some examples and
those five trading strategies. Let's switch it up here a little
bit and look at Options for shares of Tesla.
You see we can buy weekly Options in November and
December. There's Options expiring here in different months
next year as well as out to 2022 and then as late as January
2023. You can buy the right to buy or sell shares of Tesla for
a specific price, all the way out to two years. One thing
you'll notice here is the prices for these Options change for
the different months and the years. For example you can
buy these January 2021 call Options for Tesla at the strike
price of 420 dollars per share for about 44 each. You lock in
that price for Tesla by paying that $44 premium and you're
going to be able to pay just 420 for the shares on January
15th no matter how much they are in the market.
If we look at the January 2023 Options though you see that
same strike price of 420 per share that would cost you $160
each. To lock in that price for shares of Tesla out more than
two years in the future obviously you're going to have to
pay more for this because this call Option gives you that
right to buy shares at that $420 price for a much longer
time. In Options trading we say this has more time value.
You'll also notice within each of these expiration dates so
each of these weeks and months of the Options the price
changes for different strike prices up and down the table.
For example if you want to lock in the price of 405 dollars
per share of Tesla up to January 2021, you'd have to pay
about 50 dollars per share to buy those call Options. But if
you want to lock in the price at 435 dollars per share you'd
only have to pay 37.15 for each call Option there. The
difference in the price here is because of where the market
price of Tesla is right now. If you were able to lock in Tesla at
405 dollars per share with it already at 422 dollars a share
in the market, that's a great deal and it could get even
better if the stock keeps moving higher. Any investor that's
going to sell you those call Options going to want to make
more money on that deal. On the other hand those call
Options for the right to buy Tesla at 435.00 each those are
above the current market price. There's some risk that the
share price won't even make it up to 435 by January which
would make those Options investment worthless, so any
investor buying these Options isn't going to pay as much so
you get that $37 premium. That brings up an important
point about Options trading. Whereas if you buy a stock
you're going to keep that investment no matter where the
share price goes. If you buy shares of Tesla here at 422 each
you're going to keep that stock whether it goes to 500 each
or if it falls to 400 per share. Options are different though. If
you have that call Option on Tesla, let's say you buy the call
Option to buy the shares at 420 on the January expiration if
the share price of Tesla falls to $400 by then well you're not
going to use that Option to buy shares for $420 if you could
just go to the market and buy them for $400 each. Basically
that Option that you bought is now worthless. You paid forty
three hundred and eighty five dollars that's that premium of
forty three dollars and eighty five cents each times the 100
call Options but shares of Tesla fell below your strike price.
In this scenario you're just going to let those Options expire
the person that sold them to you is going to keep that
premium - keep the money that you paid and nothing else is
going to happen, so there is some risks in Options trading
even though some of the strategies that we'll look at will
help you actually lower your overall risk. There is the risk in
just buying these calls or the put Options that the share
price is going to move against you and you'll lose the
premium that you paid on those Options. You don't have to
wait until expiration date to sell your Options. If you buy
these January Options for Tesla, the price the other investors
are paying for that same Option is going to change as the
stock price changes, so if shares of Tesla increased to $450
each then that call Option to buy it $420 is going to be more
valuable so that price is going to increase as well. Instead of
the 44 dollars per share that you paid for that call Option
maybe it increases to $55 each and you'd be able to sell
your Option for that price, making a quick profit without
even having to hold them to that January expiration.
Another thing you'll notice though the blue areas on the
table.

For call Options strike prices below the current market price
- those Options are said to be in the money or ITM. They
give you the right to buy shares of Tesla here at those strike
prices that are below the current market price. By contrast
the call Options above the current market price are said to
be out of the money or OTM. These are the strike prices or
the words higher than the current market price of the stock
and it's just the opposite on the right for the put Options.
Remember that put Options give you the right to sell the
shares so they become more profitable as the share price
falls.
The put Options with the strike prices below the current
market price those are out of the money while those that
allow you to sell the shares for more than they're worth in
the market right now those are in the money. Deciding on
which strike price and which Options expiration date is
going to be a big part of the strategies that we're going to
talk about. For example you can get a cheaper call Option if
you buy a near dated one that's out of the money, so maybe
buying the Tesla call Option for January 2021 at the 435
dollar strike price. Those are only $37 each because shares
of Tesla have to rise quickly in just two months really for you
to make any money. On the other hand those call Options to
buy Tesla at $400 each right now through January 2023
those would cost quite a bit more. In each of the Options
trading strategies I’ll show you how to decide which strike
price and which Options expiration you should buy. That's
pretty much the basics of investing in Options though. We'll
go into a little bit more detail on those call Options and the
put Options, when to invest in each and how to make money
before we get to those five trading strategies. A call Option
is just the right to buy shares of a stock at a certain price by
a certain date. Some reasons you might use call Options
include taking a position in a stock for less money. For
example being able to invest in shares of Tesla for fifty
dollars a share instead of that four hundred twenty dollars
each in the market now. You can also collect money on your
investment, so selling call Options to collect the premium is
really a way to create that cash flow on non-dividend paying
stocks. You can also lower your risk in a stock by collecting
that money from selling those calls. Pros of call Options are
that they cost less money for each share and you get that
leveraged return. If shares of Tesla rise by twenty dollars
each that's less than a five percent gain on the current price
of four hundred twenty two dollars a share, but if you paid
that fifty dollars each for each call Option and the share
price rise is about twenty dollars, then you could be looking
at a forty percent return on that Options trade. Call Options
also allow you to collect some money on shares you own
and lower your risk in the investment. The downside to call
Options though is the premium you pay to buy that Option
can be pretty high. Here we're looking at call Options for a
$420 strike price costing $44 each so it costs you 40 bucks
just to buy the Option where the stock is trading right now. If
the price of Tesla shares fall below that 420 strike price then
that Option expires worthless and you're out of the money.
Another downside for call Options and some of the trading
strategies we'll look at is that call Options can limit your
upside return if you sell them even as they lower your risk.
Put Options - remember these are the right to sell shares of
a stock at a certain price by a certain date, and some
reasons you might want to use put Options include being
able to short a stock without margin, so benefiting from a
drop in the stock price. You can also lock in those gains or
limit losses on a specific stock or even against an entire
market crash. For example if I own shares of Tesla but I’m
afraid of a stock market crash might wipe out the stock, I
can buy put Options for the right to sell the shares at a
certain price. If I buy that 410 dollar strike price I pay this 36
dollars per share but that gives me the right to sell the
shares at that price - at 410 dollars each, no matter where
they're at in the market on this expiration date of January
2021. If the shares crashed to 350 each - doesn't matter - I
can sell mine at 410 each because I’ve got this put Option.
If shares keep rising I keep profiting from the increase in my
shares and I’ll just let that put Option expire without selling.
Another use for put Options and this is a great one that
most investors don't think about is getting shares of stock
for a lower price - for a discount. This strategy is called the
cash secured put and it's really interesting way to profit on
shares of a stock or just to pick up those shares of an
investment for less. For example if I wanted to buy shares of
Tesla in the market right now 100 shares are going to cost
me over $42 000 at the current market price, but I can sell
the put Options so I’ll sell one contract of the January put
Option - each contract is worth that 100 shares and I can
collect the 42.70 each share when I sell these Options to
another investor. Buying a put Option is going to give you
the right to sell those shares while selling that put Option
which is what I’m doing now means you have to buy them
at that price. If I sell the January put Options at a 420 strike
price on Tesla I’m committing to buy those shares from
another investor whoever is buying those put Options from
me for that price and then let's look at the two possible
outcomes here. That investor buying the put Options is
going to pay me forty two dollars and seventy cents each or
about four thousand two hundred and seventy dollars for
those hundred shares. I’m going to keep that money no
matter what. If shares of Tesla stay above 420 each by
expiration on January 15th, the Option buyer isn't going to do
anything - they wouldn't sell these shares of 420 each to me
with that put Option if they could just sell them more in the
market. If shares are priced at $450 each in January they
wouldn't use that put Option to sell them to me for $420 so
they would just go and sell their shares in the market for
$450. I would keep that 4 270 dollars from just selling the
put Options contract and I don’t have to do anything. I’ve
made over four grand for not doing anything. If on the other
hand shares of Tesla do fall so we'll say 410 dollars each by
January, I’ve committed to buying them for 420 from that
investor that bought the put Option. I still keep that
premium that 42 dollars for each share that they paid for
the put Option but now I have to buy this investors shares
for $420 each share. But the really cool part of this is if I
wanted to buy those shares of Tesla anyway then I would
have had to pay that 422 dollars each in November. This
way I lower my cost in the shares by that 42 dollars and 70
cents each buy that premium. I bought the shares for 420
each from the investor with that put Option but I really only
paid like 377 dollars each because I had already collected
the 42 dollar premium when I sold the put Options. So this
cash secured put strategy is just a way to either collect that
money for selling the puts and doing nothing or you get the
shares for a price less than you would have paid in the
market anyway. It's a great way to get a discount on all your
investments. So really you can make money trading Options
in a number of ways and buying calls you make money
when the share price increases, buying puts you make
money if the share price falls you can lower your risk in a
stock by selling call Options or buying puts. You can even
mix and match your Options to profit whether a stock price
rises or falls. To show you how to do that let's look at these
five Options trading strategies. I’m going to detail each
strategy exactly when you would want to use these and
then how to set it up, then I’m going to share an easy table
that's going to put all this together and make it as simple as
possible.

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Chapter 7 Trading Psychology & How to Handle
FOMO

In this chapter you will discover how to improve your trading

psychology, specifically how to handle that frustrating P&L
killer FOMO. Hence in this chapter we are going to discuss
FOMO, the fear of missing out on trades and we're going to
be specifically talking about three strategies for overcoming
FOMO. We often hear common sense advice about how to
deal with FOMO; take a break or take a deep breath or
whatever but that’s a no no. We're going to look at this
psychologically and talk about specific evidence-based
psychological strategies for overcoming FOMO. Evidence-
based means it's based in the outcome research in
psychology. We're going to be applying it to the training
situation. Here's the big idea, FOMO stand for fear of
missing out, fear of missing on opportunities but the key
word is fear. FOMO is an anxiety. FOMO is a fear. Fear and
anxiety occur when we perceive threat. The problem is not
that we have missed a potential trading opportunity. The
problem is that we perceive that to be a threat to us, to our
success and to our future. Once something becomes a
threat we go into stress mode and literally our brains
respond with a what's known as a fight or flight response,
we're priming ourselves for action. How do we do that? The
blood flow if we were in a functional magnetic resonance
imaging machine, we would see the blood flow in the brain
go from the frontal cortex to the motor areas of the brain,
priming us for action because we're perceiving an
emergency. What goes on in the brain's frontal cortex?
Higher level thinking, judging, planning - all the things we're
supposed to be doing when we're trading well, the blood is
flowing away from those regions of the brain into the action
areas. So as long as we perceive threat, we're going to be
shifting our blood flow to a more impulsive action-oriented
mode, rather than focusing our mind. The key to
overcoming fear is taking the threat out of the situation.
We're always going to miss opportunities. Where have some
of the biggest opportunities been recently in financial
markets? In crypto, in certain commodities, European power
but guess what? All of us missed every one of those moves.
Why aren't you upset? If you're afraid of missing out you
missed out on some big moves! You can only trade what you
focus on and none of us has perfect focus. We want to take
the threat out of that which means we want to normalize
that. We have a cat that we recently adopted and she is
from Thailand and she's known as a cow mani, a rather rare
cat but her owner died and there was no one available to
adopt her and so she was placed in an animal shelter under
not very good conditions. She had never been in that sort of
situation, she's in a cage, unfamiliar environment and she
was really traumatized. She was really upset when we went
to see her she was cowering in the back of her cage and she
wouldn't let anyone near her. We ended up adopting her but
we picked her up and she started purring and purring
because in the shelter no one had been really loving her.
That convinced us okay we got to get this cat but it's been a
real chore. We have to create gradual experiences of safety
for her. She's in this totally new environment and everything
is potentially threatening, so what we do is and this is a key
psychological idea, we tap into motivations that are stronger
than the fear-based motivation. For little cat what
motivation is stronger? The motivation to eat because she
wasn't given very much food in the shelter and so we took
the cat food and I put the cat food on the my fingertips and
held it close to her and she was hungry and so she goes
closer and closer to the fingertips and she starts licking the
fingertips and eating the food and that gives me a chance to
pet her a little bit and do that again and again and so
gradually we create experiences of safety. Experiences
where she sees that the fear it's not really scary and it's not
really a threat so we're taking the threat out of it. But we're
tapping into a motivation that's stronger than the fear. She
wanted the food more than she wanted to avoid us. Now
let's look at how that psychological principle can apply to
FOMO. The question is what motivation is greater than P&L?
Obviously we're motivated to make money - that's a big
purpose of trading, but if P&L is the measure of our value of
our worth then anytime we lose P&L, any time we go into
drawdown we're going to feel worse about ourselves so that
allows it to be a threat we have to find a motivation that's
greater than P&L. For successful traders the motivation
that's greater than P&L is the desire to learn and grow. The
people who don't last in the business it's all about making a
quick buck. But the people who really become successful as
traders, they're always learning always developing. They
have learned so much and they've developed in so many
different ways and that's going to be true for you as well
and so they keep score with their learning and they keep
score with their growth and they keep longer term statistics
on their trading to document that they're getting. They're
trading more size, they're trading with consistency rather
than just looking at their absolute returns because if they're
consistently profitable, they're going to get more and more
risk bumps and that's going to make them successful in P&L
terms. They are measuring themselves on the basis of
consistency of profitability and not magnitude of
profitability. That learning and growing motivation is not
threatened by the fact that we are human, we sometimes
lapse in our attention and we miss an opportunity. Does that
change the fact that we're learning and growing? It's a
disappointment if we miss a good opportunity. I’ve traded
since the late 1990s to give you an idea so I’ve missed a ton
of opportunities but if my goal is to be developing and
learning and growing, it's a pothole. It's just a bump in the
road it's no longer a threat. How we judge ourselves and
how we grade ourselves determines what is a threat and
what is expectable. The secret to permanently breaking any
bad habit is to love something more than the habit. Loving
something more than the habit, in this case loving your
growth and your development and your future as a
professional that's so much more important than the day-to-
day P&L. But let's go through three research-based
strategies for overcoming any fear or anxiety.
The first strategy is known as exposure therapy. What we're
doing in the first step of exposure work is we're training
ourselves in relaxation. We're teaching ourselves
visualization, so we visualize something peaceful and
relaxing and while we're visualizing - maybe I’m visualizing
myself walking on an empty beach and I’m feeling the sun
and the waves are coming at my feet, I’m breathing very
deeply and very slowly letting it out, very deeply breathing
and so with the slowed breathing, I’m slowing my body
down. Remember that the fear response is fight or flight. If I
slow my body down that's the opposite physical response to
fight or flight. So I’m slowing my body down and I’m
focusing my mind - I’m not getting all frantic, I’m focusing
my mind on something very peaceful and relaxing. That's
stage one of the exposure work. Step two is we create
what's known as an anxiety hierarchy. We take scenarios
from the least threatening all the way up to the most
threatening scenario. The least threatening might be you
miss an entry on a trade early in the session and you get
back in a little bit later. It's not a huge threat but it's a little
bit frustrating. Number two, number three, number four: you
create different scenarios that would be a little bit more
threatening like a draw down scenario might be the market
starts to move and your screen goes dead. Then at the top
would be big drawdown scenarios, big threats or big losses.
So you in the exposure work you create this hierarchy and
once you have gotten good at the relaxation work, and that
takes practice and typically you'll be doing that for a week
or more to get really good at it, so it's important to master
that first. Then instead of visualizing being on the beach and
being all relaxed, you are visualizing the first item in your
hierarchy, which is a frustrating scenario - something that
has a degree of threat, while you're breathing deeply and
slowly and keeping your body very still. Think about what
you're doing; you are pairing the threatening scenario with
the slowed breathing and you're focusing your mind on that
scenario, so you're staying focused and staying calm, while
you're vividly visualizing a threatening situation. What's
going to happen if you do that one time, two times, three
times, ten times or twenty times? It becomes natural. The
repetition and the pairing of the threat with the relaxation
response means that they become paired in our mind and
so we learn a new connection and actually there are
changes in blood flow as a result of doing this work. This is
the number one psychological treatment for phobias, for
PSTD, whenever people have significant anxieties. It takes
daily practice and many times we'll do it more than once a
day, but once you create that connection you've got it for
life. It's the repetition that takes the threat out of it. You're
literally training mind and body to stay chilled even in a
situation that could be a frustrating situation. That's
exposure work. It is a behavioral therapy and you are
teaching a stimulus response connection so you can think of
it in pavlovian terms. It is one form of CBT. CBT is cognitive
behavioral and the second techniques we're going to be
talking about are purely cognitive techniques, but the two
are joined together because both are learning techniques in
therapy. If you were looking up exposure therapy you or if
you were looking for a book on CBT, this would be in the
book.
In cognitive work we are not changing our behavior patterns
in that pavlovian way, we are changing our thinking
patterns and we're changing how we think about these
missed opportunities. The idea being is that our thinking
creates our responses that if I view missing opportunities as
a sign that I’m no good or I’m such a failure or if I view it as
a threat to my development, of course I’m going to react
negatively. The idea of cognitive work is that we can learn
new ways of thinking and we can process in our thinking so
it's not with the body and the relaxation work. It's by
reprocessing in our mind, we can take the threat out of the
event. The way that this is traditionally done is by keeping
what's called a cognitive journal and the journal consists of
four columns on sheets of paper, A, B, C. Column one is A -
the activating event, so that's the specific situation that got
you upset and in this case it would be missing the
opportunity. B reflects your beliefs about that event - your
beliefs mean your self-talk. Why is this upsetting to you? I’m
telling myself it was such a great opportunity. Other people
got the opportunity, I didn't and they're going to get ahead
of me and their development and it means I’m not as good
as them. All the negative thoughts going through your mind
that's what you put in column B so you're writing out the
negative thinking. You have the activating event - what
happened, your self talk to column B, and in C, are the
consequences of the negative thinking. How is it making
you feel? How is it affecting your future of your subsequent
trading? I’m so bummed out and I’m beating myself up over
missing an opportunity, I go ahead and miss the next one.
You are tracking the negative consequence and some of the
negative consequences might be that you're just stressed
out you're unhappy you're upset but all the different
negative consequences and that's where you start the
journal. So that you get very good at recognizing in real
time when activating events are activating you and you're
getting really good at identifying your negative beliefs and
you're getting very good at identifying the consequences of
those. The idea here is that we change our patterns of
thinking and we change our patterns of behavior often
because the consequences become so front and center to
us that we just don't want to go back there again. I can't
keep doing that to myself and I can't keep beating myself up
over miss trades because that's making me worse and it's
making me unhappy. Interestingly one of our best
motivations to change is hate, because if we hate our
negative patterns, we're going to push them away. We don't
want any part of it. If I hate something I don’t want it in my
life. You want to be so aware of the consequences that you
hate them. That's what gets people an AA past their alcohol
problems. At some point the consequences build up and I’ve
lost my job, I’ve lost my marriage, I’ve lost my health and so
I can't do this anymore - I gotta change - this is killing me.
That's what C is all about and you get better and better and
better at identifying the negative but also emotionally
connecting with the consequences.
Column D stands for disputation - means you're disputing
the negative thinking. It's like you talking back at that
negative thinking. One of the favorite ways I have of doing
the disputation is just to think about how you would talk to
someone else you care about, who is in that situation. If
you're in a team and your teammate misses an opportunity,
how would you want to talk to them if you're mentoring
them, if you're a teammate of theirs? It is a missed
opportunity, you'd hopefully help them learn from it but
you're not going to beat them down. There's more to you
than this one trade. You would be encouraging, you would
be caring, you would be supportive, you would be
constructive, you would help them learn from it. The irony
here is that many times we know how to talk with other
people in those situations, but we have trouble doing that
for ourselves. Column D is all about talking to yourself the
way you would talk to a best friend. Talking to yourself - not
in like people talk about positive thinking. If you miss a
great opportunity, it's not positive, it sucks, but you want to
be constructive. The way I put it is from everything you
want to take away a learning P&L. Sometimes we don't take
a monetary P&L - we take a loss, but what do you learn from
the loss? What has it taught you about the market and
about the stock? What has it taught you about how you
place your orders and how you size things? There should
always be a learning P&L and so when someone misses an
opportunity you would talk to them about the learning P&L.
What can you take away and how can you make sure it
doesn't happen again? That's how you want to talk to
yourself and that's column D. Imagine doing that every
single day, you get very good in real time recognizing the
negative thinking, you get very good in real time seeing the
consequences like I don’t want to go here and you get very
good in real time reframing talking to yourself more
constructively, so that eventually you get to the point where
you slap yourself up - there comes that negative thought
again but it doesn't disrupt you. You get really good at
putting yourself into a more calm focused state because
you've taken the threat away from the situation.
Strategy number three called broaden and build. One of the
major reasons why we get caught up in P&L is because we
don't have enough other positive things going on in our
lives. The metaphor we use in this situation is if you are
investing your money, you want to be diversified. Some of
my money is in fixed income instruments like bonds, some
of my money is invested in our home and some of it is in
stocks. The idea is you are diversified so that if one
investment goes down the others may be going up - it gives
you balance. The question becomes what is your life
portfolio? How balanced are you in your life? If all you're
doing is trading, you're going to be vulnerable. Yes, trading
is important, yes developing yourself in a career is
important, but relationships are also important. Having
personal interests outside of your work is very important.
Your physical well-being is very important and your spiritual
well-being too. You want to have a diversified life portfolio,
so when the trading doesn't go well, you're diversifying your
emotional capital. If I have a loss right now in my trading
and I have had losses, I’ve got three kids, a rescue cats, a
wonderful wife, a career that I love, so if I lose money on a
trade, it's one piece of my life. Yes I want to learn from it
and yes I want to do well, but it's in a perspective. When we
put all of our energy and all of our focus on trading, we lose
that perspective. We can do all the psychological exercises
in the world and the exposure work is very helpful, the
cognitive work is very helpful, but if we don't broaden and
build our life and if we focus only on performance in P&L,
we're going to be vulnerable. So the issue is to make trading
important but not all important, and to focus on our growth
in trading and not just P&L and to make sure that we have a
P&L from our life's activities. What's our day-to-day P&L in
life, then the ups and downs of our performance will don't
rule us and they certainly are not threats to how we feel
about ourselves.
In conclusion what gets measured gets improved. Any time
you want to develop something you want to keep track of it
and you want to measure it and that's why the trading
statistics are so helpful but tracking yourself when you have
missed opportunities, tracking how you respond to those,
you're keeping that learning P&L going. We want to focus on
growth and improvement, we want to evaluate our trading
relative to the opportunity set. For instance I’ve had
occasions where I get into a trade, it goes my way, I’ve got
some paper profit and it all reverses. What does that tell
me? It's not going to my direction anymore and quite
possibly there's not enough volume and volatility to sustain
a trending move. I’ve just learned something about that
market or about that stock that I thought we could go
higher, I thought we could take out yesterday's high let's
say if I’ve been buying and it reverses against me and I say
to myself, damn that should have worked. It didn't work.
Instead of getting frustrated it's information that can help
set up the next trade. If it reverses violently against my
position, maybe I’m going to reverse the trade. If not if the
volume is really low maybe we're just in a choppy range and
I’m going to adjust my trading to trade reversal patterns.
But the idea here is that we're evaluating our trading
relative to the opportunity set in a choppy slow market, my
P&L expectations won't be the same as in a nice trending
breakout market. Finally, in terms of the learning P&L what
the research tells us is that you don't want to set 20 goals
for improving yourself - that's what people do at new years’
time and by January 15th they can't remember any of them.
Just set a few important goals. What did I do well that I want
to build upon, what did I do that needs improvement and
I’m going to work those every single day and keep score,
keep track and that's going to make me better each day,
each week and each month. The idea here is to set a few
high priority goals and work them hard each week and each
month so that our learning P&L is front and center and that
helps us put our missed opportunities, it helps us put our
P&L into a broader perspective. We don't get too excited
when we make money and we don't get too down when we
don't make money. A key to all these techniques is the
consistency of working them and building new habits of
thinking, building new habits of behaviour. When it comes to
FOMO do you think that there could be any correlation or
any relationship at all to sometimes that a phone like FOMO
that you may experience could also be some trainer
intuition telling you something? If you think that I’m scared
to get into this position, it could go in one direction but you
aren't 100% sure but sometimes you do have that traitor
intuition and so if there is either relationship or correlation
to FOMO and traitor intuition? Well, it's a very good question
and that scenario is certainly possible that I have an
intuition that this thing could break out and it's getting more
volatile and I’m a little skittish about getting in. A lot of
times that's what's known as performance anxiety and so
often the best strategy there is just getting in with very
small size initially and building a position if you actually get
the breakup. But that could show up like a FOMO. Usually
the FOMO occurs when the thing is already broken out and
we weren't on board and we're telling ourselves I should
have caught that. But now it's moved up and after a big
move up I can't stand to see it go up anymore and I lift the
offer. Usually that's the FOMO situation, but the broader
point that sometimes if we have a fear there could be an
intuition behind it and that's a legitimate point. If it's classic
FOMO it leads you to take bad trades. But how would you
link the personality traits to FOMO in terms of the big five
especially with for example people of course who are high in
eroticism and probably have this problem more than others
who don't? Well, there are five dominant personality traits in
the psychology research and the tendency toward negative
emotions which is sometimes called neuroticism, the flip
side would be emotional balance. Some people have a very
even temperament - not a lot of highs or lows and some
people are quite emotional and they have a lot of highs they
have a lot of lows. Someone who has lots of highs or lows,
certainly could be more affected by FOMO. The thoughts
about missing out could happen to anyone, but if we're
more emotionally reactive then that could affect us more.
There's also a big five trait called conscientiousness, which
correlates with discipline and being rule-based and
consistent and if we had a very high degree of
conscientiousness, we'd be less likely to act on FOMO. We
may feel the fear of missing a move, but at the end of the
day we're not going to break our rules and go chase a trade
just because we think we're missing something. Hence
personality does play into these things, and there's some
good personality tests that you can take to learn about your
strengths and to learn about your traits. For instance on that
neuroticism measure I end up being very low because I
don’t like drama. If something starts moving away from me,
I’m not going to chase it. I just hate that drama - that's not
what I want to be doing in training. I want to be
understanding what's happening, acting on it, getting out,
rinse and repeat. In that case I’m less likely to be influenced
by the FOMO. Openness to experience is another one of the
big five personality traits and it's correlated with creativity.
When we are more open to experience, that's correlated
with creativity and so that's very much related to our
trading because if we are very open to experience, we are
very open to new ideas and if we're open to new ideas we're
going to develop new ways of trading, and we're going to
find some unique ways of trading. Finding new edges in
markets and trading in different ways, that's related to
openness. In terms of dealing with the learning P&L when a
stock goes in your favor at first by a certain amount and
you're in profit and then ultimately goes completely against
you, how what is your take on potentially not necessarily
being short-minded or scalping the opportunity but at least
collecting profits along the way if you're one to let that
emotional toll of having the entire position reverse against
you being able to at least capture size or catch a profit
along the way up while you're still in the profit zone and
then ultimately if it does go against? Well, it's great practice
and something I do try to identify that if it's a lower volume
market a lower volatility market and if it goes my way right
away I’m looking to take it - at least a piece of the position
off to ring the cash register. If it's a really slow day I might
take the whole thing off, the volume's not there, trees don't
go to the sky, take it. If it's an environment where a news
item - a catalyst came out and the thing could really move
because new players are getting involved and we can see
that in the volume then at most I would take off a piece of
the position because I want to let the next piece run and we
can let the next piece run in the form of Options which helps
our risk reward because at that point we rang the cash
register and now the most we could lose is our Options
premium, so now we've created a win-win because as it
goes further in our direction you've got the convexity of the
Option position so it's moving point for point with the stock -
you've done well. It reverses against you, you lose the
premium but you took profits on the first piece - win-win.
Psychologically that consistency can work very well. But
having a strategy in your head for when you take profits
when what you let run what would get in the way of that
would be perfectionism. If I don’t have my total full size on
for the whole move it's not good enough. Perfectionism is a
habit pattern of thinking, cognitive therapy, but that's what
we're getting away from when we take partial profits and let
the rest run because we're saying for a piece of the position
good enough is good enough. I don’t have to be perfect. I
can be consistent and I can do very well and so you're
cutting yourself slack and psychologically you're creating a
win-win because I win on the small piece and if it goes my
way further and it's a further win. But so many people have
trouble not just making goals but just completing them. New
year's resolutions are hard but in fact so many people have
issues or problems actually overcoming goals and problems
in their training. We're good at setting goals but not
necessarily good at reaching those. A big part of that is
because we need not only to set goals, we need very
concrete plans for reaching those goals and the plans are
things that we have to do daily to build new habit patterns.
Many times I look at a trader's journal and a trader says well
my goal is to not oversized things and my goal is to not over
trade. My response to their journal is great, how are you
going to do that, how specifically are you going to make
sure you size things the right way and how specifically are
you going to make sure that you are taking the right trades
and not over trade and how are you going to measure that
and how are you going to keep score on that? Many times
we don't reach the goals because we don't drill down and
have very specific ways of working on those goals. I have a
goal that I want to improve the communication in my
marriage. Great that sounds wonderful. But how do I
improve the communication? Well maybe by spending more
quality time together. What does that mean? Drill down so
that I have very concrete things to do each day to work on
the goals - every goal needs a detailed plan. Otherwise if
you have a goal without a detailed plan, what do you have?
Good intention, and that's what a lot of traders journals are -
a bunch of good intentions. Well, that's fine - it's better than
bad intentions, but that's not going to change the
behaviour.

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Chapter 8 Option Greeks for Beginners

The Option Greeks are absolutely essential to master and

understand early on when first starting out as an Options
trader. That's because the Greeks will tell you how an
Option price is expected to change when certain variables
like time, the stock price and implied volatility change. In
short the Greeks will tell you how your Option position
should perform given certain scenarios. The first primary
Option Greek that we're going to talk about is called Delta.
Delta estimates how much an Options price will change with
a one dollar change in the stock price so Delta is a
directional risk measure as it tells you how your Options
price is expected to change when the stock price goes up or
down. Call Options and put Options have different Delta
values, so first of all call Options have positive Deltas and
that means that call prices rise when the stock price
increases and call prices fall when the stock price
decreases. That's because when you buy a call Option you
have the right to purchase shares of stock at the call
Options of strike price and when the stock price increases
your call Option will have a higher probability of expiring in-
the-money and therefore being valuable at expiration but if
the stock price increases further above your called strike
price you now have the ability to buy shares at a deeper
discount compared to where they're currently trading which
explains why call Options increase in value when the stock
price increases and fall when the stock price decreases. On
the other hand put Options give you the right to sell shares
of stock at the put Options strike price if you purchase that
put Option and therefore put prices fall when the stock price
increases and put prices rise when the stock price
decreases. Because of that put Options have negative Delta
values which basically explains that exact relationship so a
put Option has a negative Delta value and that means that
if the stock price increases the put Option is expected to
lose value and if the stock price decreases the put Option is
expected to gain value. Now let's go ahead and look at a
couple of examples of how Delta works. Remember that
Delta is an Options estimated price change with a $1
change in the stock price. Let's say we have a $5 Option
with a Delta of plus 0.5 zero. As we know call Options have
positive Delta's so in this example let's say this is a call
Option. Let's say the stock price is at $100 when we buy
that $5.00 call Option with a Delta of positive 0.50. If the
stock price increase is $1.00 to 101 dollars the new Option
price is expected to be five dollars and fifty cents because
the Options Delta is positive 0.50. When the stock price
increases by one dollar we simply add the Options Delta to
the Option price to get our estimated Option price after that
one dollar increase.

On the other hand if the stock price instead falls by $1 to

$99 then the new estimated Option price is going to be four
dollars and fifty cents because in this case since the Option
has positive Delta, we're going to subtract the Option Delta
from the Option price since the stock price fell by one dollar.

Now let's switch things up a bit and look at an Option Delta

of negative 0.25. As we've just learned put Options have
negative Delta's which means they're expected to lose
value as the stock price increases and gain value as the
stock price decreases. If we purchase that five dollar put
Option when the stock price is at $100 and the stock price
increases to 101 dollars, the new put Options of price is
expected to be four dollars and seventy five cents because
it has a Delta of negative 0.25.
That means if the stock price increases by one dollar the
Option price is expected to lose twenty-five cents and if the
stock price falls by one dollar the Option is expected to gain
twenty-five cents in value.
But is Delta actually accurate in practice? Well to figure this
out let's look at a real example of a stock price change
relative to the Option price change of varying Delta call
Options. In this chart we're looking at a change in the
S&P500 ETF which is SPY and we're looking at the SPY call
Options with 25 50 and 75 Delta.

In this example in the shaded region spy increased by four

dollars. In this example everything worked out perfectly and
if we look at the point seven five - call Option the call price
increased by three dollars so if we take point seven five and
multiply it by four we get a three dollar price change which
is exactly what the 0.75 Delta call Option experienced. On
the other hand the 0.25 Delta call Option experienced a
price change of one dollar which makes sense since if we
take a point to five and multiply it by four we get a positive
one dollar price change which is exactly what happened.
Keep in mind that things will not always work out so
perfectly but in general Delta does a very good job of
estimating an Options price change when the stock price
moves up or down by small amounts in a short period of
time.
Now we're going to move on to the second Option Greek
which is Gamma. Gamma estimates how much an Options
Delta will change with a one dollar change in the stock price
so it's easiest to understand Gamma from the Option buying
perspective. When you buy Options or have a long Option
position the Gamma position will be positive. That means
call Delta's will increase towards positive one when the
stock price increases and fall towards zero when the stock
price decreases. On the other hand put Delta's increase
towards zero as the stock increases and fall towards
negative one when the stock price decreases. To understand
this in terms of probabilities Delta is sometimes used as an
Options estimated probability of expiring in-the-money, so
when the stock price increases, call Options at every strike
price have a higher probability of expiring in-the-money
which means they're called Deltas will increase. If the stock
price decreases call Options at every strike price have a
lower probability of expiring in-the-money, which means
their Deltas will fall towards zero. On the other hand when
the stock price increases put Options at every single strike
price have a lower probability of expiring in-the-money at
expiration and therefore their Deltas will approach zero as
the stock price continues to increase. If the stock price
decreases put Options at every strike price have a higher
probability of expiring in-the-money which is explained by
their Delta values getting closer to negative one. It's
confusing to think of a negative probability of expiring in-
the-money so when looking at a put Options Delta and
thinking of its probability of expiring in-the-money, you can
just ignore the negative sign. Now let's go through some
examples and look at how Gamma works in practice.
Gamma is an Option Delta's expect to change with a $1
change in the stock price. Let's go back to our $5 call Option
example and let's say that Option has a Delta of positive
0.50 and a Gamma of positive 0.10. If the stock price is at
$100 when we buy that call Option and the stock price
increases to 101 dollars, the Option price is expected to be
five dollars and fifty cents, however since the stock price
has increased by one dollar the Options Delta is expected to
be positive point six zero because the initial Delta was point
five zero and the Gamma was a positive 0.1 zero so if the
stock price increases by one dollar, the new Delta is
expected to be 0.60. If the stock price increases another
dollar from 101 dollars to one hundred and two dollars the
new Option price is expected to be six dollars and 10 cents
which is 60 cents higher than the five dollar and fifty cent
Option price after that first dollar increase.

Now let's flip things around a bit and say we have a five
dollar put Option with a Delta of negative 0.40 and a
Gamma of positive 0.15. If the stock price is at $100 when
we buy that Option and the stock price Falls to $99 the new
Option price is expected to be five dollars and 40 cents and
that's because the negative Delta of 0.40 means the Option
price is expected to increase by 40 cents if the stock price
decreases by $1. So whenever we have a decrease in the
stock price you're going to subtract the Delta from the
Option price and when we subtract a negative number we
end up with a higher number. Also we subtract Gamma from
the Option Delta when the stock price decreases by one
dollar so if the stock price goes from 100 to $99 and the
initial Delta was negative point four zero if we subtract 0.15
from negative point four zero we get a new Option of
negative 0.55.

That means if the stock price decreases another dollar to

$98 our new expected Option price is expected to be $5.95
because our initial Option price after that first $1.00
decrease was five dollars and 40 cents and with a new put
Option Delta of negative 0.55 if the stock price decreases by
another dollar, the Option price is expected to increase by
another fifty five cents so five dollars and 40 cents plus fifty
five cents is an estimated price of five dollars and ninety
five cents. With a new Delta of negative 0.55 and a Gamma
of 0.15 with that next $1 decrease in the stock price the
new Option Delta is expected to be negative point seven
zero. Now let's go through a real example using historical
Option data and visualize what Gamma represents.
In this chart we're looking at Apple's stock price changes
relative to a call and put Delta with the strike price of one
hundred and twenty dollars. On the top part of the chart
we're looking at the changes in Apple's stock price relative
to that strike price we're looking at and on the bottom we're
looking at the call and put Deltas for the 120 call and 120
puts on Apple. In the initial part of the shaded region Apple
stock price increases from $120 to around 133 dollars.
During that time period the put Delta of the 120 put gets
closer to 0, while the 120 calls Delta gets closer to positive
one. If we think in terms of probabilities the increase in the
stock price from 120 to 133 results in a significantly higher
probability of the 120 call expiring in-the-money, since the
stock prices $13 above the strike price and the put Options
Delta goes towards zero because the put Option has a
significantly lower probability of expiring in-the-money since
the 120 put is now 13 dollars out-of-the-money. In the
second part of the shaded region, Apple stock price
collapses from that price of around 133 dollars and at the
end of the shaded region the stock price is at 115 dollars. As
the stock price collapsed, the 120 calls Delta crashed from
being above 0.75 to being at 0.25 at the end of the shaded
region and the put Options Delta went from being close to
zero to negative 0.75 with the decrease in the stock price.
That's because with the collapse and Apples price to 115
dollars, that 120 call is now out of the money and now has a
significantly lower probability of expiring in-the-money,
compared to when the stock price was at 133 but that 120
put is now in the money and therefore the put Options Delta
is closer to negative one which represents a higher
probability of that put Option expiring in-the-money. In the
simplest terms possible of Gamma as an Options changing
probability of expiring in-the-money as the stock price
increases or decreases. When a stock price increases call
Options at every strike price have a higher probability of
expiring in-the-money, which is expressed by higher Delta
values and put Options have lower probabilities of expiring
in-the-money, which is represented by Delta values closer to
zero. When stock prices fall call Options at every strike price
have a lower probability of expiring in-the-money which is
expressed by Delta's closer to zero and put Options at every
strike price have a higher probability of expiring in-the-
money, which is expressed by Delta values closer to
negative one but of course we can just forget about the
negative sign and think about the raw probabilities.

The third primary Greek and perhaps the simplest Greek to

understand is Theta. Theta estimates how much an Options
price will decrease with the passing of one day. All Options
have negative Theta values and that's because as Options
get closer to their respective expiration dates, their extrinsic
or time value component decays which is expressed by
Theta. At expiration Options only have intrinsic value
remaining which means the extrinsic value will reach $0 by
expiration, so Theta is the Greek that tells us how much an
Options extrinsic value is expected to do crease with each
passing day. Let's go ahead and look at a visual example to
see how Theta works. Theta is an Options estimated price
decrease with the passing of one day. Let's say we have an
Option that is trading at two dollars and 50 cents and it's
Theta value is negative point one zero or negative ten
cents. That essentially means the Option price is expected
to decrease by ten cents with each passing day so on the
first day the Option price is two dollars and fifty cents but
with each passing day the Option price is expected to lose
ten cents. With the passage of one day, the Option price is
expected to go from two dollars and fifty cents to two
dollars and forty cents and for example if four days pass and
nothing else has changed, then the Option price is expected
to decrease by forty cents.

But let's go ahead and visualize Theta in action. In this chart

we're looking at Facebook and we're looking at the 105
straddle and we're looking at the straddles price as time is
passing. The 105 straddle means we're looking at the price
of the 105 call in 105 put combined and since Facebook is
trading right around 105 this entire period, the 105 call in
105 put are mostly extrinsic value, which decreases over
time as expiration gets closer and closer.
The 105 straddle starts around $10 and by the end of the
period, Facebook is still right around 105 dollars but that
straddle price has decreased from $10, all the way down to
around $4. This example is about as perfect as we're going
to get in real life because a stock price will never just trade
exactly at the same price as time passes and that means
we're never going to have that linear Option decay as Theta
would suggest, and as we looked at in the previous
theoretical example. But in this example we can see a
steady decrease in the extrinsic value of these 105 calls and
105 puts as time passes.
The fourth primary Option Greek is Vega which estimates
how an Options price will change with a 1% change in
implied volatility. All Options have positive Vega and that
means that when Option price has become more expensive
they have more extrinsic value which leads to an increase in
implied volatility. When Option prices become cheaper, they
naturally have less extrinsic value which means implied
volatility Falls all else being equal. Getting a little more
specific, Vega expresses how much an Options price is
expected to change with each 1% change in implied
volatility. But let's go through an example to illustrate this
point. Let's say we have a two dollar and fifty cent Option
and implied volatility is currently 25%. Let's say that Options
Vega is positive 0.25. That means if implied volatility were
to change by one percent the Option price is also expected
to change by 25 cents. For example if implied volatility
increased by 1% to 26% the expected Option price would be
two dollars and seventy-five cents because we have the
initial Option price of $2.50 and we add that 25 cents of
Vega with that 1% increase in implied volatility.

On the other hand if implied volatility falls by one percent to

24 percent, the new expected Option price is expected to be
two dollars and 25 cents, which comes from the initial
Option price of $2.50 but since implied volatility has fallen
one percent, we subtract the point two five Vega to get our
new Option price of two dollars and twenty five cents.
Implied volatility does not control Option prices. There's
nobody that's turning a dial for implied volatility up or down
which is controlling how expensive or cheap Option prices
get. Instead the change in Option prices controls the level of
implied volatility, so to say if implied volatility increases by
one percent the Option price is expected to increase by X is
backwards. Let's go back to our previous example and flip
everything around to rethink how to interpret Vega. let's say
our Option price is two dollars and 50 Cent's, implied
volatility is 25 percent and the Options Vega is positive 0.25
or positive 25 cents. If the Option preys were to increase by
25 cents, the new expected implied volatility is 26 percent
or 1 percent higher. If the Option price does not change and
stays at 2 dollars and 50 cents then the expected implied
volatility is still expected to be 25 percent.

If the Option price decreases by 2 dollars and 25 cents then

the expected implied volatility is expected to be 24 percent
or 1 percent lower. Keep in mind these are Option price
changes based on no stock price changes and no change in
time, so if the stock price were to stay exactly the same
throughout a trading day and the Option price has changed
up or down 25 cents, then the expected implied volatility
would change by one percent. In short if the Option price
increased by 25 cents in a given trading day and the stock
price did not change at all, implied volatility is expected to
increase by one percent, because that Option increased by
25 cents, which means it has 25 cents more of extrinsic
value and that is what implied volatility is representing and
therefore implied volatility is expected to increase by 1
percent since that Options Vega is 25 cents. On the other
hand if the Option price decreases by 25 cents during that
trading day and the stock price did not change, implied
volatility is expected to fall by 1 percent. So always keep in
mind that Option prices and more specifically in Options
extrinsic value is what is driving changes in implied volatility
and implied volatility is not driving Option price changes.
To quickly recap all of the for Greeks Delta is an Options
expected price change with a $1 change in the stock price.
Gamma is an Option Delta's expected change with a $1
change in the stock price. Theta is the expected decrease of
an Options extrinsic value with the passing of one day, and
Vega is the expected change in implied volatility based on
specific Option price changes.

OceanofPDF.com
Chapter 9 How to Trade Options in a Bear
Market
As of May 2022, the S&P 500 officially fell into bear market
territory, falling 20% from its previous high. In this chapter I
want to talk about bear market Option strategies and things
to keep in mind when trading Options in a declining market.
The first strategy I want to talk about is actually the bullish
strategy of selling cash secured puts. I love this strategy in
a bear market because it allows you to get paid while
waiting to buy shares of a stock that you love at a lower
price and you're also taking advantage of the higher market
volatility, which means that you'll be selling more expensive
Options as compared to a lower volatility market. Since the
put Options specifically are going to be really juicy, then
you're going to be collecting a lot of premium and
potentially making a lot of money while waiting to buy
shares of a stock at a lower price. Let's quickly cover how
this strategy works and then talk about its benefits in a bear
market environment. When you sell a put Option or short a
put Option, you are obligated to purchase 100 shares of
stock if the put Option is in the money at the time of
expiration, which means the stock price is below the puts
strike price at the time of expiration. A cash secured put is
when you're shorting put Options but you're setting aside
100% of the purchase value of the shares so that you can
actually buy those 100 shares of stock at the put strike price
in the event that you do get assigned which in a declining
market is likely. For example a bullish block investor which is
the ticker symbol SQ, they might short a 50 strike put in
block and collect 310 dollars into their account and since
the strike price is fifty dollars to buy one hundred shares of
a stock at fifty dollars a share, that would cost five thousand
dollars. But since we collected three hundred and ten dollars
into our account for selling this put Option we only need to
set aside four thousand six hundred and ninety dollars to
fully cash secure this short put position.

In this particular example the stock price is currently around

sixty four dollars and the investor is potentially going to
purchase 100 shares of stock at that put strike price of $50.
If the stock price remains above 50 and at the time of
expiration in August of 2022, if block is above $50 a share
then this cash secured put trader will keep the whole $310
that they received and then they will be able to sell another
put Option in the subsequent expiration cycle to collect
more premium and continue waiting to purchase 100 shares
of stock at their new put strike price. The big benefit of
selling cash secured puts in a bear market is that when
markets are declining, typically volatility is high or
increasing and this impacts Option prices because Option
prices are a direct result or a function of market volatility. If
market volatility is high, then Option prices will also be high
to account for those bigger swings and stock prices and
furthermore, in a declining market there's going to be a lot
of demand for put Options because traders or investors can
buy put Options to hedge against or profit from decreases in
stock prices. That's going to further push up put valuations
and as a cash secured port trader, you are selling these put
Options so you are selling those expensive put Options as
compared to selling cheaper put Options in a lower volatility
market. You'll also have a high probability of making money
since the stock price has to decline pretty decently before
you get into that territory of being assigned on that short
put contract. That really is the worst case scenario when
selling cash secured puts is that you end up buying 100
shares of a company that you actually love and want to hold
long term, but you purchase those shares at a much more
favorable price compared to if you just purchased 100
shares at the time of selling that cash secured put. Back in
that Block example the stock price was at 64 and we were
selling the 50 strike put so compared to buying 100 shares
of stock at $64 a share by shorting that 50 strike put, we
can actually collect $300 in premium and if we do get
assigned on that put then we will be buying shares at $50 a
share as opposed to 64 dollars a share. The downside of
cash secured puts is that you'll need a lot of money to set
aside and to estimate how much money you'll need, simply
multiply the put strike price by 100. In the Block example
the put strike price was 50 so we needed to set aside about
five thousand dollars to buy those 100 shares but if you're
trading a higher price stock and for example the put strike
price is 150, then you'll need about fifteen thousand dollars
set aside to potentially purchase those 100 shares of stock
at 150 per share. If you're keen on selling juicy put Option
premium and getting paid to wait to buy shares of stock that
you love at a lower price, then cash secured puts allow you
to do that. Now let's switch gears and talk about a strategy
that allows traders to profit from continued stock price
declines. The cleanest way to do this with Options is to buy
put Options which is a low risk high reward trade. Buying
put Options has a huge advantage over shorting stock
because when you short stock you have unlimited loss
exposure to the upside because there's no limit to how high
a stocks price can go and when you're short stock, you lose
money for every dollar that the stock appreciates. When you
buy put Options you can only lose the amount that you pay
for the put Option, so it doesn't matter if the stock price
increases a hundred dollars or a million dollars, if you buy a
put Option, the most amount of money that you can lose is
the premium that you pay for it which makes it much safer
than shorting 100 shares of stock. Buying put Options in a
declining market is super advantageous because buying
puts can see an explosion in their values because in a
declining market put Options have two forces working in
their favour. The first is that if the stock price is decreasing,
put Option prices increase because the stock price is getting
closer to that strike price or moving through it, which means
it has a higher likelihood of being really valuable at the time
of expiration. The second force is that as markets decline
volatility typically increases, which means the Option prices
will be expanding as market volatility increases. If you're
buying put Options and the stock market really takes a dive,
then you're going to be making money not only from the
stock price falling, but also from the explosion in volatility
that accompanies stock price declines. But there are some
downsides to be aware of as well. Bear market means high
volatility and a lot of demand for put Options because
traders and investors can buy put Options to hedge their
stock portfolios or simply speculate on prices declining. For
that reason put Options will be really expensive as
compared to buying puts in a lower market volatility
environment. Buying put Options in a more volatile market
environment means that you'll be paying more for those put
Options and that means you'll have more exposure to time
decay, or how much that Option price will lose with each
passing day if all things are held constant. You will also lose
money if implied volatility falls which typically happens as
the market begins to recover. You can get hit with a triple
whammy when buying put Options in a bear market. If you
buy put Options in a bear market and the market starts to
recover, then you will lose from the stock price is increasing
because put contracts lose value as the stock price
increases, you will lose money from the passage of time
because that stock price movement has to take some
amount of time and you will also lose money from the
decrease in implied volatility that typically occurs as
markets recover. If you buy put Options and the market
starts ripping higher then unfortunately that put Options
value could deflate really quickly and that is not good for
you, but the benefit is that you can only lose what you pay
for the put Option which is different from shorting stocks
because when you short stocks you have unlimited loss
potential to the upside. The long-term historical average of
the Vix is around 20 and currently the Vix is somewhere
around 30 so it is above the long term historical average,
but it's not insanely higher than the historical average
because in 2020 we saw the Vix above 50 for a period of
time - rarely does it get to that level but I just wanted to
point out that right now the Vix is around 30 which is about
10 points higher than that long term historical average, so
you will be paying a higher premium for all Options but
they're not insanely high at this point and if the market
continues going lower, then volatility could continue
expanding higher from 30 to 40, which would benefit your
long foot position. Now I want to talk about some things to
expect when trading bear markets and the first thing I want
to bring up is to prepare for the bear market rallies. When a
bear market hits the market doesn't just go down in a
straight line unless we're looking at something like March of
2020, which is pretty much straight down. In most cases
we'll have severe declines and then you'll have pretty
significant upside moves as well, so definitely prepare for
some vicious rallies in a bear market. First of all on the
decline you can take that opportunity to take profits on
bearish positions and then on those bear market rallies you
can take that as an opportunity to reload into some more
bearish trades. Definitely take advantage of these bear
market declines as a profit-taking opportunity, but then take
advantage of the bear market rallies as a place to
potentially reload on your bearish positions. This next tip is
a really random one and it's something I thought of but I
wanted to include and this is for covered call traders. As a
covered call trader you have 100 shares of stock and you
have a short call. In a declining market one adjustment that
covered call traders can make to their position is rolling
down the short call Option, which means that you are
buying back the original short call and then shorting a new
call Option at a lower strike price, so that is rolling down.
The problem with this in a declining market is that you can
get into a situation where you can't sell a call Option at a
strike price that is at or above your share purchase price for
a decent premium. Some covered call traders might look to
sell a call that is actually below their share purchase price
and I would avoid doing this because what you're doing
when you do that is you're essentially agreeing to sell your
shares at a loss, compared to your share purchase price. So
if you buy 100 shares of stock at 100 and the stock price
falls to 90 and then you short the 95 call Option, what
you're doing is you are agreeing to sell your shares at 95
dollars per share if the market recovers and since you
bought those shares for a hundred dollars a share, you're
effectively agreeing to sell those shares at a five dollar loss.
Of course you do collect premium for selling those call
Options, so you wouldn't be taking a real five dollar loss but
still the concept is that if you short a call Option at a strike
price lower than your share purchase price, you will
effectively be agreeing to sell your shares at a loss and I
don’t think that's a good move. As a cover call investor you
should be comfortable holding those shares long term,
because you do hold those 100 shares and you are selling
calls against them. If you can't sell a call Option at or above
your share purchase price, then I would consider waiting it
out, waiting for the market to recover until you can once
again start selling call Options at a higher price than your
share purchase price. The last tip I want to give you is to
prepare for the end of the bear market because at some
point the bear market will end and we will start a new bull
market. When that is, we don't know - it could be 12 months
from now. At some point the bear market will end so it is
good to consider preparing for the bull market, especially if
we've been in a bear market for quite some time. If you are
anticipating the bear market to come to an end then
consider adding some bullish trades such as buying long call
leaps which means you would be buying call Options in a
long long-term expiration cycle, namely over a year. A long
call leap position is a way to get upside leverage on the
stock without a margin call potential. If you're buying stocks
on margin which means you are effectively borrowing
money from your broker to buy shares of stock that you
wouldn't be able to afford otherwise, or if you are doing
something like buying futures contracts, then you have
margin call potential because those are highly leveraged
positions and as they start to move against you, the losses
can become greater than your actual account value and
that means at some point the broker will liquidate those
positions. Those are examples of leveraged upside positions
with margin call potential. I really like the idea of buying
long call leaps because you get upside leverage on the
stock price, but you have no margin call potential because
the worst case scenario is that you lose whatever you paid
for that call Option. You also have a lot of time to be right
compared to buying shorter term call Options. For that
increased time to be right, you are going to be paying a
premium for those Options but you can still make a really
good return on a very small stock price movement - at least
a much larger return than the share price will do itself. For
example let's look at the 500 strike January 2024 call in SPY.
If we look at this Option price we can see that the Option
price generally follows SPY, but the S&P 500 call expiring in
January 2024, sometimes doubled in value. Like from
October 2021 to January 2022 going from less than twenty
dollars per contract to over forty dollars per contract. Even a
small rally such as in May and June of 2022 - those small
rallies generated almost 100% returns on the 500 strike call
and this is even though the stock price never got above that
cost strike price of $500. Use this strategy cautiously but
understand that buying long call leaps is a way to get
leveraged upside exposure to stock price movements and
you have no margin call potential and for that reason, it's a
smart way to use leverage with Options.

OceanofPDF.com
Chapter 10 Vertical Spread Concepts Options
Traders Must Know

Vertical spreads are the most important Option strategy to

master as a beginner, but there are many vertical spread
concepts that so many people get wrong that once learned,
will take your Options trading IQ to the next level. The way
I’m going to approach this chapter is by using Option pricing
calculators to simulate changes in the variables that impact
how Options are priced and by changing these variables we
can understand how these positions change value when we
change implied volatility, when the stock price changes and
when we experience the passage of time. First I want to
illustrate how a vertical spreads Theta position and Vega
position will change as the stock price changes relative to
the strike prices of that particular vertical spread. For this
first example we're looking at a 100 110 call spread and
we're going to look at the spreads Theta and Vega position
as the stock price moves from $100 or the long call strike
price to 110 dollars which is the short call strike price. If the
stock price is at $100 which is the long call strike price, the
spread has negative Theta and positive Vega which means it
will lose value from the passage of time and it will gain
value from increases in implied volatility, or lose value from
decreases in implied volatility. But the Theta and Vega
position of this call spread does not remain constant.
The Greeks actually flip positions as the stock price
increases towards that higher call Options strike price. What
this means is that if I buy a call spread with the strike prices
of and 110 - meaning I buy the 100 call and short the 110
call, if the stock price is near the long call strike price of
100, my spread is going to have negative Theta and positive
Vega - meaning that I will lose money from the passage of
time and I will gain value or profit from increases in implied
volatility or if implied volatility falls, I will lose even more
money as implied volatility is falling and time is passing.
However if the stock price increases favorably and increases
to the short call strike price of 110, my vertical spread will
actually become positive Theta - meaning that it will benefit
from the passage of time and negative Vega which means
that it will increase in price if implied volatility falls. I want to
start here but I want to further isolate these changes and
first we're going to look at changes in implied volatility and
then we're going to look at changes in the passage of time
and then we're going to bring it all together and look at a
scenario where the stock price is changing and time is
passing and we're also seeing changes in implied volatility
to see which scenario results in the best vertical spread
performance. For this first test we're going to look at how a
vertical spread, namely a call spread changes value as we
have a decrease in implied volatility, and we're going to look
at a decrease in implied volatility when the stock price is at
two levels. For this initial test we're looking at a theoretical
100 105 call spread with the stock price pinned at $100
which is the long call strike price if I were to purchase this
spread. We're going to look at the spreads value as we take
implied volatility from 30% down to 20% and here's what we
get.

As we can see if the stock price is at $100 and I own this

100 105 call spread, the spread's Vega position will be
positive - meaning that it will increase in value if implied
volatility increases and decrease in value if implied volatility
falls. When the stock price is at $100 the value of the 100
105 call spread decreases as implied volatility falls from
30% to 20%. Now let's look at the same exact test, except
the only difference is going to be that the stock price is not
at $100 but the stock price is at $105, which is the short call
strike price in this particular example and that means that
my call spread will be fully in the money and as we're
decreasing implied volatility, we'll be able to see how that
changes the value of the spread. Here's what we get. This
time around we can see that the spreads value actually
increases steadily as the stock price is at 105 dollars and
implied volatility is decreasing.

The reason this is happening is as the stock price goes from

your long call strike price to the short call strike price, the
spreads Vega position flips negative and once the spread is
fully in the money, it has a negative Vega position - meaning
that it will increase in value as implied volatility falls. How to
interpret this intuitively is to understand that once your
spread is fully in the money and implied volatility is falling,
that means that the stock's expected range in the future is
also shrinking and there's a higher probability that the
spread will expire fully in the money, because since it is fully
in the money and the expected movements of the stock are
falling, there's a higher probability that the spread will
remain in the money through expiration and receive its
maximum potential value when it expires. This first example
illustrates that if you buy a vertical spread and the stock
brace is near the long Option strike price you want implied
volatility to increase because that will benefit the value of
your spread but if the stock price changes favorably and
ends up at your short Option strike price, your spread will
now be negative Vega and you want implied volatility to
decrease and that will lead to an increase in the value of
your vertical spread.
Now we're going to look at an example where we change
the amount of time until expiration versus holding the stock
price constant. So in this example we're looking at a 100
105 call spread with 30 days to expiration and implied
volatility held constant at 30 percent, so we're going to go
from 30 days to expiration to 20 days to expiration to
simulate the passing of 10 days. In this example we're
holding the stock price constant at $100 and that means
that the stock price is going to stay at the long call strike
price of $100 and this spread will be fully out of the money
and consist only of extrinsic value. When we look at this
graph we can see that the spreads value steadily decreases
as we go from 30 days to expiration to 20 days to expiration
and that's because since the spread is out of the money and
consists only of extrinsic value, since extrinsic value
decreases as time passes, the spread's value in this case
decreases as time is passing, because the chance of this
spread becoming fully in the money is decreasing because
there's less time for the stock price to move and leave the
spread fully in the money.
Now let's look at the same exact test but in this example
we're going to hold the stock price at $105 as we go from
30 days to expiration to 20 days to expiration. The spreads
price did the complete opposite and the spreads price
steadily increased as we went from 30 days to expiration to
20 days to expiration and that's because since this spread
was fully in the money and the stock price was right at that
short call strike price, the spreads net Theta position was
positive - meaning that it benefits from the passage of time.
That's because since the long call is in the money and the
short call is at the money, the short Option is going to have
a lot more extrinsic value than the in the money long
Option, and as time passes, the short Option will decay
faster than the long Option and that will lead to an increase
in the value of this call spread as time is passing.
If you buy a vertical spread and the stock price is hovering
near the long Option strike price, your spread is going to
have negative Theta exposure - meaning that it will lose
money from the passage of time, but if the stock price
moves favorably and goes to your short Option strike price,
then the spread will have positive Theta and that means
that your spread will increase in value and you will make
money from the passage of time. Now let's bring it all
together and look at a more dynamic example and in this
case we're starting with a stock price at $200 and let's say a
bearish trader buys a 200 180 put spread - meaning that
they're buying the 200 put and shorting the 180 put and
they have 60 days to expiration at the time of entry. We're
going to compare three scenarios here, the first is we're
having implied volatility remain constant at 25 percent, the
second scenario is we're increasing implied volatility to 35
percent over the life of the trade, and the third scenario is
that we see implied volatility go from 25% to 15% over the
life of the trade. The last thing I’ll mention is that we're
going from 60 days to expiration to 30 days to expiration
and that means in this example we're going to see 50% of
the initial 60 days to expiration pass. When the stock price
falls from $200 to $180 over the first 30 days of this trade
all three of these put spreads gain value which makes sense
because they are all becoming fully in the money because
the stock price is going from two hundred dollars to one
hundred and eighty dollars, which is the short put Options
strike price.

All three of these spreads are making money, however in

the early portion of this trade when the stock price was
closer to the long put strike price, these spreads have
positive Vega. That means that the spread with increasing
implied volatility is going to perform better than the spread
in the scenario where implied volatility is falling. But as the
stock price moves towards the short puts strike price of
$180, the spreads Vega position flips and becomes negative
so when the stock price reaches $180 after 30 days, the
scenario where implied volatility went from 25 percent to 15
percent, resulted in the highest spread price and the
scenario where implied volatility went from 25% to 35%
actually resulted in the lowest spread price. To make a long
story short, if you buy a put spread and the stock price falls
through your strike prices and is moving favourably, you
want implied volatility to decrease because that is going to
result in the highest spread price when your spread
becomes fully in the money. But unfortunately in the real
world when stock prices fall, implied volatility typically
increases so it's just helpful to know that in that scenario
when implied volatility is surging and the stock price is
falling, that increase in implied volatility is going to fight
against the profitability of your vertical spread. If you're
buying vertical spreads - meaning you're buying call spreads
or buying put spreads, if the stock price is at or near the
long Option strike price, then you will have negative Theta
and positive Vega. But if the stock brace moves favorably to
the short Option in that long vertical spread then you will
have a positive Theta position - meaning you will profit from
the passage of time and negative Vega - meaning you will
profit from decreases in implied volatility. If you're trading
credit spreads - meaning you're shorting call spreads or
shorting put spreads, then if the stock price is at or near the
short Option strike price, you will have negative Vega
exposure and positive Theta exposure - meaning you will
profit from the passage of time and decreases in implied
volatility. But if the stock price moves to one of your long
Option strike prices and that credit spread becomes fully in
the money, then you will have a negative Theta position and
a positive Vega position - meaning that you will lose money
from the passage of time and you will make money from
increases in implied volatility.
Chapter 11 Buying VS Options Risk/Reward
Probabilities

In this chapter I’m going to break down the big differences

between buying Options and selling Options as trading
approaches, specifically I’ll outline the probability of making
money, the risk and reward potential and how each
approach makes and loses money. When it comes to every
single trade, there is a buyer and there is a seller so when it
comes to trading Options what are the primary differences
between buying Options and selling Options as trading
approaches? It's important to understand the key
differences between buying Options and selling Options as
trading approaches so you can first figure out which camp
you align with more and so you can understand the
difficulties associated with each approach. Let's start by
analyzing the risk and reward potential when comparing
buying Options and selling Options. Perhaps the biggest
attraction of Options trading is the concept of leverage,
which is being able to make a lot of money from just a little
bit of money and the ability to control your risk and reward
potential for every trade that you put on. When it comes to
buying Options or Option buying strategies the reward
potential is typically far greater than the risk taken for that
particular trade, which is one reason a lot of traders prefer
buying Options over selling Options. Let me show you what I
mean by that by looking at some real Option prices that I
recently observed in the market. On April 18th 2019
NETFLIX was trading for three hundred and fifty eight dollars
and 19 cents. The particular expiration date that I looked at
is May 17th 2019 which at the time had 29 days to
expiration. The strategy that I looked at was purchasing the
355 call Option on NETFLIX that expired in 29 days and that
29 day 3:55 call Option was trading for a price of $14 in five
cents, which actually translates to a valuation of one
thousand four hundred and five dollars, since every Option
is quoted on a per share basis and regular stock Options
correspond to 100 shares of stock. If a trader was extremely
bullish on NETFLIX - meaning they anticipated NETFLIX
share price would increase significantly in the near future,
buying the 29 day call Option with a strike phrase of three
hundred and fifty five dollars for fourteen dollars in five
cents could be an attractive trade because one of the
benefits of buying Options is that the risk is completely
limited to what you pay for that Option. In the case of
buying the 355 call Option for $14.5 the worst case scenario
is that the Option expires worthless and the trader loses one
thousand four hundred and five dollars for every call Option
that they purchased. In this example in terms of risk and
reward the maximum loss potential or the risk is one
thousand four hundred and five dollars, while the maximum
reward potential or the maximum profit potential is
theoretically unlimited because since there's no limit to how
much NETFLIX can increase to, there's no limit to how much
that 355 call Option can be worth in the future, which
means in theory that trade has unlimited profit potential. If
unexpected news came out and the NETFLIX stock price
increased to four hundred dollars, that 355 call Option would
be worth at least forty five dollars since a call Option that
has a strike price below the stock price will always be worth
at least it's intrinsic value and four call Options the intrinsic
value is equal to the current share price, minus the strike
price and if NETFLIX is at four hundred dollars and the strike
price of the call Option is three hundred and fifty five
dollars, we know that three fifty five call Option will be worth
at least forty five dollars.
With a purchase price of 14.5 cents, an increase in that
Options value to forty five dollars would represent a two
hundred and twenty percent return on the investment that
that trader made, which is a very sizable return for a trade
that lasted less than 29 days. What's the catch? Well, when
buying Options you need something favorable to happen
and fast for you to make money on that trade. In the case of
buying a call Option that means you need the stock price to
increase and/or you need implied volatility to increase
before the Option expires for you to make money on that
trade. If either those things do not happen, you will lose
money on that Option purchase because as time passes, the
extrinsic value will come out of those Options and at
expiration an Option will only be worth its intrinsic value. In
the case of the 355 NETFLIX call Option, if NETFLIX is at
$358.19 that 355 call Option has three dollars and 19 cents
of intrinsic value because the share price of 358.19 is three
dollars and 19 cents above the call as a strike price, which
means the remaining value or ten dollars and 86 cents of
that Options value is completely extrinsic. As time passes
and the Options expiration date approaches the Option will
slowly lose all of its extrinsic value - leaving only the
intrinsic value at expiration, so if I buy this NETFLIX call
Option for $14.5 and in 29 days NETFLIX is still at the same
price of three hundred and fifty eight dollars and nineteen
cents that 355 call Option will only be worth three dollars
and 19 cents which means I will lose ten dollars and 86
cents on that Option, which means I actually lose one
thousand and eighty six dollars on that Option purchase for
every contract that I bought. For the 355 call Option
purchased for $14.5 to break-even at expiration meaning
the Options value is the same at expiration compared to
what I purchased it for, NETFLIX has to increase to three
hundred and sixty nine dollars and five cents, which comes
from the fact that if I buy the three fifty five call Option for
$14.5 for that 355 call Option to have $14 and five cents of
value at expiration NETFLIX needs to be $14.5 above the
call strike price when that call Option expires and 355 plus
the purchase price of $14.5 gives us a breakeven price of
three hundred and sixty nine dollars and five cents in short
if I buy the 355 call Option for $14.5 and NETFLIX is
currently at three hundred and fifty eight dollars and
nineteen cents. In short, if I buy the 355 call option for $14.5
and NETFLIX is currently at $358.19, I need NETFLIX to
increase over ten dollars for my position to just break even
at expiration which means I don’t make or lose any money.
If NETFLIX does not increased by that amount, my call
Option will be less valuable at expiration compared to what I
paid for it, in which case I will have a loss at expiration. So
when buying Options you need a favorable stock price
movement in a short period of time to make money on that
trade, otherwise you're going to lose money to the passage
of time because as passes extrinsic value comes out of
Options and when you're buying Options the decrease in the
extrinsic value will work against you as an Option buyer.
When it comes to selling Options, everything that I just
mentioned is reversed. Using NETFLIX again as our example,
let's look at an Option selling strategy so that we can
compare the differences between buying Options and selling
Options. For the Options selling strategy, let's look at selling
the NETFLIX put Option with a strike price of three hundred
and fifty dollars that has 29 days to expiration. In this
example NETFLIX is at three hundred and fifty eight dollars
and twenty one cents at the time, the 350 put Option was
trading for seven dollars and ninety cents or seven hundred
and ninety dollars in premium. When selling Options, the
most you can make on an Option trade is the difference
between the price that you sell the Option for and zero
dollars, because the best-case scenario as an Option seller
is that the Option is worthless at expiration. In the case of
this 350 put Option that is currently trading for seven dollars
and ninety cents, if at expiration the put Options value is
zero dollars as the Option seller, I will profit by seven
hundred and ninety dollars since if I sell an Option for seven
dollars and ninety cents and it expires worthless, my profit
on that trade is going to be seven dollars and ninety cents
on the Option, which due to the contract multiplier of 100,
the actual profit would be seven hundred and ninety dollars
for every put Option that I sold. When buying Options you
adopt a buy low sell high mentality which means that your
goal when buying an Option is to later sell it for a price that
is more than what you paid for that Option. When selling
Options you adopt a sell high buy low mentality which
means as an Option seller, your goal is to buy back the
Option for a price that is less than what you collected when
selling that Option. In the ideal scenario the Option price is
zero dollars at expiration which means that Option is
worthless and you keep a hundred percent of what you sold
the Option for. We know that if I sell this 350 put Option on
NETFLIX for seven dollars and ninety cents, the most I can
make is seven hundred and ninety dollars per put contract
that I sell. But how much can I lose in this same trade?
When selling a put Option the worst case scenario that can
happen is the stock price goes to zero in which case that put
Option will be worth the strike price. In the case of this put
Option with a strike price of 350 dollars, if NETFLIX went to
$0 the 350 put would be worth 350 dollars which would
mean the Option is worth $35,000. Since I sold it for 790
dollars, if its price increased to $35,000 I would have a loss
of thirty four thousand two hundred and ten dollars and
that's on one contract. But as we know it's very unlikely that
a stock is going to go out of business and go to zero dollars
in such a short time period such as 29 days, but the key
here is that when you sell Options, the risk that is taken is
typically far more significant than the amount of reward
potential that you have. In the case of buying the NETFLIX
call Option, the maximum loss potential was fourteen
hundred and five dollars while the profit potential is
theoretically unlimited, but in the case of selling this 350
put Option on NETFLIX the maximum profit potential is
seven hundred and ninety dollars and the maximum loss
potential is thirty four thousand two hundred and ten
dollars. Very different in terms of risk and reward, which
brings us to the first major difference between buying
Options and selling Options and that's that when you buy
Options typically the amount of money that you can make
far exceeds what you can lose on that trade and when
you're selling Options typically the amount you can lose far
exceeds what you can make on that trade. The second
major difference is that when buying the call Option NETFLIX
has to increase otherwise the trade will lose money to the
loss of extrinsic value as the Option approaches its
expiration date. In the case of selling the 350 put Option on
NETFLIX, NETFLIX does not have to go anywhere for the
position to make money, which means that as an Option
seller I don’t need anything to happen to make money and
as an Option buyer I need something very favorable to
happen in a short period of time to make money. Let's go
over these points once more using the NETFLIX trades that
we just looked at in the previous examples. With NETFLIX at
three hundred and fifty eight dollars and twenty one cents,
when selling the 350 put Option for seven dollars and ninety
cents, a hundred percent of that 350 puts value is extrinsic
because put Options only have intrinsic value when the
stock price is below the put strike price and if NETFLIX is at
358,21, the 350 put Option has no intrinsic value which
means the seven dollar and ninety cent cost of that Option
is 100% extrinsic.

That means that if time passes and NETFLIX does not

decrease significantly, that 350 put Options value will
steadily go from seven dollars and ninety cents towards
zero dollars and if NETFLIX is above three hundred and fifty
dollars at expiration, that 350 put Option will expire
worthless and me as the Option seller will keep a hundred
percent of the premium that I collected for selling that
Option.
Even if NETFLIX does decrease, NETFLIX could fall to a price
of three hundred and forty two dollars and ten cents and I
would still break even or make money on that three hundred
and fifty put that I sold, and the reason for that is if NETFLIX
is at three forty to ten at expiration, the three fifty put
Option will have seven dollars and ninety cents of intrinsic
value and since that's the same amount that I sold the
Option for, if at expiration the Option is worth seven dollars
and ninety cents, I will have no profit or loss on that
position, which means I will break even.
In short if NETFLIX is at 358,21 and I sell the three fifty put
Option for seven dollars and ninety cent, NETFLIX could fall
all the way to three hundred and forty two dollars and ten
cents and I still wouldn't lose money on that trade at
expiration. When buying Options, since the risk taken is
typically much less than the reward potential and because
you need something to happen in a short period of time to
make money, buying Options is a low probability trading
strategy, and that means in theory if you buy an Option you
have less than a 50% probability of making money on that
trade. When selling Options since the risk that you have is
typically far greater than the amount of profit you can make
and due to the fact that you don't need anything to happen
to make money on that trade, selling Options is a high
probability trading approach, which means in theory if you
sell an Option, the probability that you'll make money on
that trade is greater than 50%. It's important to understand
that everything related to Options trading ties into
probability. The more reward potential relative to the risk
taken, the lower the probability of making money on that
trade and basic Options strategies such as buying call
Options, buying put Options or combining the two into other
Option buying strategies - all of these strategies require a
significant stock price movement in the favor of that
strategy to make money, otherwise the position will lose
money to time decay. On the other hand the more risk that
has taken relative to the profit potential, the higher the
probability of making money on that trade and basic
Options strategies such as selling call Options, selling put
Options or combining the two to create other Options
strategies - all of those strategies are high probability
trading approaches because they can profit as long as time
passes without a significant movement in the stock price
against those positions. The next major difference between
buying Options and selling Options is related to exercise and
assignment. When you buy an Option you have full control
over when you exercise the Option or if you exercise the
Option, which means you never have to worry about being
assigned on that Option. As an Option seller, you have no
control over when an Option buyer will exercise that Option
and since you have no control over when that Option is
exercised, as an Option seller you will sometimes find
yourself in a sin area where you get assigned shares of
stock unexpectedly because somebody on the other side of
that trade exercised the Option and unfortunately you were
chosen at random to be assigned the opposing share
position as the person that exercised the Option. The next
difference between buying Options and selling Options is
that when you buy Options, the margin required to put that
trade on is going to be equal to the maximum loss potential
of that position. In the case of buying the NETFLIX call
Option, if the maximum loss potential is one thousand four
hundred and five dollars my margin requirement for that
trade would be one thousand four hundred and five dollars.
When selling Options the margin required to put that trade
on is typically going to be far more significant than buying
an Option because when you sell an Option the brokerage
firm has to account for potentially large changes against
your position in which case you could lose immense sums of
money, which is why when selling Options the margin
requirement for putting on a particular trade can be quite
steep. We've talked about the major differences between
buying Options and selling Options but which approach is
better if there is one. Well, there really isn't one better
approach as there are consistently profitable traders on the
buying Options side of things and there are consistently
profitable traders on the selling Options side of things. More
important than buying Options or selling is that you have a
detailed strategy and a plan that you're following to keep
your emotions in check and to keep things consistent with
that particular trading approach. But I will mention some
difficulties associated with each trading approach. First
when buying Options, since there's no limit to how much
you can make it can be very difficult to decide when to sell
your Option and take the profits since there's no limit to how
much the profit can grow to if you buy an Option for $5.00
and you watch that Option price go to $10 because the
stock price moved in your favour, you're probably going to
be inclined to continue holding that position because you're
anticipating that the stock price continues moving in your
favor in which case you could make a lot more money than
you've already made right now. When it comes to selling
Options, the more profitable the trade becomes the more
logical and easy it is to take profits on that trade because as
the trade gets more and more profitable, you have less to
make on the position but you still have all of the risk
remaining. For example if I sell an Option for $5.00 or $500
in premium and the Option price Falls to $1, I will have a
gain of $400 on that position and with the Option price at $1
if the most I can lose is another dollar or $100 in my favour,
which means I’ve already made 80% of the profit potential,
in which case it would be wise of me to close that position
and take the 80% profits because I can only make another
hundred dollars but I still have all of the risk on the table if
things turn around and the stock price moves against my
position. When it comes to holding losing positions, when
you're buying Options it becomes easier and easier to hold a
losing position because since you can only lose so much, the
closer that Option price gets to $0 the less you have to lose
but you still have time left before the Option expires which
means that since you have little left to lose but everything
left to gain, it's very easy to hold that Option in the
anticipation of a reversal in the stock price, which could
potentially turn things around for you and leave you with a
profitable Option purchase. When you're selling Options if a
position starts to move against you and you're down money
on that trade, it can be very tempting to close the position
to cut your losses because since the loss potential is
significant and you don't know how much the stock is going
to continue moving against you, it can become very difficult
to decide when to close the position or when to keep
holding it when you're selling Options and losing trade.
When comparing the two trading approaches buying
Options and selling Options do have their differences and
it's important to consider all the difficulties associated with
trading successfully from either one of those sides. To
quickly wrap up this chapter let's go ahead and recap all of
the major differences between buying Options and selling
Options that I’ve discussed in this chapter. First Option
buying strategies typically have far more reward potential
compared to the risk that has taken and when selling
Options the risk that is taken is typically far more than the
reward potential for that particular strategy. In order to
profit when you're implementing Option buying strategies,
you need a favorable movement in the stock price and or
implied volatility in a short period of time to make money on
that trade. When selling Options, you can make money
simply when time passes so long as the stock price does not
move significantly against your position. Because of the fact
that when you're buying Options you need something
favorable to happen in a short period of time, buying
Options is a low probability trading approach, which means
in theory if you buy an Option the probability that you'll
make money on that trade at expiration is less than 50%.
When selling Options, since you don't need anything to
happen to make money selling Options is a high probability
trading approach which means when you sell Options in
theory you have a greater than 50% probability of making
money on that trade. Lastly, those who buy Options have
full control over whether or not they exercise those Options
which means as an Option buyer you never have to worry
about unexpectedly being assigned a stock position
whereas when selling Options, since you have no control
over when or if someone exercises that Option, you might
sometimes be assigned shares of stock unexpectedly, in
which case you'll have the opposite position as the person
who exercised the Option.

OceanofPDF.com
Chapter 12 Options Trading Using Time

In Options trading there is a term called time decay which

refers to the decrease in an Options price as time passes
and as that Option gets closer to its respective expiration
date. In other words, Option prices are observed to decrease
as time passes, which is referred to as time decay. In this
chapter I’m going to explain time decay to you and
completely demystify it so that you can understand exactly
what time decay is and you can understand it on a basic
and deep level. Before explaining time decay, we first need
to discuss the two components of every Options price. The
first component is called intrinsic value which can be
interpreted as the value of that Options ability to purchase
or sell shares of stock at the Options strike price as opposed
to the current market price of the shares. Let me explain
with some examples. In the case of call Options a call
Option will have intrinsic value when the stock price is
above the call Options strike price. For example let's say
we're looking at a call Option with a strike price of one
hundred and fifteen dollars but the current stock price is one
hundred and thirty five dollars. In this instance the call
Option buyer has the ability to purchase 100 shares of stock
at the call Options strike price of one hundred and fifteen
dollars. Since the stock price is currently at one hundred
and thirty five dollars, the ability to purchase shares of stock
at one hundred and fifteen dollars is of course twenty
dollars better than having to purchase the shares of stock at
one hundred and thirty five dollars. In this particular
instance we would say that this one fifteen call Option has
twenty dollars of intrinsic value, since the stock price is
twenty dollars above the call Options strike price and
therefore the call Option has the ability to purchase shares
of stock 20 dollars below the current share price and for that
reason, we would say that this call Option has 20 dollars of
intrinsic value, therefore the formula for calculating a call
Options intrinsic value is the difference between the current
market price of the shares and the call Options strike price.
But this formula only works if the stock price is above the
call Option strike price because intrinsic value will either be
0 or it will be a positive number. Intrinsic value will never be
a negative number since if a strike price of a call Option is
above the current stock price, no call Option trader would
ever choose to purchase shares of stock at a higher price by
exercising the Option, when they could simply buy shares of
stock at the current market price and they don't need to use
the Option. For that reason intrinsic value is either going to
be 0 or it will be a positive number, therefore the formula
for calculating a call Options intrinsic value is the stock
price, less the call Options strike price and if you do that
calculation and you get a negative number, that is because
the stock price is actually below the strike price in which
case that call Options intrinsic value is 0 dollars. In the case
of put Options, a put buyer can sell or short shares of stock
at the put Options strike price and for that reason a put
Option will have intrinsic value when the stock price is
below the put Option strike price. For example if we have a
put Option with a strike price of 120 dollars, but the stock
price is at 110 dollars, then the person who owns that put
Option has value in the Option because they have the ability
to sell shares of stock at the put Options strike price of 120
dollars, which is 10 dollars above the current share price of
110 dollars. Obviously if you're selling something it's better
to sell it at a higher price so in this instance with a 120
strike put Option with the stock price at 110 dollars, this put
Option would have 10 dollars of intrinsic value because
selling shares 10 dollars above the current share price of
$110 is 10 dollars. The formula for calculating a put Options
intrinsic value is the put Options strike price, minus the
stock price and if you do that calculation when the stock
price is below the put Options strike price, you will get a
positive number which will obviously be the difference
between the strike price and the stock price. In the case
where the stock price is above a put Option strike price, if
you use that formula you will get a negative number and
Options intrinsic value will never be negative so that
number will either be zero or it will be a positive number so
in the case of having a put Option where the strike price is
actually below the stock price that put Option will have zero
dollars of intrinsic value. Intrinsic value is the first and the
most stable component of an Options price because intrinsic
value does not change as time passes. Intrinsic value will
only change if the stock price changes and if that Option
does have intrinsic value, so for example in the case of the
115 call Option where the strike price is 115 dollars, if the
stock price is at 135 dollars that call Option has 20 dollars of
intrinsic value and that will never change so long as the
stock price remains at 135 dollars. But if the stock price
Falls to 125 dollars, then that 115 call Option will only have
ten dollars of intrinsic value, so the only way intrinsic value
will change is if the stock price changes. Otherwise if the
stock price remains the same in the Option does have
intrinsic value it will never change as long as the stock price
remains the same. Time or the passage of time has no
impact on an Options intrinsic value, which brings us to the
second and the more unstable portion of an Options price
extrinsic value or as you may know it time value. The
easiest way to interpret extrinsic value or time value in an
Options price as the portion of the Options price that is
associated with the potential for that Option to become
more intrinsically valuable before it expires. Options with
more time until expiration will have more extrinsic value
than Options with less time until expiration and that's
assuming we're looking at Options on the same stock and
we're comparing the similar Option type and the same strike
price across different expiration cycles. But why do Options
with more time until expiration have more extrinsic value?
Because over longer periods of time a stock price has
greater expected price ranges and for that reason Options
with more time until expiration have more potential value
changes through big changes in the stock price. For
example if we look at Options with 365 days to expiration,
they will be trading with tons of extrinsic value because
there are still 365 days for the stock price to change
significantly and that means there are 365 days for that
Option to become way more valuable, particularly
intrinsically valuable through a big change in the stock
price. If you look at Options with very little time until
expiration, they will not be trading with much extrinsic value
because with less time until expiration, the Options
valuations are more certain because there's less time for
the stock price to move and therefore there's less time for
the Option price to experience a big change, as big changes
in the stock price typically do not happen in short periods of
time. We can observe time decay or extrinsic value decay
by simply looking at Options of the same type and strike
price across different expiration cycles. Longer-term Options
will have more extrinsic value than shorter term Options of
the same type and strike price. As time passes and as an
Option gets closer and closer to its expiration date, that
Options final value becomes more certain. For example if we
have a call Option with a strike price of 110 dollars and the
stock price is at a hundred and twenty dollars, and this call
Option expires in 30 minutes, we know that this Option has
ten dollars of intrinsic value because the stock price is ten
dollars above the Options strike price. But because there are
only thirty minutes left before this call Option expires, it's
likely that this call Options value is going to be somewhere
close to ten dollars, since in 30 minutes there's not a large
probability of a big stock price movement and for that
reason, the call Option is likely to be worth its current price
or somewhere near its current price up ten dollars since in
30 minutes it's not likely that the stock price will change too
far from 120 dollars, which means that expiration in 30
minutes, this 110 call Option is likely to be worth about 10
dollars. However if we look at the 110 call Option with a
year until expiration, we know that this 110 call Option still
has 10 of intrinsic value with the stock price at 120 dollars,
but since there are 365 days left until this call Option
expires, that means there's an entire year left for the call
Option to become significantly more valuable, particularly
intrinsically valuable if the stock price goes from 120 to 140,
which is obviously more likely to happen over a year's time,
relative to a 30 minute time span. That's why if you look at
an Option with 365 days to expiration, that Option is going
to have tons of extrinsic value but if you look at the Option
of the same type and the same strike price and that
Optional only has 30 minutes until expiration, that Option is
going to trade with very little extrinsic value whatsoever
because that Options value in 30 minutes is likely to be just
about where it is right now since in a 30-minute time period
there is not a large likelihood of seeing a significant stock
price change and for that reason, the Option will have very
little extrinsic value. If we plotted the change in an Options
extrinsic value from 365 days to expiration to 30 minutes to
expiration and the stock price did not change over that
entire time period, we would see a very steady decrease in
the Options extrinsic value as it approached expiration and
that is how time decay in Options trading can be
understood.

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Chapter 13 How to Get the Breakeven Price for
Any Options Strategy

Every single Option strategy out there has what is called a

break even price. When a strategy is at break even it means
that the strategy does not have a profit or a loss - meaning
that the P&L is zero. But how are these break-even prices
determined for these respective Options strategies and is
there an intuitive way that we can understand the break-
even price of any Option position? Well, in this chapter we
will explore the break-even prices of various popular Options
strategies and more importantly I want you to intuitively
understand why a break-even price makes sense for given
Option strategies as opposed to just memorizing a formula
and then relying on that formula into the future. In most
cases it's really easy to understand and calculate the
breakeven price, but as we'll see in the last example it can
be quite complex and a little bit more confusing to
understand, but the general concepts will remain true
throughout every single example. To start off our break even
price journey, let's start off with the most basic trades which
are trading call Options and trading put Options as
standalone positions. When you're trading call Options it
doesn't matter whether you are buying the call Option or if
you are shorting the call Option as an opening trade, the
break-even price will be the same. The break-even price of a
call Option trade is going to be the call Options strike price
plus the entry price of that call Option - meaning the price
that you pay or receive when you enter that position. If I buy
a call Option with a strike price of 250 and I pay 12 dollars
and 37 cents to enter that position then the break even
price of this call Option position is 262.37 which is the strike
price plus the entry price.
What this break even price means is that at expiration if the
stock price is at 262,37 then I will not make or lose any
money on this call Option purchase and that's because the
call Option with a strike price of 250 will be worth 12 dollars
and 37 cents if the stock price is right at 262.37 at the time
of the call Options expiration date. The reason this is the
breakeven price is that at 262.37 the call Option with a
strike price of $250 will have exactly $12.37 cents of
intrinsic value and intrinsic value is all that will be remaining
at expiration as all of the extrinsic or time value will have
decayed away, leaving only the Options intrinsic value at
expiration. It works the same exact way if I were to short the
250 call Option for $12.37 because at the same exact break
even price of 262.37, at expiration that call Option would be
worth $12.37 so it doesn't matter if I’m buying the Option or
if I’m shorting it the breakeven price is the exact same for
that position. Let's switch gears and talk about a put Option
trade. The formula for a put Option trades break even price
is the puts strike price minus the entry price of your trade.
For example if I buy a put Option with a strike price of 175
and I pay $7.50 for that put Option then my breakeven price
in this example would be 167.50 and that's because if the
stock price is at 167,50 at the time of expiration, then the
put Option will have seven dollars and fifty cents of intrinsic
value which is all that will be remaining at expiration and if I
buy the put Option for seven dollars and fifty cents, and it's
worth seven dollars and fifty cents at expiration then I do
not have any profits or losses on that trade.

This is the same exact break-even price if I were to short

that put Option for seven dollars and fifty cents as opposed
to buying it initially for seven dollars and fifty cents. The
reason is because it doesn't matter if you're buying or
selling, the break even price or the stock price that gives
the Option intrinsic value equal to your entry price will be
the same. It doesn't matter if you're buying it or you're
shorting it, the break-even price for both of those strategies
has the same exact formula. To get any Option positions
break even price you have to ask yourself at what stock
price will this position have intrinsic value equal to my entry
price. For simple call Option trades or put Option trades it is
going to be very simple because you just have to calculate
the price where the put Option or the call Option will have
intrinsic value equal to your entry price, and call Options
have intrinsic value when the stock price is above the strike
price and put Options have intrinsic value when the stock
price is below the strike price, and that's why in the call
Option example we added the entry price to the strike price
to get the break even price and for the put Option example
we subtracted the put entry price from its strike price.
That's because that will tell me what stock price will give me
an Option with intrinsic value equal to my purchase price or
sale price. Thus far the calculations have been pretty
straightforward and I hope you understand the break-even
prices of simple call Option and put Option trades, but we're
not done yet because we have to explore more complex
strategies such as the vertical spread, the iron condor and
lastly and most complicated is the butterfly. The first of
these strategies that we'll look at is the call vertical spread
and if you're not familiar with what a call vertical spread is
it's essentially when you buy a call Option at one strike price
and simultaneously short another call Option at a different
strike price. For example let's say I buy the 250 strike call
Option and i short the 260 strike call Option at the same
exact time, and I’m trading one contract of each of those
Options. Let's say I buy this call spread for a total cost of
$3.35 so the price that I pay for the 250 call and the amount
that i receive for the 260 call comes out to a net entry price
of three dollars and 35 cents. In this scenario what would be
my break even price and remember the question that I said
to ask yourself earlier which is at what stock price will this
position have intrinsic value equal to my entry price? In this
case the entry price is 3.35, so at what price will this 250
260 call spread have intrinsic value equal to three dollars
and 35 cents?
The answer is 253.35 and that's because at expiration if the
stock price is right at 253,35 then the 250 call Option will
have 3.35 cents of intrinsic value and the 260 call will have
zero dollars of intrinsic value, which means that the spread
overall will have three dollars and 35 cents of intrinsic value.
If that's the case, at expiration my position will be worth the
same that I paid for it in the first place and that will mean
that I don’t make or lose any money on that position. Let's
move on to the next strategy which is the iron condor which
is a very popular Option strategy that consists of trading
two vertical spreads at the same time. The most common
way to trade an iron condor is to sell the iron condor or short
it, and that is done by selling a call spread and selling a put
spread with both of the spreads being out of the money and
the way that you make money on that trade is if the stock
price remains in between those spreads as time passes.
For this iron condor let's say that I short the 110 100 put
spread and at the same time I short the 130 140 call spread
- giving me an iron condor position. Let's say that I short this
position and i collect two dollars and 50 cents for selling this
iron condor. What will be my break-even prices in this
example? We have to ask ourselves the question at what
stock price will this iron condor have intrinsic value equal to
the entry price of two dollars and fifty cents, and in this case
there are actually two breakeven prices. The first break
even price will be the short put strike price of 110 minus our
entry price of $2.50, which gives us a lower break-even
price of 107.50.
This is the first break even price because if the stock price is
right at 107.50 at expiration, then the 110 put will have 2
dollars and 50 cents of intrinsic value, but the 100 put, the
130 call and the 140 call will all have zero dollars of intrinsic
value - meaning they will expire worthless and because of
that, the overall iron condor position will be two dollars and
fifty cents. That's the first break even price. The second
break even price is the short call strike price of 130 plus the
entry price of two dollars and fifty cents which gives us an
upper breakeven price of 132.50. This is the case because if
the stock price is at 132,50 when these Options expire the
130 call will have $2.50 of intrinsic value while the 140 call
the 110 put and the 100 put will all expire worthless
meaning they'll have a value of zero and because of that
the iron condor as a whole will be worth two dollars and fifty
cents at expiration. We've got one more Option strategy to
discuss which is the butterfly spread and this will be the
most confusing one to understand by far, but it still
illustrates the point that I’ve been making throughout this
entire chapter. Let's say I purchase a butterfly spread where
I purchase one of the 125 calls I short two of the 135 calls
and I purchase one of the 145 call Options so this would
leave me with the 125 135 145 call butterfly spread and
let's say I buy this call butterfly spread for four dollars and
50 cents. The first break even price in this example is very
straightforward and it's the strike price of the 125 call, plus
the entry price of the butterfly spread of 4.50 so this gives
us the first break-even price of 129.50. If the stock price is
right at 129.50 at the time of expiration then the 125 call
will be worth 4 dollars and 50 cents because it'll have 4.50
of intrinsic value but the 135 calls and the 145 call will all be
worthless and because of that the total value of the
butterfly spread if the stock price is at 129.50 will be and
$4.50. The second break even price for this call butterfly
spread is actually going to be $140.50 so don't feel bad or
discouraged if that second break even price was not obvious
to you because by no means is it an obvious breakeven
price and we have to actually dive in a little bit deeper to
understand exactly why that is.

If the stock price is right at 140.50 at expiration, I own the

125 call Option in this butterfly spread and that means since
the stock price is at 140,50, the 125 call Option will have 15
dollars and 50 cents of intrinsic value, and since I own this
Option this is intrinsic value that I own. But with the stock
price at 140 dollars and 50 cents the short 135 calls that I
have, they have five dollars and 50 cents of intrinsic value
each and since I’m short two of them we could say that I am
short $11 worth of intrinsic value, and the 145 call at
expiration will be worthless because with the stock price
below that 145 price level, the 145 call Option will not have
any intrinsic value. We're left with the 125 call and the 135
call and now I’m going to introduce something called net
intrinsic value which is the sum of the intrinsic value that I
own, minus the intrinsic value of the Options that I am short.
With the stock price at 140 and 50 cents the 125 call Option
that I own has 15 dollars and 50 cents of intrinsic value but
the 135 call Options that I am short and remember I’m short
two of these 135 calls those Options have five dollars and
fifty cents of intrinsic value and if I multiply that by the two
contracts that I’m short I essentially am short eleven dollars
of intrinsic value. So my net intrinsic value in this scenario
with the stock price at $140,50 at the time of expiration is
actually four dollars and fifty cents. The net intrinsic value in
this situation is four dollars and fifty cents. What this means
is that since I own the 125 call Option, if I want to sell it at
expiration or right before expiration when it is only trading
with the $15,50 of intrinsic value then if I sell that Option I
will sell it for 15 dollars and 50 cents but I am short the 135
call Options and if I want to close those 135 call Options that
have and fifty cents of intrinsic value, then I will need to
purchase those Options to close them. If I need to buy two
call Options that are worth five dollars and fifty cents each
then I will need to pay a total of eleven dollars to close
those two call Options. So if I sell the 125 call for 15.50 and I
pay 11 to close the 135 calls, then I essentially am only
going to receive a net value of 4.50 so that's why I call it net
intrinsic value. This last butterfly example was much more
complicated and not as easy to understand as the first
examples that we looked at when we were calculating
breakeven prices, but the same exact concept holds true.
With a butterfly spread at what stock prices will the position
have net intrinsic value, equal to my entry price. But
remember the break-even price of any Option strategy only
really matters at expiration. Before expiration it doesn't
really matter where the stock price is relative to the break-
even price as you could have a profitable or an unprofitable
trade in that scenario. In summary, the break-even price of
any Option strategy is equal to the stock price that gives the
Option position net intrinsic value that is equal to your
position's entry price and that will hold true for no matter
what strategy you look at.

OceanofPDF.com
Chapter 14 What Are LEAPS in Options Trading

Options traders typically put on positions with 30 to 60 days

to expiration - meaning that their stock price outlook or
prediction is usually falling within a one to two month time
frame, but in this chapter we're going to talk about leaps
which are longer-term Options and more specifically we're
going to talk about the differences between trading short-
term Options and longer-term Options or leaps and some of
the things that you need to be aware of when trading leaps.
I’m also going to show you how leaps can magnify your
stock price returns by comparing a leap Option or long term
Options percentage gain, relative to the same movement in
the stock price. But what are leaps? Leaps are long-term
equity anticipation securities or leaps for short. Leaps are
Options with more than a year to expiration meaning they
have 365 days or longer until they expire but if you look
around on the internet you might find some different time
frame definitions but at the end of the day a leap Option is
an Option with a lot of time until expiration.
If we take a quick look at the available expiration cycles for
SPY, which is the S&P500 ETF, you'll notice that there are a
ton of different expiration cycles that we can choose from
ranging from 0 days to expiration meaning these Options
are expiring today all the way out to December 2022 which
is about 960 days out or 2 and a half years until these
Options expire, so these longer-term Options specifically
with a year or more until expiration are called leaps or long-
term equity anticipation securities. They're called leaps
because as the name suggests if a trader puts on a position
in an expiration cycle with two years to go, they are putting
on a trade with a 2-year time frame for whatever stock price
prediction they may have. Leap Options are typically
defined as Options with more than a year to expiration but
you could think of these longer-term expirations but you
could consider these leaps too that are six to seven months
out but typically if I’m going to make a leap Option trade I’m
going to be at least a year out and in most cases two years
out or sometimes I’ll just trade in the most long term
expiration cycle that I can such as the December 2020 to
expiration here which has 953 days to go which is about two
and a half years out. These are super long term trades and
the reason you would want to trade leap Options is that you
can amplify your gains relative to the movement in the
stock price. By purchasing a leap call Option for example if
SPY goes up 10% the leap call Option that I buy is going to
experience a far greater return than 10% and we'll look at
some examples of that and I’ll show you how you can
actually put the Option price on the chart so that you can
see the price changes of the leaps. But let's go ahead and
compare a few things.

The first thing I want to compare is liquidity so if we go to

the May 20 2010 cycle with 8 days to go this is considered
the front month expiration cycle - meaning it's the standard
monthly expiration cycle and it's the most near-term
standard monthly expiration cycle, so since we're in May
that's going to be May but once these expire the front
month will be June and so on. The first thing I want to want
to point out is that the open interest is in the tens of
thousands for all of these strike prices so that means there's
tens of thousands of open Option contracts between two
parties and all these different strike prices and that means
that there is a ton of trading activity in this particular
expiration cycle. We can also see that the bid-ask spreads
are very narrow and that is a result of all the trading activity
that's taking place, so if I look at the 290 call the bid is 352
the ask is 355 so 2 to 3 cents wide there.

If we go out to January 2022, the first thing you'll notice is

that the open interest and a lot of these strike prices is
somewhat thin so we have some strikes with hundreds of
open interest, some in the thousands and this is still decent
for a two-year Option. These Options have so much time to
expiration that people are not actively trading these, people
are mostly entering these for long term holds since they do
have 600 days to expiration. Because of the decreased
trading activity and these Options we can see that the bid-
ask spreads are wider. For example if we look at the 300 call
Option the bid is 27,43 and the ask is 27,84, so we're seeing
a bit ask spread that's over 40 cents and when we looked at
the call Option in the May 2020 cycle we saw that the bid-
ask spread was 3 cents. The first big difference when you're
trading leaps is that you will have less liquidity - meaning
there will be less open interest and that there are fewer
open contracts between two parties and the volume will
also be lower. If I go to volume, you can see that the volume
is really low and that's because people are not actively
trading these.

People are just entering these positions and holding it for

the long term as they do have over 600 days to expiration.
If I quickly go to May 2020 is in the thousands so no surprise
there. Going back to January 2022, what I want to compare
now is the prices.
If we look at the 300 call Option we can see that this price is
27 50 or so and if I click on the ask price which basically
sets up in order to buy this Option, we can see that this
Option is actually worth about $2,800 and that's because we
have to take the quoted price of about 27,50 multiplied by
100 which is the Option contract multiplier and we get the
Option value of 2,800. If we look at the 300 call in the May
cycle, the 300 call is worth 40 cents so that's $40. Obviously
there's a huge price difference here and that's because with
600 days to go, there is a much larger expected range for
the S&P500 over a two-year period and that's why these
Options are significantly more expensive. This brings me to
my next point.
Even though they're more expensive it doesn't necessarily
mean it's a bad thing because the longer term Options are
actually going to have less decay, so if I click again on the
300 call Option more specifically clicking on the ask to set
up a buy order, we can see that the Theta is negative 2.6 so
this means with each passing day assuming no change in
implied volatility and no change in the stock price, I would
lose about 2 dollars and 60 cents per day if I bought this call
Option. Losing 2 dollars a day on a $2 800 Option is not a
big deal at all and as we can see the Delta is 50 and that
means if the stock price or SPY goes up one dollar, this is
expected to gain $50 in value. Basically if SPY went up one
dollar in a day the cost of time decay would be negative two
point six dollars, but I would effectively make $50 from the
directional change and therefore I would still come out
ahead. The big difference here is the decay.
If I go back to May and I look at the at the money Option
which is the 290 it's trading for 350 but the Theta is
negative 23 so this Option is far less expensive but it has
way more decay and that's because it expires in 8 days.
Leap call Options particularly on stocks or products that you
are bullish in is a phenomenal long-term strategy,
particularly if you are bullish on a stock the next year, you
can use leap calls to gain immense upside exposure. If you
right click on either of the prices it'll save view Option and
chart, so I’m going to do that on the 300 call and we're
going to view the Option price in the chart.
This looks like a chart of SPY and that's because this is a call
Option which is a positive Delta position and this is going to
track the changes in SPY very closely. We had the big rally
up until February 2020 then we had a massive collapse and
now we're rallying back up. If we look at the actual change
in the Option price and remember this is the 300 call Option
in January 2022 which is about two years out, we can see
that at the bottom of this market move this call Option was
worth four dollars and 20 cents. The bottom was four dollars
and 27 cents and currently with a market rally this Option is
back up to 28 dollars, so if we do that math really quickly,
that's a 600 percent gain. So from the button from the
market bottom in March to the current market level this 300
call Option with two years to go experienced a 600 percent
price increase. The 300 call Option expiring in two years
increased 600 percent from the market bottom to the
current level, but SPY itself increased 32 percent. The 300
call Option expiring in two years experienced 20 times the
pricing increase compared to SPY. SPY went up 32 percent
so if you were lucky and you bought shares of SPY at the
bottom and you held until now you are up 32 percent on
your investment but if you had bought the leap call Option,
particularly the 300 strike expiring in two years and you
bought that at the market bottom and held it until now, you
are up six hundred percent on your investment. I’m not
necessarily saying that you would have bought right at the
bottom and held until now, I am merely comparing the two
price movements so that we can understand how a leap call
Option will change relative to the change in the stock price
itself. By purchasing a leap call Option you can get
immensely leveraged upside potential compared to changes
in the stock price and that's because SPY went up 32
percent but the leap call Option expiring in two years with
the strike price of 300 went up 600 percent. In terms of
trade management I would not recommend actually holding
until expiration because if you bought those calls with the
three hundred strike and you wrote them up until now, I
would actually probably take a portion of those positions off
to lock in a bunch of gains but then you could hold a portion
of those and let them ride out for another year or so. I hope
that now you have a better understanding of what leaps are.
It's important to keep an eye on the liquidity or the open
interest and volume of the leaps but more importantly the
open interest is what you're going to want to look out for.
Not all stocks are going to have good leap markets or long
term Options because in a lot of stocks you're going to find
that if you look at a two-year call Option for example, the
open interest is going to be close to zero and there will be
no volume in there and as a result I wouldn’t recommend
trading long term Options in stocks such as those but in
something that is incredibly active and popular such as the
S&P 500 ETF or popular stocks such as Apple or Google, you
can safely trade leaps as long as you pay attention to your
fill prices and try to get filled at the mid or lower. I am not
recommending that buying leap call Options or long term
call Options is an easy trade by any means, there's still a lot
of risk but the benefit of buying long-term call Options is
that if you are right and the stock price does increase, you
are going to have a significant percentage return on the
money that you've allocated to that call Option position,
compared to the same movement in the stock price. You
might be wondering why I didn't really talk about implied
volatility when talking about purchasing long term call
Options and the reason for that is that typically long term
expiration cycles that have two years out until expiration,
those implied volatilities are going to be very stable and
typically those are going to trade with higher levels of
implied volatility than the near-term cycle, and that's
typically when we're talking about a lower volatility
environment. If we had a 15 VIX the near-term SPY Option
cycles would be trading with implied volatility is around 15%
and it would be typical to see the longer-term expiration
cycles trading with implied volatility over 20% in that
scenario, but at the end of the day it is still a risk. You do
have volatility risk - meaning that if you bought Options in a
super far out expiration cycle and implied volatility comes
down a few percentage points you are going to experience
some losses on those Options, assuming that there's no
change in the stock price, but typically if we saw a few
percentage points decrease in the implied volatility, then
that means that the stock price is typically rising and the
volatility in the market is coming down as a whole. In theory
you should probably still see some profits if you saw the
stock price go up 10 or 20 percent and implied volatility
came down a few percentage points but the most important
thing is that in those long term expiration cycles the implied
volatilities will be very stable and you should not expect
them to fluctuate around a lot. If you do decide to go out
and invest in some long term call Options with two years to
expiration, just keep in mind that you are still buying
Options and if the stock price stays below that called strike
price over time, you are going to lose money on that
investment, so only invest an amount that you would be
comfortable losing 50% of or a hundred percent of, but
since you have two years to go and especially if you are
investing in SPY call Options, which is a very safe product to
be bullish on long term, you'll be fine.

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Chapter 15 Credit Spread Options Trading
Strategies

In this chapter we're going to talk about credit spreads

which are simple Option strategies that are very popular
among income-driven traders and could quite possibly be
the only strategies you ever need. But why do you want to
learn the credit spread Option strategies? Well first and
foremost they can profit from stock price increases,
decreases or even if the stock price doesn't move at all,
which means credit spreads have a high probability of
making money. Another reason credit spreads are very
attractive is that they have limited lost potential, which
means you'll never have to worry about blowing up when
the market makes huge moves in either direction, assuming
your trade size is appropriate for your account. The third
reason every trader needs to understand the credit spread
strategy is because they're very simple. The two primary
credit spread strategies only have two Option components
which means they're very easy to understand and setup,
which overall leads to a better experience when trading
Options. But what exactly is a credit spread? Well, a credit
spread is a simple Option strategy constructed by selling an
Option and buying another Option at a further strike price in
the same expiration cycle. The Option you sell is going to be
more expensive than the Option you buy which is going to
lead to a net credit when entering the position and that is
exactly why it's called a credit spread. A credit spread can
be used with call Options or put Options and when it's used
with call Options that's called a call credit spread or
sometimes a bear call spread since it's a bearish position.
This strategy is constructed by selling one call Option in
buying another call Option at a higher strike price but in the
same expiration cycle. If the credit spread is constructed
with all put Options it's sometimes called a bull put spread
since it's a bullish position and the put credit spread is
constructed by selling one put Option in buying another put
Option at a lower strike price in the same expiration cycle. If
you're trading a credit spread and you're putting on a
bearish position or you want the stock price to go down then
you're going to be trading a call credit spread and if you're
trading credit spreads in a bullish manner, which means you
want the stock price to increase then you'll be trading put
credit spreads. First let's get a basic idea of how the call
credit spread and put credit spread profit. A call credit
spread is when you sell a call Option and buy another call
Option at a higher strike price.

Call credit spreads are bearish positions that profit as long

as the stock price remains below the spread as time passes.
On the other side of the equation, a put credit spread
consists of selling a put Option in buying another put Option
at a lower strike price. Put credit spreads are bullish
strategies that profit when the stock price remains above
the put spread as time passes.
Now let's look at some examples using historical Option
data so you can see these concepts in action. In this first
example we're going to look at a call credit spread that
expires with the full profit. The initial stock price when
entering this call credit spread is a hundred and seventy
eight dollars in 87 cents in the call credit spread we're going
to look at is selling the one eighty call and buying the one
ninety call with thirty nine days to expiration. This particular
call spread position was entered for a credit of three dollars
and twelve cents since the one eighty call was sold for four
dollars and ten cents and the one ninety call was purchased
for ninety eight cents, so that comes out to three dollars
and twelve cents. The maximum profit potential of this
spread is three hundred and twelve dollars since we're
collecting three dollars and twelve cents for the spread and
we have to multiply that by the Option contract multiplier of
100 since each Option it represents 100 shares of stock. The
maximum loss potential of a credit spread is the width of
the strikes, minus the premium received times 100 which
comes out to 688 dollars in this case and so we have a ten
dollar wide call spread and we've collected three dollars and
twelve cents for it. When we multiply that by 100 we get a
maximum loss potential of 688 dollars.

Now let's take a look at how this position performed over

time as the stock price changed. On the top part of this
chart we're looking at the changes in the stock price relative
to the call credit spreads of strike prices and in the bottom
part of the chart we can see the corresponding profit and
loss of this call credit spread as the stock price is changing.
The firm heard about this trade I want to talk about is when
the stock price increased above the short called strike price.
When you sell a call spread you want the stock price to
remain below your strike prices, but when it increases the
credit spread will increase in value and if it's at a price
higher than what you sold it for, you will have losses.
Fortunately the stock price did not stay high for very long
and after hitting that one hundred and eighty dollar strike
price the stock price fell pretty quickly thereafter and at
expiration the shares were at 168 dollars and 38 cents each
and since we sold the 180-190 call spread, the 180 call and
the 190 call both expire worthless which means the entire
credit spread expires worthless as well. Since we sold the
spread for three dollars and twelve cents that means the
profit per spread is three hundred and twelve dollars. Now
let's take a look at a put credit spread example. In this
example the initial stock price is three hundred and thirty
six dollars and six cents and the credit spread we're going to
look at is selling the three fifteen put and buying a three ten
put with 31 days to expiration. The entry price of this put
credit spread is one dollar and fifteen cents since the three
fifteen put was sold for five dollars and sixty cents and the
three ten put was purchased for four dollars and forty-five
cents, so the five dollar and sixty cent premium collected,
minus the four dollar and forty five cent premium paid
comes out to a net credit of one dollar and fifteen cents.
With a net credit of one dollar and fifteen cents the
maximum profit potential of this put credit spread is a
hundred and fifteen dollars. The maximum lost potential of
this spread is three hundred and eighty five dollars since the
put spread is five dollars wide and one dollar and fifteen
cents was collected, so five dollars minus one dollar and
fifteen cents is three dollars and eighty five cents of lost
potential and when we multiply that by 100, we get a
maximum loss potential of $385 per spread. Let's take a
look at how this put spread performed over time.

On the first point of the chart we can see the stock price
collapses through the entire put spread early on in the trade
which results in some pretty heavy losses on this put
spread. At the lowest point the spread was down about a
hundred and sixty dollars per spread. Fortunately the stock
price recovered and was trading at 324 dollars and 18 cents
at the time of the put Options expiration date. With the
stock price at 324 dollars and 18 cents at expiration, the
315 and 310 put both expire worthless which means the put
credit spread that was sold for $1 and 15 cents is now worth
$0 at expiration. Since the spread was sold for $1 and 15
cents and expired worthless the profit per put credit spread
is a hundred and fifteen dollars in this example. Now that
you've seen historical put and call credit spread examples,
let's go ahead and look at some credit spreads on the
trading platform to look at how to set up these positions in
real time.

The stock I’m currently looking at is Southwest Airlines

which has the ticker symbol LUV. The reason I picked this
stock is because I want to go through a put credit spread
example. Since 2017 Southwest Airlines has been trading
above $50 per share basically the entire time but the stock
has been pretty volatile above that price range. In
September of 2017 Southwest Airlines took a strong bounce
off that $50 price level and is now approaching that price
level again. If a trader thought that this $50 price level
would continue to hold into the future, one thing that they
could do would be to sell a put spread to reflect that
opinion. All we have to do is click on the trade tab to the left
of the chart which will bring us to the Option chain for
Southwest Airlines.

I’m going to go ahead and look at the 45-day expiration

cycle which is July of 2018. I’m going to click on that to open
up the July Options and on the left hand side here we can
see the call Options on the right hand side we see the put
Options and in the middle we have the strike prices.

To setup a put credit spread we're going to have to sell a put

Option and then buy another put Option at a lower strike
price. I’m going to use the $50 strike as our short put strike
price. I’m going to click on the bid for the 50 put and that
put is currently trading with a bid price of $1 and 20 cents.
To create our short put spreader put credit spread I’m going
to have to buy another put Option at a lower strike price
which could be the forty seven and a half strike price if
we're looking for a conservative put spread or I could
purchase the 45 put if I’m looking to sell a wider put spread
with more risk and more profit potential. I’m going to start
with a forty seven and a half put.

When I create this strategy down at the bottom here we can

see that it says it's trading for 70 cents and right here we
see it says CR which is a credit. This is indicating to me that
I’ve cued up this put credit spread and it's trading for a 70
cent credit as of this moment. We can also see the
maximum profit which is set to be $70 and that's just the
price that it's currently trading at, times 100 and that gives
us $70. The maximum loss of this strategy is a hundred and
eighty dollars which is coming from the maximum width of
the spread or the maximum value of this spread which is
two and a half dollars and then we're subtracting out the
credit received, so we if we take 50 - 47 and a half this
spread is two and a half dollars wide but since we're
collecting 70 cents for it, the most we can lose on the
position is one dollar and eighty cents and if we multiply
that by 100, we get a maximum loss of a hundred and
eighty dollars.

We can also visualize this by clicking on the curve and this

will bring us a visualization of this strategy's expiration risk
profile graph. Right here we have the maximum profit
potential which is 70 dollars, which is going to occur if
Southwest Airlines is at or above $50 per share at expiration
in 46 days. The maximum loss potential of this strategy is
$180 as we've just discussed and that's going to take place
if the stock price is below forty seven and a half dollars at
expiration in 46 days. For our call credit spread example I
want to hop over to Tesla just to switch things up a little bit
and the reason I want to look at Tesla is because Tesla in
recent weeks has come off of this 310 price level a couple
times and if a trader believed that price action would
continue into the future, then a call credit spread could be a
good trade in Tesla because call credit spreads are bearish
positions that profit as long as the stock price remains
below the call spread.

For this example we're going to have to use a short call and
then purchase a call at a higher strike price so for our short
call, let's look at a 310 or maybe a 315 call to sell and then
buy a call Option above that to complete our call credit
spread. I’m going to go to the trade page and open up July
Options with 45 days to go and on the left-hand side here
we can see the call Options.
We're going to look at selling a 315 call so I’m going to go
ahead and click on the 315 calls a bid price and to complete
our call credit spread we'll have to purchase a call Option at
a higher strike price so I’m going to just start with the 320
and if I queue that up, we can see that the 315 320 call
credit spread is currently trading for a one dollar and ninety
three cent credit. I’m actually going to lock the price at one
dollar and ninety cents but on the bottom we can see that if
we sell this spread for one dollar and ninety cents, the
maximum profit potential on this spread is a hundred and
ninety dollars, while the maximum loss potential is three
hundred and ten dollars. The reason that is coming to be
about is that if you sell a spread for one dollar ninety cents,
the maximum profit potential is going to be realized if the
spreads price falls to zero dollars in which case, you will
keep the entire premium that you initially collected when
selling that spread. One dollar ninety cents times the
standard Option contract multiplier of 100, gives us a
hundred and ninety dollars of profit potential and since this
is a five point wide call spread and we're selling it for one
dollar and ninety cents, our maximum loss potential
becomes three hundred and ten dollars. That's because at
expiration if Tesla is above 320, this five-point wide call
spread will be worth five points and since we collected one
dollar ninety cents for it that gives us a maximum lost
potential on the spread of three dollars and ten cents per
spread which in actual loss terms is three hundred and ten
dollars. To visualize the profit and loss potential of the
spread all we have to do is come up to the curve and make
sure the analysis box is checked and once we do that we
can see this expiration payoff graph for this 315 320 call
credit spread and Tesla that expires in 45 days.

On the left-hand side we have our maximum profit zone and

it says the P&L at expiration will be a hundred and ninety
dollars. That's telling us that it doesn't matter where Tesla is
if it's at 315 or if it's at 220, our profit on this spread will be
a hundred and ninety dollars at expiration, because at any
of those prices the 315 call will expire worthless and the 320
call will expire worthless, which means if we sold the spread
for one dollar and ninety cents, the spreads value will be
zero dollars at expiration which means we'll keep the entire
one dollar and ninety cent premium that we collected when
selling the spread. On the right hand side we have our
maximum loss potential zone which is at any price above
320 dollars per share at expiration when these Options
expire which is in 45 days. It doesn't matter if Tesla is at 320
dollars or 450 dollars, at any price above 320 this 315 320
call spread will be worth $5 at expiration because the value
of any debit or credit spread can only be the width of the
spread at expiration. Since this spread is five points wide
then if this spread is fully in the money at expiration which
is going to happen if Tesla's above 320, then this spread will
be worth $5 at expiration and if we sold it for one dollar and
ninety cents, that means our loss of expiration would be 310
per spread. This shows why credit spreads are so popular is
that if the stock price increases significantly or decreases
significantly against your spread, then you have limited lost
potential. So doesn't matter in this case if Tesla is at 320 or
450 at expiration in 45 days, the maximum loss of this
position is 310 dollars, which is much more conservative to
say a short stock position which the losses grow as Tesla's
price would increase.

OceanofPDF.com
Chapter 16 Why Options Are Rarely Exercised

In today's chapter we are talking about an incredibly

important topic that you have to understand which is why
Options are rarely ever exercised and because of that, why
you should almost never worry about being assigned early
on an Option. We are completely getting rid of that
misunderstanding of; as soon as your Options and the
money you're going to be assigned hence we are exploring
why Options are almost never exercised and why you should
also never exercise an Option. If I have an Option or I own
an Option I can exercise that Option and convert that Option
into a stock position at the Options strike price. For example
if I own a call Option with a strike price of 120 dollars, at
some point in the future if I exercise my 120 call Option I will
buy 100 shares of stock at the call Options strike price of
one hundred and twenty dollars. Exercising an Option is
taking your Option and converting it into a stock position at
the Options strike price. If I exercise this call Option with a
strike price of 120 dollars, since I will trade the Option, I
give away the call Option, I buy 100 shares of stock at the
strike price of 120 dollars. When I do that someone else in
the world who was short that Option - meaning they sold it
as an opening trade and they are holding the short call
Option, they get assigned one hundred shares of short
stock. Since I’m buying 100 shares of stock at the strike
price of one hundred and twenty dollars, someone else has
to sell those 100 shares of stock and somebody who is
selected randomly who is short that one twenty call Option
will be assigned one hundred shares of short stock. This is
the very core of understanding where Options get their
value from because at the end of the day an Option
represents the ability to convert the Option into a stock
position at the Options strike price. In my example if the call
Options strike price is 120 dollars and the stock price itself
is at 135 dollars, I can use my Option to buy 100 shares of
stock at 120 dollars which is 15 dollars lower than the
current stock price. Because of that, the Options price will
include the benefit of buying 100 shares of stock at 120
dollars and selling the shares of stock at 135 dollars. If I do
that, I will make a $15 per share profit and when we
multiply that by 100 we get a profit of $1 500. Because of
that, the Options price will include that profit that can be
made from exercising the Option, buying the shares at the
strike price and selling the shares at the current stock price.
That $15 per share profit we actually call intrinsic value, so
if a stock's price is 15 dollars higher than the call Options
strike price that call Option will have 15 dollars of intrinsic
value - meaning if the Option is exercised you can buy
shares of stock $15 below the stock price and then you can
sell them at the current market price of the shares and since
that's a $15 difference, you can make a $15 profit per share
- that is called intrinsic value. This is critically important to
understand because when you exercise an Option, you are
only going to make the intrinsic value. In other words, if you
exercise your one-twenty call Option when the stock price is
at 135, your gain on that share transaction of buying 100
shares of stock at 120 dollars and then selling them at the
current stock price of 135 dollars is $15 per share, so your
profit will be 15 dollars per share from that transaction,
times 100 shares, your profit is $1 500. But Options do not
only have intrinsic value. They also have extrinsic value and
when you exercise an Option it does not matter at all what
that Option is worth, you are sacrificing that Option and you
are only left with the share transaction. If you exercised a
call Option, you give away the Option you buy a hundred
shares at the strike price and then you can sell the shares at
the current market price and make whatever that profit is.
But if you gave away the Option or you exercised the Option
and it had significant extrinsic value in its price, then you
just burned hundreds of dollars for no reason and traders
would not choose to do this and this is exactly why Options
are rarely ever exercised. Because of that, since Options are
rarely exercised traders are rarely assigned on short
Options. But let's go through an example to fully explain
what I mean by this. In this first example we are looking at a
call Option on Apple with a strike price of 270 dollars that
expires in 37 days.

The current price of the Option is 46 dollars and 80 cents,

which means the Options cost or premium is 100 times that
- meaning the Option is actually worth four thousand six
hundred and eighty dollars and Apple share price at this
moment is three hundred and fourteen dollars and 94 cents.
Since this call Options strike price is 270 dollars and the
stock price is 314 dollars and 94 cents we would say that
this call Option is deep in the money - meaning that the
strike price is significantly below the actual price of the
shares. In this instance you might say well I want to buy the
shares at 270 dollars per share with my call Option because
I could then sell the shares at 314 dollars and 94 cents and
make a huge profit on that. That's what I’m going to do - I’m
going to exercise this call Option that is currently worth 46
dollars and 80 cents or has a value or premium of four
thousand six hundred and eighty dollars and I’m going to
exercise this call Option because I want to buy shares for
two hundred and seventy dollars a share so that I can sell
them right away at the current stock price of three hundred
and fourteen dollars and ninety four cents. But what
happens when I exercised this Option? I exercise this Option.
The Option is gone. I now just purchased 100 shares of stock
at two hundred and seventy dollars per share - meaning I
pay twenty seven thousand dollars. But the shares but the
stock price is currently at three hundred and fourteen
dollars and ninety four cents so I sell my hundred shares for
three hundred and fourteen dollars and ninety four cents
and because of that, I receive thirty one thousand four
hundred and ninety four dollars from selling one hundred
shares of stock at three hundred and fourteen dollars and
ninety four cents. What is my profit in this scenario? Well I
just bought a hundred shares for two hundred and seventy
dollars per share paying twenty seven thousand dollars for
the shares and then I immediately sold them at the current
stock price of three fourteen ninety four - meaning I
collected thirty one thousand four hundred and ninety-four
dollars which means my profit on that share transaction of
buying at the strike price and selling at the stock price is
four thousand four hundred and ninety-four dollars, so I just
made 4494 dollars from buying at my college strike price of
270 and selling the shares immediately at the current stock
price of three hundred and fourteen dollars and ninety-four
cents. Everything is fantastic right? Well, let's back up for
one second. I just gave up my call Option that was worth 46
dollars and 80 cents or had a value of four thousand six
hundred and eighty dollars. I decided to exercise it -
meaning the Option is gone, I buy 100 shares at the strike
price of 270 and I sell the hundred shares at the current
stock price of 314,94, making a gain on that share
transaction of four thousand four hundred and ninety-four
dollars. But my Option that I just gave up was worth four
thousand six hundred and eighty dollars, so by doing that, I
actually just burned about two hundred dollars for no reason
whatsoever. Even though I made money on the share
transaction, I did not make as much on the share
transaction as the call Option was worth when I did that and
because of that, I burned a hundred and eighty six dollars
because I gave up an Option that was worth four thousand
six hundred and eighty dollars and my benefit from giving
up that Option was that I bought 100 shares of stock at two
hundred and seventy dollars and then I sold the one
hundred shares at three fourteen ninety four, so my profit is
four thousand four hundred and ninety four dollars, but I
gave up an Option worth four thousand six hundred and
eighty dollars to do that. If this sounds like a really bad deal,
it's because it is. But why does this really matter? Well let's
say I bought this call Option initially for twenty five dollars -
meaning the premium or cost when I purchased it was
twenty five hundred dollars. If the premium increases to four
thousand six hundred and eighty dollars, I have an
unrealized profit on my call position of two thousand one
hundred and eighty dollars. I could just sell the call Option
and secure the 2 180 dollar profit, or some people would
think that they need to exercise the Option because you can
buy shares of stock at a deep discount to the current market
price and then you can sell the shares right now and you'll
make a huge profit. But as we just discussed if I do that I
would buy a hundred shares at 270, sell a hundred shares at
3:14 94 and my profit would be four thousand four hundred
and ninety-four dollars. But since I paid 2 500 dollars for the
call Option initially, my profit is actually 1994 dollars if I
bought the call Option for twenty five hundred dollars and it
became forty four dollars and ninety four cents in the
money, meaning that if I exercise the Option and buy 100
shares at 270, sell 100 shares at 314,94 which is the current
stock price, I will make four thousand four hundred and
ninety-four dollars. But since I paid $2 500 for the Option
initially if I do that my net profit is four thousand four
hundred and ninety-four dollars, minus the cost of the
Option which is twenty five hundred dollars - meaning my
net profit is 1994 dollars. So if we compare those two
scenarios buying the Option for twenty five hundred dollars
selling it for four thousand six hundred and eighty dollars
that's a two thousand one hundred and eighty dollar profit,
but when that Option was worth forty six eighty and if I
exercised it I only make four thousand four hundred and
ninety-four dollars from buying 100 shares at the strike price
of 270 and selling the shares at three fourteen ninety four.
Since I paid twenty five hundred dollars for that Option
initially, my profit on that share transaction is four thousand
four hundred and ninety-four dollars my net profit and in
that case is 1994 dollars. Scenario one is just sell the Option
for forty six eighty and make two thousand one hundred and
eighty dollars or exercise the Option, lose the Option and
make the difference in the stock price and the strike price
which gives me a net profit of 1994 dollars, after accounting
for the initial Option cost of $2 500. The difference between
these two prices or these two profit scenarios is 186 dollars
and that is the Options extrinsic value when I exercised it. I
hope you understand now why Options with a lot of extrinsic
value remaining will never be exercised and if you are
shortened in the money Option and it has a lot of extrinsic
value and you did get assigned on it, that would be a gift
from the gods because you've just made free money
because somebody didn't understand what they were doing
and they exercised an Option with a ton of extrinsic value in
it and therefore as someone who was short that Option you
instantly make all of that extrinsic value that was in the
Option and you essentially make an instant profit. So if you
are short and in the money Option and it has lots of
extrinsic value and for some reason you did get assigned,
that would be tremendous for you - that is exactly what you
would want to happen. We need to stop worrying about
being assigned early on in the money Options and I hope
this chapter helps you understand exactly why Options with
extrinsic value or plenty of extrinsic value are rarely
exercised. The only exception is if an Option is a call Option
and the stock is paying out a dividend soon and the
extrinsic value in the call Option is less than the dividend
that is going to be paid out because in that scenario a
trader would exercise the call Option and they would buy
100 shares of stock and they would lose the extrinsic value
in the Option but if the dividend is more than the extrinsic
value in that Option, then they will make back their money
from the dividend and in fact they'd make more from the
dividend than they lost in extrinsic value. It is a very
necessary to understand and I really hope that after reading
this chapter, you understand why Options with lots of
extrinsic value will never be exercised and if they are and
you are short that Option, that is a very favorable scenario
for you because you will instantly make the extrinsic value
that was in that Option and when you are shorting Options,
your main goal is to see all of the extrinsic value come out
of that Option, barring that it's in the money and that's why
the extrinsic value is coming out. To make a long story
short, if an Option is in the money and it has two hundred
and fifty dollars of extrinsic value in the premium and
somebody exercises that Option, they will essentially give
up two hundred and fifty dollars that they did not have to.
Usually people are very rational illogical and that's not
something that a logical or rational person would do. They
would never give up the extrinsic value and the Option if
they don't have to and since they own the Option they don't
have to which is why they don't exercise the Option when it
has lots of extrinsic value in its price. But let's say
somebody owns a call Option and it is extremely deep in the
money and it expires very soon and there's only ten dollars
of extrinsic value in the calls premium. Let's say the call
Option is actually worth $3 000 but ten dollars of that is
extrinsic value. In that scenario there would be much more
likely to exercise the Option because the gain made from
exercising the Option; buying at the strike price and selling
at the market price of the shares is virtually the same thing
as just selling the Option because if they exercised the
Option they will only give up ten dollars of extrinsic value on
a $3 000 Option, which means the extrinsic value is close to
zero and that is when Options are more likely to be
exercised. But if an Option has hundreds of dollars of
extrinsic value in its price, such was the Apple call Option -
despite being almost 45 dollars in the money, that Option
would not be exercised and it's because when they exercise
the Option. You literally burn the extrinsic value in that
Option and for that reason Options are rarely ever
exercised. The only way an Option will have extrinsic value
close to zero when it is in the money is if it is extremely
deep in the money before expiration or if it is in the money -
very close to expiration. Those are the only two scenarios
where an in the money Option will have very little extrinsic
value and therefore have a higher likelihood of being
exercised.

OceanofPDF.com
Chapter 17 How to Buy Options with Less Decay

In this chapter we are going to be talking about how to buy

Options with less decay and I’m going to discuss three
methods with which you can purchase Options and minimize
the decay that you would otherwise experience. When you
buy Options time is working against you because Options
are decaying assets, but there are three ways with which
you can minimize the decay associated with buying Options
- meaning there are ways that you can mitigate the extrinsic
value losses that will naturally occur when you buy Options.
Method number one that you can use to minimize the decay
associated with buying Options and losing that extrinsic
value that we just discussed is to buy an in the money
Option. This means to buy an Option with intrinsic value -
meaning for a call Option you are buying an Option with a
strike price below the stock price and for put Options buying
an in the money put Option, means that you are buying a
put Option with a strike price above the current stock price.
When you buy an in the money Option, the Option will have
intrinsic value and less of extrinsic value, so if we take a
look at a strip of Options and we look at the call Options we
will notice that the further in the money we go - meaning
the lower the strike price of the call Option, we will notice
that the Option has less and less extrinsic value the further
in the money that we go.
If we take a look at this image of Facebook Options from
today we can verify what I just said. If we look at the
Facebook call Option with a strike price of 250 we will notice
that this Option price is currently around 11.80 and since
Facebook stock price is actually slightly below the strike
price of $250, we know that this 250 call Option has no
intrinsic value whatsoever, meaning that any price or value
that it has is 100% extrinsic. If we look at the call Option
with a strike price of 225 dollars, we will notice that this 225
call Option in Facebook is worth around $29 but if we look at
the Ext column, meaning the extrinsic value in this Options
price, we will see that this Option has extrinsic value around
four dollars, which is only a small portion of the overall $29
Option price that we are observing in this moment. If we
compare these two trades we'll notice that if I purchase the
250 call Option for eleven dollars and eighty cents -
meaning I actually pay one thousand one hundred and
eighty dollars and at expiration the stock price is still slightly
below the strike price of 250, then this call Option will
actually expire worthless and I will lose $1,180 on this trade.
But if Instead I purchased the 225 call Option and Facebook
was right where it was right now, since that 225 call Option
has 400 dollars of extrinsic value - meaning 400 of the 2900
Option value is extrinsic, then I would only lose $400 by
holding the 225 call as opposed to holding the 250 call, and
that's because the 225 call is mostly intrinsic value and only
has four dollars of extrinsic value in its price. Lastly if we
look at the 200 call Option we can see that the price of that
Option is around $51.25 and of that $51.25 Option only
$1.43 is extrinsic value. As we look at further and further in
the money Options, we will notice that in general the Option
will have more intrinsic value and less extrinsic value, so the
further in the money an Option is, the less extrinsic value it
will have and because of that, if you purchase a deep in the
money Option you will be paying for mostly intrinsic value
which does not decay as time passes but you will be paying
a very small portion of extrinsic value which does decay as
time passes.
Method number two for minimizing the extrinsic value decay
when purchasing Options is actually a little bit more unique
and this is to purchase Options when a company has an
upcoming earnings announcement. When a company has an
upcoming earnings announcement or any announcement
that there's a lot of uncertainty around, the Option prices in
the short term, meaning that if you look at the very short
term Options that include that uncertain announcement or
whatever announcement it may be, then those Options are
going to price in a potential large movement in the stock
price. The Options will still include that pricing or
expectation until the announcement has been made and the
uncertainty is no more. As an example if a company is
reporting earnings on Thursday after the market close and
today is Monday, I could purchase Options in this week's
expiration cycle - meaning that the Options expire on Friday
and I could hold these Options through Thursday and I
would have to close them before the closing bill on
Thursday. By doing that, I would own Options but since the
Options are going to continue to price in this big expected
price movement in the stock, then the Options are not going
to decay as normal. Because of that, I have an opportunity
for a very limited amount of time to own these Options and
not experience the same amount of extrinsic value decay
that I would if this announcement was not taking place this
week. The key here is just to make sure you close these
positions before the earnings announcement, otherwise
you're turning it into an earnings trade and you are fully
exposed to the stock price movement after the earnings
announcement has been made, but also the subsequent
collapse and extrinsic value that will happen after the
company announces earnings.
Now let's move on to the third and final method that you
can use to minimize the extrinsic value decay that is
typically experienced when you buy Options. This method is
perhaps the most straightforward and the most flexible and
it is to buy a spread as opposed to buying naked Options. So
instead of buying a call all by itself you buy a call spread
and you structure it in a very specific way. Buying a call
spread would consist of buying a call Option at one strike
price and then shorting another call Option at a higher strike
price so you actually own one Option and you're short
another Option so the decay of the short Option offsets the
decay of the Option that you own and if you structure it a
certain way, then you can have a position that has no
exposure to time decay, meaning that you will not lose
money as the Options lose their extrinsic value as time
passes, but you can also structure a call spread or a put
spread to have positive exposure to the extrinsic value
decay. The first way to structure a debit spread to minimize
extrinsic value decay is to purchase an in the money Option
and short and out of the money Option. This way you are
buying an Option that is mostly intrinsic value and it has
very little extrinsic value, and the Option you are shorting is
purely extrinsic value which means as time passes, the
extrinsic value decay of the Option that you are short will
only be beneficial to you and the Option that you own has
very little extrinsic value, meaning that you won't be losing
much from that Option decaying as time passes. But let's go
ahead and take a look at an image of a call spread that I just
set up with this exact structure. If we look at this called
debit spread on Facebook you'll notice that I use the 240 call
as the Option being purchased and the 260 call as the
Option being shorted.

The Facebook stock price is right in the middle of these

strike prices at two hundred and fifty dollars. The spread in
this case is trading for ten dollars and thirty five cents,
giving the spread a break even price of 250,35 and I got
that by adding the spread price of $10.35 to the long call
strike price of 240. At $250.35 the call spread will have ten
dollars and 35 cents of intrinsic value at expiration because
the 240 call will have 10.35 cents of intrinsic value and the
260 call will expire worthless, therefore the overall spread
price at expiration will be $10.35 and since that's the same
price we are looking at here, there would be no profit or loss
on this trade at expiration if Facebook were to close right at
250,35.

But if Facebook stayed right at its current price of 249.76

through expiration, then the spread we are looking at would
be worth $9.76 because the 240 call would have $9.76 of
intrinsic value and the short 260 call would be worthless.
This would leave us with a spread that is worth $9.76. So if I
buy this call spread for its current price of 10.35 and
Facebook does not change through the expiration date of
this call spread, based on the current price of Facebook
shares this spread would be worth $9.76.
If I buy a spread for $10.35 and it falls to $9.76, that is a
very minor loss and barely any loss on that spread
whatsoever and that would be caused by the extrinsic value
decay. Of course the stock price is going to move between
now and expiration, but it illustrates that if we structure a
debit spread this way - meaning that we are buying it in the
money Option and we are shorting an out of the money
Option and more specifically, if the stock price is right in
between those two strike prices, then you will have a call or
put debit spread that will have very little exposure to the
extrinsic value decay that will happen as time passes. The
second way to structure a debit spread will actually give you
positive exposure to time decay or extrinsic value decay. If
you structure a debit spread in the way that I’m about to
describe you will have a position that will make money as
time passes and assuming the stock price does not change
or even moves in favor of your spread.
In this image I’ve used the same spread as before but I
moved the short strike to 250 from 260. This call spread
setup is purchasing an in the money Option which is the 240
call and shorting and at the money Option which is the 250
call. The price of this spread is five dollars and 80 cents and
the stock price is currently at 249.29. At expiration if
Facebook is right at its current price of 249.29 the 240 call
will be worth $9.29 and the 250 call will expire worthless.
This will leave us with a spread value at expiration of $9.29.
If I buy this spread right now for five dollars and 80 cents
and at expiration the spread price is $9.29 but the stock
price did not move, then that means as time passed and as
we got closer and closer to the spreads expiration date, the
spread price was actually increasing in value and that's
caused by the loss of extrinsic value in the Options in this
particular call spread. Because the current stock price is
actually well above the break-even price, then by
purchasing this spread I can actually put myself in a
situation where I make money from the passage of time. As
said there are a number of ways that we can implement
Option buying strategies while mitigating the negative
effects of extrinsic value decay as time passes. Each of
these approaches that we discussed have benefits and
downsides in their own regards, but the key is that by
focusing on extrinsic value and working with the structure of
our strategies and even the timing of our strategies, we can
strategically minimize the negative effects of losing the
extrinsic value in our Option purchases as time passes.

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Conclusion

Congratulations on completing this book! I

am sure you have plenty on your belt, but
please don’t forget to leave an honest
review on Amazon. Furthermore, if you
think this information was helpful to you,
please share anyone who you think would
be interested of entrepreneurship as well.

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About The Author

Will Weiser is a successful serial

entrepreneur, born in New York in 1961.
Will has graduated for Business
Management in New York 1989, but only
started his first company 12 years later in
2001 selling t-shirts on the street. Will
made his first million dollar in 2014 and
then his first 10 million by 2017. Will’s
total portfolio has reached $76 Million by
the end of 2021 and keeps growing. Will
got married with Kate Hirsh, and having
three beautiful children; Jack, Tony and
Andrew. Together with his wife they both
looking after several businesses they own
including Retail Businesses and Beauty
salons.

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