options strategies

Since options decay as time passes, selling them has an advantage.  Every day that passes, including weekends and holidays, lowers their value.  Since the goal in selling options is to buy them back lower, having the certainty of time’s passing is a great ally.

Selling uncovered or “Naked” Calls has theoretical unlimited risk.  Call option sellers, or writers as they are also known, obligate themselves to deliver a stock at a set price no matter how high the market goes.  The seller of a Covered Call doesn’t have market risk of a runaway stock, because they can deliver out of their own inventory.

Selling Naked Puts obligates the sellers to buy the stock at the strike price if the buyer of the Put chooses to exercise their right.  In a sense, writing a Put is like writing an insurance policy.  If the stock crashes, it crashes on the insurance company, the Put seller.

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Selling options can be played two ways.  First, you can sell them with the intent of buying them back later for less.   The basic buy low/sell high, albeit in reverse order.  Or you can sell them and hope they expire worthless for the person who bought them.  Sell high without ever having to buy.  Question:  Is it Infinite Return Investing when you profit from things without a cost basis?

Naked Puts have the same risk characteristics as Covered Calls.  Basically if the stock price closes below the strike price, the writer of either option will own the stock.  On the Covered Call, they will own the stock because they won’t be called out.  The writer of the Naked Put would own the stock because it would be Put to him.

On the same token; if the stock price is above the strike price, both option writers would NOT own the stock.  The Covered Call writer would be called out, while the Naked Put seller would have stock assigned to them.

The Put premiums should almost equal the Call premiums.  Their only true difference should work out to the Interest Rate and/or Dividend calculations.


A big advantage to selling Put options is the lower margin requirements.  When you buy a stock, whether you write Covered Calls or not, you have to pay for it.  You may be able to buy it on margin.  Typically margin works this way; your broker will loan you 50% of the value of a stock.  They’ll use stock as the collateral for the loan.  Interest rates vary from broker to broker.

If the stock increases in value, your broker will let you borrow additional sums.  But if the stock price drops, the broker may ask for more money.  Generally, they want to have at least 35% equity.  Any less than that will cause a house call or margin call.

Margin calls are not phone calls you want to receive.  If you can’t come up with the extra money to bring your account to the minimum requirements, your broker has the right to sell your position off at a loss to you.  There’s nothing you can do but turn an unrealized loss into a realized one.  You ‘re obligated to give them security or pay them their money.

Margin also measures security.  When allowing Naked Put selling, brokers will require a certain amount of good faith money.  This is also known as margin.  Typically the margin requirements for selling Naked Puts will be 50% lower than buying stock.  It works out to around 25% of the value compared to 50%.  Since it only takes a small fraction of the price to obligate oneself to buy it, only more experienced traders should consider selling uncovered options.

Margins can and do change, often dramatically.  Brokers typically want a minimum 25% of the strike price before allowing Put writing.  Some will allow you to subtract the amount Out of The Money (OTM) on the option.  Example: a $50 Put on a $55 stock is Out of The Money by $5.  The margin required to write this Put would be $7.50.  One fourth of the $50 strike equals $12.50, minus the $5 OTM totals $7.50.  If the stock were to drop, the margin required would increase.  A $50 Put on a $53 stock equals $9.50, $12.50 less the $3 OTM.  If the stock dropped another $5 down to $48, the margin would increase to $14.50.

A One Dollar drop in the stock raises the margin requirement by the same dollar.  A Five Dollar move on a $50 dollar stock equals 10%, but the margin could move by 50% or more.

Either start with a lot of money or be prepared for margin calls.  For that matter, only consider Naked Puts with your excess money.  Cash lying around in accounts doesn’t provide income like selling Puts can.  But solely selling Puts can tie up money that could be used better buying options.


It’s one thing to invest in stocks, it’s another to trade them.  Trading implies a shorter time frame.  Investing means looking for price appreciation.  Dividends play an important part to many investors.  Most traders have never received a dividend, nor do they miss them.

Investors are willing to tie up most of their money.  Their gains are the product of appreciation and time.  They look for better than average returns to maximize their investments.  As well as selecting plays, traders manage money.  They tie up as small an amount as possible.  Their gains are the product of repeatability and speed.

An option’s limited time frame match better to the trader mentality.  Most option traders have a much smaller time horizon than the long term buy and hold investors.  Trading options adds leverage to the mix.  Options fit perfectly to the trader time and money management mentality.

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To trade successfully, option buyers need to be right and right on time.  Buying options resembles betting on direction.  Buy Calls on bullish expectations.  Buy Puts on bearish expectations.

Options cost money, their premium pays for the potential stock price movement.  Potentially up for Calls, potentially down for Puts.  You need big fast price moves to make any money trading options.  If a stock doesn’t move far or fast enough, you will lose money.

If you buy the right option, the stock may only need to move a little before being profitable.  Buy the wrong option, the stock will need to move farther and/or faster to make a profit.  Playing the right stock may heal any wounds caused by picking the wrong option.

Option buyers have rights which if the option is as little as 1 penny in the money get exercised automatically.  The seller, also known as writer, has an obligation.  Call options give the right to buy stock and the obligation to sell.  Put options give the right to sell stock and the obligation to buy.

If we buy Calls on bullish expectations, why not sell them on bearish expectations?  If we buy Puts on bearish expectations, why not sell them when bullish?  Remember, until the option is closed, there can be no profit.

If we sell a Call option we are obligating ourselves to deliver stock at the strike price anytime until the option expires.  For that obligation we collect a premium.  If we already own the stock, it’s known as a Covered Call.  Our obligation to deliver is covered, guaranteed by the fact we already own the stock.  Our broker should put a lien against our stock.  They won’t let us sell it to anyone else.  In the end, they are responsible.  When you think about it, they are covered.

The profit in Covered Calls potentially comes two ways, from the premium collected and from any appreciation in the stock’s price.  Like long term investors, Covered Call writer’s gains come from appreciation and time.  Only, not from the multiplication of time on a return, but from the decay of time’s value on options.

Selling an uncovered, or naked, Call is the riskiest of all option strategies.  The seller, or writer, of uncovered calls is obligated to sell stock they don’t own.  If the price skyrockets, their losses take off.

Selling Put options obligates the writer to buy the stock at a set price for a specific period of time.  Think of a Put option as an insurance policy.  The buyer of the policy pays the insurance company a premium, for that premium they can insure against loss.  Unlike naked Calls, which have unlimited risk, uncovered Puts maximum risk is if the stock becomes bankrupt.

Put selling profits comes from two sources.  Time’s passage deflates the value of options.  Time passing is truly the only guarantee in life.  When you buy them, they decay on you.  When you sell them, they decay on you.  The other profit doesn’t come from appreciation, but the lack of depreciation.  If buying Puts is a bet the stock will go down, selling Puts is not a bet it will go up but a bet it won’t go down.

Selling Covered Calls and selling Naked Puts have the same risk curve, but not the same reward curve.  Our example will be a $20 stock, one position will be buying the stock and selling the $20 Covered Call.  The other position will be selling the $20 Naked Put.

Buying the stock for $20 and selling the $20 Covered Call gives no room for appreciation, the only profit comes from the premium collected.  The only Profit from selling a $20 Put would be the premium.

In either case, if the stock were to go above $20, you would not own the stock.  The Call buyer would call you out on the Covered Call.  The Put buyer would have their option expire worthless.  If the stock closed below $20 before option expiration, either position would end up owning stock.  The Call Buyer wouldn’t exercise.  The Put buyer would force the Put seller to buy the stock.

A great strategy combining both would be to initially sell a Put Option – I prefer selling a Weekly Put Option.  If the Put Option expires worthless then you get to keep the premium and repeat for the next week.  If the Put gets exercised you end up with the stock and then the next step is to sell a Call – resulting in a Covered Call.  Let me know what you think!

If you knew for a fact, two companies were going to merge you could make a killing.  Of course you could end up cellmates with a killer.  Insider trading, using non-public firsthand knowledge is illegal.  But as with many laws in this country, it’s broken all the time.

Most people’s experiences with insider trading revolve around reading stories in newspapers.  High profile cases make headlines on a regular basis.  Low brow cases fill back pages and little corners of financial papers.

It happens more often than most people would think.  And violators get away with it more often than reported.

The Security Exchange Commission’s (SEC) responsibilities include investigating insider trading, along with other possible securities violations.  It’s their job to investigate possible crimes after the fact by searching for irregularities and violations.

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They look for rule breakers after the rules have been broken, after the damage has been done.  They only try preventing violations with passive deterrents: potential jail time and fines.

The financial markets are a faceless game where players hide behind nameless account numbers and foreign banking secrecy laws.  Discounting the risks of punishment, many trade illegally for great rewards.

Knowing the SEC’s system checks for violations after the fact causes many more violation attempts than a more aggressive policy might stop.  If the SEC would follow the red flags that violators leave, maybe they could stop illegal trades before they take place.

If we understand the signs left behind, we can track down potential profits like hound dogs following a scent.  We can act like cub detectives, private eyes, Colombo, call it what you may.  Profits belong to those able to follow clues.

Option traders may stumble onto crime scenes in the natural course of their trading.  Option traders should be looking for clues to potential stock moves.  If you understand a few features of option pricing and price movement, you can watch the smart money.

If someone knows a stock is going up, they can buy the stock and profit greatly.  But stock returns pale by comparison to option profits.  An option’s leverage can magnify stock price movements, giving monstrous returns.

In The Money (ITM) options give more leverage than stocks, or stocks bought on margin.  At The Money (ATM) options can give still higher rates of returns than ITM options.  The greatest percentage returns can come from being on the right side of a trade with Out of The Money (OTM) options. They have the most leverage.

The normal problem with playing OTM options is their higher probability of expiring worthless.  OTM options need big fast moves to have any chance of being profitable.  Generally a bad play, OTM options pay the most when right.  The key is being right.  Insider info helps to be right.

Options traders should keep regular track of option volume and open interest.  Look for size anomalies.  If the open interest appears too large in OTM options, something big may be in the works.  On the other hand, you need to be able to discern a large institution selling OTM covered options to pull in premium.

You must remember, there are two sides to option trades, buyers and sellers.  A rule of thumb is sellers sell to the Market Makers at bid and buyers pay ask.  If you find big trades, look at a time and sales report.  If the trade went at or near bid, chances are it was a seller collecting the premium.  But if the trade went off at or around the ask level, maybe a buyer has shown his cards.

The next thing to do would be to search for any corresponding trade that may be part of a spread.  If a large block of ITM options goes off at ask, with an equally large block ATM or OTM at bid, a directional spread has probably been placed.  These intrigue me, but not as much as straight plays.

If the first block was a Call trade, search the Puts for a potentially corresponding trade.  The opposite is true as well.  A combination of Puts and Calls is known as a straddle or strangle.  Both are volatility plays.  They tend to come from hedge traders, not people in the know.

These clues only tell part of the story.  If an enormously big trade takes place, check the newswires.  Occasionally a story might be connected.  Sometimes reporters interview Market Makers or other professional traders about questionable transactions.

Only big players with big accounts can make big block trades.  A person with inside information may not want to make big block trades showing their hands.  More often than not, they’ll buy many different contracts. Making it much harder for us to profit on their coattails.

Knowledge of probability and statistics will allow traders to greatly increase profit possibilities while limiting risk.  But knowledge of math is not required to enhance one’s trading.

Recognizing chart formations acts like recognizing opportunities.  Both opportunities to profit, but also opportunity to avoid bloodbaths.  Stock and option traders can either participate in major moves to their benefit or detriment.  Numerous common technical patterns exist that can be employed to identify favorable entry and/or exit points.

Trend lines, support and resistance are required for any technical assessment.  But these may be considered as just building blocks for more complex patterns.  One of the simplest of these complex chart formations is known as a “Head-and-Shoulders.”

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Made famous by Charles Dow, this major reversal pattern was and has appeared in every major market top or bottom in the last fifty years.  This formation is a precursor to both market rallies and major corrections.  It is accurately described as a “Head-and-Shoulders” top or bottom.

“Head-and-Shoulders Tops” look just like their name implies a “Head” (highest high) flanked by “Shoulders” (lower highs).  Separating the head from either shoulder is the neckline.  Made up of lows of similar time and price formation the “necks” do not have to be identical, but the closer to being a mirror version of each other, the higher the probability for a trend change in the other direction.

Double tops are widely considered as points of great resistance.  Think of a “Head-and-Shoulders Top” as a triple top with the center top having a higher high.  Add to that the fact that the neckline adds a point of support that if broken often foretells a stocks rapid decent.

As with any pattern, there can be a number of small variations.  For example, there may be two or more left shoulders near the same price range, or two or more right shoulders.  In any case, the most important component of the formation is the neckline.  When it is broken, the pattern is complete and a significant change in character often follows.  The following drop is often the most precipitous of the entire formation and occasionally will eclipse the height of the pattern (the top of the Head to the Neckline).  As the new character evolves, successive rallies commonly fail at lower highs until the overall decline is far greater than the magnitude of the initial formation.

For the next paragraph either stand on your head or hold your monitor upside-down.

Once a trader learns “Head-and-Shoulders Tops,” they should have an easier time understanding “Head-and-Shoulders Bottoms.”  Basically, bottoms are tops upside-down.  That is, the shoulders are higher than the head and the necks are short-term highs not lows.  “Head-and-Shoulders Bottoms” signal trend reversals with high probabilities of upward price appreciation, bullish reversals instead of bearish reversals.

It’s obvious you should never overlook the potential of a clearly formed and definitely broken trend.  The historical traits of well know patterns demonstrate the ease in profiting from their analysis.  But the difficulty may come from seeing the second shoulder before the opportunity has been diminished.  Experience will help traders see them as they’re formed.

The Beauty of understanding chart patterns surrounds the fact traders can study them without risking their accounts by looking at existing charts.  Study as many as possible.  I hope that my examples have helped.  I hope this article has also helped.

My goal is to help people become better traders.  It is less a goal to teach which stocks to trade, and more a goal to teach identifying situations, and matching strategies to those situations.  If you know ahead a stock’s price is rocketing to the moon, it’s easy, just bet the farm.  However, if you’re not sure, you don’t know if a stock will soar, but you have sound fundamental information and technical analysis to help reasonably know the direction of price, you can learn to develop successful strategies.

I would like to think, I can give information worthwhile to read, worthwhile to learn, and more important, worthwhile to trade.

Most investors do not understand the difference between price and value.  Value is what a stock should be worth.  Price is the last trade of record.  The key to successful investing is finding undervalued and overvalued stocks whose price becomes more in line with their value.  This is also called reversion to the mean.

The daily opinion poll, known as the market, determines price.  Like the political climate in America today, the financial climate is often a confusing and changing environment.  Bill Clinton and Amazon.Com have a lot in common.  Contrary to long time expert opinions, both are scoring amazingly high in the public opinion polls.  Trying to call their early demise might be the biggest mistake of the end of the 20th century.

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My major problem is that I am a one man army.  Attacked on all flanks and seriously out gunned.  I had to develop a hand to hand combat method of investing… Trench Warfare.  I knew my weaknesses (market predictions) and my strengths (logic, mathematics, analysis, and experience).  I would pick my battles and my battlefields…Options.

I hate stocks.  Their valuations are one dimensional…PRICE.  Stocks don’t know time.  This is evidenced by one of the oldest forms of Technical Analysis: Point and Figure Charting.  Options on the other hand are multi-dimensional.

Option pricing is based on the values derived from the Nobel Prize winning Black-Scholes formula.  Options are derivatives.  That is they have no value in and of themselves, their values are derived from something else.

Sounds scary, doesn’t it?  Aren’t derivatives responsible for breaking a British Bank?  Actually it was a young rogue trader in Singapore misusing derivatives that broke the long time institution.  If he knew some of things I plan on teaching, history could have been different.

I intend to take a complicated mathematical equation and give you the basics to successfully trade with this information.

You will learn how options are valued.  The components are simple; Time, Price, Potential, Dividends, and Interest Rates.

Time:  The one true constant.  Stocks go up, stocks go down, stocks stay the same, TIME passes.  The value of time does not decay linearly.  For true math heads only… Time Value decays at its square root.

Price:  Not only the price of the stock, but the difference of the Strike price versus the Stock price.

Potential:  Known as Volatility, measured in Standard Deviations.

Dividends:  Applicable only to stocks that pay dividends.

Interest Rates:  Short term risk free rate of borrowing.

These Mathematical counterparts have Greek terms.  This adds to the difficulty experienced by seasoned Stock Brokers as well as neophyte investors.

Time Decay-Theta, Price movement-Delta and Gamma, Potential-Vega, Interest Rates-Rho.

Strategies include almost every kind of spread imaginable, and some only a veteran such as myself could dream up.  They will include:

Bull Spreads, Bear Spreads, Put Spreads, Call Spreads, Credit Spreads, Debit Spreads, Calendar Spreads, Ratio Spreads, Back Spreads, Butterfly Spreads, Condor Spreads, Anticipation Spreads, Subsidy Spreads, Straddles, Strangles Combinations, Time Diagonals, Synthetic positions and Position Trading.

If risk can be minimized or hedged away, there is a spread that can do it.

Sounds Great?  Well it’s meaningless if you can’t trade it.

The public opinion poll on Advanced Micro Devices (AMD) recently shown a less that happy result.  The price gapped down.  Not unlike many other stocks have done.

If you look at a long term chart of AMD you will see exactly why you don’t want to be a “long term buy and holder”.  This is a high tech company and the price hasn’t moved much?  Actually it has moved nicely, up and down!  Is now the proverbial Low from “Buy Low-Sell High”?  I don’t know.  But I can trade on the possibility.

AMD is almost a commodity.  They manufacture CPU’s to compete with Intel (INTC).  With consumers wanting less and less expensive computers, one would think things would be well for AMD.  However, Intel wants not only a bigger market, but bigger market share.  They have come out with cheaper chips to compete with AMD.  Chips that allow box manufactures the low entry price with the familiar Intel Inside logo.

We’ll enter a Position Trade, buying a long term call and selling short term calls against it.  We’ll look at a number of hedged positions where we buy and sell risk, buy and sell time decay and buy and sell potential.  It will cost us a certain amount of money to enter this trade and then a certain amount of money to maintain this trade.  The key to Position Trading is to have less money in the trade as time goes on and more profit potential.  It is money management.