Option Investor
Educational Article

Happy Holidays!

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By Lee Lowell

I'm hoping that everyone is enjoying the holiday season and I'd like to wish all of our readers a healthy and prosperous 2001.

I'd like to use my article this week as sort of a year-end review of what we've seen and what we can look forward to in terms of trading options.

It's been a wild ride to say the least in the financial markets this year. We came off of one of the most fantastic and shortest bull moves we've ever seen. The period of November '99 to March '00 witnessed a move in Nasdaq that will probably never been seen again. 50-100 point upmoves was the norm for some of the tech stocks and it made millionaires for some lucky souls. But it also changed the psychology of the investing public in general. We got very greedy and became oblivious to what really should move the markets - long-term growth and earnings potential of each company. But these incredible moves blindsided us and left us with the thought that tech stocks will always go up and every dip should be bought. That worked for a little while but you can see where we are now. All you had to do was buy some out-of-the-money calls and reap the returns. Not so anymore.

The smart money took us all for a ride from April '00 - present. The expression, "it can't go any lower", took on a new meaning. I know I was caught many a time trying to pick a bottom on some of my so-called favorite tech stocks. I'm still hurting from that. Just look at the price of some past high fliers - YHOO, CMTN, BVSN, INSP, TERN, INTC, etc, etc. It was not only contained within the Nasdaq. Some Dow components were rocked as well - LU, IBM, MSFT, T, etc. These were companies that were supposed to be core holdings that never went down. Yeah right. We've been hit with earnings warnings up the wazoo. If someone asked you a year ago if you wanted to buy YHOO for $30/sh, you probably would've mortgaged your life for that opportunity. Well, have fun pal. Take all you want.

Our thinking has changed from looking for solid growth companies to "just get me in on the next net stock." And, "If the Nasdaq let some people retire early, I want to be a part of that." We thought any internet stock that we bought would go to the moon. Some were smart and sold early while others were left holding the bag. "It's a good company, I'll just buy some more on the way down." Well, look who's still holding that stock at $2?

Do I sound mad and depressed? Sure, but at least I've learned a lesson and how to avoid it in the future. Before I started trading stock options I made my living (and still do) by trading commodity options. I've learned that there's a world of difference between the two in terms of what affects the prices of the underlying securities. There's nothing inherently different about a stock or commodity option because an option is an option no matter what the underlying security. But there are many more factors to consider when it comes to trading stock options.

For example, here's what I've found to affect the stock market and in turn the option prices: The Fed, interest rates, employment numbers, government reports (CPI, PPI, Retail Sales, Housing Stats), overseas markets, Presidential races, day traders, earnings reports, etc, etc. That's so much information to absorb when trying to decide on the future movement of a stock.

Now the commodity markets are much simpler. It's all supply and demand. What's Orange Juice going to do this winter? Just look at the crop report. What about Coffee? Look at the Brazilian weather. How about Crude Oil? Look at the OPEC numbers. Corn, Wheat, and Soybeans? Monthly Government estimates. Sounds easy? It's really not. But there are less outside influences in the commodity markets than there are in the stock market. (*Please don't take this as advice to trade commodity markets). My point is: trading stock options requires lots of work and research. Found out as much as you can about the underlying stock before you jump into the options. In addition to the outside influences I just mentioned, make sure you check the stock's support and resistance levels, know when its earnings are released, check on its stock split calendar (if it's splitting), and always check implied volatility levels of the options.

So what are we going to do in the new year? We are going to be smarter option traders. We are going to always try to increase our knowledge base. Read more books on option trading, make sure we keep up with this great website, get a good option broker, and get some good option trading tools. We will not rely on stock advice that we heard in a chat room, and we will always research our picks whether it was a self-made decision or a recommendation from someone else. Make sure you realize that option trading entails risk. You can lose your entire investment if you don't take an active role. You can always hold onto a stock indefinitely but all options expire at some point. I've made this point before: Your money is an asset just like your house, car, and life. You insure those with car, life, and health insurance, why not insure your investments? Options trading gives you that opportunity. Whether it is buying puts or selling covered calls, take an active role and use all the resources.

The life of options trading is maturing nicely. More and more brokers are finally realizing that options trading is becoming increasingly popular and they are revamping their websites to accommodate this change. Make sure you are part of this wave. Don't settle for brokers that charge you an arm and a leg for a single option transaction. Direct Access brokers are good and you can specify which exchange to send your order to. That is good for single buy and sell orders. But as of this writing, Direct Access brokers don't allow spread orders on a single ticket yet. You must still use a web-based broker for that. But there are excellent brokers out there for that. My favorite is mrstock.com. Keep up with the changes. Periodically surf the web for updated information on these brokers. Some brokers even give you free streaming real-time quotes now. That's a great perk.

If you do use a real-time quote vendor, make sure they have good options chains in their system. I've talked about this in the past too. What's the point of paying a few hundred bucks a month if the data feed can't give you reliable options information. Once again, a monthly web search can keep you updated on data feed providers and upgrades. Don't forget to use the option calculators that not only give you an estimated fair value of your option but also the "greeks" that go along with it. CBOE.com has just what you need for that. And of course my favorite - volatility analysis. Most people don't even know what volatility is when it comes to options trading. Volatility helps you figure out the relative "expensiveness" or "cheapness" of an option premium based on its past behavior. I've talked about it before and you know I will definitely discuss it again.

I look forward to keeping my place here at OptionInvestor.com so I can supply our readers with quality educational material to enhance their trading skills. This is "Options 101" so I will continue to gear the articles toward the basics and give each reader the foundation to build a successful options trading career.

Thank you and good luck.

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