Todays article will take a little different turn then any I have written thus far, I will offer a bigger lesson, then the option lesson that I will present as an under current. Just a few things to think about as you go on your journey through the world of option trading. In this lesson I will share a very important concept that you should never lose sight of. It is sort of a self-examination of what trading is and is no about. There is a message in this lesson, but not as pragmatic as any of the others I have written But before I start I want to introduce you to someone we have all run into on more than several occasions.
He is with you on every trade, and follows you from the very first day you place a trade until the final day of expiration. We have come to know him, but will never really totally accept him; we do our best to avoid him. But alas! We cannot escape from his wrath. He constantly torments option traders, whether novice or seasoned, and causes the most frustrating things to occur at the most inopportune times, by making his presence felt at the worse possible moment and exacting upon his the worse possible consequence. Who is this antagonist? Who is this misfit that has been sent to make out trading life miserable at times. He needs no introduction, for we all know him well. He is called Murphy and when he visits he brings his infamous law of occurrence with him, and there is very little a trader can do but to hold on for the ride. How does one avoid this character Murphy and his law, which basically says, ("If anything can go wrong, it will") or if something possibly can go wrong, in all likelihood it will go wrong. Well, traders have been trying for years, but with no success.
Of course, I am making light of this phenomenon; however his appearance is very apparent in the world of option trading.
- Manage your spread risk with stops and trailing stops.
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Here is a little hypothetical story I would like to relate to you. It is hypothetical, but probably is very true and has happen on a number of occasions. Bill a option trader, decides that he likes this little technology company that has the potential to be a take over candidate, but even if it isnt he feels it is a great option play and proceeds to purchase 10 calls of Gystar International Enterprises, Symbol: GIE. Gystar is selling at $20 a share and Bill buys the October $20 calls and pays $1.75 each, for a total of $1,750 plus commission. Bill feels pretty good about his purchase as he goes into the month of October. GIE still hasnt move much, but Bill notices the daily volume has doubled in the last week. Bill really feels strong about this company, stronger then he has felt about any stock issue in a long time and decide to take the plunge and buys another 50 contract at $1.55, with the stock still roughly at $20.30 with about 2 weeks left to expiration. Another week goes by and still the stock has not moved as Bills options now are worth about $0.50 with 1 week to go and the stock still at $20.20. Bill starts to worry, maybe I should have not taken the plunge, I used all my discretionary money and I will not have any for at least 30 days. Bill quickly dismissed the thought and pondered the remaining four days left until expiration. It was now Wednesday morning and Bill began checking his option prices and noticed that GIE was up 5.50 points on the opening! Upon further observation there were several large blocks of stock coming across the ticker as GIE climbed to $30.50, up over $10 points for the day. Finally, it happens. The exchange halted trading on GIE, due to influx of buy orders, which was probably a subtle way of saying that that buyout might be in the offing. Anyway GIE stopped trading and the indication when it opened was $120 - $130. Bill had hit the big homerun, and not a day to soon, with only today, Wednesday and two days left to the option expiration. Bill had 60 contracts of GIE at the price of $20 that are now worth $over $120 a contract. $720,000 dollars! Bill had made over $685,000. Profit. Well, the rest of Wednesday goes by and GIE doesnt open, Indication are now $150 - $175 on opening. Bill will have some sweet dreams tonight. We flash forward to Thursday; Bill didnt get much sleep, and could not wait to see what GIE was going to open at. Thursday morning, the bell goes off for the opening of trading and still no opening of GIE. AND IT IS NOW AT THIS POINT WHEN MURPHY BEGINS HIS VISIT TO BILLS HOUSE! Suddenly bill realizes, its Thursday the day before option expiration and he has well over $685,000 profit tied up in GIE Oct 20 call options, but he can do nothing as the market has not opened in GIE and they are still disseminating the order imbalance. Indications are $160 - $170. Thursday goes by and GIE does not open.
Flash Forward! It is now Friday, October option expiration day and GIE has not yet opened. What is Bill to do? Bill is nervous now, as he cannot sell his options because the stock has not opened for trading. Now not to labor the story, but the GIE does not open at all Friday and because Bill did not sell his options by close of the last business day, he cannot sell them! Murphy at his best! Bill getting hit at his worst.
What would you do? , besides jump off a cliff.
Something to think about it