Options 101, Tuesday, 09/12/2006
Let's Play 21 Questions
by OI Staff
HAVING TROUBLE PRINTING?
It's been brought to my attention that a few of my remarks about "traders" may have been interpreted as less than flattering to the "trader" occupation as a whole. A "trader," in the true sense of the word, is someone who understands all the aspects of trading, who implements the strategies, and makes money in the process. Just because a person opens a brokerage account and clicks the mouse a few times, it doesn't make him a trader. It makes him fresh meat. Even if some of the trades happen to work - it's often more a matter of luck than skill. Some may say that it's a question of semantics.
If you jump into the deep end of a swimming pool and make it to the other side, does that make you a swimmer you would bet on against professionals? Hardly. If you make a basket on the playground, does that make you a basketball player you would bet on against NBA players? Of course not. When you are a retail option player, you are competing with experienced professionals in the option trading pits. They have option newbies for lunch. Will a newbie have winning trades? Occasionally, but the money will magically find its way back into the market maker's pocket in short order.
I remember, when I first started trading, I thought I knew what I was doing. Then, the worst thing that can happen to a newbie happened to me - I was right on my first four trades. I had made about $5,000 in two months and thought "this is a piece of cake." I felt like I had a cape and a big "S" on my chest. Well, I did have an "S" on my chest. It didn't stand for Superman. It stood for "STUPID."
In my case, it took a year and about $200,000 before I realized I didn't know what the hell I was doing. It was an expensive lesson and a blow to my ego. I started over, learned what I had to learn, and slowly recouped it all and then some. I'm just trying to save you that $200,000. I tell it like it is. If you want sugar coating, there's always Dunkin Doughnuts.
A POP QUIZ - (that doesn't mean a quiz for your father!!)
I know. In the last column I said we'd be discussing more about Option Chains, bid/ask spreads, option cycles, etc. Well, I lied. We'll cover that material very soon. This seemed like a good time to find out how you're progressing in your quest to learn about these marvelous tools called "options."
I've been writing about options here for about a while now - and hopefully you've been reading the columns. Now, let's see how much you learned (or didn't learn) - or have learned through osmosis.
1. When you purchase a call option, you are buying the ____________ , but not the _______________ to buy shares of the underlying asset on, or before, the ______________ ___________ at a predetermined price called the ____________ price.
2. When you purchase a "put" option, you are buying the ___________, but not the ________________ to sell shares of the underlying asset on, or before, the __________________ _______ at a predetermined price called the __________ price.
3. Most people buy options because of the _________________ it provides.
4. Some people buy puts because it enables them to _____________ protect their stocks.
5. When you buy an option, your risk is ________________ .
6. The increase or decrease of an option's value is based on the up and down movement of the ______________ .
7. The decrease of an option's value can also be due to _____________ __________ .
8. Once you purchase an option, you can sell the option before expiration. True False.
9. Once you sell an option, you are obligated to hold the option until expiration.
10. When you sell an option, you receive the funds _________ business days after the sale.
11. Option expiration takes place on the third _________ of each month.
12. Strike above $30 are in ____________ increments.
13. Strike prices below $30 are in ____________ increments.
14. Strike prices above $150 are in _____________ increments.
15. To buy an option you would look on the option chain for the _________ price.
16. To sell an option you would look on the option chain for the _________ price.
17. The difference between the bid/ask spread go into the pocket of the ____________ __________ .
17. The "last price" is valuable information because ______________________ .
18. The fourth letter of a five letter option symbol represents the _____________ .
19. The fifth letter of a five letter option symbol represents the ______________ .
20. Open Interest represents the number of ______________ that are currently __________ .
21. If the bid on XYZ stock is 3.40 and the ask on XYZ is 3.90, the bid/ask spread is _____________ .
Where Are The Answers?
If you have to ask that, Houston, we've got a problem. The answers are at the end of this column. Of course, they are also in the previous six columns. Good luck and don't cheat. If you get a high percentage of these correct, you're on the right track.
So, how did you do on the quiz? Honestly. Did you even take it? The answers to the quiz are below. I promise there will be more. Read, study, absorb like your options financial survival depends on it. Because it does.
This Is Good Stuff
Just a reminder that, if youre new to options, these basic articles are valuable. Print these articles out so you can reference them at your leisure. This is your bible for the options basics. Its information you need to know before you risk your hard earned dead presidents and it may very well become a collectors item. What better reasons can there be?
Mike Parnos - A Little Knowledge Goes A Long Way
The outspoken Mike Parnos has been writing Option Investors very successful Couch Potato Trader column for over four years. Hes been trading and teaching options for over 15 years and knows what you NEED to know to trade options profitably.
Too many traders trade the more advanced option strategies without having a good understanding of options, how they work, and how they are meant to be used. The results? Say goodbye to your money. That is why there such a stigma attached to options. And thats a recipe for disaster. If you have more money than you know what to do with, losing $5,000 or $10,000 is no big deal.
However, if youve worked hard for your money, and you appreciate the value of a dollar, you should make every effort to learn everything you can about options before you put your money at risk.
Mike tells you like it IS, not how you hope it will be. As you read through the columns, feel free to send him your questions at Contact Support, with Options 101 somewhere in the subject line.
1) Right, obligation, expiration date, strike; 2) Right, obligation, expiration date, strike; 3) Leverage; 4) Hedge; 5) defined; 6) underlying asset; 7) time erosion; 8) True; 9) False; 10) One; 11) Friday; 12) $5.00; 13) $5 increments, then $2.50 increments below $25; 14) $5.00; 15) Ask Price; 16) Bid Price; 17) Market Maker; 18) Month; 19) Strike Price; 20) Contracts, open: 21) $.50.