Butterfly Option Strategy » Stocks

The Complete Guide to Option Strategies: Advanced and Basic Strategies on Stocks, ETFs, Indexes and Stock Index Futures (Kindle Edition)

admin — Sat, 10 Jul 2010 16:30:15 +0000

Important insights into effective option strategiesIn The Complete Guide to Option Strategies, top-performing commodity trading advisor Michael Mullaney explains how to successfully employ a variety of option strategies, from the most risky selling naked puts and calls to more conservative strategies using covered positions. The author covers everything from options on stocks, exchange-traded funds, stock indexes, and stock index futures to essential information on risk management, option “Greeks,” and order placement. The book provides numerous tables and graphs to benefit beginning and experienced traders. Written by a CTA who has successfully employed various options strategies to generate market-beating returns, The Complete Guide to Option Strategies will be an important addition to any trader’s library.Michael D. Mullaney (Jacksonville, FL) is a high-ranking commodity trading advisor who specializes in option selling strategies.

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The Complete Guide to Option Strategies: Advanced and Basic Strategies on Stocks, ETFs, Indexes and Stock Index Futures (Wiley Trading) [Hardcover]

admin — Wed, 07 Jul 2010 12:11:50 +0000

Important insights into effective option strategies In The Complete Guide to Option Strategies, top-performing commodity trading advisor Michael Mullaney explains how to successfully employ a variety of option strategies, from the most risky–selling naked puts and calls–to more conservative strategies using covered positions. The author covers everything from options on stocks, exchange-traded funds, stock indexes, and stock index futures to essential information on risk management, option “Greeks,” and order placement. The book provides numerous tables and graphs to benefit beginning and experienced traders. Written by a CTA who has successfully employed various options strategies to generate market-beating returns, The Complete Guide to Option Strategies will be an important addition to any trader’s library. Michael D. Mullaney (Jacksonville, FL) is a high-ranking commodity trading advisor who specializes in option selling strategies.

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Trend Following and Mean Reversion Strategies With Bollinger Bands

admin — Wed, 13 Jan 2010 02:49:28 +0000

Bollinger Bands are a very useful indicator developed by John Bollinger based on a moving average and standard deviations. There are four parts to Bollinger Bands:
1. Moving Average: By default, a 20-period simple moving average is used.
2. Standard Deviations: A measure of the volatility of the price series.
3. Upper Band: The upper band is usually 2 standard deviations (calculated from 20-periods of closing data) above the moving average.
4. Lower Band: The lower band is usually 2 standard deviations below the moving average.
At 2 standard deviations, Bollinger Bands should contain 85% of the movement of the instrument being measured. The higher the number of standard deviations used will make it so that even more of the price data is contained in the bands. Conversely the smaller the number of standard deviations used will result in less price data in the bands.
Knowing that you can see how these can be used in several ways, a few of which we will mention here. For stock trading the two most used strategies using bands are breakout and mean reversion trading.
Breakout-Since roughly 85% of a securities price action is contained in the bands many traders see a movement outside of the bands as a significant sign that something is happening whether it be an earnings announcement, buyout, or just a big move in the sector or market. So if the stock hasn’t been moving too much and then breaks up above the upper band they would consider buying it (You would do the opposite if it broke down below the lower band). A simple breakout strategy would be to buy (or short) when a security closes above (or below) the upper (or lower) band and exit when it closed below (or above) its moving average.
Mean Reversion-Since approximately 85% of a stocks price action is contained in a 2 standard deviation Bollinger Band another way to use them is to sell or sell short when a stock gets to the upper band and buy when it gets to the lower band.
As you can tell there are several ways to use Bollinger Bands. For instance you could take the mean reversion strategy and overlay a Bear Call Spread/Bull Put Spread strategy over it by selling a slightly out of the money call and buying the next strike up when the stock pierces the upper band and doing the opposite (sell the slightly out of the money put and buy the next strike down) when it pierces the lower band. This is but one of many variations of trading strategies where Bollinger Bands can come in useful.

Trading Profit in Any Market Conditions

admin — Mon, 11 Jan 2010 02:26:00 +0000

To every investor, stock market is a challenge. One wishes to meet these, aiming high profits. Is it possible to stay on the pedestal of profits at all times? Is it possible to beat the market with your every move? The answer is clearly in the negative. Profits and losses are part of this game.

Profit is all about to understand the market conditions clearly, before trading and doing right things at the right time. This is said easier than done. For a new investor, the beginning has to be on cautious premises. Choose blue-chips companies, whose reputation is above board and which have been consistently paying dividends and bonus/right issues. Alternatively, in the course of your research, you spot some companies whose share prices are low, it means that you have managed to beat the market and this investment is likely to fetch you good profits.

When you are unable to catch the trends of the market, and move away from them, instead of beating the market, you are beating the retreat. In such conditions, take advice from reputed stock analysts, who can tender appropriate advice, on the basis of the inputs secured from the fundamental and technical analysis. No method provides one with 100% guarantee of success, but workout such plans so that the odds are in your favor. The results of the research before you provide confidence, you understand the market better, and catch the right signals. In addition, your psychology and sentiments are important part of your trading and they are the practical elements in making money. When you provide suitable cut loss limits, they will keep you off trouble and you are able to prevent major losses.

Profit from share trading is not a profound science. The methods to deal with the exchange are amazingly simple. Only you need to employ them effectively and in a timely manner. If you are able to catch the signals of early stage of price rise movements, one can take advantage of the maximum profit opportunity with minimum chances of risk and losses.

Any condition is a good condition for a shrewd investor. The market bows before such investors, and provides them with a series of profit opportunities, whether the shares are moving up, down or sideways. Those are the masters of option trading. Such people wear ‘all weather proof jackets.’ They are mostly stock trading millionaires.

In any given market conditions, as far as possible, avoid day trading. Howsoever great are your strategies, risk looms large in such trades. Intra-day trading in the same security is fraught with great risk. Some one with limited resources and trading experience and with low risk tolerance should not enter this trade zone at all. Those who claim large profits from day trading, are perhaps are conducting their clandestine business to promote a particular share of the company, with some hidden agenda. Even in the normal course of day trading, your competitors are professional licensed traders engaged by securities firms, institutional finance companies and the commercial banks. A small investor stands no chances of engaging them in voluminous trades.

For immediate profits, option trading strategy is less risky and the chances of profits are more. There are many kinds of option trading strategies. Call Option, Sell Naked Put Option, Bull Put Option, Bear Put Spread, Straddle, Covered Call, and Short Straddle etc. Use these strategies as per your specific portfolio needs.

When you think of making profits in all market conditions, it is important for the investor to know, in which condition the market is passing through at a given moment. Unpredictability of the market is well-known to all investors. It so happens, when the well is full, you do not have the drums to store water, and when you have enough empty drums, the well is empty! Such are the tantrums of the share market; one fails to appreciate, its behavior. You can not question it with your reason, only accept the fact and respect the trends. There is no other way to do business dealings in the share market.

Option Trading – Understanding Options and Risk

admin — Fri, 08 Jan 2010 02:57:44 +0000

When it comes to option trading, the most important lesson to retain is an understanding of what’s actually being traded. The real commodity in any option trading strategy isn’t the underlying stock itself, and it has little to do directly with phrases such as implied volatility, net debit, net credit, strike price, or expiration date. Fundamentally, what’s really being traded when an option transaction is enacted are degrees of risk.

Option trading, in and of itself, is not inherently risky. Options are simply tools. Imagine a big dial labeled, Options. You turn the dial one way and your risk goes down (as do your potential rewards). You turn the dial the other way and your risk goes up (as do your rewards, either in the form of upfront cash, or in the form of potential profits). In short, you can use options (for the right price) to reduce your risk, and you can use options (if the price is right) to generate lucrative income or receive other compensation in exchange for taking on someone else’s risk.

Let’s look at some scenarios that show each side of the risk trade.

Using Options to Reduce Risk

There are various option trading strategies you can employ to reduce the risk to your stock holdings. The price you will have to pay may come in the form of an actual cash payout to purchase that protection, or it may involve exchanging some of your future potential profits in order to acquire that protection.

Here are two trades that will reduce your risk:

Using Options to be Compensated for Assuming Someone Else’s Risk

If you are willing to assume someone else’s risk you can be compensated–and sometimes quite handsomely–for your trouble. The compensation may take the form of sharing the capital gains on someone else’s stock, or it may simply take the form of a cash payment.

Here are two types of trades in which you are compensated to assume someone else’s risk:

Conclusion:

The option trade examples above are all relatively simple but they illustrate the true nature of stock options. Trafficking in options is essentially trafficking in risk. No matter how elaborate and complex an option trade becomes, the core equation of risk is still present.

Developing and maintaining an awareness of this reality of options is crucial to your own option trading success. Whether you’re looking to reduce your risk or to be compensated for assuming someone else’s, a conscious awareness of what’s really happening in any given options transaction is invaluable. Once you know what’s really at stake, you’re in a much better position to consciously look for ways to accomplish your objectives as efficiently as possible. The outsourcer of risk will seek to reduce risk as cheaply as possible, and the assumer of risk will seek the highest compensation for the risk assumed.

Trading the Infamous Iron Condor

admin — Tue, 05 Jan 2010 03:03:20 +0000

Placing iron condor spreads on the broad market indexes is a relatively conservative, non-directional trading strategy that may be used for consistent income generation. This strategy profits as long as the index trades within the channel formed by the two spread positions. It is best used during sideways or slowly trending markets.Condor SpreadsA condor spread is a debit spread, established by placing a bear call spread at or above resistance and placing a bull call spread at or below support. The condor may also be established using puts with a bear put spread above and a bull put spread below. The iron condor is a variation on this trade by using a bear call spread above and a bull put spread below the price of the underlying stock or index. The iron condor is a credit spread and achieves maximum profitability if the price of the underlying closes between the short options (the strike prices we sold) of the two spreads at expiration. In that case, all options expire worthless and you achieve the maximum profit, i.e., the credits originally collected. The profitability of the iron condor is assisted by the fact that the broker only requires margin for one of the credit spreads, effectively doubling the return on investment.Condor spreads are effective when the underlying is expected to trade within the channel defined by the spreads during the life of the options. The closer one places the spreads to the current price of the underlying, the higher the returns; however, this comes with a higher risk of the price of the underlying stock or index entering one of the spreads and causing a loss on that spread.Trading the stock indexes with condors is effective for several reasons: 1) the indexes generally move slower than most individual stocks, 2) the indexes are less affected by an individual stock’s bad news, 3) the premiums of the index options are generally much higher than individual stock options, 4) index options trade in high volume because large institutional investors use these options to hedge their portfolios; this results in high liquidity, and 5) 60% of the gains with broad index options are taxed at long term capital gains rates, regardless of the length of time in the trade. Money ManagementMoney management refers to the rules used for determining the amount of capital devoted to a trade and spreading risk among strike prices and time. Determine the total dollar value you wish to devote to this strategy. For this example, we will assume we have a $100,000 account we will exclusively trade using the iron condor strategy. Take 40% of the total portfolio ($40,000) and divide by $1000 to get 40. This is the total number of contracts you will trade in this strategy each month (40 contracts total in the bear call spreads and 40 contracts total in the bull put spreads). This approach lessens your exposure during any particular month and leaves you room in the account to put on next month’s positions before last month’s positions have expired. This also reserves an additional 20% of capital as a safety margin and for possible use in trade adjustments. IMPORTANT: when learning this or any options trading strategy, start very small with one or two contracts and gradually increase your size as your experience and confidence grow.Money management also includes the concept of limiting your losses. Playing iron condors on the indexes as outlined in this paper are conservative, high probability trades. However, the potential loss is quite large, even though the loss has a low probability of occurrence. Therefore, one loss may wipe out several months of profits. Stop loss and adjustment rules and the discipline to strictly follow them are critical to the success of trading iron condors. Those stop loss and adjustment systems are taught in detail in the Advanced Options Trading Strategies course offered by Parkwood Capital, LLC.Timing (Days to Expiration)You can establish your condor position sometime in the range of 40 to 50 days until expiration. The precise time is not critical. The trade-offs are as follows: the earlier I put on my spread positions, the more time premium is present in the options and therefore I can receive the minimum credit I am willing to accept farther out from the current levels of the index; therefore, more safety margin is achieved. However, the more time I use in the spread, the more time that exists for the market to move against me; thus, I am incurring more risk. As time decay reduces the option premiums, I must move my spreads in closer to achieve a reasonable credit, reducing my safety margin and increasing my risk. It is also possible to trade the iron condor starting at about 30 days to expiration, but the system rules and adjustments must be adjusted accordingly.Determining Optimal Entry PointsSome traders place the call spreads when the index is hitting resistance and appears to be turning down, and place the put spreads when the index is hitting support and appears to be turning back upward. This will maximize the size of your credits. However, if the index continues to move in that direction, your position could be in trouble quickly and you will not have the compensating spread position helping to hedge your position. For this reason, I generally establish both the call spreads and put spreads on the same day.Choosing the StrikesWe can apply basic statistics to our deciding which strike prices are “far enough” out to be safe. The classic “bell shaped curve” we have seen in various contexts is the mathematical function known as a normal or Gaussian distribution. If we assume that future moves of the index price will be random and similar in frequency and absolute size to previous fluctuations up and down, then we can calculate the probability of the index price being at a particular price on a particular date in the future. I calculate the standard deviation for the index, based upon its level of implied volatility and the time left to expiration. The call spreads are placed just outside one standard deviation above the index price and the put spreads are placed just below one standard deviation below the index price. This results in an iron condor position with a probability of success of approximately 80-85%. The details of this methodology are taught in the Equity and Index Options course offered by Parkwood Capital, LLC.Entering the Order and Getting FilledNow that we have determined the strike prices for our spread, we need to calculate the credit we are going to ask for in our order. Compute the natural price for the credit spread, the natural debit spread price, and the midpoint of the spread (most online brokers calculate this for you).Enter your order at a credit limit at the midpoint and wait to see if the order is filled. After a few minutes, adjust the credit downward by $0.05. Repeat until both spread orders are filled. But do not drop below the lower quartile of the bid/ask spread.Never place an order for less than $0.60 to $0.70 in credit; trading commissions become too large a factor for smaller credits. My spread credits normally range from $0.60 to $1.05 per spread or about $1.20 to $2.10 per iron condor.Stop Losses and AdjustmentsThe topics of setting stop losses and the variety of adjustment methodologies available are beyond the scope of this paper. An effective, but simple, risk management technique is to monitor the debit spread necessary to close your condor spreads, and when that debit is double the original credit received for that spread, close that side of the condor. This technique will close out positions more frequently, but it will result in very small losses or near breakeven results in the “bad” months when the index moves against you.Index Option SettlementIndex options are cash settled options; there is no underlying instrument like stock shares to be called away or put to you. You simply lose or gain the dollar value at expiration, e.g., you hold 10 contracts of the $1400 call and the SPX settlement price is $1405; your account will be credited with $5,000 ((1405 – 1400) x 100 x 10). If you were short the $1400 calls, your account would be debited $5,000.Most index options are somewhat unusual in that they cease trading for the month at market close (4:15 pm ET) on the Thursday before expiration, but the settlement price is not that closing price on Thursday or the opening price Friday morning. Therefore, all final adjustments to positions must be done on Thursday before the close. On Friday morning, the settlement price will be computed based upon the opening prices of each of the stocks that make up that index. Since each stock may not trade immediately at the open, the settlement value may not be available until later that Friday morning. Since the settlement price may vary several dollars up or down from Thursday’s close, one must be cautious about going into settlement with any spread positions remaining open.Expected ReturnsIf you are placing your spreads for credits of $0.70 or more, then the returns for that iron condor will be about 15% for the month (remember that margin is only charged for one half of the iron condor). If we are using roughly half of our capital for an iron condor each month, then you can expect to average returns of about 6% to 8% per month. Of course, you may have to defensively close one of the spreads a few times per year and that will reduce the annualized return of this strategy. SummaryThe iron condor trading strategy is a relatively conservative, non-directional options strategy that may be used for consistent income. However, this strategy is typical of low return strategies with high probabilities of success. The probability of a loss is small, but one large loss will wipe out several months of profits. Thus, the key to success for trading iron condors is solid risk management rules for entry and exit, stop losses, and adjustments. When deployed conservatively as outlined herein, this strategy should reasonably be expected to return 5% or more per month.

Financial Trading – so many markets, so little time

admin — Tue, 29 Dec 2009 03:52:28 +0000

Would you like to make money from trading but don’t know how to trade?
Have you heard of others making a killing on the markets and wished yourself in their position?
Trading covers a multitude of sins, or at least a multitude of markets. Mention “trading” to a non-trader and they’ll probably think of stock and shares but there are many other markets you can trade in. These include commodities, futures, indices, CFDs and options. They all have their pros and cons and some require specialized knowledge.
The most popular markets used by traders are stocks, commodities, futures, indices and forex. Some traders switch between markets, others stick to just one. Let’s highlight some of the similarities and differences between them.
Shares
In the USA there are over 40,000 shares so you have a lot of markets to choose from. You can’t deal in all of them so you need to home in on those that offer good trading opportunities using whatever trading methods you decide to use.
When buying shares you usually have to put up all the money at the time of sale. That might seem obvious but it’s not so with all markets. Some brokers offer a 50% margin with shares which means you can trade to the value of twice the amount in your account. This seems like a good deal but if your shares start to go down you’ll get a “margin call” and will either have to put more money in your account or sell the shares at a loss.
Shares are normally traded in lots of 100. If you want to trade an expensive share – and some shares are very expensive, particularly in the US markets – you need a considerable amount of money in your account.
It’s not easy to sell shares short. Selling short is a strange concept to many people who think of buying shares at a low price and selling then at a higher price. But it’s often easier to predict that a share will fall rather than rise so what you’d like to do is to sell it at a high price and then buy it back later at a low price. The net result is the same whatever the order of the deals – buy low, sell high.
However, you can’t sell something you don’t own so in order to sell shares short you must “borrow” them from your broker. This is not quite as straightforward as buying and not all shares are available for selling short.
Finally, share dealing takes place during market hours so if you don’t live in the country where they are being traded you must adjust your trading hours to suit.
Futures, commodities and indices
Commodities are goods such as corn, copper, crude oil, orange juice, oats, gold and wheat.
Technically, a futures contract is an agreement to make or accept delivery of a commodity on a certain day at a certain price. In practice this rarely happens unless you’re a manufacturer who actually wants the goods. The vast majority of futures traders are simply speculating on whether the price will go up or down and never take delivery of an item.
Futures contacts include commodities and also stock market indices such as the S&P 500, Dow Jones and the Russell. Indices are simply a composite of securities that provide an overall reading of the market or some section of it.
The S&P 500 (Standard & Poor’s 500) tracks 500 of the largest companies in the US market. The Dow Jones Industrial Average tracks only 30 of the largest and longest-established companies while the Russell 2000 is an index of smaller stocks.
Essentially, commodities and indices are futures and traded in much the same way although traders may use the terms interchangeably.
Unlike shares, futures can be sold short just as easily as they can be bought. Each futures contract has its own fluctuating price and many traders deal in just one lot contracts.
Brokers usually charge a flat fee commission per contract, often expressed as a “round turn” which is one buy and one sell transaction. This may be a few dollars, often less than the value of a point or two on the contract. If you’re trading a long time frame the commission is negligible but if you’re day trading and scalping for a few points here and there it becomes a considerable part of the cost.
Futures brokers usually offer a margin of around 20% of the value of the underlying instrument so you can control $10,000’s worth of a contract for maybe $2,000. However, the same rules apply – if you over-leverage your account you’ll receive a margin call or your positions will be closed at a loss. Margin and leverage are a two-edged sword.
Many brokers offer a demo account so you can get used to the trading platform and test your trading strategies before you put real money on the line.
Forex Currency Trading
Currency trading, foreign exchange or forex as it’s more commonly known, has fast become one of the most popular markets for private traders in recent years.
As its name suggests, it involves buying and selling foreign currency. The most commonly traded currencies are referenced against the US Dollar and are sometimes referred to as a “currency pair” even though you are only trading one instrument. For example, the GBPUSD is the UK Pound/US Dollar pair. A value of 1.7625 would mean that the one Pound is worth 1.7625 Dollars. Other popular pairs include the Euro (EURUSD), the Swiss Franc (USDCHF) and the Japanese Yen (USDJPY) although there are others.
So unlike shares and futures, you don’t have a mass of markets to choose from, but there is variety within forex currency trading to give you a range of markets to trade.
The value of each pair differs slightly but the minimum movement – called a “pip” – is worth approximately $10. The GBPUSD has been averaging 100-150 pips per day which would be $1000-1500. Many brokers let you trade half or even quarter-size lots which are useful when you’re starting out. Also, many brokers offer a demo account so you can practice before risking real money.
The total value of the forex market is worth trillions of dollars per day, far larger than shares or futures. It is also a truly international market with dealing taking place all around the globe 24 hours per day from Monday to Friday. You can, therefore, trade at any time of the day or night at times to suit you. It’s worth noting, however, that the bigger moves generally occur during the US and European trading sessions.
You can sell short forex just as easily as you can buy and brokers offer highly-leveraged accounts too – but the same warning regarding margins apply here as well.
Brokers tend not to charge a commission for trading forex and you will often see adverts for “commission free” trading. However, they make their money on the spread which is the difference between the buying price and the selling price. The spread is usually between 3 and 5 pips although some brokers may offer a 2 pip spread on some pairs, and some less-popular pairs may have a larger spread.
Paying on the spread is particularly useful when trading mini lots. A 3-pip spread on a quarter lot will be about $7.50 whereas on a full-size lot it would be $30. Again, the spread is more important when trading short time frames where you’re only aiming to make a few pips per trade. You need to build the spread into your trading system so you don’t overestimate the amount you might make per trade.
One interesting aspect of forex currency trading is that there is no central clearing house where absolute prices are quoted, unlike shares and futures. So it’s quite possible to see different brokers quoting slightly different prices for the same pair. As the market has become more efficient, this difference has reduced, in most cases, to a few pips but it highlights the importance of checking that the data you are using for analysis is the same – or close to – that used by your broker for placing your orders.
The market you decide to trade will depend on many things, not least of all, your budget, but also how many markets you want to look at and what hours you want to trade. There are trading vehicles to suit all preferences and pockets.

Financial Trading – So Many Markets

admin — Mon, 28 Dec 2009 15:07:33 +0000

Trading covers a multitude of sins, or at least a multitude of markets. Mention “trading” to a non-trader and they’ll probably think of stock and shares but there
are many other markets you can trade in. These include commodities, futures, indices, CFDs and options. They all have their pros and cons and some require specialized knowledge.
The most popular markets used by traders are stocks, commodities, futures, indices and forex. Some traders switch between markets, others stick to just one. Let’s highlight some of the similarities and differences between them.
Shares
In the USA there are over 40,000 shares so you have a lot of markets to choose from. You can’t deal in all of them so you need to home in on those that offer good trading opportunities using whatever trading methods you decide to use.
When buying shares you usually have to put up all the money at the time of sale. That might seem obvious but it’s not so with all markets. Some brokers offer a 50%
margin with shares which means you can trade to the value of twice the amount in your account. This seems like a good deal but if your shares start to go down you’ll get a “margin call” and will either have to put more money in your account or sell the shares at a loss.
Shares are normally traded in lots of 100. If you want to trade an expensive share – and some shares are very expensive, particularly in the US markets – you need a considerable amount of money in your account.
It’s not easy to sell shares short. Selling short is a strange concept to many people who think of buying shares at a low price and selling then at a higher price.
But it’s often easier to predict that a share will fall rather than rise so what you’d like to do is to sell it at a high price and then buy it back later at a low price. The net result is the same whatever the order of the deals – buy low, sell high.
However, you can’t sell something you don’t own so in order to sell shares short you must “borrow” them from your broker. This is not quite as straightforward as buying and not all shares are available for selling short.
Finally, share dealing takes place during market hours so if you don’t live in the country where they are being traded you must adjust your trading hours to suit.
Futures, commodities and indices
Commodities are goods such as corn, copper, crude oil, orange juice, oats, gold and wheat.
Technically, a futures contract is an agreement to make or accept delivery of a commodity on a certain day at a certain price. In practice this rarely happens unless you’re a manufacturer who actually wants the goods. The vast majority of futures traders are simply speculating on whether the price will go up or down and never take delivery of an item.
Futures contacts include commodities and also stock market indices such as the S&P 500, Dow Jones and the Russell. Indices are simply a composite of securities that provide an overall reading of the market or some section of it.
The S&P 500 (Standard & Poor’s 500) tracks 500 of the largest companies in the US market. The Dow Jones Industrial Average tracks only 30 of the largest and longest-established companies while the Russell 2000 is an index of smaller stocks.
Essentially, commodities and indices are futures and traded in much the same way although traders may use the terms interchangeably.
Unlike shares, futures can be sold short just as easily as they can be bought. Each futures contract has its own fluctuating price and many traders deal in just one lot contracts.
Brokers usually charge a flat fee commission per contract, often expressed as a “round turn” which is one buy and one sell transaction. This may be a few dollars,
often less than the value of a point or two on the contract. If you’re trading a long time frame the commission is negligible but if you’re day trading and scalping for a few points here and there it becomes a considerable part of the cost.
Futures brokers usually offer a margin of around 20% of the value of the underlying instrument so you can control $10,000’s worth of a contract for maybe $2,000.
However, the same rules apply – if you over-leverage your account you’ll receive a margin call or your positions will be closed at a loss. Margin and leverage are a double-edged sword.
Many brokers offer a demo account so you can get used to the trading platform and test your trading strategies before you put real money on the line.
Forex Currency Trading
Currency trading, foreign exchange or forex as it’s more commonly known, has fast become one of the most popular markets for private traders in recent years.
As its name suggests, it involves buying and selling foreign currency. The most commonly traded currencies are referenced against the US Dollar and are sometimes referred to as a “currency pair” even though you are only trading one instrument. For example, the GBPUSD is the UK Pound/US Dollar pair. A value of 1.7625 would
mean that the one Pound is worth 1.7625 Dollars. Other popular pairs include the Euro (EURUSD), the Swiss Franc (USDCHF) and the Japanese Yen (USDJPY) although there are others.
So unlike shares and futures, you don’t have a mass of markets to choose from, but there is variety within forex currency trading to give you a range of markets to trade.
The value of each pair differs slightly but the minimum movement – called a “pip” – is worth approximately $10. The GBPUSD has been averaging 100-150 pips per day
which would be $1000-1500. Many brokers let you trade half or even quarter-size lots which are useful when you’re starting out. Also, many brokers offer a demo account so you can practice before risking real money.
The total value of the forex market is worth trillions of dollars per day, far larger than shares or futures. It is also a truly international market with dealing
taking place all around the globe 24 hours per day from Monday to Friday. You can, therefore, trade at any time of the day or night at times to suit you. It’s worth noting, however, that the bigger moves generally occur during the US and European trading sessions.
You can sell short forex just as easily as you can buy and brokers offer highly-leveraged accounts too – but the same warning regarding margins apply here as well.
Brokers tend not to charge a commission for trading forex and you will often see adverts for “commission free” trading. However, they make their money on the spread which is the difference between the buying price and the selling price. The spread is usually between 3 and 5 pips although some brokers may offer a 2 pip spread on some pairs, and some less-popular pairs may have a larger spread.
Paying on the spread is particularly useful when trading mini lots. A 3-pip spread on a quarter lot will be about $7.50 whereas on a full-size lot it would be $30.
Again, the spread is more important when trading short time frames where you’re only aiming to make a few pips per trade. You need to build the spread into your trading system so you don’t overestimate the amount you might make per trade.
One interesting aspect of forex currency trading is that there is no central clearing house where absolute prices are quoted, unlike shares and futures. So it’s quite possible to see different brokers quoting slightly different prices for the same pair. As the market has become more efficient, this difference has reduced,
in most cases, to a few pips but it highlights the importance of checking that the data you are using for analysis is the same – or close to – that used by your broker for placing your orders.
The market you decide to trade will depend on many things, not least of all, your budget, but also how many markets you want to look at and what hours you want to trade. There are trading vehicles to suit all preferences and pockets.

Stock Trading for Bold Brave Investors

admin — Sat, 26 Dec 2009 14:09:10 +0000

Stock trading is one of the last true meritocracies. All that matters for your investment success are your own decisions. Stock trading is a precision-based activity and one tiny mistake in judgment could send you plummeting right to the bottom and result in a huge loss.
Likewise, the opposite could happen. You may make a great buying decision that will put you on the path to riches. Traditional stock trading is done at stock exchanges, which are places where buyers and sellers meet and decide on a price, although electronic trading is gaining in popularity. Stock trading is affected by how well the economy is doing and by basic supply and demand considerations.
Stock Trading is a get rich slow process. Money can be made, but it takes time. Stock trading is something that interests many people because it offers them a chance to make money without breaking into a sweat. In addition, it has a lot of excitement attached to it especially when using short term strategies that help pit traders against the stock market.
Stock Trading is trading stocks and shares of different types of companies and organization at the stock exchange. In every country, there is a stock exchange where various companies get their shares listed, when they arrange to raise required funds by means of issuing shares.
Stock trading is a very competitive field and in order to succeed you need to FOCUS on a set of simple strategies that you can implement without hesitation. The real “secret” of the stock market game is enclosed within the trading set ups and market signals you rely on to decide when to buy or when to sell shares. Stock trading is a business (because it is done for making money).
So as in a business, in stock trading, one needs to complete solid planning before making any buy/sell/trade. Stock trading is viewed by some people as a very complicated matter. This is regarded by many as an arena better reserved for those who have extensive exposure and experience in stock trading.
Stock trading is a game in which you cannot afford to be average. Thousands of new and inexperienced traders are being charged hundreds, even thousands of dollars by scam artists and self proclaimed experts for dubious stock picking services and mechanical buy and sell signal generators.
Stock trading is a relatively simple activity compared with other professions, particularly with the tools available in today’s Internet world. It is certainly within your abilities, and as you educate yourself on and build your skills, you’ll find that your fears subside as your confidence grows.
Researching a stock and then buying online it is one part of the story. The other part being how to plan a trade with an exit strategy? You must research the risks attached to online trading to make sure you are prepared for the worst. Be determined and goal orientated.
Exchange traded funds are good to use for trading and investing. By keeping trading simple, there is less stress and more opportunity to profit. Exchange Traded Funds, also known as ETFs, are index funds traded on the major stock exchanges just like stocks. An index fund involves a collection of securities, much like mutual funds, except that ETFs differ from mutual funds in some distinctive ways.
Options are bets about the future price movement of exchange traded securities. The prospect of unusually high returns always signals unusually high risk so be careful about trading options. Timing is everything.
Options are a great way to both earn and lose a lot of money. If you’re interested in involving yourself in the more unpredictable, risky, and spontaneous part of the stock market then trading options is something you should investigate. Option strategy is about selection of the best stock opportunities and following your signals. Here, you can achieve success if you are acquainted with the correct option trading strategy .
There are online resources available that will provide you with free simulated stock and option trading. You will easily find enough information to start your trading venture. You can practice trading stocks, options, spreads, futures, short sells, and so forth. Just run a search for “demo stock trading accounts” and you will find a good list to research.
Stock and option trading is a big game in many ways. But as it is a game involving the exchange of money if you play you need to take the game seriously.

Vertical Spreads and Implied Volatility

admin — Tue, 08 Dec 2009 14:33:01 +0000

One will commonly hear or read the following “rule of thumb” for options spread trading:When implied volatility is high, sell credit spreads and when implied volatility is low, buy debit spreads.Unfortunately, this is simply not true. The credit spread and its corresponding debit spread at the same strike prices will always have virtually identical returns on investment (ROI). This paper addresses the role of implied volatility in the vertical spread, both at initiation and over the course of the trade.BackgroundVertical spreads derive their name from the wall originally used to display option prices when they were first traded in Chicago many years ago. The months of expiration were displayed horizontally across the top of the board and the strike prices were displayed vertically along the left edge. Thus, spread trades using two options at two different strike prices in the same expiration month were in the same column and thus constituted a vertical spread. This includes bull call, bear call, bull put, and bear put spreads.Similarly, horizontal spreads are created by buying and selling options from the same row – different months of expiration, but with the same strike price. Horizontal spreads are also known as calendar spreads or time spreads.Diagonal spreads are created when different strike prices and different expiration months are used – thus, a diagonal line across the board between the option sold and the option purchased. An example would be buying the September $300 GOOG call and selling the July $320 GOOG call to create a diagonal bull call spread.Vertical spreads either require a net investment to initiate (a debit spread) or we initially receive money into our account (a credit spread). For this reason, it is common terminology for us to say we are “buying a call spread” when establishing a debit spread and “selling a call spread” to refer to initiating a credit spread. Bull call spreads are created by buying a call and selling another call at a higher strike, or farther OTM (a debit spread). A bear call spread is created by buying a call and selling a lower strike price call, or farther ITM (a credit spread). Similarly, a bear put spread is established by buying a put and selling the lower strike price put that is farther OTM (a debit spread). And a bull put spread consists of buying a put and selling another put at a higher strike price, farther ITM (a credit spread). Credit or Debit?There are many decisions made before we put on a trade, but for this discussion we will assume that a vertical spread strategy has been chosen as the optimal trading strategy for this situation. The next decision is whether to use a credit or a debit spread. The maximum potential gain for the vertical spread, all variables held constant except the choice of calls or puts, will be indifferent to whether the trade is established as a credit or debit spread. For example:GOOG closed at $310.71 on October 5, 2005. If one were bullish on this stock, one could place an Oct $310/$320 bull call spread for a debit of $430 ($960 – $530) and a maximum potential gain of 133%, assuming expiration with GOOG trading above $320.Similarly, one could place an Oct $310/$320 bull put spread for a credit of $560 ($1400 – $840) and a maximum potential gain of 127%, assuming expiration with GOOG above $320.The small difference between the two returns is insignificant; we are using the closing bid and ask prices for these options, and the option prices are very fluid, so picking prices at any arbitrary point and getting exactly identical results would be unusual. The conclusion is that any difference in returns between a credit and debit spread for the same underlying stock, strike prices, and expiration month will be small and temporary, because market forces will quickly adjust them to parity.It is commonly taught that one should establish a credit spread when placing a trade with high implied volatility (IV) options and a debit spread with low IV options. But the previous example illustrated identical returns for the credit and debit spreads. So, in that example, we would be indifferent to placing a debit or a credit spread. But let’s take it a step further.We will use the Black-Scholes model to compute the theoretical prices of the GOOG $310 and $320 options from the previous example, but with IV boosted up to 60% (the actual IV values in the above example ranged from 33% to 34%). Now the spread values become:The Oct $310/$320 bull call spread could be placed for a debit of $436 ($1613 – $1177) and a maximum potential gain of 129%, assuming expiration with GOOG above $320.Similarly, the Oct $310/$320 bull put spread could be placed for a credit of $563 ($2058 – $1495) and a maximum potential gain of 129%, assuming expiration with GOOG above $320.Thus, if we were considering placing a bullish vertical spread on Google, the returns would be virtually identical whether the IV was 34% or 60%, or whether we used a credit or debit vertical spread. The higher IV value increased the individual option values dramatically, but the spread values were unchanged. Higher IV does result in higher option prices, but in a spread, we are both buying and selling that high value.I also computed these option values with IV adjusted to 20%. As we see below, at this very low IV, the returns for the credit and debit spread were still identical so there would be no advantage to placing the debit spread for this low IV stock as some have taught.The Oct $310/$320 bull call spread could be placed for a debit of $381 ($580 – $199) and a maximum potential gain of 162%, assuming expiration with GOOG above $320.Similarly, the Oct $310/$320 bull put spread could be placed for a credit of $623 ($1084 – $461) and a maximum potential gain of 165%, assuming expiration with GOOG above $320.However, the returns for both spreads at IV of 20% are higher than we saw with the other examples with volatilities of 34% and 60%. This is consistent with the overall financial laws of balancing risk and return, i.e., higher returns always carry higher risk. This example has us placing a bullish spread on a stock currently priced near the bottom edge of the price spread; the stock price must make a significant price move of over $9 before expiration for the spread to achieve maximum profitability. However, the low implied volatility tells us the probability of a significant price move is low. Therefore, the returns will be higher, commensurate with the lower probability of success, and therefore, a higher risk of loss.These examples illustrate two important conclusions:• The returns for a credit spread and a debit spread placed at the same strike prices for the same equity or index will be identical. Any price differences seen in the marketplace will be transient, as arbitrage will quickly bring the prices back to parity.• The level of implied volatility (IV) is not a consideration when placing a vertical spread and deciding on a credit or debit spread. High IV does increase the individual option prices, but we are both selling and buying option premium in a spread, so the returns for the credit and debit spreads remain identical.Changes in IV During the TradeThe maximum profitability of a vertical spread, once placed, cannot change due to changes in implied volatility after the trade was initiated. The initial investment and the width of the spread are fixed; therefore, the maximum potential return is fixed. This is equally true for both credit and debit vertical spreads. However, the time decay curves of the spreads are affected by changes in implied volatility. The value of the spread varies with time to expiration, implied volatility, and the price of the underlying stock. Of course, interest rates and dividends will also affect spread values, but these will be less significant effects. Experienced spread traders know that even though the underlying stock price may have moved as predicted above or below the spread strike prices, the spread cannot be closed for a value close to the maximum theoretical profit until close to expiration. The value of the spread will gradually approach the maximum profit as the time value of the options decays away.Increasing implied volatility (IV) during the trade results in the time decay curves being flattened so that the value of the spread approaches the ultimate value at expiration more slowly. Therefore, the probability of closing the trade early for a majority of the maximum profit is reduced. We won’t illustrate it here, but the flattening effect on the time decay curves due to increasing IV during the life of the trade is identical for credit and debit vertical spreads. Therefore, if one is expecting a large IV increase, such as in advance of an earnings announcement, there is no inherent advantage to either a credit or a debit spread. But one should expect to have to carry the trade closer to expiration to achieve a majority of the potential profit if IV increases.Vertical spreads have an inherent advantage over long or short option positions in that the ultimate profitability of the vertical spread is unaffected by IV changes while we are in the trade. By contrast, if we buy a call option in anticipation of a positive earnings announcement, we may be disappointed in the results. Most likely, IV will decrease dramatically following the announcement, and this will drive down the value of our call option. This negative effect may be of equal or greater magnitude than the positive effect on our call option due to the increased stock price.Decreasing implied volatility (IV) during a vertical spread trade results in the time decay curves spreading out so the value of the spread approaches the ultimate value at expiration more quickly. This effect on the time decay curves due to decreasing IV during the life of the trade is identical for credit and debit vertical spreads. The maximum profit available hasn’t changed, but the prospect of closing the trade early for a large portion of that maximum profit is now more probable.ConclusionsThe maxim to use credit spreads when implied volatility is high and debit spreads when implied volatility is low may be a confusion that arose out of long and short option positions. It is indeed true that one should consider buying low volatility options and selling high volatility options. If we are considering a long call or put position, we would look for options with low implied volatility because these are inexpensive options. And similarly, we would target high IV options if we were considering a short call or put position.However, when playing the stock’s directional move with a vertical spread strategy, the choice of a credit or debit spread is largely a personal preference. Some prefer a credit spread because they can earn interest on the credit monies in their accounts while in the trade; another advantage of credit spreads is fewer trading commissions (assuming the spread is allowed to expire worthless). Others prefer debit spreads because they have spent the maximum that can be lost on the trade; there is no possibility of an ugly surprise later if the trade turns against them (as there is for a credit spread). The returns for credit and debit spreads will be identical and IV levels will have no effect on the returns. The effect of the volatility (either high or low) effectively cancels itself out by the opposite nature of the two legs of the spread. Thus, vertical spreads are an excellent way to trade high volatility options when establishing a long or short option position would be both expensive and risky.The change of IV during the course of the vertical spread trade will shift the time decay curves. Decreased IV will make it easier to exit the spread early for a large portion of the maximum profit, while increased IV during the trade will make it more likely one will have to take the spread into expiration. But the ultimate profitability of the spread is unaffected by the change in implied volatility.