SAFELY INVESTING FOR THE LONG TERM

When markets decline, and especially when the decline is deep enough to frighten a substantial number of investors, put options become much-desired commodities and prices soar. This price change comes from an increase in the implied volatility.
The conservative, well-prepared, investor understands risk management and has some method in place that cushions his/her net worth against a stock market debacle.
Those investors never panic and buy/sell decisions are made on their merits, and never out of fear. When they want to own put options -- or adopt a different portfolio management technique -- they already own them as part of their ongoing strategy. There is no need to pay up for options just because unprepared investors (and speculators) drive prices higher.
I absolutely believe that stocks are the best game in town. I don’t think there is a better way for the average investor to grow their wealth. However, this is called investing and the price of admission is gut wrenching drawdowns and sometimes years and years with nothing to show for it. If you can accept that this is the way things work, you can be an enormously successful investor.
The majority of investors tend to remain 100% bullish at all times. That investment philosophy can be successful for people who understand how the market works. Such investors invest in risk management ideas that limit the size of any drawdown (i.e., they do not lose so much money that they feel a need to sell everything in a panic).
This allows them to remain invested and to participate in all bullish markets.

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USING POSITIVE THETA STRATEGIES WHEN BULLISH OR BEARISH

COLLECT  THETA AND EXPRESS A MARKET BIAS
MARKET-NEUTRAL STRATEGIES earn a profit when time passes and the "magic" of time decay (Theta) does its thing. Of course it is not as simple as opening a position and waiting for the profits to accumulate. There is always the possibility of a profit-destroying price change in the underlying stock or index.
Nevertheless, these strategies work well when the markets trade within a narrow price range. The beautiful characteristic of these versatile option strategies is that they can be used by the bullish or bearish investor as well as by the market-neutral trader.
LET'S EXAMINE THREE STRATEGIES.
CALENDAR SPREAD
ABCD is currently trading at $65 per share. Believing that the stock price will rally towards $70 as the December 18, 2015 options expiration date approaches, you buy an out-of-the-money calendar spread.
Traditionally, the calendar is used by traders who believe that the stock price will remain near $65 when a specified expiration date arrives.
But there is no reason why it cannot be used by traders who believe that the stock price will differ at expiration. One advantage of using the OTM calendar spread is that it is less expensive than an ATM (at the money) spread.
Example:
     Buy 6 ABCD Jan 15 '16 70 calls
     Sell 6 ABCD Dec 18 '16 70 calls
As times passes and the stock moves towards $70 per share, the position becomes more valuable and you earn a profit. That profit is maximized if the stock is almost exactly $70 per share on Dec 18, 2015. At that time (or earlier if you wisely do not attempt to earn the maximum theoretical profit) you close the position by selling the calendar spread. 
If the stock price does not conform to your expectations, then the spread will lose value as the December calls expire (and become worthless).
You can keep your Jan calls, hoping for a miracle, but it is often wise to sell the call and recover some of the cost of buying the spread.
NOTE: One factor that affects profitability is volatility. When implied volatility is relatively high, the profits are even larger than anticipated. When implied volatility is low, the profits are reduced.

DOES THE REWARD JUSTIFY THE RISK?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RISK MANAGEMENT FOR THE NEWER TRADER

BUYING OPTIONS AND PREDICTING MARKET DIRECTION
Newer option traders tend to adopt the strategy of buying calls when they are bullish and puts when they are bearish.
It is very easy to buy some options based on your market savvy. In other words, you -- like the majority of new investors -- probably believe that the trade will be profitable because you believe that the stock price will behave as you predict.
That is based on the belief that you have a talent for stock picking and timing the market.
Despite a ton of data to the contrary (Numerous available data sources illustrate that individual investors perform far worse than the market averages when making buy/sell decisions) most still believe that they are not average investors and have the ability to beat the market.
RISK VS. REWARD
Those beliefs often lead to unwise investment decisions. That brings up the topic: How much money can you afford to risk when making investment decisions based on your ability to know what the future holds?
The more difficult questions are:
·         Can you estimate the probability of earning a profit from a given trade?
·         How does the potential profit compare with the money at risk?
EXAMPLE
The inexperienced option trader may look at a RS 40 stock, decide that the price is heading higher and seeing that the two-month option with a RS45 strike price costs 'only' RS0.15 (that's RS15 per contract), decides to invest RS75 by buying 5 contracts.
ANALYSIS OF THE TRADE
The risk is only RS75, so at first glance this seems to be an acceptable trade. After all, the potential gain is theoretically unlimited and the maximum loss is just RS75.
However, that is not the whole story. This is a stock whose price fluctuations are tiny. Translation: this is a non-volatile stock. In fact, over the past couple of years, the average daily price change is only 5-cents per share. The probability that the price can rally far enough in 45 trading days to turn this investment profitable is less than 1%. In other words, the likelihood of earning any profit from this trade is dismal and the most likely outcome is a 100% loss.

YOUR FIRST OPTION STRATEGY. SHOULD IT BE BUYING OPTIONS?

CATEGORY: FOR THE OPTION NEWBIE

It seems natural to buy options. After all, isn't that why they exist? The answer is no. Options were created to shift risk from the risk avoider to the risk taker. They were not created as a tool for speculators, although speculators play an important role in the options world.
It is important to understand that all investing has a certain resemblance to gambling. However, investors gamble only when they make trades based on too little information or when the trades are based on ‘hoping’ that something specific will come to pass.
I discourage gambling with options and I hope to encourage you to adopt a similar attitude. Nevertheless, it is convenient to use gambling vernacular when discussing certain aspects of trading.
TRADING OPTIONS IS QUITE DIFFERENT than trading stocks. When buying a call option, the investor (or trader) Is making a bet that the underlying asset (usually a stock, but it may also be an ETF (exchange-traded fund), index, currency, commodity etc.
Will move higher or lower before the option expires. Under most circumstances, it is a bad bet.
These are the primary reasons:
DIRECTION. Although most investors/traders believe they have the skill to know when the market will move higher or lower in the future, there is a ton of evidence that says just the opposite. For example, studies show that most individual investors under-perform the market averages, year after year. This is more a result of buying and selling at the wrong time, rather than of owning the wrong stocks. No matter the reason, the average active investor does worse, on average, than those who tend to buy and hold. Much of the poor results can be blamed on buying when everyone’ is bullish (near the market top) and selling when traders dump stocks in a panic (near the bottom).
Another study shows that most investors perform far worse than they believe they do. This seems strange, but perhaps this finding can be blamed on a poor memory. More than likely it is a result of traders remembering good results while tending to forget their worst trades.
If you believe you are a good stock picker and will get the direction right significantly more than half the time, then perhaps you can make money buying options.
However, there is much more to consider. See below.
Keep a written record of every buy/sell decision. This is part of your trade plan. Do not fudge the results because you would only be hurting yourself. If you have a proven (in writing) track record of being able to earn far more than your trading expenses, then buying options may work for you.

OPTIONS FOR BUSY INVESTORS

Both investors and traders can use options.
The generally accepted difference between investors and traders is that investors make portfolio changes far less often and that they have the time and patience to allow their investments to grow. In other words, investors are not interested in instant gratification whereas traders prefer to make a trade, collect a quick (a few minutes to perhaps a couple of weeks) profit and exit the position.
Traders seek stock-market profits by selling as soon as a profit target is met. They never get married to a position. Nor do they have loyalty to the company whose stock they own. They often ignore the nature of the company itself, relying on charts to make buy/sell decisions. Some traders own positions for as little as a few seconds, while others may wait as long as two months for a position to work.
There is also another major difference. Trading is a full-time job because there is a continuous need to monitor positions and to make important decisions. Investing is something that anyone can undertake. Don't misunderstand. It is not a simple process. Instead it requires that an investor finds the time to do the necessary work for making important decisions. Unless you want to pay someone to manage your portfolio by buying mutual funds (a poor choice), ETFs (a good choice) or hiring a financial advisor, the successful individual investor does his/her homework. 
Investors tend to hold positions for years, decades, or even an entire lifetime. As a consequence, they make few investment decisions.
Investor portfolios should be examined on a regular basis (at least yearly) with the goal of unloading stocks that no longer deserve a spot in the portfolio. Alas, that seldom happens and many buy and hold investors believe in holding forever.
Timing is not a big issue because paying a few cents more per share, has little effect on the long-term results.

PHILOSOPHY BEHIND WRITING COVERED CALLS

COVERED CALL WRITING is a popular strategy among individual investors. It has also attracted the attention of mutual fund and ETF managers and there are a number of funds that use covered call writing as part of their investment strategy. I would offer a short list, but I do not want to recommend that anyone use such funds. 
If you have the time and willingness to trade your own money (as millions of stock investors do), then writing covered calls is something to consider.
It is not a good investment choice for everyone. 
When writing covered calls, stock selection is the single most important factor in determining your success or failure. Yes, selecting which option to write plays a big role in your performance, but if you own stocks that under-perform the markets on a regular basis, then you cannot expect to earn much (if any) money.
WHO WOULD WRITE COVERED CALLS?
Covered all writing begins with stock ownership and this article is written for such stockholders. It presents the pros and cons of adopting covered call writing (CCW) as a small or substantial portion of your investment portfolio.
CCW is also used by investors who have no current position in the individual stock, but who would buy shares with the intention of writing options and collecting the premium.
WHY WOULD ANYONE WRITE COVERED CALLS?
As with any other trading decision you must compare the advantages and disadvantages of the strategy and then decide whether the risk vs. reward profile suits your investment goals.
WHAT DO YOU HAVE TO GAIN?
·         INCOME. By selling one call option for each 100 shares of stock that you own, you collect the option premium. That cash is yours to keep, no matter what happens in the future.

NEUTRAL STRATEGIES FOR THE NOVICE

Options are versatile investment tools. They can be used for both bullish and bearish strategies. But what separates options from all other investment tools is that they can also be used for neutral strategies. Those are appropriate when:
·         You do not have an opinion on market direction.
·         You believe that the markets will be relatively unchanged over the near term.
Let's discuss some of those strategies.
Note: This article is intended for the novice options trader. More experienced traders can find additional information by clicking the links below.
Market-Neutral Option Strategies
Important note: Unless you are a very experienced trader, always enter these orders as "spreads." A spread order tells your broker that
·         The order contains two or more different options (each option is a "leg")
·         The order requires that the broker fill each leg, and not just one. By  entering a spread order with two legs, you will never find that you bought or sold one of the legs.
If you don't know how to enter such orders, ask your broker's customer service department  how to enter an option spread order. 
Calendar Spread. The trader buys one option (call or put) and sells another option of the same type (i.e., call or put) with these restrictions:
·         The option bought expires after the option sold (i.e., it is "longer-dated")
·         The underlying asset is the same for both options.
·         The strike price is the same for each option.
The longer-dated option always costs more than the near-term option.
Thus, the calendar is a debit spread.
Fact: Shorter-term options decay (i.e., lose value) more quickly than longer term options. (See Theta)
Rationale for buying a calendar spread: When time passes and the stock price remains essentially unchanged, the spread gains value because the option that you bought loses (or gains) value more slowly than the option that was sold.
Therefore, the price of the spread (the difference between the price of the two individual options) increases. This spread is appropriate when you believe that the stock price will remain near its current level.
Risk:
·         If the stock price moves far away from the strike price, then the spread loses money because calendar spreads are worth more when the options are at the money.
·         When the stock price runs higher, the nearer-term option gains value more rapidly than the option that you own (this is due to gamma).

NAKED PUTS; CASH-SECURED PUTS

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Selling puts option for income and for buying stock below market price.
Put writing (put selling) is a conservative option strategy and is ideal when you want to buy stock below current market prices. Cash-secured means that there is enough cash in the account to buy stock if assigned an exercise notice.
SELLING NAKED PUTS; CASH-SECURED PUT OPTIONS
Selling puts is not a high-risk strategy. It is no more risky than buying stock.
Despite everything you may have heard to the contrary, put selling is a strategy worthy of consideration by almost every investor who buys stock. The very bullish trader who expects to see a large upward change in the stock price represents the single class of investor who should not sell puts.
PRUDENCE
The so-called "prudent investor" is told that buying stocks is a good and conservative investment idea.
That investor is also told that selling put options is far too risky. Let's compare two investors who make a trade today:
·         The stock buyer pays for the investment in three days, when the trade "settles." If the stock price moves higher, the trader earns a profit. If the stock price declines, the stockholder incurs a loss. Very straightforward and easy to understand.
·         The put seller collects cash upfront when making the sale. He/she puts up collateral (to meet the margin requirement) to guarantee his/her ability to pay for the stock -- if and when it becomes necessary. If the option expires worthless, the collateral is released and the trader keeps the cash premium as the profit.
In other words, the stock buyer pays for shares at the time of the trade and the put seller promises to pay for stock at a later date. They each have the same risk: If the stock price undergoes a steep decline, each loses money.  This is not a risky proposition for the put seller who understands that he must not sell more than one put for each 100 shares he is willing to own.
Selling too many puts is a risky proposition, but selling too many represents poor risk management skills by the trader. it is not a reflection on the prudence of the strategy.
The put seller agrees (a binding contract) to pay $30 (the strike price) for shares at a later date, but only if he is required to do so. He collects $100 (premium, or option price) for accepting this obligation.  If the stock rallies, both earn a profit. However, the stock holder's potential gain is unlimited while the put seller cannot earn more than the $100 premium that he collected.
If the stock price falls, the stockholder always loses money.
For the put seller to have any loss (assuming that the position is held until the options expire):
·         The stock price must be below the strike price ($30 in this example) by more than the premium.
          EXAMPLE: If the stock is $28, the put seller must pay $30 for the shares. Because they are trading at $28, that is a $200 loss. However, the $100 collected earlier offsets a portion of that loss.
          EXAMPLE: If the stock is $29.40, the put seller earns a $40 profit ($100 premium minus $60 loss on stock price).
·         The put seller often earns a profit when the stockholder loses money. This is the part of the strategy that makes it so appealing. You sell a put option (taking a bullish stance), the stock price declines, and you still earn a profit! 
          EXAMPLE: The stock price moves from $34 to $32 and the stockholder loses $200 for every 100  shares owned. The put seller makes money because the option expires worthless and the profit is $100 (premium collected). 
 Some terminology useful for traders who sell put options
·         ASSIGNED AN EXERCISE NOTICE. When the owner of any option elects to exercise her rights, then the account of a trader who has a short position in that specific option (i.e., XYZ Jun 20 '14 30 puts) is chosen at random and notified.  The notice informs the trader that the option owner exercised an option and that he has been assigned (via a random process) as the person who must honor the terms of the option contract.  
In simple terms: When your account is randomly chosen you must buy 100 shares at the strike price for each option assigned to your account. There is no way out of this. By the time you see your account in the morning, the shares have already been purchased.
·         NAKED PUT OPTION.  A put that is sold unhedged (no offsetting, risk-reducing positions) and the trader does not have enough cash in the account to pay for stock, if it becomes necessary. The trader must borrow that cash from his  broker (using margin).
·         CASH-SECURED PUT. An unhedged put sale, but the trader does have enough cash in the account to but stock, if it becomes necessary.