OPTIONS FOR STOCKHOLDERS

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HEDGING WITH OPTIONS

Most investors invest their money in mutual funds or individual stocks. If you take the time to find good stocks that are worth owning, have you ever considered reducing the risk of stock ownership?
We all appreciate the profit potential of investing during a bull market, but as you know, periodic bear markets can be financially and emotionally devastating. There is something you can do about that. You can hedge (reduce the risk of owning) stock. This article describes two simple strategies to do just that.
FIRST, THERE ARE SOME BASIC FACTS THAT YOU MUST UNDERSTAND:
1.       These strategies are not for everyone.
2.      To gain the benefits of reduced risk, there is a cost. That cost can be either: reduced profits, or limited profits. Thus, if your goal is to earn the maximum possible profit from every investment, hedging is not for you.
3.      The strategies do not eliminate all risk. They reduce risk.
STRATEGY ONE: WRITING COVERED CALLS
BENEFITS: Earn profits more often; reduce cost of buying stock.
NEGATIVES: Profits are limited.
THE IDEA: Sell one call option for each 100 shares of stock owned. Use the cash
·         To provide a small cushion that eliminates or reduces losses if the stock price declines.
·         As a steady source of income.
·         To earn profits when the stock price is not rising. The cash premium becomes the profit.
By selling the call, you sacrifice the following:
·         If a rally takes the stock price higher than the strike price when expiration arrives, your selling price for the stock is the strike price. You do not earn any profit above the strike price.
Thus, it is a trade-off: You get cash, but must accept limited profits.

HEDGING: REDUCING RISK WITH SPREADS

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THE FIRST STEP IN MANAGING RISK
One of my basic tenets of investing is the idea that a trader cannot find success without a healthy respect for risk. Therefore learning to manage risk is a mandatory part of any trader's education.
Today, I want to encourage you, the new option trader, to think in terms of hedging whenever you trade. So let's begin with a definition of the term:
Hedge: An investment position intended to partially offset gains or losses from another position. In the options universe such positions are referred to as spreads.
In simple terms, a hedge limits profits and losses. When used properly, trading hedged positions increases your chances of having a profitable trade. 
If you have ever heard anyone use the expression "hedging a bet" this concept is the origin of the expression.
In the options world, a hedge is the combination of two different  positions. Most commonly, one of the positions is bullish and the other is bearish (although there are other risks, besides market direction, that can be hedged).
The resulting hedged position can be:
·         MARKET NEUTRAL. Such positions earn or lose money when the stock market undergoes a significant price change. You can construct the position to profit from the big move. You can also do the opposite: and own a position that earns money when the market is fairly stable and no such large price change occurs.
·         BULLISH. The hedge is created such that the bullish portion of the trade (terminology: bullish leg) is more influential than the bearish leg. That translates into a position that earns money when the stock moves higher.
·         BEARISH. The hedge is created such that the bearish leg is more influential than the bullish leg. That translates into a position that earns money when the stock moves lower.
 Examples
If you are brand new to options, the examples below may not mean anything to you. That's okay for now.
I will explain these spreads in great detail as we progress. For others,
MARKET NEUTRAL: Buy one call and one put; or sell one call and one put with the same expiration. These positions are calls straddles or strangles.
BULLISH: Buy one call and sell another. Both options expire at the same time and the call bought is more expensive than the call sold and is a debit spread. Also: Buy one put and sell another. This time the put sold is more expensive (credit spread).

LEARNING TO TRADE OPTIONS

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TRADING OPTIONS: A LITTLE BIT OF SOPHISTICATION
The stock market is not only about making money. For many investors it is also a way of preserving capital, especially during periods of rapid inflation.
The vast majority of investors buy stocks -- either individual stocks or mutual funds or ETFs (exchange traded funds) -- and not having any realistic alternatives -- hold onto their investments for decades. More sophisticated investors practice diversification and asset allocation techniques by:
·          Selling some stock when prices have increased by so much that the investor is over-invested in stocks and under-invested in other asset types.
·         Buying additional stock when prices have undergone a significant decline and the investor is under-invested in stocks. The needed cash comes from selling the part of the portfolio in which he/she is over-invested.
STOCK OPTIONS
There are other methods and tools that investors can use to reduce the possibility of losing money from any specific investment. That reduced-loss situation is another way of preserving one's assets.
And the tool of choice to accomplish that objective is the stock option.
The problem with options is that too many individual investors learned to fear options and never bothered to learn how they work. Each of the following gives option trading a bad name, but these do not apply to you:
·         A handful of rogue traders have gambled with money that was not their own and caused irreparable damage. News coverage emphasized that these traders used options or other derivatives in their trading and helped spread negative opinions regarding options trading. Examples: Barings Bank.

USE OPTIONS TO EARN PROFITS MORE OFTEN

OPTIONS ARE YOUR FRIENDS
Investing vs. Trading
Traders tend to ignore the nature of the business and rely only on their ability to predict short-term price movements.
Investing is different. It is based on your ability to understand the basic financial condition of the company, compare it with its peers and make a good evaluation of how well-poised this company is for the future. That's research. When you find a business that is worthy of making an investment, you buy shares and wait for your good judgment to pay off. But you do not wait idly. Investing requires periodic re-evaluation of your holdings because the world changes and you do not want to be married to a poor investment.
Option Traders
Option traders are not investors.
Nor are they very short-term traders. The option markets, with their wide bid-ask spreads, are not designed for day traders.
·         Option buyers require that the stock make a move -- in the right direction -- in a relatively short period of time.
·         Option sellers require time to pass and for the options to decay without the stock moving in the wrong direction.
Option traders also have built-in risk-measuring tools (the Greeks) that make it more efficient to use options than stock. The Greeks include Theta (the risk of holding as time passes), Vega (the risk of holding a position as implied volatility changes) and Delta (the risk of being too long as the market falls; or too short as the market rallies). These Greeks allow traders to get a good estimate of how much money is at risk -- as well as the potential reward -- that comes with their market prediction.
Why is this important?  Too many traders ignore the following question:  
Why do I believe that I can correctly predict which stocks are moving higher or lower?
Even when traders lack proof of any ability to correctly predict direction, they still take bullish and bearish positions with a high expectation of making money. That is not reasonable. 
Predicting direction is difficult. Most professional money managers cannot consistently beat the market averages. And they are paid big bucks for that inability. Instead of trying to do what they cannot do, why not trade with a much improved chance of success? Options allow you to do just that.

EQUIVALENT POSITIONS

Puts and calls are obviously different option types. However, there is a mathematical relationship between calls and puts when the put and call expire at the same time, have the same strike price, and are on the same underlying asset.
Because of that relationship, there is more than one way to build any option position -- and that means that there are equivalent positions (i.e., positions with identical profit/loss profiles) -- even though the positions appear to be very different. 
Although you can survive by avoiding the small amount of homework involved in understanding this concept, but it does mean that you will occasionally be leaving money of the table for no good reason. Isn't that why you are trading? To make money?
Traders own positions with an expectation of earning a profit when the markets behave. If you can own a different position that results in the same profit (or loss), but which requires paying less in commissions, wouldn't that be preferable?
Infrequently you may discover that the markets are temporarily inefficient (it won't last long), and that one of the equivalent positions is available at a slightly better (perhaps $0.05) price than its equivalent. If you spot that difference, you can own the position with that $0.05 discount. 
The basic equation is often referred to as put-call parity. You can find more details here.  For the purpose of introducing this topic, the effect of interest rates is ignored. 
Put-call parity describes the relationship between calls, puts, and the underlying asset.
Owning one call option and selling one put option on the same underlying asset (with the same strike price and expiration date) is equivalent to owning 100 shares of stock. Thus,
S = C – P
Where S = 100 shares of stock;   C = one call option ;   P = one put option
Simple proof:  Consider a position with one long call and one short put. When expiration arrives, if the call option is in the money, you will exercise the call and own 100 shares. If the put option is in the
money, your account will be assigned an exercise notice and you must buy 100 shares. In either case, you own stock.
NOTE: If the stock is exactly at the money when expiration arrives, you are in a quandary. You don’t know whether the put owner will exercise and therefore, you do not know what to do with your call. The best solution is to buy the put to cancel any obligations. It should not cost more than $0.05. Next, if you do want to own stock, exercise the call option. If not, allow the call to expire worthless. By covering the short put, you are in control.

BEAT THE MARKET: COVERED CALL WRITING

A CONSERVATIVE OPTION STRATEGY

COVERED CALL WRITING is a strategy designed to modify an investor's profile. It is not a magic strategy. 
·         It a strategy for investors with a bullish bias. 
·         It is not suitable for the very bullish investor because profits are limited.
·         It is appropriate for investors who want to slightly outperform the stock market over an extended time -- and to achieve that result with a less volatile portfolio (i.e., the value of the portfolio experiences smaller losses when markets decline and smaller profits when markets surge.) 
When you own individual stocks, exchange traded funds (ETF), or mutual funds, the value of your portfolio (obviously) moves up and down with the general movement of the stock market. As an investor, you may not have thought about the truth of the following statements, but in the back of your mind you surely understand that they are true.
·         Owning an ETF -- especially an ETF on one of the broad based indexes -- is an attempt to match the general performance of the stock market. The investor is not searching for ways to beat the market -- merely to match its performance. Such ETFs include: SPY (based on the S&P 500 Index), IWM (based on the Russell 2000 Index) , and QQQ (Based on the NASDQ 100 Index).
·         Investors who buy mutual funds are looking for out-performance, trusting the professional portfolio managers to choose investments that do outperform. In general, this is a poor investment plan because most fund managers fail to to beat their benchmark indexes. On top of that, they change an annual management fee for their failure. If you prefer to allow others to manage your money and make investment decisions for you, then you will probably do better with index funds and index ETFs, rather than traditional mutual funds. Sure, some mutual funds produce outstanding gains, but how are you supposed to find those funds in advance? You cannot.
COVERED CALL WRITING
When writing covered calls, the most important part of the strategy is choosing which stock to own. It is true that you can add to your profits by skillfully trading the options, but that pales in comparison with how your overall results depend on whether the stock rises or falls. The objective with covered call writing is to find stocks that do not lose significant value. There is no need to find stocks whose prices skyrocket.

HOW SHOULD ENTER AN OPTION ORDER?

When beginning to trade (stocks, options, commodities, etc.) you want to avoid the costly mistake of entering orders incorrectly. I know that this seems trivial, but the overly anxious beginner can get it wrong. 
One expensive way to avoid mistakes is to telephone your broker and place the order. There is no reason to do that because it is more efficient, and less expensive, to enter orders via the Internet.
There are two separate considerations when placing an order. 
1. Buy or Sell exactly the options that you want to trade.
Most of the time it is a very simple process to use your broker's online trading software because they make every effort to make it bulletproof. However, first-time traders may have difficulty understanding some of the terminology. NOTE: If you take the time to understand options and how they work before placing your order, then this will not apply to you. However, many traders are so anxious to get started that they take shortcuts.
 Solution: If you have any questions, or if any part of the order-entering process is confusing, then call customer service and ask for a detailed explanation of anything that is not 100% clear.
If you are entering a spread order, be aware that some brokers use the term "buy" while others use the term "sell" for the identical trade. There is no way that a new trader can overcome such a problem - especially when that you are not aware that this problem exists.
Solution: Take the time to look at the specific options being bought and sold and be certain that this trade gives you the position that you want to own.
For example, when it comes to trading iron condors, some brokers "buy the iron condor" while other brokers "sell the iron condor" - and the difficult-to-understand truth is that these two trades result in the trader owning exactly the same position. But the brand new trader cannot be expected to know that -- and can easily make a mistake when deciding whether he/she wants to buy or sell the spread.

IMPORTANT TRADE DECISIONS

"BUY DLF 120 CALL @ 2 TGT 2.75/3.90 SL 1.20"

TRADING REQUIRES FREQUENT DECISION MAKING
The generally accepted difference between investors and traders is that investors have a much longer-term time horizon.
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 (technical analysis) 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. 
Investors tend to hold positions for years, decades, or even an entire lifetime. As a consequence, they make (too) 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. 
Traders make a ton of decisions.
These include more than just "when to buy" and "when to sell." Most of the time the decision is to take no action and continue to own the position. It is very important to recognize that "doing nothing" requires a real decision. ["You've got to know when to hold 'em; know when to fold 'em."] It should not represent your inability to decide whether to initiate a new trade or exit a current position. For example, when you own a stock position, intending to exit very quickly with a target profit of five-cents per share, it is essential to recognize whether the stock price is behaving as expected.
If the price does not follow the predicted trajectory, then the trader must decide whether what he/she sees is still acceptable, or whether the original premise for making the trade has been violated. That is an active decision-making process. It is a very poor practice to tell yourself that "the profit is not yet five-cents per share, so I must continue to hold." There has to be a sound reason for holding.

TRADING TENETS ; MY PHILOSOPHY OF TRADING

There is no guarantee that you will earn money as a trader. Knowing that simplistic rule represents the first step towards finding success in the trading world. Why? Because those who appreciate the truth of the statement know that much hard work is ahead of them. They also understand that becoming a consistently profitable trader is a task that is difficult to accomplish. But it is far from impossible. 
When you, as a trader, have a winning mindset and understand reality, then your chances of coming out as a winner in the trading game is significantly higher than if you just take tips from other people or follow advice from a newsletter.
I began trading options for my own account in 1975 (and as a professional, beginning in 1977). I have leaned many lessons. Based on that experience, today's post contains nuggets of information that I want to share because I believe that every trader can benefit from being aware of these ideas -- even those of you who may not agree with all.
I offer them with the hope that they will help you make more money over the longer term -- and more importantly -- save you from self-destruction during the beginning phases of your career.
1.       ALWAYS KNOW HOW MUCH OF YOUR MONEY IS AT RISK FOR EVERY POSITION IN YOUR PORTFOLIO. Consider the the worst possible scenario and be certain that your exposure to loss is never more than you can afford to lose. This is especially true for anyone who sells options (naked) or buys and holds individual stocks, ETFs, or mutual funds.
2.      HOPE IS NOT A STRATEGY. Prayer will not help. Protecting your assets comes from careful risk management. 
3.      COMPARE THE POTENTIAL REWARD AND LOSS FOR EACH TRADE. Be certain that seeking that reward is worth the risk. For each trade, establish a profit target AND know the maximum sum that you are willing to lose. Remember that it is possible to lose more money than you plan because there are times when there is nothing you can do to hedge risk -- for example when the markets are poised to gap higher or lower. Thus, know your financial liability if the worst possible scenario occurs and have the discipline to get out of the position when your profit or loss target is met.
4.      WHEN YOU ARE SHORT AN OPTION, or when you sold an option spread, allow someone else to collect the last few pennies of profit by covering the short position -- before expiration -- at a low price.
5.      DEFINE YOUR COMFORT ZONE. Do not blindly accept the risk tolerance of another trader. A trade may be suitable for someone else, but that does not mean that it is suitable for you. Trade within your comfort zone -- especially as a new trader. Later, you will probably (slowly) expand that zone.
6.      Greed is not good.
7.      CONFIDENCE IS NECESSARY FOR SUCCESS. Fully understanding what you are doing leads to confidence. However, overconfidence may result in blowing up your account.
8.     ALWAYS KNOW HOW MUCH MONEY IS AT RISK. (Worth repeating). This applies to when you initiate the trade as well as to every day that you continue to hold the position.
9.      UNLIKELY EVENTS DO OCCUR. Do not seek tiny rewards, despite the high probability of success, unless the worst case scenario results is a small loss. Translation: Do not sell far-out-of-the-money options @ $0.05 to $0.15 with the belief that they will always expire worthless. If you ignore this piece of advice, every once in awhile, something bad will happen. That is how careless traders go broke.
10.  EXAMINE POSITIONS EVERY DAY AND DECIDE WHETHER THEY ARE WORTH OWNING AT CURRENT MARKET VALUE. This has nothing to do with whether the position is currently underwater or profitable. The trade should pass the simple test: Do you want to own this position today?

IRON CONDOR: PRE-TRADE CONSIDERATIONS

IRON CONDOR TRADING
There are several items to consider when using this strategy. You will discover that there is no blueprint for an exact, rule-based position that suits your needs. You can afford to be flexible when trading the iron condor.
UNDERLYING
Diversification is important for any investor, and especially when selling premium (i.e., collecting cash for an option spread). If you prefer to trade individual stocks, I suggest owning four or five simultaneous positions.  
I prefer to trade index options because that eliminates the risk of trading individual stocks which are always susceptible  to an unexpected news release.  Another benefit is that trading a single iron condor on an index makes it much easier to manage risk (i.e., adjust positions) -- if and when the market is undergoing a significant price change.