CASH-SECURED PUT OPTIONS

SELLING NAKED PUTS
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.

OPTIONS FOR BUSY INVESTORS

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OPTION STRATEGIES FOR LONG-TERM 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.

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THE IRON CONDOR TRADER'S MINDSET

HOW THE IRON CONDOR TRADER EARNS MONEY
Every option strategy comes with the possibility of earning a profit. There is also the possibility of losing money -- and that represents the risk of trading. Whenever you initiate a trade, you should have some expectation of the likelihood of incurring a loss when seeking the potential reward.
Most traders have a market bias -- they initiate a trade when expecting that the overall stock market (or at least the price of the individual stock being traded) will move higher or lower. Such traders adopt a bullish or bearish strategy.
Other traders have no specific bias. They look at the market in one of two ways:
·         They have no opinion on market direction and by default, adopt market-neutral strategies.
·         They expect a non-volatile, non-directional market and elect to adopt market-neutral strategies.
The iron condor is one such strategy.
Definitions
·         Bullish Strategy: Earns a profit for the trader when the market moves higher.
·         Bearish Strategy: Earns a profit when the market declines.
·         Market-neutral Strategy: Earns a profit when the market trades in a relatively narrow range and all rallies and declines are small.
There is one other important consideration for traders:
Bullish and bearish traders earn money from market movement; i.e., they correctly predict whether the market rises or falls.
Market-neutral traders earn money from the passage of time -- but only when rallies and declines are small enough that they do not generate a loss that is larger than the positive time decay. Ideally, the trader waits for Theta to work its magic. 
How Does a Trader Make Money from the Passage of Time?
Options are wasting assets, and (all else being equal) lose value every day. Theta measures the decay rate.
Traders who buy options must have their market opinions come true -- sooner rather than later -- or else the options bought will lose too much of their value while the trader holds onto the position and waits for his/her prediction to come true. 
Option sellers don't have that problem. They make money every day -- unless the underlying asset (stock, ETF, index) moves too far in the wrong direction. [Call sellers do not want the stock price to rally and put sellers do not want the stock price to fall.]
Iron Condors: Risk and Reward
Let's examine a typical iron condor.
Buy 1 INDX Jan 16 '15 1240 call
Sell 1 INDX Jan 16 '15 1230 call (These two options form the call spread; premium $0.95)
Buy 1 NDX  Jan 16 '15 1110 put
Sell 1 INDX Jan 16 '15 1120 put (These two options form the put spread; premium $1.05)
Let's assume that the premium collected is $2.00 per share, or $200 for one iron condor. 
The Iron Condor Trade
The losing situation: When the stock moves too near the strike price of one of the options that you sold, its price increases rapidly and the iron condor loses money. Sometimes there is a good offset: If enough time has passed, and if the time decay is large enough to offset the entire increase in value, you may still have a profitable position. 
When the trade is not working
If the index (INDX) price nears 1230 (the short call option) or 1120 (the short put option), the corresponding spread gains significant value and the whole iron condor position would cost more to exit than the $200 collected when the trade was originated. As a result, the position is losing money or is "underwater." 

HOW TO TRADE A SPREAD

THE BASICS
Options are special. They are unlike other investments because they were invented (circa 600 BC) as a tool for reducing and managing risk. In other words, one person (the option buyer) pays for the right to transfer a specific risk to the option seller. The seller charges a fee (premium) and agrees to take on that risk in return for the cash.
Think of put options as being similar to an insurance policy whereby an investor can guarantee the value of a specific investment by purchasing a put option. As a reminder the put owner has the right to sell the underlying asset at a specific price (the strike price) at any time before the put option expires, thereby eliminating any further loss when the stock price is below the strike. That is very similar to how an insurance policy works. (If your house burns to the ground, you can sell it to the insurance company for the insured sum.)
When dealing with call options, in return for paying a premium to buy the option, the buyer gains all upside movement (above the strike price).
The seller accepts the risk of losing a large sum if the stock price surges. For example, if you sell the right to buy 100 shares of a given stock at $50 per share to another investor, then you must deliver that stock if and when the call owner elects to exercise his/her rights. If that stock is trading at $70, you must buy stock at $70 and sell it to the call owner at $50. That is a loss of $2,000 (minus whatever sum you collected when selling the option).
THE SPREAD
it is possible to gain protection against losing a large (essentially unlimited) sum when selling options. The way to do that is to trade a spread, rather than just selling calls or puts. The spread is a hedged (risk-reducing) position. Let's see how it works.
In addition to selling the call option, per above, let's assume that you also buy a call option on the same underlying stock, with the same expiration, but with a strike price of $55 per share.

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 WHY IT IS SO DIFFICULT
It has been documented that on average, individual investors lose money from trading stocks. The majority of losses can be traced to trading expenses. However, those costs do not tell the entire story. Individual investors tend to buy stocks that underperform and sell stocks that outperform the market averages.
A 2011 study looked at day-trader's profits and losses over a 15-year period and included something special: It traced the performance of the best and worst traders over a number of years, trying to discover whether successful trading is a "skill" or a random event. The conclusions: "The top-ranked day traders go on to earn money (after expenses) in the following years and the bottom-ranked day traders continue to lose money... Investor skill is an important feature in financial markets...The results of our analysis suggests that less than 1% of day traders are able to outperform consistently. Trading skill is rare."
He concludes that: "Thinking that you can be in the elite group of performers without substantial deliberate practice and experience is stupid. I know of several day traders who have enjoyed very long careers of consistent success. Every one spends significant screen time absorbing market patterns and working on their craft.
If you accept the evidence that short-term trading requires skills that are not easy to acquire, it becomes logical to ask:
Is there any reason to believe that you and I can do better with options?
ANSWER
I hope the bottom line is clear: A short-term trader in any market must have the ability to consistently predict market direction. Whether your holding period is 5 minutes, 5 hours, or five days, a short-term trader cannot afford to pay commissions unless he/she is accurate enough to come out with some cash -- after expenses are deducted. This remains an elusive skill for the vast majority.
Trading options does not help traders for one very important reason: The bid/ask markets are much wider with options than with stocks. A short-term stock trader can buy a position and sell it for a gain of a few pennies per share. But options are different. If you buy a high-delta, in-the-money call option (and that is the type of option that speculators should buy, in my opinion), the bid ask spread may be forty cents to one dollar wide. Thus, when you buy the option (at a price near the asking price) there is no chance to quickly sell it at a profit when the stock price rallies by those same few pennies. It would take a far larger change in the stock price. Why? Because no one will be willing to pay much above the bid price for your option. When the bid and ask prices are not near each other, any you buy near the ask price, there is no possibility of scalping (buying and selling for a quick profit) with options.
The same is true for spreads. To be able to complete a trade (buy and sell), the option trader must overcome the large price differential in the bid/ask prices. That money-losing phenomenon is known as slippage.
My conclusion: It is far more difficult to make money as a day trader when using options than it is with stocks. 
Don't give up on options 
There is no reason why anyone has to become a day trader. Option strategies can be adopted by traders who have longer time horizons -- perhaps a few weeks to six months. Such strategies include.

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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.