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.

USE OPTIONS TO EARN PROFITS MORE OFTEN

OPTIONS ARE YOUR FRIENDS
I exchanged e-mails with a new trader who wanted to discuss his trading strategy. He uses technical analysis to decide which stocks to buy/sell -- and has been losing money. He asked about using options. The following is a major part of my reply.
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.

BINARY OPTIONS EXPLAINED

A Binary Option is more like a wager with a bookie than an investment tool. Nevertheless, binaries are advertised as a method for traders/investors to make money from a correct prediction on the future price of a stock-market index, commodity, or currency pair.
The payoff is all or nothing, but the payoff is too small.
The typical bet with a bookmaker requires the bettor to risk $55 for the chance to win $50.
That represents a payoff of 91% ($50 ÷ $55).  The best payoff I could find for binary option trading platforms is 85% (for some trades), and other platforms offer much lower payoffs.
From my perspective, betting on a football game is similar to buying a binary option. If you want to wager that your favorite team will defeat (after adjusting the final score for the point spread) its main rival, you can buy a call option on your team.
·         It your team wins (after accounting for the point spread), the option is "in the money" and the bookie owes you $50.
·         It your team loses, the option is "out of the money" and you owe the bookie $55.?
BINARY OPTIONS ARE EUROPEAN STYLE AND THAT MEANS
·         They cannot be exercised before expiration arrives (i.e., until the game has ended). 
·         They are settled in cash.
That is all there is to a binary option. Pretty simple stuff.
However, some trading platforms (the online website where binary options are traded) accommodate traders who require simplicity and do not allow binary options to be sold. By offering a binary option on both the "over" (the stock price will be equal to, or above, the specified price at the cutoff time) and the "under" (the stock price will be below the specified price at the cutoff time), there is no need to sell binary options.
Binary Options -- compared with stock options -- are probably easier for some traders to understand. And that's not good for inexperienced traders who tend to trade first and ask questions later.

NAKED OPTIONS AND RISK

When you anticipate that a stock (or index) will undergo a bullish or bearish price change, there are several (very basic), limited-risk, option strategies that you can adopt. These involve buying option premium.
·         Buy calls or call spreads when bullish.
·         Buy puts or put spreads when bearish.
The more experienced trader may also want to consider selling option premium in order to collect time decay (Theta is one of the Greeks that helps traders measure and manage risk).
·         Sell call spreads when bearish.
·         Sell put spreads when bullish.
·         Sell naked (cash secured) puts when bullish -- but only when you are willing to own shares of the underlying stock.
NOTE: The more sophisticated reader knows that buying a call spread and selling a put spread are equivalent positions (with essentially identical profit and loss parameters) when the underlying asset, strike prices, and expiration are identical.
Likewise, selling a call spread and buying a put spread are equivalent positions. 
Selling naked (unhedged) call options is considered to be too risky for most investors for two very sound reasons:
1.    The sum at risk is theoretically unlimited, and too many inexperienced investors destroy their trading accounts when adopting this strategy. Thus, very few brokers allow their inexperienced traders to sell naked call options. It is just as easy to go broke when selling naked put options, even though most brokers allow their customers to adopt this strategy.
 2.    Careful, skilled risk management is mandatory. It is very difficult for the novice trader to realize how unprepared he/she is to handle the risk associated with being naked short call options as the price of the underlying asset rises day after day.
Advice: If selling naked options is attractive to you (I shudder), please be certain that you sell an appropriate quantity of option contracts. Unexpected market events occur far more often than statistics predict -- and you must never own a position so large that it can jeopardize your entire brokerage account when one of those events does occur.
P/L Graphs illustrate Ultimate Risk
Buying options: Gains are unlimited whiles losses are limited to the cost of the options bought.
Risk Graphs: Buying calls and buying puts.
Buying spreads: Both profits and losses are limited, but the potential loss is reduced when compared with the strategy of buying options.
Risk Graphs: Buy call spread;  buy put spread.
Selling spreads: Selling call spreads;  selling put spreads.
Naked Options :  Selling naked calls;  selling naked puts.

MORE IRON CONDOR BASICS

Opening and Closing the Position
USEFUL TERMINOLOGY
When you own an iron condor position, there are four different options in the position: It is important to describe a position because it is far too easy to enter a trade order incorrectly and therefore you must be able to tell your broker which specific options to buy and sell. There is more than one way to accomplish that:
An iron condor position consists of two call options and two put options.
·         You can describe the put portion of the iron condor as follows:
·         You sold a put spread. 
·         You own a put credit spread.
·         You own a bullish put spread.
·         Each of these terms describes a position where you bought a less expensive, farther out-of-the-money put option and sold another put  option (same expiration and same underlying asset) that is more expensive and less far out of the money. You collected cash when trading these two different put options.
·         You can describe the call portion of the iron condor as follows:
1.       You sold a call spread. 
2.      You own a call credit spread.
3.      You own a bearish call spread.
Each of these terms describes a position where you bought a less expensive, farther out-of-the-money call option and sold another call option with the same expiration, on the same underlying asset and which is more expensive and less far out of the money. You collected cash when trading these two different call options.
 The most efficient method for entering an order to trade an iron condor is to find your broker's method for trading iron condors on their trading platform. Call customer service if you have any difficulty. Your plan is to enter a single order with the following information:
·         The specific options that you plan to buy and sell
·         The quantity of each option to trade. It should be the same number for each of the four options
·         The minimum net cash credit (that is the limit price, making this a 'limit order') that you want to collect when trading one-lot of each of the four options. Never enter a market order.
EXAMPLE: 
Sell 5 XYZ Nov 100 calls
Buy 5 XYZ Nov 110 calls
Sell 5 XYZ Nov 80 puts
Buy 5 XYZ Nov 70 puts
·         Never indicate the price at which you prefer to buy or sell any of the individual option because the only number that matters is the total cash that you want to collect when trading a 1-lot of each option. Always enter an order stating the minimum price (premium) that you will accept when entering an order that nets a cash credit, and a maximum acceptable price when paying cash. Never enter a market order. Never enter a market order. Never enter a market order.

PIN RISK

AN EXPIRATION CONCERN
Option sellers who hold their short positions until they expire understand the basics: An option owner has three choices. As a result, the option seller can expect:
·         The option owner to exercise his/her rights and (as the option seller) to be assigned an exercise notice whenever the option is in the money when expiration arrives.
·         To see all out-of-the-money options expire worthless.
The astute reader may ask what happens when the stock closes exactly at the strike price on expiration Friday.
When that happens the stock is said to be “pinned” to the strike and it represents uncertainty for the option seller. Note that the option owner has no such uncertainty because he/she has the decision-making power and may exercise the options or allow them to expire worthless. The option seller (who does not cover the short option) must wait for the option owner's decision.
That is where uncertainty (risk) comes into play.
Most of the time when the stock is pinned to the strike price, the person who owns the option chooses not to exercise and the option expires worthless. However, there is times when the option owner must exercise in order to maintain a long (or short) equity position in his/her portfolio. In addition, market makers often exercise ATM options at expiration in order to remove all risk of owning positions that are too long or too short. It is acceptable for any big trader to be short 10,000 shares of stock, hoping for a decline -- as long as he/she owns 100 calls to mitigate upside risk. When the stock get pinned to the strike price of those 100 options, the trader must exercise all 100 calls to cover the short stock position.
That trader cannot afford to take the risk associated with holding the short position over the weekend. These situations are not rare, so do not be surprised when you are assigned an exercise notice on an option that you thought would expire worthless.