Sheridan Options Mentoring Blog |  |
| Manage By the Greeks Workshop – Lesson One Trade Update Posted: 03 Aug 2011 02:50 PM PDT
Dan first class for the new Managing By The Greeks Workshop is ready for you to watch! Click for more information about the class and to sign up for the class The next class is also FREE on Friday at 1:00 PM Central. |
| Posted: 03 Aug 2011 02:15 PM PDT Time to expiration, price of the underlying, implied volatility, historical volatility, puts, calls, delta, gamma, theta, vega, in-the-money, at-the- money, out-of-the-money, intrinsic value, extrinsic value, higher commissions, egregious bid/ask spreads, no options traded on a stock with a beautiful technical set up, multiple potential beasts and physiologies, LEAPS; why would one even bother with options? If I retain a shred of rationality, an open question to be sure, there must be some reason to complicate my life with these additional variables. Ronald Reagan was fond of making a point with the story of the 8 year old boy who while visiting his grandfather's farm fell into a pile of horse manure. When his father found him a short while later, the boy was smiling ear-to-ear and happily shoveling away the muck. When asked why, the son replied: "With this much poop, there must be a pony in here somewhere." Traders new to options often incorrectly focus on the ability to leverage positions, but in his classic summarization of this approach Jared Woodard of CondorOptions.com opines: But leverage, as anyone who's followed the fate of the investment banks knows, is just a means for magnifying outcomes. A leveraged risk-taker will experience more glorious wins and more disastrous losses, like a deranged person who shouts both poetry and obscenities (instead of whispering them quietly to himself, like the rest of us). The knowledgeable options trader uses the inherent flexibility of these derivatives in a variety of ways in order to achieve a number of advantages that are not available to the trader who limits his actions simply to trading equities. It is these additional benefits that represent the pony hidden in the muck of the additional complexities with which an option trader must become conversant. Before I sound too negative about these additional factors, it is important to recognize that while their understanding may take a little effort, the inclusion of these factors into a trade structure can dramatically increase the probability of a successful outcome. The stock trader has only two actions to initiate a position: buy or sell short. A direct result of either of these two actions is that he must correctly predict price movement in order to benefit. This inevitability is summed up in the classic maxim of the stock trader, "only price pays". The options trader has many more choices. Obviously, he can simply buy or sell individual options analogous to the stock trader. However there are far more potential structures for trades available to the knowledgeable trader. An options trader has far more potential position trade structures available for him to use in order to enhance the probability of a successful trade. The precise structure and use of these potential trade structures is beyond the scope of today's blog and will be the subject of future writings. Suffice it to say that option prices are impacted by a number of factors, the most important of which are the three primal forces ruling the world of options – price of the underlying, time to expiration, and implied volatility. It is the interplay of these three factors that provide additional profit opportunities for the educated trader. An additional important point that is often overlooked is the ability to crisply define risk in an options position. The current position of a stock trader, whether long or short, results in the entirety of his committed capital being exposed to a potential "Black Swan" event. Traders who confront risk rigorously realize that existing stop orders may well not protect a position. Losses well in excess of those projected by assuming that positions will be closed at the stop price can easily occur. Option positions are routinely designed to have an absolute maximum potential risk well below that which would exist for a similar position constructed entirely in stock. Perhaps we option traders are not quite ready for the asylum. Option trading volume continues to set new records. The pony has been found.
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