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Guest Blog: Important Trade Lessons

Options for Rookies New Home Page

Bill Burton
is a retired physician who practiced medicine in suburban Dallas for
over 25 years. He became interested in options in the late 1980's. Since
then, he's been perfecting his craft and focuses on equity and index
options over a short- to medium-term time frame, using both directional
and non-directional strategies. Bill contributes to the
options blog at

New Grooves on the Brain

The human brain is a wonderfully complex organ that is masterfully organized in both structure and function. To the observer first studying its anatomy, the most readily appreciable feature is the complex topographical organization of the external cortical surface of the frontal lobes, where higher levels of thinking occur.

The external surface is thrown into broad serpentine ridges (gyri) separated by deep narrow grooves (sulci). I always thought it an apt metaphor that knowledge gained by experience made the grooves more complex, much as the experience gained in life is often reflected in a deeply furrowed brow.

These things I learned the hard way:

  1. Ancient Chinese philosophers realized that with great danger often comes great opportunity. This nexus is further reinforced by the fact that the Chinese character representing both danger and opportunity is the same. Remember that only those who possess and use the necessary skills to survive the period of great danger are in position to profit from great opportunity. Risk control is paramount.
  2. The extrinsic (time) component of the option premium goes to zero at options expiration. Always.
  3. Although statisticians would argue, the probability of occurrence of an extremely unlikely event is much greater if you "bet the farm" on the event not occurring. Never forget that black swans do exist.
  4. The human brain is not inherently logical. It evolved for survival and is prone to make erroneous assumptions and draw incorrect associations. To guard against these potentially costly errors, continuously challenge your assumptions.
  5. Absence of proof does not constitute proof of absence.
  6. Thinly traded options are usually characterized by egregious B/A spreads. You may be able to negotiate acceptable spreads to enter the trade. You will not be able to do so if you need to exit. It is usually better to stay away from these snares.
  7. Option orders executed as spreads always receive better fills than individually placed orders.
  8. Failure to consider current IV in an historic framework for the particular underlying will usually cost money.
  9. Failure to follow predicted changes in volatility prior to a known event (e.g. earnings) indicates there is some factor of which you know not. When discovered, it usually impacts your position negatively.
  10. Failure to use and understand option modeling and option modeling software puts you at a significant competitive disadvantage to other participants in the options market. The only thing more expensive than having appropriate tools is not having them.
  11. It is stunningly easy to "roll more than you can smoke". It is usually disastrous to attempt to smoke all you rolled if you find yourself in these circumstances. This is another reason to model trades and crisply define risk.
  12. If you create multi-legged option beasts by manually entering the orders as opposed to entering from a graphical presentation, you will enter positions incorrectly and end up "upside down" and commit other similar errors more often than you thought possible. You must monitor the magnitude of extrinsic value when short options are ITM. Failure to do that and considering your trade plan in light of these developments, will result in unanticipated early assignment at the most inopportune times. Option positions can be easily adjusted to improve their structure only before they enter the ICU.
  13. Forgetting to honor time stops when holding certain varieties of option beasts can be as costly as forgetting price and/or P/L stops.
  14. Good traders know what they know; great traders also know what they don't know.
  15. If you don't understand the trade and its structure, you will lose money.
  16. Buying OTM options as a single position (as opposed to representing one of several legs of a spread) is almost always a bad idea.
  17. Keep your trade sheets tidy. Allowing short options with minimal value to remain on your sheets as opposed to closing them for trivial cost is not being frugal; it is denying the existence of unforeseen and unforeseeable risk.
  18. When trading options, as in life in general, you will make many errors. Each mistake contains a lesson. Study your mistakes and learn the lesson each teaches. You already paid for the instruction.
  19. Pickpockets prowl the option markets with great regularity. Their bread and butter trade is buying ITM options for less than the intrinsic value. Never sell an option for less than intrinsic value. Be aware of "Plan B" to capture the entirety of the intrinsic value.
  20. If all you have is a hammer, everything looks like a nail. The available option strategies are numerous and designed to accommodate a variety of market conditions. If you limit yourself to 1 or 2 strategies, you are not taking full advantage of the inherent flexibility of options. Learn several strategies, their nuances, and indications for their use.
  21. Avoid having open option positions on stocks that will split. Option trading has adequate complexities without dealing with non standard strikes and changes in contract size resulting from splits. Your head will explode trying to deal with these complications. Avoid them like swine flu; spend your energy elsewhere.
  22. Understanding the various concepts of volatility is essential for success. Volatility can be considered in light of:

    a. What was (SV, statistical vol; HV historical vol; different words and abbreviations for the same thing),

    b. What is,

    c. What shall be (IV, implied volatility, Market Implied Volatility (MIV); confusingly disparate words and acronyms signifying identical concepts)


    Of these three, IV is by far the most important. The nexus point is right here, right now. The future is unclear and always will be so. It is essential to understand IV and its various implications.

  23. Be relentless in your pursuit of perfection but accepting of the fact that you are human and will never achieve it.
  24. The first half hour of each day in the option markets is usually quite noisy; the predominant activity is fleecing the sheep. Don't be one of the sheep.
  25. Obfuscation of the basic concepts and structure of option strategies is the everyday business of the option community. The names of various strategies are multitudinous and confusing. Understand the concepts and be conversant with the various names of the strategies; success lies in analysis and execution not nomenclature.


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Guest Contributor at Bargaineering

Today I'm a guest contributor at Jim Wang's very popular and well written personal finance blog, Bargaineering.  Jim's work has been cited in the NY Times and Business Week.

The vast majority of passive investors are just that – passive.  The idea of combining option strategies with a passive investing approach may seem to be a contradiction in terms, but I believe the idea has merit.

All investors can benefit by owning stock market investments that are protected against large losses.  In other words – investments that are insured.  Collars are appropriate for passive as well as active investors.


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Interview with Adam Warner of The Daily Options Report

Today it's my privilege to conduct an interview with Adam Warner (agwarner on Twitter).  Adam writes the highly acclaimed and popular blog, The Daily Options Report.

He co-wrote the options
column on Street Insight from spring 2003 to spring 2005, and is
currently Options Editor at

When not writing, Adam is a proprietary option trader with Addormar Co, Inc.  He graduated John Hopkins University with a degree in Economics. 

Adam's blog is both educational and fun to read.


I see
that you have a lot of fun with your blog, Daily Options Report,
including posts on sports, bikinis, and making fun of Lenny Dykstra.  I
like that.  What made you include material of that sort?  How does
your wife feel about the photos?

The Dykstra
photo's? Not a big fan, too much chaw.

bikini's? That's probably what you mean.  She tolerates it I guess. I try to not
cross any lines. I honestly don't remember why I started doing it, but at some
point I noticed that if I popped on a chart I could literally hear the
tumbleweed blowing, then if I popped on Melissa Theriau I'd get 20 comments.


Then unfortunately I discovered there's a brand of bikini named
"ViX", and they run ads without quite attractive models……

Back to
Lenny. When I started writing him up, he was taken somewhat seriously in the
biz. He had recommendations on TheStreet, was on Fox's "Bulls and
Bears" et. al. But I could see in about 3 paragraph's that it was utter
nonsense. So it just started with pointing out the flaws in his early Deep Call
illogic. Ironically, his actual stock picks were not bad, though we later found
out he was just cribbing picks from Rick Suttmeier and then paper-buying Deep
Calls. And then doubling down if it went against him….and doubling
again…and….you get the picture. His representations became increasingly
fraudulent, so I suppose it's no surprise that his representations about
everything else way beyond options proved fraudulent as well.

It may have begun as fun, but the anti-Lenny campaign was a true public service.

I know
you were a market maker on the Amex.  How long were you there and how did
you get started?  Is this experience in any way related to what you
studied in school?

I started
as an MM on the AMEX in February of 1988, so managed to miss the crash.
Probably a fortunate thing because my first lessons were on the wisdom of
options selling, lol. In August '99, the exchanges started to dually list
everything and poof, there went our spreads [NOTE: The bid/ask spreads narrowed, due to competition]. But it was still the bubble, so it
was still a viable biz for a little while longer. But with tight spreads I just
didn't see the advantage staying in a trading crowd and taking the other side
of order flow. But on the other hand, I really loved the floor. But finally
gave in to reality and left in October 2001 and have traded off-floor ever

I was an economics major at THE Johns Hopkins
University. So just kind of tangentially related to what I studied.

You post
several times per day and are active on Twitter.  Do you have
enough time to do justice to your trading?  Do you watch the markets all

I've kind
of grappled with that. I'm a little ADD-ish, and literally can't stare at a
trading screen for long stretches of time. So I probably don't do justice to my

The writing kind of goes in spurts, and often off hours, so sometimes
I'll have a bunch of ideas after the close or early evening and then just pop
it out the next day, so maybe I don't write as much during hours as it appears.
The twitter I kind of like as a pseudo floor
experience. Some value-added and some-nonsense of course, but sitting at home
for work all day, it's a bit of a lifeline sometimes. I thought twitter was
kind of pointless at first, now I wouldn't want to be without it during the
work day.

I see that
your first book is about to be published by McGraw Hill and is titled:

Options Volatility Trading: Strategies for Profiting from Market Swings.
That must feel good.  Congratulations.

From Minyanville: "Options
Volatility Trading
educates novice to intermediate investors on the
nuances of the volatility index (VIX), the psychology behind it, and the best
strategies to employ during dramatic market shifts. It provides a solid
grounding in historical volatility patterns, distortions created by market
noise, and how to use tools other than VIX."

Do you have any pre-publication tidbits to share with the readers of Options
for Rookies? 

Well, as a measure of how great I find your site,
I've done this for 21+ years now and I still learn things reading info for
"Rookies". My book is a bit of compliment to the material you cover.
It's maybe "Options for Intermediates". I assume a basic knowledge of
options and options Greeks (although I do have a chapter on Greeks). Much is
similar to your material though, I discuss position management, different
strategies, et. al. A rather unpublicized area imho was the natural ebbs and flows
of the expiration cycle. So perhaps of interest are a few chapters on timing
certain types of options trades within the expiration cycle.

What gave you the idea to begin writing a blog, and when was that?

was really just a whim. I was writing for StreetInsight (which I believe now is
called Real Money Silver). I enjoyed it and liked all the people there, but it
was a bit of an expensive service and I kind of felt like I was writing in a
vacuum. It was 2005 I believe and blogs were just getting popular, so I figured
I'd give it a try. I emailed the random few I knew read me over on SI, and my
actual "break" came with a link from Charles Kirk (The Kirk Report) who at the time
was THE name in biz blogs. Still is probably. We've had contact over the years
and I'd also add he's about as nice as they get.
[MW: I confirm that The Kirk Report is a well-done, influential blog]

Do you have a favorite option strategy that you consider to be your 'bread and butter.' or do you stay flexible and trade based on market conditions?

I try to
stay flexible. In general I prefer selling options to buying, but reading you
and Condor Options and others, I tend to spread them and keep the risk
contained that way. I may end up with an Iron Condor, but I often leg it by
selling the put spread first and then sometimes leaving it at just that, or
sometimes legging a call spread short later.

There's much more to talk about, but that's more than enough for today.  Thanks Adam.

Adam's book


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How I Beat The Market And Bought A Candy Bar With My Profits; a Guest Post

Today, I'm pleased to present a guest post written by an excellent writer whose blog discusses a myriad of interesting topics.  I'm a loyal reader.

About the Author: Josh Hanagarne writes World’s Strongest Librarian, a blog with advice about living with Tourette’s Syndrome, book recommendations, buying pants when you’re 6’8”, kettlebells, old-time strongman training, and much more. Please subscribe to Josh’s RSS Updates to stay in touch. John resides in Australia.


A Librarian’s Perspective on Analysis Paralysis, or: How I Beat The Market And Bought A Candy Bar With My Profits

I got bitten by the stock bug a couple of years ago after
reading one of Jim Cramer’s books. It
came across the desk at the library and I just wanted to know what the bald guy
on the cover was screaming about. At the
time, I didn’t know about the show, which was for the best.

I got excited while reading the book.  The thought of making money in the market
sounded really, really nice. So, as any
respectable librarian would, I started doing some research. You don’t do things without educating
yourself, right?

I wanted to make an informed decision before I started
throwing what little money I had into the whirlwind.

So I began educating myself.

A Common Character

I know a lot of writers, bloggers, powerlifters,
bodybuilders, and professional strongmen. These groups all share a common characteristic—successful members of
these clubs attract hordes of newcomers who blaze with enthusiasm before they
realize how hard and thankless the work can be.

The books and gurus pump them up, they vow to knuckle down
and get after it, and they do…for a while at least.

When the initial passion subsides, many of these people
convince themselves that what is required is further study. Unfortunately, it is easy to convince
yourself that reading about writing is actually writing.That reading other blogs is “research” for your
own blogging. That reading a book about
isometrics is making you stronger.

The “Preliminary”Reading

Here was my reading list before I convinced myself I was
“ready” to jump into stocks:

Mad Money

The Little Book That Beats the Market

Against The Gods

A Random Walk Down Wall Street

The Only Investment Guide You’ll Ever Need

After that last one, I thought: okay, I’ve got to be ready.  So
I got an account on Sharebuilder and Scottrade.

Then, instead of investing, I read:

Hundreds of Articles on Morningstar

Lots of charts on the library’s expensive Value
Line database

Tons of archived articles on Investor’s Business

Something else Jim Cramer wrote

A few thing by the Motley Fool guys

The Five Rules For Successful Stock Investing

One Up On Wall Street

The Intelligent Investor

Rule #1: The Successful Strategy For Successful
Investing in Only 15 Minutes A Day

And then, I was ready. 
Sort of.

I closed my eyes, spun in a circle, gritted my teeth, and
bought three shares of Research In Motion just like everyone else was

It did really well for a while, but eventually I sold it in
time to make about $5.00.  Thrilled by my
cunning, I went and bought a King Sized Twix and savored it to death. 

What I Learned

After talking with friends and family members who are more
involved in the market than I am, I learned that they either:

Invest in unsexy stocks that grow over time or chase things
that are sexy at the moment.  A lot of
people tend to do that all at once, which I learned can create its own

Regardless, it was the people who acted who had something to
show for it, whether it was a financial profit or just a hard lesson learned.

Even calling me a beginner is generous.  But my limited experience has convinced me
that like anything else, investing can be over-analyzed.  There can only be so much hand wringing
before you admit you’re just stalling, even when the stakes are high.  If an ER heart surgeon debates for too long,
the results will not be good for anyone involved.

The risk of losing money terrifies me, but reading about
investing without really committing around to it felt like a waste of
time.  That’s on me. 

But it was better for me—better emotionally, mentally, and
fiscally– to waste my time than to potentially waste my money.  That’s why I’ll never have a mansion.  That’s why I’ll always be a beginner.  Because when something is uncomfortable to
me, analyzing it is easier than doing it.

Study gets you just so far, and then you’ve got to
choose.  The choice will be different for
anyone, because we all think in very different ways.  The pendulum of common sense and reason
swings far indeed.

But man that candy was good.


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Guest Blogger at Canadian

Larry MacDonald who writes the Canadian Capitalist was kind enough to invite me to write a guest blog.  It was published today and offers a brief argument for conservative investors to adopt a collar strategy.


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Guest Blogger at The Oblivious Investor

Today I am guest blogger at The Oblivious Investor.

Mike and I have been having a friendly discussion.  As the name of his blog and book indicate, he is a passive investor and uses prudent methods for maintaining a safe and growing portfolio.  I suggest adding the extra protection (and profit limitation) of collars to that mix.

Feel free to join in the conversation.


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Barron’s: The Striking Price, Guest Columnist

Today I'm guest columnist for The Striking Price column in Barron's.  I thank Steve Sears and Barron's for graciously giving me this opportunity.

The piece is titled:  "The Greek Alphabet Soup of Options"



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Guest Blogger

Harriet Johnson Brackey, personal finance writer for the
South Florida Sun-Sentinel, has been an award-winning business reporter
for more than two and a half decades.

Her blog is entitled: It's Your Money.  She invited me to be a guest blogger on the continuing discussion of the controversy over whether short selling should be banned.


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