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The Rookies Guide to Options

Update May 9, 2013
The paperback version of the Rookies Guide to Options is no longer available. All copies have been sold.

A new, expanded 2nd edition should be available within the next several weeks.

Paperback

The Rookie’s Guide to Options is no longer available.

e-book (.pdf)

If you are interested in an e-book version of the FIRST EDITION (.pdf format), the PRICE is only $10. I use PayPal.

note: I do not expect an e-book version of the revised edition to be available anytime soon.

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Subscribe to mailing list

Options for Rookies is an educational blog, with an emphasis on information that is especially beneficial to the rookies trader. As steady readers know, we also post stories for the more experienced trader.

Today, for the first time, I’m asking readers to subscribe to my e-mail list.

It’s for special promotions or announcements. These messages will be sent infrequently.

Subscribing is a double opt-in process. Translation: When you request to be added to the list, you will receive one immediate e-mail. You must respond to confirm that you choose to be on the list. This double opt-in process protects you from receiving unwanted e-mail.

Messages to be sent

  • Updates on Options for Rookies Premium (set to launch on April 1, 2011)
  • Information on new books, should I ever have the time to write another
  • Special promotions
  • Other news of interest

My promises:

  • No spam
  • Your address remains secure and I will never divulge it to anyone for any reason
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Meet our Readers

Most of the time, I do not post over the weekends.  That gives me an idea, and I have no way of knowing whether readers will want to take part in this project.

If there is sufficient interest, I'm going to devote Saturdays to stories from you, readers of Options for Rookies.

Anything goes, as long as it is options related.  If you have stories to share – perhaps specific trades or why you became interested in trading options – please send them via e-mail: blog (at) mdwoptions (dot) com

DO NOT post submissions as comments.

Send a lesson learned, or something humorous.  Write about a lucky, frightening, or some other interesting trade. Perhaps you want to share your personal story describing how you got involved with trading.  All ideas welcome.  Feel free to mention other bloggers.

I know that I'm taking a risk that no one will respond.

Feel free to include your name and any information that you want published. Or send your story with a note stating you prefer to remain anonymous.

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Holiday Greetings

 

I wish everyone a joyous Christmas holiday.  May each of you find 2011 to be prosperous, healthy, and filled with the good things in life.

 

I'll be back Monday

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Options Crossword Puzzle

Something different today.

If you are are crossword fanatic, this puzzle will not please you.  It's not symmetrical and has many other flaws.

To compensate, there are prizes.

Rules

It's best to print the puzzle, fill it in, copy, and send via e-mail.

If that's impossible, send a list of correct words, in numerical order, across first, then down.


1) First correct entry wins a one year subscription to Expiring Monthly, a $99 value.  To learn more about the magazine, visit this page.

2) For those who don't see this blog early in the day, I'll offer the same prize to every 25th entry (note that's the 25th, 50th etc. entry, not just correct solutions), if that entry has the correct solution.

3) One entry per person.

4) Submission deadline: Aug 19, 2010 5AM Eastern Time (USA)

5) To enter, send e-mail to:   contest (at) mdwoptions (dot) com.

Please do not send to any other e-mail address.

Have fun.

 

 

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Puzzle_#1_Clues

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Contest: Win an Annual Subscription to Expiring Monthly

Bill Luby, at VIX and More is running a contest.  The winner receives a one-year subscription to Expiring Monthly: The Option Traders Journal.

To enter, submit an idea for Chart of the Week.  Instructions at Bill's blog. 

NOTE:  Deadline tomorrow, Sunday 6PM PT.

If you have been working with charts – and especially when you have be devising your own – this is an opportunity to share your ideas and perhaps win a nice prize and see your chart published.

Good charting!

***

Steve Sears, who writes The Striking Price for Barron's, wrote about Expiring Monthly in today's Barron's.


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The Truth About Stock: It’s a Call Option with a Zero Strike Price

Originally posted at The Options Zone


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When it comes to investments, most people have the idea that owning stock is a sound and prudent thing to do.  In fact, the Prudent Man Rule tells us that not investing a significant portion of one's assets in a diversified stock portfolio is imprudent.

Owning options is different.  Hardly anyone considers the strategy of buying options to be less than speculative.  To some, it's outright gambling.  In this discussion, I only mention call
options.  Why?  Traditional investors buy stock and probably never
consider selling them short.  Thus, a post relating to investing in
stocks must be from the stockholders perspective.  And that means owning
calls, not puts.

I don't like the idea of owning options as an investment, and never suggest that anyone invest that way.  The rationale behind my stance is that the vast majority of option buyers pay far too much in time premium, in effect placing a wager that the specific stock will move sharply higher soon, or before the option expires.  That is gambling and not investing.  A stockholder can afford to wait for his/her reason for buying the stock to be recognized by the market.  The individual investor who buys options cannot afford to wait as time erodes the value of those options.

For the small minority who have proven skills as a market timer, owning at-the-money or out-of-the-money options may prove profitable.  But buying those options is a trap for the average individual investor.

On the other hand, if a trader buys call options that are already in the money by several points, the picture is entirely different. These options have a high delta (75-85) and increase in value at a pace that almost matches that of the stock.  Obviously owning calls is less profitable when the hoped-for rally occurs. However the profit from that rally is 'good enough' when you consider that there is a big benefit that comes with owning these options.

In return for paying time premium, the call buyer gains a big advantage.  Specifically, loss is limited to the price of the call.  In a market downturn, instead of being exposed to a large loss (example, a $42 stock declining to $25), the owner of the call with a $35 strike price can lose no more than the option premium.  That amount varies depending on the stock's volatility and the remaining lifetime in the option, but it's likely to be in the $1 to $2 range, plus intrinsic value).

It's a trade-off that is not suitable for every investor.  But if you are willing to sacrifice a little upside potential in return for additional protection in a down market, these calls are suitable investments.  See a recent post on stock replacement.

If you heard of the strategy referred to as buying 'protective puts,' this is an identical approach.  Buying one put per 100 shares of stock is a method that is equivalent to owning the call option – with the same strike and expiration date.  When you consider trading costs, it's more efficient to buy calls than to buy stock and puts.

I am not trying to convince investors with long-term investment objectives to switch from stock to options.  My purpose is to compare stock with options and be certain that you recognize what you get when buying stock. 

Let's consider that $42 stock mentioned above.  It pays no dividend.  The table indicates the value of a 6-month call option, assuming the options trade with an implied volatility of 35.



Table 


Buyers of the 6-month 35 call option pay $148 per contract in time premium. Investors who hate paying anything for time premium may prefer the 6-month 25 call, which carries a time premium of only $29.  By buying this call with a lower strike price, you accept an additional downside risk of $1,000 per option.

For investors who insist on paying zero extra premium, and who are willing to take even more downside risk (but it's a small risk.  There is little likelihood that this stock can move below $25 – but it is possible) there's the 6-month call option with a strike price equal to zero.  Such options don't trade on any of the option exchanges, but they do trade on the New York Stock Exchange.  These options with a strike price of zero come with a bonus.  They never expire. They are called stock.

The point of this exercise is to illustrate that buying ITM options is not so different from buying stock.  I've seen brand new investors buy low-priced stocks for the simple reason that they cannot afford to buy higher priced stocks.  That's a big mistake.  It's much better to buy a few shares of a stock you truly want to own than being forced to choose from the universe of low-priced stocks.  That trader ought to understand that buying ITM $8 call options on quality stocks is better than buying $8 stocks.

A recent discussion with a reader prompted this post.  He is willing to invest cash in a stock position, but considers his option purchases to be speculative and uses far less cash when buying options.  That makes sense – from his perspective.  Without so-stating, it's clear: this trader buys low-priced ATM or OTM options.  The thought of owning deep ITM options instead of stock was not considered.  This post is dedicated to him and other stock owning investors.  Please keep in mind that call owners do not collect dividends and this discussion is targeted to non-dividend paying stocks.

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The two Mark's disagree over the idea of 'playing with house money" in the     Pro & Con column.

Tyler Craig contributes a guest column and offers his take on the popular strategy of writing covered calls.


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The Dilemma at Options for Rookies

A few days ago, when beginning a reply to [Here's the reply], I realized I had reached a turning point.

When responding, my goal is to move the questioner from a state of confusion to one of enlightenment.  That may be overstating my abilities, but it is the objective.

I'm trying to solve the reader's immediate problem and make it possible for the person asking the question to experience an 'aha moment' in which he/she now understands the answer.  I prefer not to provide a brief reply that offers only immediate gratification.  I'm hoping the reader can handle a similar situation the next time it appears.

I receive many words of appreciation, and the positive feedback is appreciated.

These loooong questions have become a problem.  They cannot be answered in a few minutes.  Look at the length of the aforementioned question:  It's a whole blog post by itself. 

As Options for Rookies grows in popularity, the number of comments and questions increases.  I love it and welcome every question.  But how can I find the time to reply when so many of the answers are complicated?  I must devote part of my work day towards earning an income.  And that's the dilemma.  My trading has become limited due the time devoted to the blog – and other writing.

I was told (very soon after I began this blog) that providing lengthy, detailed answers was going to get me into a pickle.  Well, it's happened. 

To date, I've replied to each question, whether it arrives via e-mail or through a blog comment (preferred method).  I no longer have the time to do justice to all.

One  solution is to reply to some questions and allow the others to go unanswered.  However, I owe a debt of gratitude to  each
of you as a treasured friend. 
I don't want to pass over your questions.

I don't know how to proceed.

ADDENDUM: Immediately after finishing this post (last week), another question arrived.  It was a good question about kite spreads and required more than one-half hour to reply.  I timed the reply (35 minutes) and came to a clear decision: The day is too short to reply to all questions.

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After due deliberation, I believe I found a viable solution.  Your input is sought.  No final decision has been made.

I. Options for Rookies continues with one change: 

  • All comments are welcome
  • I will respond to questions, if a couple of sentences suffices
  • Unless I deem the question of general interest and convert it to it's own blog post, I will not reply to questions that cannot adequately be answered briefly
  • Some unanswered questions will be answered as described below

II. Begin a membership blog:

  • New, special content will be included in the membership blog

After many requests from readers, I'll be following live trades.  More details on this topic – Monday, Feb 8, 2010

I'll experiment with live interaction with members, if I can master the technology (Upstream)

                Q & A sessions

                Mini-lessons or short webinars

  • Video posts of unknown content.  I don't know what to include here
  • Answers to some questions from Options for Rookies
  • Answers to all questions from Options for Rookies, if not overloaded with questions on the new blog
  • No Google ads to get in the way.  In fact, no ads, period.  A cleaner look.

When asking for a subscription, it's important to me that readers believe it's a fair and reasonable request.  Please participate in this poll:




If site is started, I guarantee: fee will never increase for a subscriber




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