Options Trading: “Getting the hang of it”

When visiting an online forum, I recently found a comment from an option rookie.  He mentioned that he has a little experience with options and that he is beginning to 'get the hang of it.' 

[To the portion of our audience that hails from abroad, the phrase is an idiom  meaning that he starting 'to understand how it works']

I must confess that I shuddered when reading that comment. It's true that study and practice increase one's skill level when trading options, but no one should be investing with real money before understanding what he/she is doing.

But there's more to it than that.  I lack additional details, but I believe what this investor was trying to say is that he was occasionally earning a profit from a trade, and not losing money on every trade. 

Most investors who enter the option arena begin by buying puts or calls, based on an opinion on which way the stock is going to move next. 

They lack the education to know which options to buy and which to avoid.  They don't understand anything about implied volatility or how to gauge whether the option being bought is fairly priced or too costly.  They don't fully understand that the passage of time can quickly destroy the value of their options.  Yet they trade, using real money.

"Beginning to get the hang of it" is just not enough.  I usually express that idea in these words:

Learn first.  Trade later.

***


Dr. Brett
always has something intelligent to add to any discussion:  "Trying to jump from initial learning
of trading skills to actual trading is like making the transition from
diagramming a pass play on the blackboard to running it in a football
game."

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7 Responses to Options Trading: “Getting the hang of it”

  1. Tyler 12/15/2009 at 9:39 AM #

    Hey Mark,
    My understanding of how dividends affect option prices has always been a bit fuzzy. Someone asked me this question the other day and I wasn’t sure of the answer. TRA (Terra Industries…)issued a $7.50 dividend yesterday causing the price of their stock to gap from $43 to $35 and change. Although the stock chart shows the price now around $34, the option chain is still pricing the December options as if the stock is still around $43. Say someone is short the Dec 38 puts. Based on the option chain, they still look and are priced as if there OTM (current price = $.10). In addition it looks as if there are some months still pricing based off of the old pre-dividend price and others pricing off the new post-dividend price. Can you shed some insight on this? Thanks!

  2. Tom Clark 12/15/2009 at 9:42 AM #

    Mark,
    Just thought I’d drop you a line and say thank you. I dedicated one of my IRA’s to a covered call program last December after reading your book “Create Your Own Hedge Fund”. I guess it was the right book at the right time. I used the ETF’s SPY (70%-80%) & QQQQ (10% – 20%) exclusively to write monthly calls. The only twist I added was to write calls against the quarterlies as well in March, June, Sept & Dec. After one year the account is up just a tad over 30%. I am really getting in tune with the once a month trade and then taking a hands off approach until expiration.
    I have since bought & read your other books but I think the Hedge Fund book was the best for me. I’m now starting to experiment with small diagonal spreads using SPY in another account as well as some CC’s against individual stocks which make me appreciate the lower volatility of the ETF’s while still satisfying the trader that still lurks within me. You really have to get a little “skin in the game” to feel all the nuances of any option strategy.
    I appreciate your spreading the word, keep up the good works.
    Tom Clark
    Burlington, NC

  3. Mark Wolfinger 12/15/2009 at 10:11 AM #

    This is not a typical dividend, and options pricing is ‘special,’ and the options that existed prior to the ex-dividend date become ‘non-standard.’
    The CBOE has a detailed list of what must be delivered when a call or put option is exercised.
    The exerciser of a call receives 100 shares of the stock plus the cash value of the dividend. For example, the owner of a Dec 36 call pays $3,600 and gets 100 shares (currently priced near $34) plus that $750 dividend.
    The owner of a Dec 38 put (your example), collects $3,800 (if dumb enough to exercise) and in return, delivers 100 shares of stock plus that $750 dividend.
    Normal, regular dividends are very different.

  4. Mark Wolfinger 12/15/2009 at 10:15 AM #

    Thanks Tom,
    I just want to be certain you understand that covered call writing is a bullish strategy. I congratulate you for doing well, but bear markets may not be so kind. Stay alert.
    Best regards

  5. Tyler 12/15/2009 at 11:17 AM #

    Thanks Mark!

  6. Jesse 12/16/2009 at 4:06 AM #

    Mark,
    Thanks for explaining “Getting the hang of it”. You really take care of all your audience.

  7. Mark Wolfinger 12/16/2009 at 8:02 AM #

    Thanks Jesse