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Conversation with a misgudied options rookie

Today's post, is a follow-up to my earlier discussion with Larry.  My original thought was to reply to his comment/questions and let it go.

However, I consider this to be a good topic for a post because it shows how some people can grab onto bad information right from the beginning of their options education, and once off course, must be persuaded to stop what they are doing and try to re-learn what they already believe they know about options.

That's not so easy.  And it's even more difficult if they have been taking lessons and paying someone for all the bad information (I doubt that is what happened to Larry).

I truly sympathize and hope I can get him back to the beginning so that he can get it right this time.



Thanks for taking the time to answer my questions. Regarding puts, I need a little more clarification. Here is what I understand so far: Underlying stock price is $20. For a premium of $2, I buy an at-the-money put with the strike price of $20. The stock goes down to $15. I close the put and realize a net gain of $3 ($5 minus $2 premium). Right?

So here is what I don’t understand: I expect the seller of the put is hoping that the stock stays the same or goes up so that I do not exercise the put and sell or buy the stock. But if is goes down so that I want to exercise my rights under the put contract, it is not clear what happens.

When I exercise the put, the seller of the put parts with his stock, which he committed to selling at $20, but now is worth $15. Where does the $5 come from to fund my realization of gain? Out of pocket from the seller? He has the $2 of the premium, but it seems he has to make up the other $3 with cash.

RE: Selling covered calls: If the worst happens to the seller, namely that the price goes up and the call buyer exercises his option, it is not so bad: the seller did get a what once was fair price for the stock plus the premium. He might have missed out on some upside gain, but it was never really his, so the loss of said upside gain is not so painful.

RE: Selling covered puts, I assume they are covered, when the buyer of the put exercises the option, A.) the seller gives up the stock at a lower price and B.) has to also part with the difference between the strike price and the current price, in this case $5 ($3 cash and the $2 premium). It seems a lot more painful to experience an actual out of pocket cash loss than missing out on a potential gain. Am I close to understanding this?



You seem to have some ideas in place, but this disucssion of put options is discouraging.

You do not seem to understand what a put is, or which rights granted to put owners.  Let's handle your question in sequence.

1) Yes.  Stock is $15, your put is worth $5 (or more) and you realize a minimum profit of $300 ($3 per share).

2) You NEVER know what the seller of the put hopes for.  He may have a large position in which he makes a ton of money if the stock drops.  Just because you bought one put from that trader, don't think you know anything about why he sold that put.


He is committed to buying stock at the strike price of $20.  He/she does not sell stock.

In this scenario, he buys stock, paying $20 when it is worth $15.  He appears to have a loss.  But, depending on how he was hedged, he may have a profit on his whole position – even if he has a loss on this specific option.  None of this is any concern of yours.  And even if you deem it to be a concern, the information of his private transactions is not available to you.

3) Your gain is not $5, it is only $3.

4) Where does the cash come from? The person on the other side of the trade – in this case, the put seller, has a $3 loss.  Yes, he [in reality, it can be anyone who has a short position in that put.  Your connection to the person with whom you made the trade is severed as soon as the trade is made] has to come up with that $3.  Is this surprising to you?

For simplicity sake, just assume that the gain or loss was absorbed by the person with whom you made the trade.

5) Covered calls:  The worst that can happen is for the stock price to tumble and you lose a lot of money.

Your scenario of 'the worst that can happen' is actually the BEST that can happen.  It gives you the maximum possible profit for the chosen strategy. What I cannot understand is why you believe this is the worst case.

Would you rather make a profit that is less than the meximum you might have earned, or lose $1,000?  I think the choice is clear. This is important. This is a crucial concept.  You must understand this concpet.

If you believe that the best possible result is 'the worst that can happen' you must – I mean must – go back to square one and begin learning about options all over again.  This time use a different source to learn.  I suggest The Rookie's Guide to Options.

6) A covered put position consists of 100 shares of SHORT stock plus one SHORT put option. That is NOT the situation you are desscribing.  Long stock and short one put is not a covered put. 

a) The seller of the put does not 'give up' the stock at the lower price.  He/she must BUY more stock at the higher strike price.  This is the definition of a put option.  Do not shrug off this point.  It is essestial.

b) The put seller, and person forced to buy stock at $20 per share, does not have to part with any money at any specific point in time.  Yes, if that seller chooses to exit the trade at the point when he/she is assigned an exercise notice, then $3 per share is lost on the trade.  However, there is no requirement that the trade be closed at this time.

7) If this is truly a COVERED PUT, then the assignment, forcing the purchase of shares, offsets the original SHORT stock position for the covered put writer.


NO. YOU ARE NOT EVEN CLOSE. TO UNDERSTANDING.  Please do yourself a big favor and start all over again.  Do not skimp on time.  Read the most basic concepts about options.

Larry you can do this.  You just have some bad misconceptions and they can be unlearned – if you work with an open mind.


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Options Education: Course for Rookies

Options education is a topic that is near and dear to me.  I spend much time and effort helping readers understand how options work, rather than merely presenting a "do it this way" instruction manual.

The better that a trader understands the principles behind making intelligent trades and trade decisions, the better prepared that trader is to continue making good decisions on his/her own.

Options education is offered in several formats.  There are books, webinars, expensive weekend courses, individual (or group) mentoring, to name the most popular. 

Some people avoid the education process and prefer to pay others to suggest specific trades.  This is a non-starter for me.  I believe the trader must understand the trades being made and the rationale behind the trade.  Consider this:  How can someone pick trades for you and each of his/her other customers when that person has no idea of your investment goals, your risk tolerance, your investment time horizon etc?  It cannot be done.  Trusting your hard-earned cash to such 'trade pickers' is foolish at best.  It's okay to get suggestions, and then make the final decision on your own, but a basic understanding of options is required to make that judgment.

Blogs are a good source of information, with some, such as Options for Rookies, having education as the primary goal,  and others offering intelligent (or otherwise) commentary on a myriad of options-related topics.

Some information is free.  For example, most brokers provide education, usually in the form of written lessons or webinars.  The options exchanges also provide information as does the Options Industry Council (OIC).  Most blogs offer free content.

Other education requires payment of a fee.  Some courses are very expensive.  Some  are available at a more moderate cost.  The quality of the teachers, courses and the material taught runs the gamut from high to low quality and it's difficult to know what you are paying for, in advance.

I am preparing to enter this arena in a more formal manner.  My primary purpose is to fill what I see as a void. Potential option users ought to be able to

  • Get a good feel for options and how to use them
  • Decide if options trading fits into their investing style
  • Decide whether the investor can use options to hedge current and future investments
  • Understand risk and reward potential when using options
  • Learn all of the above at a very reasonable cost

We all acknowledge that options trading is not for everyone, but it should not cost an arm and a leg to discover whether options are a suitable investment tool.

And once the newcomer decides that options offer attractive opportunities, he/she should have an opportunity to get a sound, practical education at a reasonable cost.  The problem is that this newcomer does not know where to turn for help and is easily captured by television infomercials, full-page newspaper advertisements, or other hype on the Internet.  Impossible promises of success are touted, and the beginner has no idea that such promises are not going to be kept.  One such example is the 'promised' return of at least 10% every month.  As a result, many people who want to learn to use options pay large fees and are lucky if they find reputable teachers.

There's not much I can do to overcome the hype, but for people who make an effort to research education opportunities, I want to offer a basic course (plus other courses) that gives the new trader a better than average chance to succeed.  We've all heard the stories:  most beginning traders fail to make the grade.  I'd like to help increase the rookie's odds of becoming a winning trader, and to that end am developing a basic course for those option rookies.

If you are a regular follower of this blog, or if you have read The Rookie's Guide to Options, then you are aware of my teaching style, which includes the following:

  • Details
  • Explanations that make it easier to understand the basic concepts of options
  • Emphasis on risk management
  • Using examples
  • Repetition when necessary for emphasis
  • Replying to all questions

My plan is to construct a course that continues to do all those things.  Plus voluntary homework and optional tests.

I'm using today's post to request input from anyone willing to contribute. Suggestions, comments, questions are all welcome.  Please use the comment link below (all suggestions will be considered).


The beginner courses

I will begin by designing one (or more) course for rookies.  What should this course look like?  Here are some thoughts:

I. A multi-week, comprehensive course that provides a thorough introduction to options, including enough information for students to begin trading with confidence.  It would include all the material below, plus more.

  • Written lessons that look like lengthy blog posts or short book chapters.  Each focusing on a specific topic.
  • Video webinars that similarly cover one specific topic
  • Occasional live Question and Answer sessions.  The difficulty with 'live' sessions is that it's impossible to find a time that is suitable for everyone. A recorded session will allow those who cannot attend to view the content.
  • A special page (for course takers only) where questions, based on the course, can be posted.   'Regular' questions can still be asked through the Options for Rookies blog

Should the course include time for individual mentoring?  The feasibility of this idea would be based on the number of students in the class.

How long should this course run?  How many lessons? Currently, the plan is 13-weeks with four or five lessons per week.  Comments?

These last two items affect the cost.


II. Shorter courses, each dedicated to teaching one specific aspect of option trading

  • A thorough discussion of one specific strategy, soup to nuts. Inlcuding what to look for when initiating the trade, risk management suggestions and making plans to exit the trade.  One obvious course is: iron condors.
  • A general introduction to several strategies.  Enough to get you started using these methods (preferably in a paper-trading account), but  much less in depth treatment that the iron condor example mentioned above.  The benefit of this course is to give a rookie options trader a 'taste' of what can be done when trading options.  This course is truly not designed to be used as the gateway to trading.  It's designed to provide a better idea of where the student's interest lies.  Risk management would be discussed only briefly. 
  • How to design, write and maintain effective trading plans
  • Risk Management for option traders.  An introduction
  • Synthetic equivalents and how to use them
  • My philosophy of trading, as developed over the past 34 years

Intermediate Courses

III. What would an intermediate level course contain?

to be continued…


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