Essential Option Strategies Understanding the Market and Avoiding Common Pitfalls

Essential Option Strategies is an introductory guide to options trading, designed to help new options traders better understand the market and the potential opportunities that exist. This book is designed to bring you up to speed with current practices and help you implement your own option trading strategies. You'll create a plan, track indicators, and understand underlying instruments, then apply that central investing knowledge directly to the options market. The discussion on pricing determinants and probabilities uses an intuitive approach to complex calculations, providing clear examples with no advanced math required, and extensive explanation of spreads, butterflies, and condors brings advanced strategies down to earth. Easy-reference appendices clarify the Greek terms and technical analysis charts, while focused discussion and expert insight throughout provide a highly informative crash course on options trading. 

Options trading has undergone a rapid evolution beyond stocks and commodities into asset classes including fixed-income, precious metals, energy, and more. This book helps you build a solid foundation in the fundamentals, giving you a knowledge base that applies no matter how the instruments change. This book is designed to help you:

• Understand the options market inside and out
• Avoid common mistakes
• Learn some basic positions, and trades
• Read charts and interpret probabilities

Once the domain of the elites, the options market has been thrown wide open thanks to real-time price quotes, through brokerages, and the free flow of information online. The process of buying and selling options contracts is faster and more efficient than ever, and Wall Street is facing stiff competition from independent analysts and financial websites. As much as the market has changed, the fundamentals are the same?and Essential Option Strategies aims to provide expert guidance throughout the learning process.

Foreword xiii

Preface xv

Acknowledgments xix

About the Author xxi

Part I Getting Started in Investing 1

Chapter 1 The Opening Bell 3

Probabilities 4

Getting Started 5

Research 6

Data 9

Charts 11

Commissions and Fees 13

Virtual Trading Platforms 14

Summary 15

References 15

Chapter 2 First Days of Trading 17

Brief History of Stock Market Averages 17

Key Market Indexes Today 19

The Volatility Index 21

Futures 22

The Bond Market 25

Fed Watch 26

Economic Indicators 27

Earnings 28

Find Your Niche 29

Summary 29

References 30

Chapter 3 Know the Underlying 31

Where Do Options Trade? 32

Stock Talk 34

Exchange-Traded Funds 38

Short Selling 40

On the Margin 41

Summary 41

References 42

Chapter 4 Avoiding Mistakes 43

Position Size 44

Volume and Liquidity 44

Order Entry Techniques 46

Understand Risk 48

Summary 51

References 51

Part II The Options Market 53

Chapter 5 Options Basics 55

Stock Options 57

Option Value 61

Exercise and Assignment 62

Volume and Open Interest 64

Index Options 65

Summary 66

References 67

Chapter 6 Introduction to Call Options 68

Call Options versus Stock 69

Risk and Reward of Long Call 70

Real-World Example 72

Short Calls 75

Index Call Options 78

Summary 82

Reference 82

Chapter 7 Introduction to Put Options 83

Long Puts versus Short Selling 84

Risk and Reward 84

Real-World Example 86

Protective Puts 89

Index Put Options 92

Summary 94

References 95

Chapter 8 Components of Options Prices 96

Delta and Other Greeks 97

Strike Price 98

Theta and Time Decay 100

Vega and Implied Volatility 100

Dividends 103

Rho and Interest Rates 104

Put-Call Parity 105

Summary 108

References 109

Chapter 9 Probabilities 110

Probabilities 101 111

Probability of Profit 112

Probability of Touching 113

Example 114

Delta to Measure Probabilities 119

Summary 121

References 121

Part III Strategies and Positions 123

Chapter 10 Covered Calls 125

The Covered Call 125

Example 130

Summary 133

References 134

Chapter 11 Cash-Secured Puts 135

Short Puts 136

Example 138

Summary 142

Chapter 12 Long Vertical Spreads 143

Bull Call Spread 144

Example 147

Bear Put Spread 152

Example 153

Summary 157

Chapter 13 Short Vertical Spreads 158

Short (Bull) Put Spread 159

Example 162

Short (Bear) Call Spread 167

Example 168

Summary 171

Chapter 14 Calendar Spreads 173

Call Calendar Spread 174

Example 177

Put Calendar Spread 181

Example 183

Summary 187

Chapter 15 Butterfly Spreads 188

Butterfly Spread 189

Example 191

Iron Butterfly Spread 196

Example 198

Summary 201

Chapter 16 Condor Spreads 203

Condor Spread 204

Example 205

Iron Condor Spread 209

Example 210

Summary 214

Chapter 17 The Close 216

Risk Management 216

Options Orders 218

Using Options to Reduce Capital Commitment 220

Rolling with Spread Trades 222

Investing and Social Media 223

Final Thoughts 224

Appendix A The Greeks 227

Delta Defined 228

Delta Neutral 229

Gamma 230

Theta 231

Vega 231

Rho 234

Reference 234

Appendix B Strategy Recap 235

Long Call 235

Short Call 237

Long Put 238

Protective Put 239

Covered Call 241

Collar 242

Cash-Secured Put 243

Long Call Spread 245

Long Put Spread 246

Short Call Spread 247

Short Put Spread 248

Call Calendar Spread 250

Put Calendar Spread 251

Call Butterfly Spread (Long) 252

Put Butterfly Spread (Long) 253

Iron Butterfly 255

Call Condor Spread (Long) 256

Put Condor Spread (Long) 257

Iron Condor 259

Quick Strategy Guide 260

Appendix C Charts and Volatility Studies 265

Stock Charts 101 265

Time Frames 267

Volume and Volatility 269

Glossary 277

Index 295

JJ Kinahan is Chief Strategist and Managing Director for TD Ameritrade. A thirty-year trading veteran and a Forbes contributor, he began his career as a Chicago Board Options Exchange (CBOE) market maker trading in the S&P 100 (OEX) and S&P 500 (SPX) pits. After leaving the floor, he joined thinkorswim, later purchased by TD Ameritrade, where he led initiatives on trading tools and education for retail clients.