Introduction to Options Made Easy: Your Guide to Profitable Trading
- Criteria for Successful Investing
- Risk Profile Charts
- The Definition of an Option
- The Valuation of Options
- Intrinsic and Time Value for Calls
- Intrinsic and Time Value for Puts
- The Seven Factors that Influence an Option’s Premium
- Risk Profile Charts for Call Options
- Risk Profile Charts for Put Options
- Memory Tips for Long and Short Calls and Puts
- Basic Risk Profiles Summary
- Chapter 1 Major Learning Points
This chapter is from the book
This chapter is from the book
This chapter is from the book
Why is it that options are so misconceived as a minefield of danger and risk? How can we make sense of this and look at options as tools to limit our risks, maximize our returns, and SEE WHAT WE’RE DOING at the same time? This is the essence of OptionEasy and this book—how to make seemingly complex things simple.
Options are becoming more and more popular each day. Far from being confined solely to the institutions and professional money managers, options trading is now a worldwide phenomenon for "retail" traders of all walks of life. The concept of options is still, however, treated with fear and trepidation in some quarters. When I first embarked upon serious trading, one of my friends warned me profusely about what I was getting into. I calmly pointed out that I wasn’t a gambler and that I would be perfectly safe and successful. And so can you.
Criteria for Successful Investing
- patience
- perseverance
- knowledge
- honesty
- pre-planning
- discipline
Patience
Learning that you can make a lot of money on the markets is one of the most exciting moments you can experience in your professional life. A whole new world of possibilities opens up before you as you begin to imagine your dream house, car, boat, and vacations with your family. I’ve seen people get so excited after just one little seminar that they actually started trading right there and then. Not smart! Give yourself some time to get used to the idea. And never start trading on an emotional wave of any kind whatsoever. You need to be switched on, alert and calm. Many workshops give you the emotional high but without the substance of real experience (and sometimes many other things, like knowledge!).
Think about it this way. Would you consider yourself able to do brain surgery after just one conference? Well, in a different context the same applies to trading, and even more so for options trading (although the same principles apply). Give yourself time to learn. By reading this book, you are doing just that, giving yourself a learning opportunity. By now, you’re probably used to trading stocks or futures in the markets. So now is the next step. And just as you had to get comfortable with trading stocks or futures at first, you also now have to get comfortable with trading options.
I’ve seen people get so excited after just one little seminar that they actually started trading there and then. Not smart!
Furthermore, when you are comfortable enough to trade, you need to have an abundance of patience to do the trading itself. We’ve all had the experience of jumping into an investment too early even when we weren’t quite convinced it was the right thing to do. Be patient, take a deep breath if you have to, and stick to your plan of action.
Finally, patience also involves selecting a trading strategy where time works in your favor and where your downside is covered. Be patient in your attitude to acquiring wealth. The more patient you are in this way, the better off you will be. This doesn’t mean sitting back and doing nothing—that’s apathy, not patience! Give yourself time to learn, gain experience and then start to apply consistently time and time again so that you begin a process of making money and building wealth.
Consistent with the art of patience is your embracing the concept of compounding. If you can make just 1% per week, this would mean more than 67% in just one year, a record of which any fund manager would be envious. The following table illustrates the power of compounding if you start with just $10,000 in your account:
|
Weekly Return % |
Monthly Return % |
1 year |
2 years |
3 years |
3-year return % |
|
1% |
4% |
$16,777 |
$28,146 |
$47,220 |
472% |
|
2% |
8.24% |
$28,003 |
$78,418 |
$219,597 |
2,196% |
|
3% |
12.55% |
$46,509 |
$216,307 |
$1,006,021 |
10,060% |
|
4% |
16.99% |
$76,866 |
$590,836 |
$4,541,517 |
45,415% |
|
5% |
21.55% |
$126,428 |
$1,598,406 |
$20,208,201 |
202,083% |
This table is simply here to convince you about the need to be patient. Allow your returns to accumulate, and let the magic of compounding do its work for you. We’re not suggesting these as consistent, realistic growth targets for you, but it helps to see where you’d be in three years even if you were succeeding with modest returns.
Perseverance
Keep going for it! If there’s one thing I’ve learned in life, it’s that if you believe in something you have to keep at it until you reach your goal. And once you’ve reached your goal, then set another target.
Having embarked on the mission of becoming a successful trader (whether full-time or part-time), you must stick to it. Anyone can do it. Even those who don’t think they can. Babies don’t give up trying to walk or talk after a few unsuccessful attempts, do they? Well, follow their example and now you’re here, stick to it and prepare yourself to be rewarded richly from this process of learning.
To be practical, give yourself attainable targets to reach in a realistic time frame. So by next week you’ll be fully familiar with the four main options risk profiles. You may be able to do it tonight. Keep on setting the attainable targets (do make them a slight challenge, though!) and in this way you’ll be able to keep up the momentum of learning and gaining experience. You’ll also start to build up your confidence as you go along, reassuring yourself of your ability to understand anything you put your mind to. This book will help you in building your confidence because it’s a practical book and it’s easy to follow and understand. So keep going and enjoy the process of accumulating. . ..
Knowledge
Having established the need for patience for both acquiring the knowledge and for trading itself, let’s remember that knowledge is attainable now with such ease and speed that it is eminently achievable in a reasonably quick time. Tools exist now to simulate the trading experience, and there are myriad publications and web sites designed to help you build up your knowledge database.
The best knowledge you will ever get is experience. It’s all very well to say, "trade mechanically," but very few people do. Why? Because we’re human beings and have emotions and feelings. It’s true to say that they are best left away from the trading environment, but we have to learn how to do that first. It’s no good just saying, "Do it!" Moreover, why can’t we use our feelings and emotions to our advantage? Well, we can, and that’s what we discuss in Chapter 10 on trading psychology.
Remember that learning is experience-based. We can all remember the most extreme of our teachers at school, right? You can recall the funniest, the scariest, the prettiest and the ugliest, but I’ll bet you have a problem remembering anything about the teachers who were somewhere in the middle—those who barely made an experiential impact on you in years of being in the same classroom!
The same applies to trading. A lot of the learning involved in trading is experience-based. In fact, the most pertinent form of learning about trading is experience-based. It’s through the extreme experiences that you find more out about yourself in good times and bad. Most brilliant traders have had terrible experiences but, crucially, have stepped back up to the plate and applied what they had learned. Just like me. I made a lot of money very fast, thought I was "the don" (tut-tut!) and then gave some of it back again! Believe me, then I didn’t feel too good at all, but did I learn! And more importantly, did I apply those lessons? . . .you bet I did!
So, remember, learning is based on experience, so allow yourself to get experience, which is what this book and our workshops are all about—building experience. As you continually acquire experience, apply it consistently, continually, and carefully.
Honesty
You must be honest with yourself if you’re to develop into a decent trader or investor. A company has not made you make or lose money, so part of being honest is to cut out the emotions of trading. Ultimately, your decisions are down to YOU! No matter what you were taught, even if it was by someone who had no right to teach, you’re the one who’s in control, and when you look in the mirror, make sure you’re being true to yourself. I’ve always found that blaming other people never really helps, and in trading you’ll save yourself a lot of time if you can apply this lesson fast. Blaming the stock or the teacher or tipster only wastes energy and stops you asking what more you can do to improve your technique, your knowledge, and your performance. We’ll cover more of this in Chapter 10.
Pre-Planning
You must pre-plan each and every trade. By this you must know your:
- maximum risk.
- maximum reward.
- breakeven points.
You also must plan
- your entry point.
- your exit point whether it’s to. . .
- take profit or
- stop losses.
With options trading, I tend to base any loss cut on the basis of the underlying asset. In most cases the underlying asset will be more liquid than the options chain, so it makes it easier to make your loss-cutting decision based on the price of the stock, future, or whatever the underlying asset is.
This pre-planning stage also embraces the choice of the underlying asset itself, the strategy you’re using, and using fundamental and technical analysis to assist you in the decision-making process. The most important thing, though, is to make a good plan and then stick to it by using massive. . ..
Discipline—the Key to Success
When you have had the patience to acquire the knowledge and apply the principles above, it’s imperative not to waste it all. You must be disciplined and apply that discipline rigorously each and every time.
This means that:
- you do your pre-planning every time.
- you use your (and others’) experience.
- you do not deviate from your stated sensible plan.
In this way you are taking the first steps to becoming more mechanical. Discipline is the single most important part of trading. In other words, it is money management, and without money management, even the most sophisticated of trading systems will not work.
By sticking rigorously to sensible money-management principles, you will ensure that your losses are minimized and your profits are allowed to run.
By sticking rigorously to sensible money-management principles, you will ensure that you will avoid suicidal risk profiles. I’m often amazed at so-called experts teaching options strategies that have terrible risk profile curves. So let’s have a look at a risk profile and why it is so important to your success as an options trader. . .