Options fundamental - continue ...

~If there is one thing we should wish for our children, it is to become an optimist. If there is one thing we should teach our children, it should be trading/investing.~ 

The first phrase is quoted by Daniel Kahneman, while the 2nd phrase is by me :). Trading/investing is both art and science which can benefit us whole-life if we do it correctly, be it a profession or a hobby.

In the previous post, I did mention about Buy Call or Sell Put if you aspire the stock/underlying price to increase; Buy Put or Sell Call if you own the perspective that the stock/underlying price to decrease. In this post, I will explain when we should buy or sell an options. 

As an options trader, we can be an options buyer or an options seller. In order to avoid confusion, we would normally say we buy to open (BTO) a position, we sell to open (STO) a position, we buy to close (BTC) a position or we sell to close (STC) a position. Hence,

1. When we want to be an options buyer, we will BTO now and STC the position later.

2. When we want to be an options seller, we will STO now and BTC the position later. 

We can be an options buyer in a trade and an options seller in another trade. These two positions can be open simultaneously and independently from each other. The next question is, when we should be an options buyer or a seller. There is no one size fits all answer. When the stock volatility is high (We can add volatility indicator to the chart to gauge the high/low volatility of the stock, this will be shown next time), it is advantage to be a seller (hope you remember the concept of reversion to mean that i explained in the previous post). In this scenario, 2 options greek, vega and theta (out of the 4 options greeks, Rho is not important hence I will ignore this Greek) will work FOR you as an options seller. Hence, in this scenario, if you view is the market will be flat or slightly bullish (stock in uptrend moving up), you can Sell to Open a PUT.  If you view is the market will be flat or slightly bearish (stock in downtrend moving down, then you can Sell to Open a CALL.

When the stock volatility is low, it may not be advantages to be a options seller because of low vega. Low vega will also indirectly means lower options premium. When we are a buyer, we always want to buy low sell high and when we are a seller, we prefer to sell high first then buy low later. With a lower options premium due to low volatility, we can consider to be an options buyer. As an options buyer, we need to note two important points:-

#1, 80-90% of the options expired worthless, this means from statistical perspective, being an options buyer is not favorable as this indicates 80-90% of options buyer are losing money. 

#2, as an options buyer, theta (time value) will always go against us. Even if our direction is right (we want stock/underlying to increase and it does go up), but due to the theta value decaying, we may still face a lose. 

With such an unfavorable position to begin with, does it mean that we shouldn't buy to open an options position? When we mention about Sell to Open a call or Buy to Open a Put, which strike price should we open? which Date to Expiry options should we look at? How to read an options chain? All will be revealed in the next post. Stay tune :) Cheers!

Options Greek demystified..

When we trade options, we cannot and should not ignore the important of Options Greek. Options Greek is like dashboard in your car. In car dashboard, there are speedometer, odometer, fuel gauge etc. These indicators enable the driver to control the car and drive smoothly. Ignoring the Options Greek in trading options is like neglecting the car dashboard while driving. It may lead to disaster.

As we understand the important of the Options Greek, the next question that we should ask is how extensive we need to study and learn the Options Greek. Fortunately, we just need to know the usage/concept and we don't need to know how it get calculated as a good trading platform should auto-calculate for us.

Options Greek consists of Delta, Gamma, Theta, Vega and Rho. A complex formula that consists of all these 5 Options Greek will calculate the Options Premium Price. For those who have heard of using options as an income investing, selling options (When Seller sell the options contract to the Buyer) will enable the Options Seller to collect the options premium as an income.

Delta - For Call Options, a delta of 0.3 means when the stock/underlying move up $1, the options price will move up $0.30. For Put Options, delta will always be -ve because when the stock/underlying move up, the options price will decrease.

Gamma - The velocity of the Delta changes against the stock/underlying price changes. E.g. when you buy a Call Options at Strike price 100 and the stock is trading at $99, we call this options OTM (Out of The Money), the delta is 0.4. When the stock price is moving up from $99 to $100 (Options ATM), the delta increases to 0.5. When the stock price is moving up from $100 to $101 (Options ITM), the delta now increases to 0.7. The changes of the delta from 0.4 to 0.5 when the stock price changes is represented by Gamma. The important point here is that, when the options is going to expire, gamma risk will increase, the margin will therefore increase drastically against the naked options seller (without hedge).

Theta - It represents time value. For OTM options, the time value will continuously dropping and become zero when options expires. Hence, theta works for Options Seller and work against Options Buyer.

Vega - It represents volatility. The more volatile the stock/underlying, the more expensive the options premium. There is a concept called reversion to mean. If the stocks volatility is high now, it may drop back to the norm/average level. In a high volatility environment, it is good to Sell Options (as options premium is expensive), in a low volatility environment, it is good to Buy Options (as options premium is cheaper).

Rho - It measures the options price changes to the changes of interest rate. Basically, we can forget about this Greek and it is the least important Greek.

Do take some time to digest the Options Greek. We just need to know enough to take advantage on this 'dashboard'. We will explore more in the next post. Cheers!
 

Back to the fundamental!

Good evening everyone! Let's talk about the basic building block of options trading. For those beginner who has never traded options before, options is a derivative which derives from the financial instrument. The financial instrument can be stock, ETF, futures, forex, etc.. We would normally call the financial instrument as 'underlying'.

The options market that I trade is US market. We all understand that US market is the most liquid market in the world which provides plenty of trading opportunity. For those of us who live in Asia, it is definitely an advantage as we can trade in the evening/night while keeping our full time job in the morning.

When we want to initiate a position in stock market, we will buy if we perceive that the stock price will go up or we will sell short if we think the stock price will go down. This short sell opportunity is not applicable to retail investor with smaller trading account. However, in options market, there are more flexibility in this essence. We can easily buy or sell the options.

There are two types of options; call options and put options.
1. Call options : Provide the Buyer the right to buy the stock/underlying at the agreed price on pre-defined date.
2. Put options: Provide the Buyer the right to sell the stock/underlying at the agreed price on pre-defined date.

Example, Stock A is trading at $100. The Buyer buys a Call contract from the Seller today. The agreed price is $110 and the pre-defined date is 1 month from today. After 1 month, the Buyer and the Seller check the price. There will be three scenarios. (Do note that as an Options trader, we can be either the Buyer or the Seller)

Scenario 1: The Stock A is trading at $140  - This options is ITM (In The Money)
Scenario 2: The Stock A is trading at $110 - This options is ATM (At the Money)
Scenario 3: The Stock A is trading at $90 - This options is OTM (Out of the Money)

When an options is ITM, Call options Buyer can exercise his right to buy the stock at this agreed price (which is $110 in this example) from the Seller. It also means that the Call options Seller has the obligation to sell the stock at $110 to the Buyer. Of course, as a Buyer, in order to enter into this contract, he/she needs to pay a small fee (options premium) to the Seller.

If the options is ATM or OTM, the Call options Buyer will not exercise it. The main reason is the Buyer can buy the stock directly from the market with cheaper price as compare to the agreed price. Since the Buyer does not exercise the options, he/she will lose his options premium that has been paid to the Seller upon entering into this Call contract.

Before this post becomes too academic, I would like to stop here. The idea above should be adequate for your to understand the concept and you can derive the concept to Put Buyer and Seller.

I have one tips to share. This should be a very original idea as I haven't seen anyone using it yet. For those new options trader who always confuse the Buy Call, Buy Put, Sell Call, Sell Put, you can try the following:-
1. Call (use + sign as it represents up)
2. Put (use - sign as it represents down)
3. Buy (use + sign as it represents up/aspire the stock price to go up)
4. Sell (use - sign as it represents down/aspire the stock price to go down)

Next, we have 4 combination
1. Buy Call (++) -> +
2. Buy Put  (+-) -> -
3. Sell Call (-+) -> -
4. Sell Put  (--) -> +

Conclusion,
a. 1 & 4 show + sign; it means that if you Buy Call or Sell Put, you hope the stock price to go up
b. 2 & 3 show - sign; it means that if you Buy Put or Sell Call, you hope the stock price to go down
c. If you Buy, you pay premium and if you Sell, you receive premium

At a glance, you may feel that there isn't much different between 1 & 4 or 2 &3. In reality, there are a huge different. The different would require the understanding of Options Greek to appreciate. So what is Options Greek? I will leave it to the next post to explain. Cheers!

A journey of a thousand miles begins with a single step...

... a single step which I believe will improve my trading skill as I take time to ponder and document my trading journey. A journey which will bring me to achieve my aspiration of becoming a successful options trader, investor, author, trainer, traveller and philanthropist.

As this is my first post, I would like to share the reason why I choose to trade options over other financial instruments. I traded stocks equity, ETF, forex, futures, commodities prior "falling in love" with options. Options is the only instrument which allow us to trade conservatively, being wrong but still able to turn it into a winning trade, enjoy a greater margin of safety and timing the trade is not too important. I will provide more elaboration against each advantages in the future posts.

In my own classification, there are four stages to complete prior reaching the ultimate goal to become a consistent profitable options trader.
Stage 1: Understanding Options (No Trading Experience)
Stage 2: Hedging, Leveraging (Buying a Call or Put)
Stage 3: Income Trading (Spread Trading)
Stage 4: Achieving > 90% Profit (Advance Repair Method)

In the next post, I will use my own method to explain the basic of options. I will also elaborate the four stages in detail in the following post. Cheers!