Friday, 27 November 2015

Common pitfalls in trading options!

If you read my previous articles, you may be confused why there are so many people still losing money if trading options can be very conservative. Let me compile a list of contributing factors of losing money in trading options.

1. Buying out of money options with short day to maturity
This is indeed a speculation. Imagine this, Apple share is trading at $120 now and we open an options position we wish that the share price to hit $150 in 1 month. We pay $0.30 for every options we purchase and happily wait for the Apple share price to shoot up. Unfortunately, this type of trade seldom success. We are expecting Apple to go up 25% ([150-120]/120) in a month, if we project it to a year, we are expecting 300% rise! If after 1 month, the Apple share does rise sharply and end up at $150, we are still losing all our money. We will only start making money when Apple share goes beyond $150.30 (Remember the $0.30 options price that we have paid?). So, this is a very low probability of success trade.

2. Over-magnifying the power of Call Options
Continue from #1, if we are too indulged with the thinking of putting small money in our account to make big money in a short period of time, we may scale up the number of options that we want to purchase. Instead of paying $30 ($0.30 *100units) to buy 1 options, we increase the number of options to 100 options and hoping that the Apple shares will sky-rocketing before the options expired. If the Apple shares reaches $200, we will be making $497,000 ([$200share price - $150strike - $0.3premium] * 100options * 100units] in a month! An astounding result? Again, do assess the probability of success.

3. Over-leveraging options trading
Imagine we have identified Starbucks as a great value stock that is currently trading at $63. Instead of buying the stock directly, we sell an options, with the intention to buy the stock if it goes below $61 in a month time. As an options seller, we are paid with $1 for every options that we sell. It looks great so far. After a month, assume the Starbucks share price trades at $62, we will be happily pocketed $100 as 1 options represent 100 units. After a few rounds of not converting to stocks, we may be greedy now. Instead of 1 options, we now want to sell 10 options to collect $1000. Here's the problem now. If Starbucks drops to $55 (using the same example) on maturity date, we are obliged to buy the stock now. As we sold 10 options, we need to buy 1000 units of Starbucks (10 options * 100units), which means we need to have $60,000 ([$61strike-$1premium]*1,000units). If our account does not have sufficient cash to buy $60,000 worth of Starbucks, the brokers will liquidate on the spot by selling the stock away at $55 and book in the loses of $5000 ($60,000 - $55,000) into your account. A disaster, isn't it?

Avoiding mistakes and always keep in mind the factors that will make us lose money will increase the chances of our success in trading and investing! Cheers!

Sunday, 22 November 2015

Probability of trading/investing success and the probability of sighting the Northern Lights

After spending 2 weeks in Norway chasing Northern Lights and savoring one of best panoramic scenic view in life, I am back to action again! I am also glad that I managed to complete few books and magazines throughout the long haul flights, did some deep thinking apart from indulging into Norwegian's culture and great nature.

I believe many knows that viewing Northern Lights is by chance/luck and there is no 100% certainly of seeing it at any specific night. We can however increase the odd by choosing a better location, say Tromso, Norway, rather than Finland or Sweden, engaging an experience local guide, selecting the month/year that provide higher probability of viewing, etc. All the above can definitely increase the chances of viewing but it still does not guarantee a successful viewing. Hence, are we still going to take the chance to view Northern Lights by knowing all these? I believe the answer is yes for many people as this is definitely one of the bucket list of many I presume. Why? Because the reward of getting to view and capture it in live is just astounding!

How does this relate to trading/investing? There are various method we can use to determine the stock picks, we use fundamental valuation method, we may use technical indicator, price action, volume analysis, etc to project the share price. Does it mean that we are destined to trade/invest successfully by applying valuation method or technical method? While we can safely say that financial tool/education can greatly increase the odd of success in trading/investing, it will not 100% guarantee a success in every trades that we perform. Hence, are we still going to trade and invest? I believe the answer is yes. Why? Because the reward of getting to trade and invest successfully will be tremendous!

Perhaps the next question in mind is that, do we need to profit in every single trade? Quoted from the grand strategy, we can lose a battle but to win a war. If each battle represents a single trade and the war represents our portfolio, then focusing to grow our portfolio by not too carried away with few lose trades should be a wise move.

In summary, the chances of sighting Northern Lights in a specific day (analogy to a single trade concept) may require a bit of luck but to sight Northern Lights in a whole week (analogy to a portfolio concept) would almost a guarantee. Needless to say if you stay there for a month or two, the chances of not sighting should be zero. Hence, try to chase more days if you happen to be there in the future! Cheers!

Sunday, 15 November 2015

Trading/investing and metaphysic science

While waiting to check in a hotel in Tromso, Norway, I would like to do a short post against something that I ponder during the journey. I believe those who have been in the trading/investing business for long should understand the concept of letting profit run and cutting losses fast (extremely important for short term trader but not too crucial for long term value investor). However in reality, not many trader/investor can fully execute this concept seamlessly, mainly due to the human pyscholoygy of risk seeking when the odd is against us and risk adversing when we are in the domain of gains.

Interestingly, there are still traders/investors who can execute this successfully. This lead me to look at this phenomena in different angle. As an avid reader, I do have immense interest in Chinese Metaphysic. In the study of metaphysic, we aware that every individual has their own path to success. Some people can be very successful in short term trading while some are more suitable to do long term investment. Some are very comfortable to cut losses swiftly without much 'pain' but some just can't do it in style. While education and continuously learning to become a successful trader/investor is crucial, we still need to find a way which we can feel very comfortable to trade/invest.

By understanding ourselves through metaphysic, we are sort of de-coding our DNA in learning ourselves in-depth in order to select the least resistance path to en-route a trading/investing success. We will avoid pushing or forcing ourselves to follow a set of rules which may lead us to success but would also strain us throughout the journey. All roads lead to Rome, let's pick the most comfortable way to reach Rome in style!

The good news to us is that regardless we are short term/long term, aggressive or converative trader/investor, options is versatile to suit all circumstances of our trading/investing journey!

Monday, 9 November 2015

Rolling-over mechanism

Let me do a quick post before heading to the airport soon to embark my journey to Norway to chase Northern Light! I should be away for two weeks before resume writing the next post.

In the previous post, I introduced a technique called "rolling-over" an options position. Rolling over an options position means closing the existing options position that is going to expiry and opening a new options position with longer date to expiry.

(1) Position Now (Before Rolling Over)
-1 AAPL Nov 15 120 Put

[This means I am holding 1 unit of Sell to Open Put Options position of Apple share at $120 strike price that is going to mature in Nov 2015 (3rd week of the expiration Friday, 20 Nov 2015)]

(2) Rolling Over Mechanism
+1 AAPL Nov 15 120 Put (Close the existing position via Buy to Close)
-1 AAPL Jan 16 120 Put (Open a new position via Sell to Open)

[If I intend to roll the position to a further date of expiry, I should execute the above 2 transactions]

(3) Position After Rolling Over
-1 AAPL Jan 16 120 Put

[Now, this is my position and the only different of this position against the position in (1) is the maturity date. In technical term, it means that we have rolled over the position from Nov 15 to Jan 16.]

I mentioned four stages of becoming a successful options trader in the first post. In stage 4, we aim to achieve > 90% profit by using advance repair method. One of the advance repair method requires us to roll position skillfully. Hence, it is important to internalize this concept in order to become a successful options trader. Cheers!

Saturday, 7 November 2015

Holding a great value stock and win, win, win in any circumstances!

It has been almost a week since my last post, mainly due to my hectic business travel to Taiwan over the past couple of days. There is one incident which I would like to share with the readers, which I felt quite inspiring, is the street singers that I came across on my way to Elite Bookstore after having my dinner in Taipei 101. They sang pretty well and I believe they deserve a bigger platform for them to showcase their talent. Nevertheless, they portrayed their passion in singing despite the venue and the crowd. Passion is the key and the driver that pushes us to achieve bigger goal in life. In trading and investing world, passion is the most important element to fire us up to continue learning, improving and persevering...

In the previous post, I discussed a strategy which enable us to reduce cost base in acquiring great value stocks. In this post, I will discuss a strategy which we can use when we are holding the shares. I will use the example given in the last post to illustrate this concept. Hence, if you haven't read the previous post, you may want to go through it first.

Imagine now we have 100 unit Apple shares, which we bought at $108 per share and the stock is trading range-bounce with resistance $110 (In other words, it means Apple stock will find difficulty to trade above $110 base on technical chart/analysis due to market psychology). We can sell to open a Call options at $110 with 2 months date to expiry and collect a premium, say $1 per options contract. There are three scenarios when this options matured.

Scenario 1: if Apple stock trades at $100 (below Options $110 strike) when options is matured (Options OTM)
We are happy to pocket $1 premium and we can consider to initiate another sell to open Call options to collect the next premium. At this point of time, we have further reduced the cost base from the original buying price of $108 per share to $107 per share ($108 - $1 premium). We can also look at this from another dimension, where we are making $1 out of $108 in two months, which give us a yield of 5.56% per annum.


Scenario 2: if Apple stock trades at $110 (equal to Options $110 strike) when options is matured (Options ATM) 
Most brokers would exercise ATM options, which means as this call options seller, we need to sell the stock at $110 to the options buyer. When this happen, we will profit $3 per shares ($110 selling price - $108 buying price + $1 premium). If you are still happy to hold the shares, you can easily buy to close the call options before the maturity. If you buy to close the call options at $0.10 per share, you are still collecting the premium of $0.90 ($1 - $0.10) per share.


Scenario 3: if Apple stock trades at $115 (above Options $110 strike) when options is matured (Options ITM)
Our ITM options will get assigned, which means as this call options seller, we need to sell the stock at $115 to the options buyer. When this happen, we will profit $3 per shares ($110 selling price - $108 buying price + $1 premium). Do note that our profit potential is capped at the options strike price. We will still profit $3 per shares even if Apple stock goes up to $200 when the options matured.  We can consider the technique of rolling-over the options if we prefer to hold the stocks. I will explain more on this technique in the next post.


In summary, regardless of which scenarios happen, we are still either making a good profit or reducing our cost base further. This demonstrate the power and the flexibility of using options to enhance our portfolio! I hope I have stimulated your interest to learn further to add options to your trading/investing journey by now! Cheers!

Sunday, 1 November 2015

Trading Options is more conservative than value investing!

When we talk about value investing, we must mention the world class great investor Warren Buffett. The idea of value investing is basically picking up stocks with great fundamental by studying the company financial statement, understanding the company business, management, competitive advantages, growth etc. and value the company to gauge if the company is undervalue. If yes, buy it and wait for the value of the company to be unlocked to it's fair value. When this company stock is overvalue, we sell it and move on to search for the next value stock.

Example, Apple is a great stock, the stock price is currently trading at $120 per share and after we apply valuation method (e.g. Discounted Cash Flow or Price-Earning Growth, etc), assume $112 is the intrinsic value (disclaimer: this figure is just for illustration purpose only, I do not really calculate Apple's intrinsic value) and we are happy to buy the share at any price lower than $112 and hold it for many years, there are 2 things that we can do.

Option #1, add Apple stock to watch-list, wait for the price to hit $112 then initiate to buy Apple Stock.

Option #2, initiate a SELL PUT Apple @ Strike price $110 for 2 months DTE (Date to expiry), receive options premium, say $2. Wait until options to mature.

Scenario 1: if Apple stock hits $115 when options is matured (Options OTM)
We can initiate another SELL PUT Apple @ Strike price $110, receive options premium, say $2.5 for the next 2 months. Basically, we can continue to sell a put as long as the stock price does not hit the strike upon maturity and the stock is trading range-bounce.

Scenario 2: if Apple stock hits $106 when options is matured (Options ITM)
The options is exercised! We are happy because we can purchase the stock/understanding at the strike price, which is $110. As we have received $2 as premium upon the selling of the put options, our cost base is reduced to $108 ($110 - $2). If compare to the Option #1, where we buy the stock at $112, by using options, we are now buying the stock at the cheaper rate, $108.

Warren Buffet loves to deploy this strategy to reduce cost base in acquiring great value stocks. this strategy improve the margin of safety further and allow the best use of capital to create income while waiting for the stock price to drop to fair/undervalue.

What should we do if Scenario 2 happens? Shall we just wait patiently for the stock price to appreciate or we can do something differently to further enhance our yield? I will share it in the next post! cheers!