|June 14, 2010
Starting at the Beginning
For readers who came here looking to start at the very beginning, I
tried to provide some background before doing that.
It's time to present the options story for the person who knows
essentially nothing about using options.
An option is an investment tool. It can be used aggressively to take
big risk, seeking large rewards. I don't believe in doing that, but
many other do. Unfortunately, when taking such big risk, the chances
of success are small. Most of these traders fall by the wayside.
Options can be used conservatively. There are low risk methodologies
that provide a modest profit potential (there are no huge profits
available when you trade conservatively). This is the trading style I
adopt and hope to convince you that playing the with probability of
success on your side is prudent.
Options can be used to provide insurance or protection for other
investments in your portfolio. In this use of options, there is no
specific attempt to earn additional profits. With a 'regular'
insurance policy, there is a cost to pay. The good news is that this
cost can be very modest when using options. In fact, it's also
reasonable to collect a cash payment when you own such insurance. Now
that's something special. Of course, there is no free lunch, and that
cost free insurance comes with limited profits. But that's an
excellent trade-off for many conservative investors.
When using options, we employ a strategy, which is simply a
description of which options to buy and sell.
There are many possible strategies to sue when trading options, but for
now, you will learn much more quickly if you try to understand only one
or two such strategies. This is an education process, and the better
you understand the basic principles, and the fewer different trading
methods you attempt to learn (at this point), the easier it becomes to
grasp the more advanced concepts of option trading.
One example of a strategy is buying a call spread. For this strategy,
you buy one
call option and sell another. The obvious question is how does one
decide which option to buy and which to sell. Much of the answer
depends on what you are trying to accomplish by making the investment.
This specific strategy (buy a call spread) is a bullish play. Thus, it
is to be made only when you are willing to invest cash in a position
that profits when the stock moves higher and loses (or probably loses)
when the stock holds steady or declines.
Next time we'll look at constructing a call spread.
Mark D Wolfinger
Expiring Monthly: The Option Traders Journal
Note: I am a partner and contributing editor for Expiring Monthly magazine. We offer special discounts for bivio.com members.