RECENTLY ASKED QUESTIONS

1.       Can you explain the difference between a call and a put?  Thanks.

Here is an option chain for Apple (AAPL).  An option chain shows the call and put options for a stock or index.  This option chain I will use to help you see the difference between calls and puts.  I use Optionshouse as my online broker.  Other online brokers like TD Ameritrade, or TradeKing or Fidelity will also have option chain screens, and they will look similar, although not the same, as this one.

First of all, calls and puts are basically the same thing.  What changes is the perspective of price.  Take a look at the option chain.  Calls are on the left and puts are on the right.  All the terms we will talk about next apply to both call and puts. Now for the definition of calls and puts:

A Call option gives the buyer the right, but not the obligation to buy 100 share blocks of stock (called the Underlying) at a specified time (called the expiration time) and a specified price (called the strike price)

A Put option gives the buyer the right, but not the obligation to sell 100 share blocks of stock at a specified time and a specified price.

In the option chain above look at the darkest blue highlighted line.  Let’s look at the call side first.  Just like stocks the ask price is what you pay when you buy an option.  So the December 23 $385 call option is selling for $244 (2.44/share x 100 shares).

Underlying Stock = AAPL – Apple Computer

Expiration Date = December 23, 2011 On our option chain this is in the gray area in the center, shown as Dec 23 - The (w) indicates that this is a weekly option

Strike Price = $385 – This is also in the gray area in the center of the option chain

The option we are looking at is called At The Money (or ATM) since it is the closest option to the closing price of AAPL.  If the market is open then the ATM option is the option that is closest to the current price of the underlying stock.

All of the options below the $385 option are called In The Money (or ITM).  They are called in the money because if the options are exercised you could then sell the 100 shares you bought for higher than you had to buy them  Notice that the price for ITM options go up greatly the farther away from the ATM option you get.

All of the options above the $385 option are called Out Of The Money (or OTM).  They are called out of the money because if you bought them they would not be automatically exercised like the ITM options.  They would expire worthless because it would cost you more than the market price to buy the option at contract expiration.

So, that is the difference between a call and a put, with some extra info thrown in.  Starting next week, I will start putting up a basic primer on options and how I trade the way I trade.  I will expand greatly on the call and put options concept then.

2.       Why do you almost always use index options in your trading?

Good question.  There are two main reasons I primarily use index options.  (1)  The credit I receive on my spreads is usually higher with less risk using index options over traditional stock options.  (2) They are cash settled.  Cash settled means that instead of having to take possession of or sell off 100 block shares of stock, I pay a cash amount if my spread is assigned.  This just makes my life easier if I get caught in a bad situation. 

For example:  last week I used a 1245-1255 Call spread as one of my trades.  This meant that I sold the 1245 SPX option and bought the 1255 SPX option.  This trade was profitable for me because the SPX closed below 1245.  BUT say the SPX closed at 1246 instead.  I would have been assigned a charge of $100 per 1245 contract I had ($1 x 100 shares). 

We do the technical analysis (charting), and the statistical analysis (use of probability calculator, and Std Deviation analysis) and some gut feeling so that we DON’T get into that situation.  Getting assigned is a good way to lose your profits in a BIG hurry! 

Again, I will be covering this topic in MUCH more detail in upcoming weeks when I outline how I trade the way I do.  Soo, keep checking back to get all this great info!!!

3.       Why do you trade option spreads?

There are literally thousands of methods to trade in the markets.  I have chosen to trade credit spreads because:

1.       I get paid immediately for my trade

2.      The returns are the best I have found in the markets

3.      It is an easily understood strategy, I don’t trip myself up trying to be too clever

4.      It fits my personality

5.      A business I can do from anywhere with VERY little startup money was needed

Let’s go through each of these points.  First, when trading credit spreads, money is actually deposited in my account when I make the trades.  Now of course the commissions are taken out before the deposit is made, but instead of paying for stocks or straight buying options, people pay me for these trades.

Second, I am averaging right at 5% return per week in my spread strategy.  That is over 200% a year.  When CDs are around 2% and savings accounts offer interest only for insanely high balances 5% a week is a number I love.  This type of return also allows this strategy to be a great source of income to the point where trading is now my occupation.

Third, the strategy is basically one that is easy to understand.  I will go into the specifics as I discuss the hows and whys of my trading philosophy starting next week.  But in a real small nutshell I trade opposite the market, called a contrarian strategy, if the market is trending up I go with put options, if the market is trending down, I go with call options.

Fourth, it fits my personality.  I am basically am risk averse person when it comes to my money.  This strategy makes it so I know how much I have to put up each week, and how much I can potentially lose each week.  It also tells me exactly what I will earn each week as I calculate the trade.  I like this certainty.

Lastly, it is a VERY easy business to get into.  Most online brokers require $2,500 to open an account.  If you already have a laptop and printer and a desk with a few pens and pencils, you are all set up.  That is the beauty of online trading!  I can do this work from anywhere – home, café down the street, anywhere I can get a wifi signal.

Ok, that is enough for now.  Thanks for waiting this out with me.  Internet outages are very annoying.

TTFN,

Ash