No-Hype Options Trading: Myths, Realities, and Strategies That Really Work

Acknowledgments xi

Introduction xiii

Part 1 The Foundations of Options Trading 1

Chapter 1 Option Basics 3

Definitions of Calls and Puts 3

Are You Long or Short? 4

Option Contract Size 4

Is My Option In- or Out-of-the-Money? 5

Option Trade Orders 5

Option Expiration 6

LEAPS Options 7

Option Settlement 7

Options Cycles 8

Chapter 2 Probability Distributions 11

The Gaussian Distribution 11

Application to the Real World 12

Risk-Adjusted Returns 15

High-Probability Trading 17

Low-Probability Trading 18

Options Trading Myths 20

What Is a Conservative Trade? 21

Exercises 22

Chapter 3 Options Pricing and Implied Volatility 25

The Black-Scholes Pricing Model 25

The Greeks 26

Implied Volatility 27

Building the Price of an Option 28

A Closer Look at the Greeks 29

How Will We Use the Greeks? 31

Exercises 32

Chapter 4 Vertical Spreads 33

Building the Vertical Spread 33

Effects of Implied Volatility 35

Early Exercise 41

Expiration and Exercise 43

Margin Requirements 44

Application of Probability Calculations 45

Risk/Reward and Probability of Success 46

Exercises 47

Part 2 Options Strategies for Income Generation 49

Chapter 5 Using Options to Boost Income in a Stock Portfolio 51

The Classic Covered Call Strategy 52

Strategic Considerations 53

The Notorious Selling Naked Puts Strategy 53

Selling Naked Puts for Income 54

Buying Stocks at a Discount 56

Combining the Covered Call with Selling Naked Puts 56

Early Exercise 58

Risk Management 60

The Achilles’ Heel of Directional Strategies 61

Exercises 62

Chapter 6 Calendar and Double Calendar Spreads 63

Vega Risk and Calendar Spreads 66

Volatility Skews 67

Searching for Calendar Candidates 70

Entering and Managing the Trade 71

Early Exercise 71

Adjustments 72

Out-of-the-Money Calendar Spreads 73

Double Calendar Spreads 73

Determining the Optimal Strike Prices 76

Trade Management and Adjustments 82

Multiple Calendar Spread Positions 83

Exercises 83

Chapter 7 Double Diagonal Spreads 85

Diagonal Spreads 85

Double Diagonal Spreads 87

Managing the Trade 90

Double Diagonals vs. Double Calendars 91

Exercises 92

Chapter 8 Butterfly Spreads 95

At-the-Money and Out-of-the-Money Butterfly Spreads 95

Iron Butterfly Spreads 99

The Broken-Wing Butterfly 99

Margin Requirements 101

Trade Management 103

Closing Butterfly Spreads 106

Butterfly Spreads as Adjustments 111

Exercises 112

Chapter 9 Condor Spreads 113

The Basic Condor Spread 113

The Opportunistic Model 116

The Insurance Model 119

Iron Condor Spreads 121

Vega Risk and the Condor 124

The Short-Term Iron Condor 128

The Long-Term Iron Condor 129

Capital Management 131

Risk Management 131

Adjustment Techniques 132

Adjustment Pros and Cons 134

Adjustment Case Studies 135

Managing the Iron Condor with the Greeks 138

Advanced Adjustment Techniques 140

Iron Condor Trading Systems 140

Butterflies and Condors are Cousins 144

Exercises 146

Chapter 10 Delta-Neutral Trading Strategies 149

Risk Management Systems 151

Challenging Markets for the Delta-Neutral Trader 152

Two Distinct Trading Philosophies 153

The “Secret” of Success 155

Chapter 11 Make Your Trading a Business 157

Getting Started 157

Managing Losses 159

The Trading Plan 159

Money Management 160

The Psychology of Trading 161

Living with the Two-Headed Monster 163

Required Tools for This Business 164

What’s Next? 165

Appendix: Answers to the Chapter Exercises 169

Glossary 185

Index 193