ContentsChapter 1 Introduction 1
Who Can Benefit from This Book 1
What Sets This Book Apart 2
Can Options Really Be Simplified? 2
What This Book Provides 2
Overview of Option Trading 3
Understanding Risk by Using Risk Curves 6
Asking the Right Question 9
Analyzing Risk: What Separates the Winners
from the Losers 11
Summary 18
Chapter 2 The Basics of Options 21
Option Definitions 21
Options on a Specific Security 26
Intrinsic Value versus Extrinsic Value 30
In-the-Money versus Out-of-the-
Money Options 32
Summary 35
Chapter 3 Reasons to Trade Options 37
The Three Primary Uses of Options 37
Leveraging an Opinion on Market Direction 39
Hedging an Existing Position (and Generating Income) 41
Taking Advantage of Neutral Situations 44
Summary 46
Chapter 4 Option Pricing 47
Theoretical Value 47
Examples of Theoretical Option Pricing 49
Overvalued Options versus Undervalued
Options 50
Summary: Theory versus Reality 52
Chapter 5 Time Decay 55
The Effect of Time Decay on the Price of
an Option 56
Implications of Time Decay 58
Time Decay Illustrated 58
Summary 62
Chapter 6 Volatility 63
Volatility: The Most Important Concept in
Option Trading 63
Historic Volatility Explained 63
Implied Volatility Explained 65
Is Implied Volatility High or Low? Relative
Volatility Explained 69
Relative Volatility Ranking 72
Considerations in Selecting Option-
Trading Strategies 72
Why Does Volatility Matter? 74
The Effect of Changes in Volatility 77
Summary 80
Chapter 7 Probability 81
Weighing the Pros and Cons 81
Strategies for a Bullish Scenario 82
Profit/Loss Comparisons 86
Delta 89
Probability Analysis 91
The Correct and Incorrect Ways to
Use Probability 95
Summary 96
Chapter 8 Market Timing 99
The Underlying Security Is Expected to Move
within a Specific Period 100
The Underlying Is Expected to Move in a
Particular Direction but Not in a
Specific Time Frame 102
The Underlying Is Expected to Move Significantly
but the Direction Is Unknown 103
The Underlying Is Expected to Stay within a
Range or Not Move Much in Any
Direction 105
Summary 106
Chapter 9 Trading Realities 107
Exercise and Assignment 107
Bid and Ask Prices and the Importance of
Option Volume 110
Appreciating the Effect of Bid-Ask Spreads 111
Factors in Dealing with Bid-Ask Spreads 113
A Word on Limit Orders 113
Summary 115
Chapter 10 Important Concepts to Remember 117
Valid Reasons to Trade Options 117
Option Pricing 118
Contents ix
Time Decay 118
Volatility 119
Probability 120
Market Timing 120
How to Lose Money Trading Options 121
The Keys to Success in Option Trading 125
Summary 128
Chapter 11 Overview of Trading Strategy Guides 131
The Two Key Elements in Selecting a
Trading Strategy 131
Trading Strategy Matrix 133
Overview of Trading Strategy Chapters 133
Chapter 12 Buy a Naked Option 139
Key Factors 139
Position Taken 146
Position Management 148
Trade Result 150
Chapter 13 Buy a Backspread 151
Key Factors 151
Position Taken 157
Backspreads versus Naked Calls and Puts 157
Volatility and Backspreads 159
Position Management 162
Trade Result 164
Chapter 14 Buy a Calendar Spread 165
Key Factors 165
Position Taken 173
Position Management 173
Trade Result 174
x Contents
A Decline in Volatility Is Deadly to
Calendar Spreads 175
Chapter 15 Buy a Straddle 179
Key Factors 179
Position Taken 186
Position Management 188
Trade Result 190
Chapter 16 Sell a Vertical Spread 191
Key Factors 191
Position Taken 197
Position Management 199
Trade Result 200
Chapter 17 Sell a Naked Put 201
Key Factors 201
Position Taken 206
One Method for Managing Stock Position
If Assigned 208
Position Management 209
Trade Result 209
Chapter 18 Write a Covered Call 211
Key Factors 211
Position Taken 216
Position Management 218
Trade Result 219
Writing Covered Calls without Limiting
Upside Potential 220
TEAMFLY
Team-Fly®
Chapter 19 Enter a Butterfly Spread 223
Key Factors 223
Position Taken 229
Position Management 233
Trade Result 235
Chapter 20 Placing Trades 237
Considerations in Placing Option Orders 238
Placing Orders by Phone and On Line 238
Summary 246
Epilogue Some Random Thoughts for Option Traders 247
Appendix A PROVEST Option Trading Method Criteria 251
The PROVEST Option Trading Method: A
Framework for Trade Selection 251
Appendix B Option Exchanges, Option Brokers, Option
Symbols, and Option Volume 255
Exchanges 255
Brokerage Firms 257
Resources 257
Stock and Stock Index Option Symbols 258
Stock Option Volume Statistics 258
Index 265
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