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. . . A little stingy with the "likes'? Yeah, me too. . . . Wonky (adj.): askew, awry, unsteady, off-kilter. Like gadgets or stock markets. Techwonk (me): someone who likes wonky stuff. . . . ..................and a fan of . .
  • Options Timing - Trading With The Market 0 comments
    Apr 21, 2013 10:31 AM

    You've heard the saying, "you can't time the markets." Whether you believe the saying is true or not, there is one area in which we must be aware of timing. That's when we're using options to manage a portfolio.

    As investors and traders, we already know to "buy low" and "sell high" whenever possible. As we begin to explore options, they provide us with opportunities to "buy lower" and "sell higher."

    The process used to trade options profitably depends on whether we are trading with the market direction, or against the market direction.

    Today let's look at how to do two kinds of simple trades in the same direction as the market is moving.


    I'm going to assume you've talked options over with your professional investment advisor, and checked on details like wash sale rules, and read the CBOE brochure (you can get a copy from their website or from your broker) and that you've looked up the brokerage fees that apply to option trades, assignments, and exercises.

    If not, you'll want to add those 4 steps to your to-do list and get them done before you trade.

    You'll also want to be sure your stock position is in "round lots" or multiples of 100, because this is how options are bought and sold. Divide the number of shares by 100 and you should have no shares left over. You don't have to sell options for all your shares in one trade, but you'll almost always buy or sell one option for each 100 shares.


    Let's start with a trade that uses a covered call to sell stock.

    As stock owners, we have a long position. We want to sell the stock, but we'd like to get a little more for it than the market's price today. If it is a "hot stock" that is very expensive and popular, we might do this by selling an option that is "at the money" with a high "premium", or seller's fee. We'd also have the choice of selling an option that is a little "out of the money". The premium on the OOTM call will be lower than the ATM call, but the selling price for the stock will be higher.

    We want to sell the call on a day when the market is trending up and the stock is trading up. We'll get a better price for the call when demand is high, and there will be more buyers. Once we sell the call, we've committed to selling the stock - unless we decide to buy the call back - so we need to be sure to consider carefully in advance whether this is the best way to sell the stock.


    Step-by-step, the trade looks like this: you own the stock. You choose a sell price for your stock, the "strike". You enter your trade order at the option's "ask" price, and hopefully get filled on the trade without having to bargain your option price down. Once you sell one or more call options at that strike, you'll receive asome money from the sale - this money is the premium. Your broker deducts a fee for processing the option trade. Later, when expiration day arrives and the option is "exercised" by the buyer, the broker will assess a second fee to close the stock trade. The stock will be removed from your accoun, and you'll receive the settlement value - the strike priice times the number of shares.


    Next, let's look at what happens if we want to purchase shares of stock using a put.

    Once again, we want to stay in line with the direction of the market.

    We'll want to use a "put-to-acquire" technique on a down-trending market day when the stock we wish to buy is also trending down.

    You know the saying "buy when others are fearful?" We want to sell puts when people are fearful and most willing to let go of their stock. The puts will be more valuable then, and option sales volume will be higher.

    Once again, the option represents a commitment - it is a contract. When we sell a put, we agree to buy the shares if the stock reaches the strike price by expiration day. The brokerage will freeze some of the funds in the trading account - enough to complete the sale - until the day when the option is exercised or the option expires unused. We must be sure we have the funds to complete the sale before we trade the put.


    Step-by-step, the trade looks like this: You chose a price at which you'd like to buy stock. You enter a trade order and sell a put, thus saying you agree to buy stock at the "strike" or settlement price. You'll try to receive the "ask" value rather than the "bid" value for selling the option. Once the transaction has closed you'll receive a premium payment, from which the broker will have subtracted the option transaction fee.

    The total cost of the stock purchase -- the strike price times the number of shares -- will be frozen in your account. Part of those funds will be the premium you received, and that will reduce your out-of-pocket costs on the total purchase. When the option expiration day arrives, the funds are debited, the stock is delivered to you, and the broker takes a second fee for closing the sale and "assigning" the stock to you.


    In contrast to this, the third kind of simple option that is frequently traded, a "protective put," requires us to trade against the market direction to get the best price.

    I won't go into detail on trading against the market in this post. But keep in mind that we want to buy low. Think about it: when will we get the best price while buying a put to use as a "hedge", or insurance for stock prices? When we don't need one, because the stock and the market are trending up!


    The best way to get used to this process is to practice trading options using a virtual trading program. This will give you a sense of how prices are changed by option spreads, volume, time value decay, and volatility. With virtual trading, you won't have to commit real money while learning.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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