Option trading volume is exploding as more traders become aware of the ability to establish trading positions for a variety of hypothesized scenarios while controlling risk with precision. For those who seek to thrive in the current market environment, I consider the routine use of option strategies to be essential in order to produce consistent profits.
In my weekly missives to come, I will endeavor to give a tour of my world. It is a world frequently visited by stock traders, but the locals in our world love tourists. It is these visitors to whom trinkets of little value can be sold with potential promises of great fortune, yet extremely small probabilities of success are realized.
We welcome a constant stream of guests, thanks in large part to an unending cacophony of various marketing efforts promising bountiful profits from simply buying options. Nothing could be further from the truth.
To our beloved and dazed visitors, on whom we depend to buy the worthless detritus we routinely offer for sale, we bid you welcome. The ordinarily reliable touchstones of your trading world become distorted in the world of options.
As an example, the basic trader's maxim of "only price pays" is no longer true in the world in which I operate. While price does indeed pay, time decay pays more reliably for the options trader.
The trading screens of an option trader are populated by a menagerie of weird and seemingly exotic trade structures. This collection includes condors, butterflies, iron condors, iron butterflies, and verticals. These spreads as they are called exhibit the almost effortless ability to transmogrify as the result of minimal manipulation. Verticals become condors, butterflies become condors, and condors easily return to their vertical origin once again by basic adjustments to the trade structure.
An inexperienced trader who chooses to make an attempt to engage in these modifications should be aware that these operations are not for the novice. Massive capital dislocations can easily result from unschooled trade adjustments performed by aspiring practitioners new to our world.
The trading platform of an options trader is ruled by the three primal forces of options: price, time, and implied volatility. Our world exists within the financial construct, but is rarely utilized for its true value. All too often, stock traders mistake our world as a leveraged playground that operates congruently with the world of stock trading. Unlike stock trading which is as basic as checkers, option trading is a chess game. Stock trading is entirely based on one dimension, while option trading is three-dimensional.
To make matters more confusing, we option traders speak a different language wrought with subtleties of our nuanced approach to trading. For example, "selling a call spread" and "buying a call spread" communicate to the experienced option trader a radically different price expectation for an underlying entity. The nuances of this language serve to communicate clearly with other knowledgeable option traders and to confuse mightily beginners and wannabes.
My writing is an attempt to pull back the curtain of what I consider the intentional obfuscation of basic concepts of the world of options trading. This regular column will strive to be your guide in providing beginning option traders with ammunition that can fuel your quest for consistent profits and maximum probability skews. Your task as the aspiring options trader is to accept and enlarge upon these introductory thoughts and comments.
I welcome your comments, suggestions, and criticisms. This is my view of reality and it is not that complex. Welcome to my world. Option trading is a wonderfully varied environment which offers a wide variety of trading opportunities for the knowledgeable participant. My task is to point out the pits of quicksand and the carnivorous plants that seek to digest your profit opportunities. We will begin in earnest next week.
Article Date: January 31, 2012
Article Author: J.W. Jones