Trader’s Guide to Options · You will crash and burn. Treat your trading and financial security as seriously as you would any other important areas of your life. In this guide,

Trader’s Guide to Options Options Money Maker, LLC

Mark Dannenberg [email protected]

www.OptionsMoneyMaker.com

Trader’s Guide to Options

P a g e | 1 Copyright 2013, Options Money Maker, LLC

About the Author Mark Dannenberg is an options industry veteran with over 25 years of experience trading the markets. Trading is a passion for Mark and in 2006 he began helping other traders learn how to profitably apply the disciplines he has created as a pattern for successful trading. His one-on-one coaching, seminars and webinars have helped hundreds of traders become successful and consistently profitable. Mark’s knowledge and years of experience as well as his passion for teaching make him a sought after speaker and presenter. Mark coaches traders using his personally designed intensive curriculum that, in real-time market conditions, teaches each client how to be an intelligent trader. His seminars have attracted as many as 500 people for a single day. Mark continues to develop new strategies that satisfy his objectives of simplicity and consistent profits. His attention to the success of his students, knowledge of management techniques and ability to turn most any trade into a profitable one has made him an investment education leader. This multi-faceted approach custom fits the learning needs and investment objectives of anyone looking to prosper in the volatile and unpredictable economic marketplace. Mark has a BA in Communications from Michigan State University. His mix of executive persona, outstanding teaching skills, and real-world investment experience offers a formula for success to those who engage his services.

This document is the property of Options Money Maker, LLC and is furnished with the understanding that the information herein will not be distributed to any person who is not a client of Options Money Maker, LLC. Additionally, this manual will not be reprinted, copied, photographed or otherwise duplicated either in whole or in part without written permission from Mark Dannenberg, Founder of Options Money Maker, LLC. This work has been created and provided as part of a paid service and is intended to be used by the person who is the registered client of Options Money Maker, LLC. Each copy has a numerical identification registered to the person who paid, or has otherwise been authorized by, Options Money Maker to use the material. This work is protected by copyright.



Introduction Congratulations! You have made the decision to take control of your own financial security and are about to begin an exciting journey of learning how to trade options. Through the instruction provided by Options Money Maker, LLC, you will learn how to earn more from your investments than 99% of most other investors. You will learn how to generate consistent profits while mitigating the risks associated with trading options.

When you mention to your friends and colleagues that you are trading options, the reaction is usually, “Oh that is really a risky investment strategy!” They are correct regarding people who simply speculate and who have not received proper training. Proper training to trade is no different than training in other areas of your life. You learned how to drive a car from someone skilled and experienced. When I was in flight school I relied on the knowledge and expertise of an instructor who had years of experience and who could guide me to be successful. Although flying may be different than trading, the uneducated, untrained outcome is similar. You will crash and burn. Treat your trading and financial security as seriously as you would any other important areas of your life.

In this guide, you will learn the basics of options and how their values change as the underlying value of the stock changes. You will become well-versed in all the terminology necessary to trade options. More importantly, as you progress through the seminar, webinar or one-on-one coaching, you will learn a consistently effective, methodical process that you can understand and personally control.

This process begins with an understanding of options basics, followed by detailed education on technical chart analysis, which leads to the structure and execution of specific trading strategies that produce results while covering risk. Our process will build confidence, help you structure a safe investment strategy, teach you how to manage positions regardless of how the market moves, and—most importantly—put you in control.

The information in this guide is intended to get you started with your understanding of options, the terminology and their basic characteristics. In addition to this guide, it is recommended that you study all information available under the education section of your broker’s website. Most brokers who cater to options traders provide good information that will help you learn. tradeMONSTER, for example, is the primary broker we use at Options Money Maker and their website provides very useful information. Visit them at the following link: https://education.trademonster.com/trading-education/.

“My advice on stock: buy low and sell high and if it doesn’t go up don’t buy it!” - Will Rogers



Option Terminology

Contracts - 1 = 100 shares

Expiration - 3rd Friday

Strike Price – The price all rights and obligations is based on

Bid and Ask – Sell the bid and buy the ask

Delta – Change in option value for each $1.00 change in stock value

Options Chain - shows all the information you need for any option.

Options Basics What is an option? An option is a financial contract between a buyer and a seller. It is an agreement to buy or sell the underlying equity (stock or index) at a set price by a pre-determined date. Options have the following characteristics:

• Traded as contracts and each contract represents 100 shares of the underlying stock or index.

• Pre-set expiration dates. Standard monthly options expire the third Friday of each month. Some index options like SPX and NDX cease trading on Thursday before the third Friday. Weekly options expire each Friday.

• Price points, referred to as the strike price, are the prices at which buyers and sellers trade option contracts. Options are, usually, available to trade in standard price increments of $5 and $10.

• Quotes to buy or sell an option are presented as the bid and ask. When selling an option, the bid price is used. When buying an option, the ask price is used. Sell the bid / Buy the ask.

• Delta is the change in the value of an option relative to each $1.00 change in the value of the underlying stock. If an option has a Delta value of .45, it will change in value by 45 cents for each $1.00 change in the value of the stock.

o GOOG is trading at 785 o The 785 call strike has a Delta of .48 o GOOG goes down $10 o The 785 call will decline in value by $4.80

The Options Chain: All option information for any stock or index is listed on an options chain. The options chain can be found on the website of the broker you use to trade. The chain will list all available strikes and expirations, the Delta, and the bid and ask prices. It will also display both Call and Put options. (See diagram 1 for an example of the options chain on AMZN).



Options Chain…Continued...

Diagram 1

Ways to trade Options: There are four actions that could possibly be taken when trading options:

1. Buy To Open (BTO) - buying an option as part of opening a new position. 2. Sell To Open (STO) - selling an option as part of opening a new position. 3. Buy To Close (BTC) - buying back an option that was originally sold to open 4. Sell To Close (STC) - selling an option that was originally bought to open

When a position is Bought-To-Open, it is referred to as a long position.

When a position is Sold-To-Open it is referred to as a short position.

Use the chain in diagram 1 to study the following trades:

• BTO a May 260 call for $15.30 • BTO an April 255 put for $2.80 • STO a June 270 put for $17.85 • STO a May 265 call for $12.40

Notice how the prices change between strikes and expiration months?



Say you wanted to buy XYZ stock because you think it is going to move up from its current price of $84. Instead of buying the stock a trader could buy a call option for a fraction of the price of the stock. Remember, all the trader is doing is buying the right to buy the stock without any obligation to actually buy it. The option only costs $4.00 for the right to buy the stock at some future date. Buying 1,000 shares of the stock would require $84,000 but buying 10 options contracts would only cost $4,000.

Spreads Some option trades involve combining more than one option into a single trade. For example, when opening a spread, (which will be discussed in the Trader’s Guide To Spreads), one option will be STO and a different option will be BTO. As you will learn, spreads are an excellent way to mitigate risk.

Types of Options: Call options increase in value when the underlying stock rises.

Buyers of calls have the right, without any obligation, to buy the underlying stock at the strike of the options contract. They retain their right until the option no longer exists, defined by the expiration date. Call buyers anticipate the value of the underlying stock will rise. When it does, the value of the option will also increase at approximately the rate of the Delta. Buyers pay for the right to buy the stock in the future, sometime before expiration of the option. When buying the option, they pay the ask price. The premium they pay is less than buying the stock yet they will still benefit from any appreciation in the value of the stock.

Call Options – The Sellers… Sellers of call options are selling to someone else the right to buy the underlying stock from them. When/if the buyer chooses to buy the stock from the seller, (remember, the buyer has no obligation to do so) it is referred to as an exercise…the buyer is exercising the right to buy the stock. The seller is obligated to deliver the stock to the buyer. A seller’s obligation ends when the stock is exercised, the option expires or the option is BTC.

Call sellers receive a premium from the buyer. The buyer is paying the seller for the right buy the stock in the future. Sellers want the price of the stock to go down. Why? If the price goes down, the buyer will have no reason to exercise since they could buy the stock for less at the current market price. In this case, the seller gets to keep the premium paid by the buyer.



Scenario 1: It is discovered that the back of the painting has a signature of a famous artist, which drives the value of the painting up to $10,000. Because the owner sold you an option which gives you the right but no obligation to purchase the painting at the previously agreed price, he is obligated to sell the painting to the buyer for $1,000. The buyer would make a profit of $8,950 ($10,000 value – $1,000 purchase price – $50 for the cost of the option).

Scenario 2: After closer review of the painting, it is discovered that the signature on the back is not of a famous artist, but is the brother of a famous artist. This actually drives the value of the painting down to $500. If the buyer exercised their option to purchase the painting it would cost $1,000. This would not make sense because the buyer could instead just buy it at “market price” for just $500. Since the buyer had no obligation to purchase based on the option contract, the agreement, or contract, would just expire.

Call Options…Continued…

So, what does this mean in plain English? The concept of a call option is present in many situations. For example, you discover a painting that you would love to purchase. Unfortunately, you will not have the cash to buy it for another two months. You talk to the owner and negotiate a deal that gives you an option to buy the painting in two months for a price of $1,000. The owner agrees and you pay the owner a premium of $50 for the right to buy the painting.

Consider two possible scenarios that can impact the value of this “option”:

The example demonstrates two important points. First, when you buy an option, you have a right, but not an obligation, to do something. You can always let the expiration date pass, at which point the option becomes worthless. If this happens, you lose 100% of your investment, which is the money you paid for the option.

Put Options Put options increase in value when the underlying stock decreases in value.

Buyers of puts have the right, without any obligation, to “put” the underlying stock to someone else at the strike price of the options contract. They retain their right until they STC the option or it no longer exists, defined by the expiration date.



Say you thought XYZ stock is going to move down from its current price of $84. Buying a put with a strike of $85 gives the buyer the right in the future to sell or put the stock to someone else at $85. So, if the stock declined to $75, the buyer of the option could buy the stock at $75 and immediately exercise their right to sell/put the stock at $85, making a $10 profit. Remember, all the trader is doing is buying the right but has no obligation

Put Options…Continued…

Put buyers anticipate the value of the underlying stock will go down. When it does, the value of the option will increase at approximately the rate of the Delta. Buyers pay a premium for the right to be able to put (sell) the stock to someone else in the future, sometime before expiration of the option. When buying the option, they pay the ask price.

.

Put Options – The Sellers…

Sellers of put options are selling to someone else the right to sell/put the underlying stock to them. When/if the buyer chooses to put their stock to the seller, this is referred to as being assigned……the buyer of the put option is assigning the stock to the seller. The seller is obligated to buy the stock based on the strike price of the contract. A seller’s obligation ends when the option expires or the option is BTC. Put sellers receive a premium from the buyer. The buyer is paying the seller for the right to sell the stock to the seller in the future. Put sellers want the price of the stock to go up. Why? If the price goes up, the buyer will have no reason to assign the stock since they could sell the stock for more at the current market price. In this case, the seller gets to keep the premium paid by the buyer.

Exercise and Assignment

Most stocks are American style options. This means that if the buyer of an option chooses to exercise or assign their rights they may do so at any time prior to expiration.

Indexes such at SPX, NDX and RUT are European style options. This means that any exercise or assignment may only occur at expiration.



Who wins when the stock moves?

1. Buyers of Calls – win when the stock goes up 2. Sellers of Calls – win when the stock goes down 3. Buyers of Puts – win when the stock goes down 4. Sellers of Puts – win when the stock goes up

Intrinsic Value In-the-money

Call options are in-the-money if the stock price is above the strike price. Put options are in-the-money when the stock price is below the strike price.

The amount by which an option is in-the-money is referred to as intrinsic value.

Diagram 2

At-the-money Options are at-the-money when the stock price is trading at or very near the strike price.



Out-of-the-money Call options are out-of-the-money if the stock price is below the strike price.

Put options are out-of-the-money when the stock price is above the strike price. If an option is out-of-the-money it has no intrinsic value.

Diagram 3

Time Value Options have two parts that comprise their value; Intrinsic value and time value. When an option is in-the-money (ITM) it has intrinsic value equal to the amount it is ITM. Option price minus intrinsic value = time value.

Refer to diagram 3 and find the ask price for the 450 call. • The 450 strike is two points ITM so, there is $2.00 of intrinsic value. • $10.10 is the ask price. $2.00 of this is intrinsic value. • $8.10 of the $10.10 ask price is time value.



Time value decays as expiration approaches. The closer to expiration, the faster time value decays. Sellers of options use time decay as part of their winning strategy. Time decay is a benefit for option sellers and a problem for option buyers.

The Reality of Trading

In the real world, investors very rarely exercise their option contracts to take profit from a trade. Instead, they simply BTC or STC the options prior to the expiration date. The advantage of doing so allows them to capture some of the time value of an option, in addition to the intrinsic value. It also allows you to use the leverage of options that do not require the larger amounts of capital required to actually buy and sell the underlying stock.

Let’s analyze some examples to become familiar with common terminology:

GE is trading at $21 and the following shows a BTO of 3 call contracts of the September $20 strike at an ask price of $1.40:

• The underlying General Electric stock value is $21 per share • The expiration date of the call is the third Friday in September • The strike price is $20 • The call is in-the-money because the stock price is above the strike price • The premium is $1.40 per share • There is $1.00 of intrinsic value (in-the-money) and; • 40 cents of time value (out-of-the-money) • Number of shares represented is 300 (3 contracts x 100 shares per contract) • Buyer is hoping the stock rises, causing the value of the option to also increase.

MA is trading at $425 and the following represents a STO of 2 put contracts of the January 420 strike at a bid price of $27.00:

• The underlying Master Card stock value is $425 per share • The expiration date of the put is the third Friday of January • The strike price is $420 • The Put is out-of-the-money because the stock price is above the strike price • The premium is $27 per share • Number of shares represented is 200 (2 contracts X 100 shares per contract) • Seller is hoping that stock remains above $420 at expiration. This will result in time

value decaying thus, reducing the price of the option. Since it was STO for $27, when time value decays, the seller will be able to BTC for less than $27 and lock in a profit.



Call and Put options can be bought and sold in combinations that offer other investment strategies. Some of these include credit spreads, debit spreads, and combination options spreads, to name a few. These will be discussed in the Trader’s Guide To Strategy.

Visual Quick Reference Guide

NOTES

NOTES

Mark Dannenberg [email protected]

773-496-4757 www.OptionsMoneyMaker.com

Take Home Points

• Options trading does not have to be risky.

• Options provide leverage to make profits with less money than owning stocks.

• Having an experienced coach is a great way to learn options trading, minimize errors, and create a skill set you can use for a lifetime.

Documents

Trader’s Guide to Options · You will crash and burn. Treat your trading and financial security as seriously as you would any other important areas of your life. In this guide,