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A tragic accident at age 15 left Chris unable to walk, but turned him into one of the most

motivated and successful traders that Wall Street's ever seen. Chris is a 12-year Wall Street
veteran and an internationally respected authority on options with nearly 80% of his trades
being profitable since launching his advisory service, The Trend Rider, in 2005.
Today he offers his options tutorial to you for free!
Table of Contents

I. Table of Contents .................................................................... 1



II. A Note from Chris Rowe ......................................................... 2

III. Some Very Important Definitions ........................................... 7

IV. Understand the Basics (Options 101).................................. 12

More Basics: Types of Options ..................................................................... 14
The Beauty of Leverage ................................................................................. 18

V. Time Value – How I Learned About Time Value (Or I Should


Say, “Time Decay”)................................................................ 23

VI. Understanding Risk............................................................... 33

So Let’s Talk a Bit About Put Options ............................................................ 34

VII. COVERED CALLS .................................................................. 41



VIII. Important Tips and Terms..................................................... 53

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Options Trading Simplified 2008
by Chris Rowe
A Note from Chris Rowe
A tragic accident at age 15 left Chris unable to walk, but turned him into one of
the most motivated and successful traders that Wall Street's ever seen.

Then, 5 years ago, Chris Rowe turned his back on a Wall Street career worth
tens of millions of dollars and said;

“I Quit!”

Dear Investor:

“I quit.”

Five letters ... two simple words.

But as soon as I said them, I knew my life had changed forever.

The year was 1998. I was making so much money in the markets I had become a
millionaire while still in my 20's.

And yet, I still quit. I'll never forget the look on my boss's face. He was shocked.
He didn't understand (and still doesn't to this day) how I could so easily turn my
back on tens of millions of dollars in future income.

But I was leaving for a reason. I was sick and tired of watching the Wall Street
"establishment" lie, cheat and steal just to make a buck off the backs of hard
working Americans.

That may sound like a cliché, but it's the honest-to-goodness truth. It was the
nature of the "game" on Wall Street, and I had decided that I wanted no part of it.

So I took what I had learned about options directly from the richest and most
successful investors on earth -- the secrets of how money is REALLY made in
the markets -- and put it to work to help my people like you profit along with the
big players.

Lately, I've started to think about slowing down, taking it easy, and enjoying my
money.
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Yes, I'm only 30. So you may think it's absurd for me to even consider something
like "retirement" at such a young age.

But when you have tragedy early in life, you see things differently.

When I was 15 years old, a doctor walked into my hospital room and told me I
would never walk again.

My father, seeing that his son was never going to be able to play varsity sports,
dance at the prom, let alone walk again, wanted to give me a happy and active
life.

He told me that the stock market was the best gig in town for people with the time
and patience to really study it. And as a disabled teenager, time was something I
had plenty of.

While others were dating and hanging out at the school-yard, I was poring over
price charts, reading every book on trading I could lay my hands on, and making
successful paper trades.

A business associate of my father's saw my raw ability, and offered me a job at a


Wall Street brokerage on the spot.

Soon after, the richest and most successful trader at the firm, Wall Street legend
Mark Rosenberg, took me under his wing as his first and only apprentice.

The next 5 years under his tutelage were grueling and painful. Many good days
and bad days.

But I persisted, and my persistence paid off: I learned to master the markets ...
and make vast sums of money for me, my firm, and our clients ... at an age
where most of my contemporaries and co-workers were getting drunk on
weekends or going to Pearl Jam concerts.

Of course, I also lost many years of "normal" living that most young people enjoy.
And now that I am financially independent, I'm thinking of making up for lost time.

Yet I don't ever want to leave you ... and so many other individual investors ... at
the mercy of boiler-room operators, high-pressure stock brokers, hype-filled stock
sales brochures (er, I mean "analyst reports"), and the other sharks on Wall
Street.
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It's because I know from hard-earned experience that ...

1. THE ONLY WAY TO GET RICH ON WALL STREET IS TO HAVE


INFORMATION NOBODY ELSE HAS.

Truer words have never been spoken.

Knowledge handed down to me by one of the richest men on the planet and has
taken me almost fifteen years of my life to master and perfect.

2. IT'S AS EASY TO MASTER AS WATCHING A MOVIE:

My goal is to make it as learning options as easy as watching a movie. That's the


only way I could ensure that what I teach you can be put to use right away to
make outsized profits.

Trading options is not at all complicated. It scares a lot of people. But it shouldn't.

How Much is Your Financial Independence Worth to You?

My last 7 closed trades were:

Avid Technology Inc. (AVID) +65.46% in 4 months.


BE Aerospace (BEAV) +54% in 7 days!
Morgan Stanley (MS) +24.82% in 3 months.
Merrill Lynch & Co. (MER) +69.82% in 2 months.
ImClone Systems (IMCL) -26.55%Terex Corp (TEX) -30.24%
Gafisa SA (GFA) +64.87% in 72 Hours!

I can't "fake it" when discussing my track record. It's public knowledge, easily
available to any of my members with a PC and an Internet connection.

Fortunately, I have nothing to hide. Most mutual fund managers under-perform


the broad markets, and most financial advisors cherry-pick their track records.
They show you only the handful of winners, conveniently "forgetting" to mention
that most of their stocks lose money.

The more investors like you I train to be completely self-sufficient ... and to gain
real mastery and understanding of the markets ... the sooner I can sit back, relax,
and ease into semi-retirement.

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You know the old expression: give a man a fish, feed him for a day; teach a man
to fish, feed him for life.

Of course, I don't think I'll stop cold and do nothing. I'll continue to trade my own
accounts ... and write my articles, reports, courses, and maybe a book or two.
Freedom has a lot of meaning and appeal for a man stuck in a wheelchair.

Before reading this guide it is important that you understand something,


and I’m speaking to options traders of all levels, from novice to advanced.
Some of this guide, especially the first half, covers the bare bones basics
of options trading. I strongly urge you, no matter how much of it you
already know, to read the entire guide. Worst case scenario, you refresh
your beginner level knowledge, which will strengthen your foundation of
wisdom. When it comes to options, you absolutely must have a solid
foundation. Without that, the house will collapse.

I speak with options traders of all levels, and you would be very surprised
at how many people who are way past this “beginner’s level” eventually
encounter confusion, or make a mistake that they never should have made
had their foundation been concrete.

So if you find yourself saying “yeah, yeah, blah, blah, blah, I already know
this” or “duh” at any point during this lesson/guide, just give it a chance
and read through it anyway. It won’t hurt, and it will ensure that you will
grasp everything that is discussed.

Before I go any further, let me first just say that my #1 suggestion to you is to
start by playing very small.

You can’t learn to ride a bike by reading a manual or having someone explain
how to do it. You need to get up and try, but at the same time, you don’t want to
start learning how to ride a bike by entering the Tour de France. The best way to
learn about options is to actually be in the game, just like riding a bike. And just
like riding a bike, you ought to start on a very small level (with training wheels, so
to speak).

So after you get these basic concepts down, and you understand how options
work in general, get out there and trade one option at a time. If you make a profit
on your first three tries, don’t go crazy and put a huge amount in the next few
trades. Have discipline.

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If you lose on trade number one or two, be absolutely sure to stop what you are
doing, take some time, and understand exactly what happened on the trade.
This is crucial. But don’t let it get to you! Keep pushing ahead with your
education.

What if Warren Buffett lost money on his first stock investment and decided to
stop investing in stocks? He wouldn’t be #2 on the Forbes 400 list.

You may take some minimal losses and gains (dollar wise), but whether you are
up a little or down a little, you will have learned several very valuable lessons, as
long as you carefully review each trade after executing them.

I hope that what I have written will help you, and if it doesn’t, please let me know
so that I may improve this guide for you and others.

Without further ado, enjoy this guide that I’ve put together for you on the basics
of trading options.

Best,

Chris Rowe
October6th, 2008
Delray Beach, Florida

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Options Trading Simplified 2008
A Guide to Huge Profits Using Options

Some Very Important Definitions

Take a minute to read the definitions below of the two different types of options,
which are call options and put options. Don’t spend too much time with it, but
read it over once or twice. If you don’t completely understand it, just continue
forward and – as you read on – it will all sink in. We will cover this part again as
we get further into this guide.

Call Options

At a very basic level, a call option is a way to bet that a stock will go up in
value within a certain timeframe, and generally offers the buyer more leverage
than simply owning shares in that stock.

Call Option (Buyer/Owner)

This is a contract that gives the buyer the right to call (buy) 100 shares of the
underlying stock covered by the contract, at a stipulated price (exercise price)
sometime before the option contract expires (expiration date), in return for paying
a premium to the seller of that call. Numerous exercise prices (strike prices) are
attached to each stock. They generally go in 2 ½ point intervals up to 22 ½, and
in 5 point intervals above that level.

Call (Seller/Writer)

The seller (writer) of a call option contracts to sell 100 shares of the underlying
stock covered by the contract, at a stipulated price (exercise price) sometime
before the option contract expires (expiration date). The seller receives the
premium (cost of the options) from the buyer.

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Put Options

Again at a very basic level, a put option is a way to bet that a stock will go
down in value within a certain timeframe, and generally offers the buyer more
leverage than simply shorting shares in that stock.

Put Options (Buyer/Owner)

The buyer of a put has the right to put (sell) stock to the writer of that put, at a
stipulated price (exercise price), sometime before the option contract expires
(expiration date), and for that right must pay a premium to the seller of that put.

Put Options (Seller/Writer)

The seller (writer) of the put stands ready to buy stock at a stipulated price
(exercise price) sometime before the option contract expires (expiration date),
and receives the premium from the buyer.

“Leaving Las Vegas”

Some people think that trading options is a big mystery, and that you’d have to
be a sophisticated Wall Street trader to understand how they work. This really
isn’t the case at all. Once you break through a few simple barriers of
understanding, it becomes very easy.

It took me my whole career to


truly master options. When I
first started working on Wall
Street, I only knew what a
stock was. The options
traders were always these
fifty-something-plus Wall
Street veterans who had been
trading every day for decades.
I mean, even the experienced
younger guys at the firm
stayed away from options
contracts for the most part.

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The impression I got was that they would only play options when they wanted to
gamble, but didn’t have time in their schedule to take a trip out to Atlantic City or
Las Vegas (it was always hard to pull these guys away from the action).

Stocks were much easier for me to understand. I mean, the concept was clear-
cut, and I was spending all of my time starting business relationships with
investors and building up my client base and career. I decided to stay in my
comfort zone.

But after I established myself on The Street with a solid track record and a strong
money managing business, I decided to try buying my first option. I remember
spending a little over $400.00 on a “Schering-Plough $45 call option” (I forget
which month it expired).

Danny T., an older trader who sat next to me (well, he was in his 40s, which at
the time, I considered to make him one of the “older guys”), convinced me to do
it. I didn’t know how or why it worked, but it worked well.

The stock only traded up about 4 points (a 9% gain) … for no reason other than
the entire market moving up … and I turned my $400.00 into about $750.00,
because the option I had bought increased in value by almost 90%! Cha-CHING!!

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Wow! Well that was a pretty cool test! What did I just do again? Although this
was a small trade, I remember being nervous (and excited).

Next, I remember buying options on Capital One Financial (the credit card
company). I bought “the COF 40 calls” (again, I forget the expiration month, but
I’m sure that the option contract expired within a couple of months).

I bought the option contract for $1.25. The stock traded 11% higher, from $40.00
to $44.50.

That caused the option contract to trade 300% higher … from $1.25 to $5.00. I
was starting to grasp the true power of leverage.

But I also knew that I ran the risk of losing the entire amount that I put into the
trade, so I continued to play very small.

After picking about 9 winners in a row (it was the 90s), I decided to do some
investigating, and a lot of reading. I was lucky that the older and wiser traders in
the firm really took a liking to me and wanted to help me. I think it was because
guys like that always tend to root for the hard-working underdog. I’ll admit: I
usually got some special treatment.

I had only read about options when I was studying for my series 7 license, which
is the license that you need to be a stockbroker.

At first I thought to myself – I wouldn’t dare put my clients’ money at such a large
risk, and there’s no way that I’m going to shoot craps with a business that I spent
years building.

In the 90s, every money manager was making their clients money. The clients
rarely had any reason to leave their money manager and transfer the account for
me to manage.

But I was intrigued with the idea of finding an angle. I wanted to find an
untraditional way of making money for my clients that would separate me from
the average money manager.

Options required me to think outside the normal zone of comfort, and I had
learned that options weren’t always a “craps-shoot.” I knew that there were ways
to reduce risk and protect profit, as well as to use them to speculate on stocks.

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I also knew that I’d have to learn through experience and make a few mistakes
along the way. The mistakes I proceeded to learn from were common for rookie
options traders. Once I got out of the rookie phase, I learned a few other
important basic concepts.

To spare you the pain of learning any hard lessons for yourself, I’ll list the hurdles
that I had to get past … and explain the 4 most important lessons that I learned:

Hurdle #1: Understand the basics (options 101).

Hurdle #2: Understand time value (and how to overcome it, and take
advantage of it).

Hurdle #3: Understand how to use options to reduce risk.

Hurdle #4: Understand how to sell covered calls.

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Understand the Basics (Options 101)

Most investors know that buying stock entitles them to partial ownership in the
company who issued those shares. In other words, you’re purchasing an "equity"
participation in the company. Most stocks listed and traded on U.S. stock
exchanges are termed equity securities.

So what is an option? In a word, an option is actually a


contract. (When talking about an option contract,
sometimes people drop the word “contract” and simply refer
to it as an “option”.)

Unlike stock, however, an option does not convey to the


purchaser any ownership in anything. Instead, an option
contract conveys the right of its owner to buy or sell the
underlying stock on which it is based.

For example, you can have an option contract on IBM,


which gives you the right to buy or sell IBM stock at a fixed
price.

An option contract is publicly traded, just like a stock. And


just like a stock, option contracts are constantly fluctuating in price.

As IBM stock fluctuates up and down, there are many different option contracts
on IBM that are also fluctuating up and down daily.

It is crucial that you get these essentials down before we go any further, so I’ll
explain it again.

The owner of an option contract has the right to exercise the contract.

What do I mean by “exercise the contract?”

If you have a piece of paper that says that you have the right to buy IBM at $50
(even though the stock is trading at $70), and you decide to exercise that right to
buy IBM at $50, you have “exercised the contract.”

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The (option) contract owner has no
Wall Street Lingo
obligation to do anything. The owner
Remember: doesn’t have to buy IBM at $50. But if
he wanted to, he could.
When we say that we are long an
option, it means that we own an That is where the word “option” comes
option. We have paid money, we
now own a contract – we now own
from. The owner of the option contract
the right to do something. has the “option” to exercise the contract,
or to not exercise the contract.
When we say that we are short an
option it means that we have sold an
Remember: The owner of an option
option for our opening (initial) trade.
We have received money. In return contract has spent money to buy the
for the payment that we received, we option contract. So it’s the owner’s
made a promise to either buy or sell choice, or right, to exercise the option
a stock at a fixed price.
contract.
I hate to sound repetitive but we
have to be sure that you get this … The obligation is on the seller of the
option contract.
- When you are long an option
contract, you own the right to
exercise it. The seller of the option contract has
received a payment.
- When you are short an option
contract, you have an obligation if The person who has sold the option
the buyer wants to exercise it.
contract to the buyer/owner has the
obligation to fulfill the terms of the
option contract if the owner decides to
exercise the option.

CALL PUT

LONG (owner) Right to Buy Right to Sell

SHORT (seller) Obligation to Sell Obligation to Buy

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More Basics: Types of Options

There are two types of stock options:

1. The “call” option

2. The “put” option

A “call” option is an option contract that gives the owner


Calls vs. Puts – An Easy
of the contract the right (not the obligation) to buy a stock
Way to Remember
at a fixed price over a given period of time.
When you own a call option, you
It gets its name from the fact that, as the owner of the want the underlying stock to
option contract, we are able to “call” the stock away from move up. This is because when
a stock moves up, the call
the person who sold us the call option contract, which option moves up in price.
means that we can buy the stock from that person (at a
predetermined price). When you own a put option, you
want the underlying stock to
move down. This is because as
In other words, a call option contract gives its owner the a stock moves down, a put
ability to say “hey, remember the agreement that I paid moves up in price.
you money for? Well, I want to buy this stock from you at
the price that we had previously agreed on.” An easy way to remember this:

You call up …
A “put” option is an option contract that gives the owner … You put down.
of the contract the right (not the obligation) to sell a stock
at a fixed price over a given period of time.

It gets its name from the idea that the owner can “put” the stock to someone, or
to “sell” the stock to someone at a fixed price.

A put option contract gives its owner the ability to say “hey, I want to sell this
stock to you at the price that we agreed on.”

So remember: in regards to either a put or a call option contract, if you bought


it you have a right, and if you sold it you have an obligation.

Now, do you remember where the word “option” comes from?

Remember, when you own an option contract, you have the “option” of exercising
the contract if you want to.
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Option contracts aren’t always exercised. In fact, the majority of the time, an
option contract is purchased for one dollar amount, and sold for another dollar
amount.

Option contracts fluctuate in price just like stocks do. Therefore, they can be
bought and sold like a stock.

When you own an option contract, not only is it your “option” to exercise the
contract, or not exercise the contract, but it is also your “option” to sell the
contract itself at whatever dollar value that the market is giving it at the time.

First I’ll give you a real life example, and then I’ll explain the
mechanics behind the concept.

I recommended to members of my trading service The Trend Rider that they


purchase call options on a company called Suncor Energy. At that time,
Suncor’s stock was trading at $52/share, and the options I recommended were
trading for $15.20.

When Suncor Energy’s stock hit a high of $80.00 per share on January 31, 2006,
the call option that I recommended had traded all the way up to over $36.00
apiece.

Now, if you had simply bought the stock at $52 on October 12, 2006 you would
have been up 53%. Great.

But if you had bought the call option that I recommended, you would have been
up 136% … on the same exact movement in the underlying stock.

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(Of course there were some much riskier call options that traded 900% higher
within that time-frame if you were willing to take that huge risk, but the call that I
recommended was much more conservative.)

Here’s the difference between buying the stock vs. buying the call option:

- If we had bought 100 shares of Suncor Energy stock, we would literally own a
(very small) percentage of a business called Suncor Energy.

- By owning a Suncor Energy 45 call option, we owned a contract that gave us


the right to buy 100 shares of Suncor Energy at $45/share.

It doesn’t matter what price Suncor Energy is trading at in the stock market.
Suncor Energy could be trading at 38-56 or at 104. If you own a Suncor Energy
45 call option, then you own a contract that gives you the right to buy Suncor
Energy at $45.00, even though the stock might be trading at a completely
different price.

Here’s a closer look at the trade in question:

When Suncor Energy was trading at $52.00 per share, I send out a trade alert
recommending the purchase of a year 2007 January 45 call option.
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This particular call option gave my Trend Rider members the right to buy the
stock at $45.00 per share. The purchase price of the option contract that I
recommended was $15.20.

Here’s what the option quote looked like: 2007 Jan 45 call - $15.20

Always remember: One option contract represents 100 shares.

That means that each one of those 2007 January 45 call options trading at
$15.20, would have cost $1,520.00 to buy at that time.

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The Beauty of Leverage

Here’s another way of looking at it: When I buy an option, I am using leverage.

Use this analogy:

If I buy a house for $300,000.00, and I put down 10%, and mortgaged 90%, then
I have only invested $30,000.00.

If the house goes up in value by 20%, then the house would be valued at
$360,000.00 right? So if I sell the house, that’s a $60,000.00 profit.

Although the house went up in value by 20% (from $300k to $360k,) since I only
put up $30k, I actually made 200% on my money ($60k profit on my $30k.)

How Buying a Call Option is Like Buying a House

Some people are confused by options, but the reality is that people have been
using options for ages in the form of contracts such as real estate and auto
insurance.

One way of looking at a call option is drawing a comparison to a contract to buy


a house.

If I were considering purchasing a house, I would agree on the purchase price


before actually purchasing the house.

Let’s say in this example that I would put down a deposit of $5,000.00, and I
would draw up a contract, guaranteeing that I could purchase the house at the
agreed upon price.

(When I put money down to buy a call option, I also receive a contract,
guaranteeing that I can buy a stock at a fixed price.)

But let’s say that a catastrophic event sent real estate prices down. I could find a
way to back out of the deal and choose not to buy the house at that price, but I
would lose my $5,000.00 deposit.

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If the house went down in value by $100,000.00 I wouldn’t worry too much about
backing out and losing a $5,000.00 deposit. (Good thing I didn’t actually own the
house, or I would be down $100,000.00!)

But if the value of the house suddenly went up by $100,000.00, then the contract,
which guarantees me that purchase price that we agreed on, suddenly becomes
much more valuable. (I’d sure hate to misplace that piece of paper!)

How Are Options Like Pizza???


Here’s one way that you may have used an option contract long before you even got
interested in the stock market…

Does this look familiar to you?

It’s a coupon!

When buying a call option, think of the


agreement that is made when a business
issues coupons.

Owning a coupon gives you the right to buy


an underlying asset at a fixed price.

Owning a call option gives you the right to


buy an underlying asset at a fixed price.

Of course you don’t have to use the coupon,


but it is your “option” or your right, to use it.

The issuer of the coupon has the obligation


to sell you (in this case) the pizza at a fixed
price ($10.99.)

Similarly, the seller of the call option (or the person who is short the option) has the obligation to
sell you a stock at a fixed price.

If the price of pizza goes through the roof and now sells for $30.00 each, the issuer of the coupon
can’t just decide not to honor the coupon. The coupon is a contract! The issuer still has to
honor the coupon and sell you the pizza at $10.99.

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How Buying a Put Option Is Like Buying Insurance
When you purchase an insurance policy, you have purchased a contract that you
pay a “premium” for. The insurance company isn’t giving you anything you can
hold in your hand … just a promise to fulfill a specific obligation in the future.

If you’ve paid for an auto insurance policy, and then you crash the family car, the
insurance company is obligated to take whatever action necessary to return the
car to its prior condition.

As a matter of fact, a put option is commonly used as an insurance policy on a


stock position.

For instance, let’s say you own 100 shares of stock in H&R Block, which was
trading at $23.00, and you absolutely loved the stock.

I mean, you believed with every fiber of your being that the stock was going to
trade to $40 this year. But they were going to announce earnings in a week, and
you heard a silly rumor that the earnings would be terrible, which would send the
stock crashing down!

A smart choice would be to simply hold on to your stock, but at the same time
buy a put option with a strike price of $22.50. That would give you the right to
sell your stock at $22.50 if you chose to do so.

This way, even if the H&R Block stock traded down to $7.00 per share, it’s okay
because you bought insurance on your stock (in the form of a put option) that
says that you can sell the stock at $22.50.

That’s a very simple example of how you can use options to protect yourself
against losses.

Other Terms You Should Know


Below is an example of an “options chain,” which basically lists the options that
are available on a particular stock (in this case, IBM).

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Although an options chain
may seem like a foreign
language to an options
novice, as long as you keep
looking at it, and keep trying
to understand it, it will
certainly become crystal
clear to you.

(You can find an options


chain by clicking here)

Let’s go over a couple of


key terms …

Strike (or Exercise) Price


is the price at which a stock
can be bought or sold as
specified in the option
contract.

For example, with the IBM


April 80 Call, the “strike
price” of 80 would give the
holder the right to buy the
stock for $80 per share.

Where with the Exxon April


70 Put, the “strike price” of
70 would allow the holder
the right to sell the stock at
$70 per share.

The Expiration Date is the day on which the option is no longer valid and ceases
to exist. The expiration date for all listed stock options in the U.S. is the third
Friday of the month (except when it falls on a holiday, in which case it is on
Thursday).

For example, the IBM 80 Call option will expire on the third Friday of
April, 2006.

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Options Trading Simplified 2008
by Chris Rowe
The next part of options trading that we’ll discuss should to be the easiest to
understand:

When opening a new options trade, you must specify that you are doing so
by using the term “to open”.

When you are closing out an existing options trade, you must specify that
you are doing so by using the term “to close”.

That sounds simple enough right?

For example:

If you think the XYZ June 15 call will trade higher and you want to open a trade
by purchasing it at $3.00/contract, then you would enter your trade like this:

“I would like to Buy one June 15 call to open.”

Then, when the June 15 call option is at $5.00, you would close the trade by
selling it at $5.00/contract like this:

“I would like to Sell one June 15 call option to close.”

Remember this similarity between stocks and options:

You have the ability to either buy a stock first and then sell it second – OR – you
can sell (or “short”) a stock first and then buy it second.

When you short a stock, the idea is to profit by selling it, and then buying it at a
lower price. You can do the same thing with options. The only difference is that
you must always specify, when entering the trade, whether the trade is an
“opening” or “closing” transaction.

I will use this terminology in this guide going forward.

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Time Value – How I Learned About Time
Value (Or I Should Say, “Time Decay”)

When I was a rookie, I lost an obscene amount of hard-earned cash on a single


trade for two reasons: Time Decay and Greed ...

I bought a call option at $4.00 “to open.” This particular option gave me the right
to buy a stock at $100.00. At the time, the stock was actually trading at $101.00
per share (so the call option was one point in-the-money.)

The price that I paid ($4.00) was based on two factors:

1. Intrinsic Value (which accounted for 1 point out of 4)

2. Time Value (which accounted for 3 points out of 4)

Let me explain what that means.

1. Intrinsic Value

The gain that I would automatically have if I were to exercise the option contract
at that time is called "intrinsic-value."

In other words, I had a "call option" that gave me the right to buy IBM stock at
$100 per share. Meanwhile, the stock was trading at $101 in the open market.

If I had decided to use the option to buy IBM at $100 ($1.00 below the price that
it was actually trading at), then I would automatically have a 1 dollar gain on
the stock.

Said differently, the option that I owned only had $1.00 of "Intrinsic Value."

So if I only would have had a $1.00 profit on the stock, then why did I buy the
call option at $4.00?

Because the option contract is worth more than just the $1.00 in profit that I
would make on the stock on THAT DAY.

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What about the future profits that the option could potentially bring me tomorrow,
or in a week or two?

What if, on the following day, IBM traded to $112? That would mean that I could
use the call option to buy IBM at $100, and I would then be up 12 points on the
stock!

That would be at least a 200% gain if I bought that call option for $4.00 (since I
would have $8.00 in profit on the $4.00 investment).

As a matter of fact, I remember that the reason that I bought that call option (to
open) was because I thought that the stock would trade from $101 to $120 within
a month (remember: it was the 90s), which would have given me a 400% profit
on my options.

(If the stock traded to $120, it would have caused the call option to trade from
$4.00 over $20.00/contract. At that point, it would have been my OPTION to
either use the call option to buy IBM at $100, OR to simply sell the contract itself
at over $20.)

Here's the problem: As time passes, time value deteriorates. (This is also known
as “time decay”.) This is one of the most important parts of options trading that
you absolutely must understand.

Look very closely at the time decay curve below. Notice how the deterioration
accelerates much faster in the last 3 months of the option contract’s life
compared to the 3 months before that. In the 30 days prior to the options
expiration date, the time value deteriorates rapidly!

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by Chris Rowe
(Intri
nsic
valu
e is
not
affe
cted
at
all
by
time
dec
ay.)

Although the stock ended up trading 50 cents higher (to $101.50), I lost 62% of
my option trade in a couple of weeks.

Let’s get back to my story of how I learned about “time decay” (the hard way).

When the option had 1 day left before expiration, all of the time value had
deteriorated.

The contract was worth $1.50 because I could still use it to buy IBM at $100,
and sell it at the market price of $101.50.

I was left with a contract that was worth $1.50. Notice that the intrinsic
value portion of the option was not affected whatsoever by time passing.

Only the time value portion of the options price can be affected by time
decay.

I sold the call option at $1.50 (to close) and I had lost $2.50 on my $4.00!
AAARRGH!

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Options Trading Simplified 2008
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How?

2. Time Value! Or, I should say, Time Decay.

As time passed, my call option lost over half of its value. The call option expired,
and after that, to add insult to injury, the stock hit $145 in a month and a half (of
course).

All I got from it was a huge tax write off, and a very expensive lesson. So
expensive that, to this day, I'm too embarrassed to tell you the dollar amount that
I lost.

Even though the stock traded slightly higher, I lost 62% on the trade! This is
because the time value portion of the option price deteriorated.

If this has ever happened to you, then you can certainly relate to the
overwhelming feeling of frustration that I felt that day. Oh! I just had another
grey hair pop out from thinking about it!

So what went wrong?

Let’s review:

- I bought the call option at $4.00 (to open.)

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- Since the call option gave me the right to buy IBM at $100 when the stock was
at $101, the call option was only one point "in the money."

In other words, when I paid $4.00, only $1.00 (out of the $4) was real, "intrinsic
value."

The remaining $3 (out of the $4) was "time value," and was therefore at the
mercy of the most inevitable event that we know of: Time Passing.

So, since 3 out of 4 points that I paid for


were time value, that meant that if the Don’t Make the Same
stock traded flat at $101.00, over time,
my call option would have gone from
Mistake!
$4.00 to $1.00, because once the call Not understanding the effect of diminishing
option had no more time left on it, the time value is probably the number one mistake
time value ($3.00) would no longer exist. that I have seen beginners make.

If you understand how it works, you are ahead


Terms to Remember of the game and on the path to a much less
expensive education.
The term “premium” just refers to the
In my story, 75% of the option that I bought (3
price at which an option is trading. So, in out of 4 points) was time value. This was
this case above, the “premium” was extremely risky.
$4.00.
But there are always options available out there
that have very little time value.
Premium = Intrinsic value + Time value.
Those less risky options are the only options
($4.00= 1.00+$3.00) that I recommend to my Trend Rider members.

Intrinsic Value: The “in-the-money”


portion of an option's price.

In-the-money: An adjective used to describe an option with intrinsic value. A call


option is in the money if the stock price is above the strike price at the time of
purchase. A put option is in the money if the stock price is below the strike price
at the time of purchase.

Time Value: The part of an option's total price that exceeds its intrinsic value. The
price of an out-of-the-money option consists entirely of time value.

Time Decay: A term used to describe how the theoretical value of an option
“erodes” or reduces with the passage of time.
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Here, I’ll show you how each one works with real life examples:

Here is an old alert that I sent out on December 6, 2005 to BUY: Citrix Systems
2006 June 20 call options.

This particular call option, which was set to expire in June 2006, gave me the
right to buy Citrix Systems at $20.00 per share. The recommended purchase
price for the option was at $840 per contract.

The stock was actually trading at about $27.00 at the time.

See if you can answer these questions:

1. What is the “premium”?


2. What is the “strike price”?
3. What is the “intrinsic value”?
4. What is the “time value”?
5. How much time did the option have before the expiration date?

Answers:

1. The “premium” is the price of the call option, which was $8.40.
2. (In the case of a “call option”) The “strike price” is the price that the owner
has the right to buy the stock at, which was $20.00.
3. The “intrinsic value” was $7.00 because the stock was at $27.00, which is
$7.00 above the strike price of $20.00, or $7.00 “in-the-money”. If this
were a put option on the other hand, it would be in the money if the stock
were trading below the strike price.
4. “Time value” is the premium (price of the option) minus the intrinsic
value/in-the-money value ($8.40 - $7.00). So the time value is $1.40.
5. The option had a little over 6 months before expiration. I recommended
the call option on December 6, 2005 and the expiration month was June.
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Remember: options always expire on the third Friday of each month
(except if it falls on a holiday in which case options expiration is on
Thursday).

You should notice a couple of key points here:

1. In the trade recommendation, you will notice that my timeframe for the
stock to do what I anticipated was 2-3 months … so I recommended call
options that expired in 6 months. Time value deteriorates faster in the
last 3 months of the life of the contract, so you should always give yourself
plenty of extra time for your trade to work out.

2. Notice that the stock was actually trading at about $27.00 at the time. The
option was $7.00 in-the-money. That means that if Citrix Systems were to
trade flat for 6 months, the lowest that the call option would trade would be
to $7.00.

Since the option was $7.00 in-the-money and had $7.00 of intrinsic value,
only $1.40 was at the mercy of time decay. In other words, only $1.40 of
the $8.40 that we paid would actually be affected by time passing.

The deeper in-the-money that an option is, the less time value there will
be. For instance, if I bought the June 15 calls, instead of the June 20
calls, they probably would only have had about $1.00 in time value
(instead of $1.40.) But they were probably at $13.00 (compared to the
calls that I recommended at $8.40).

Now take a quick look for a minute at the actual trade alert that I sent to our
members, along with the two charts that follow:

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Options Trading Simplified 2008
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Options Trading Simplified 2008
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Options Trading Simplified 2008
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Options Trading Simplified 2008
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Understanding Risk

So you see, when you buy options, you don’t necessarily have to try to make
400% - 3,000% profits while “betting the house.”

Instead, you can choose to trade a more conservative option that puts you at less
risk, but still gives you above average return!

The reason I focus on this part is that I want to dispel a myth. Many people think
that buying options is a game where you invest a very small amount of money,
and either you make hundreds or thousands of percentage points, OR, you lose
everything.

Let’s change the numbers around a little bit here.

Here is an example of a super risky “craps-shoot” type of options strategy:

Citrix Systems is at $27.00

Joe thinks that it trades to $35.00

Joe buys the June 30 calls to open (which are “out-of-the-money” since
the stock is not trading over the strike price of $30.00)

The calls cost $2.00 (which is 100% time value.)

Now if Joe is right and the stock hits $35.00, then his options will go from $2.00
to over $5.00, netting him more than a 150% gain. Heck, if the stock rips to
$40.00, it’s a grand slam home run because he’ll make 500%. Nice to think
about, huh?

But if Joe is wrong and the stock trades flat, his call option will lose value each
week – especially in the three months before the option expires – and very
rapidly in the last 30 days, until the option is worthless.

In this case, the stock could trade a few points higher, but if it takes a few months
to do so, the option could actually end up at the same price, or even lower!

Joe is putting his entire investment at great risk. The option that he bought at
$2.00 was all “time value.” Even if Citrix Systems traded to $31.00, if it
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Options Trading Simplified 2008
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happened close to the expiration date, the option could end up somewhere
around $1.00!

(No “lucky seven” for Joe. Actually, I think his odds are better at the craps table.)

At this point I must apologize. I realize that in most of my examples, I’ve used
call options to explain each concept.

It’s just that in all my years of having thousands of conversations about options, I
found that people have an easier time grasping the concept with call options first,
and put options second.

So Let’s Talk a Bit About Put Options


Put options are basically the opposite of call options.

Remember: Put options give you the right to SELL a stock at a fixed price.

A person buys a put option (to open) for one of two reasons:

1. As a “Bearish” Strategy:
The person is betting that the underlying stock is going to trade lower.
Generally, when a stock trades down, a put trades up.

2. As Insurance:
If a person owns XYZ stock and is concerned that the stock might trade
much lower, but doesn’t want to sell that stock. If the stock trades down,
the person can still sell XYZ stock at the fixed/agreed on price.

Let’s look at a real life example:

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Options Trading Simplified 2008
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CAI 2006 March 70.00 Put options

This particular “put option,” which expired in March 2006, gave me the right to
SELL “Caci International Inc” at $70.00 per share. Our recommended purchase
price of the put option was at $12.25.

The stock was actually trading at about $58.75 at the time.

See if you can answer these questions:

1. What is the “premium”?


2. What is the “strike price”?
3. What is the “intrinsic value”?
4. What is the “time value”?
5. How much time did the option have before the expiration date?

Answers:

1. The “premium” is the price of the put option which was $12.25.
2. (In the case of a “put option”) The “strike price” is the price that owner of
the put option, has the right to sell the stock at, which was $70.00.
3. The intrinsic value was $11.25 because the stock was at $58.75, which is
$11.25 below the strike price of $70.00. This means that this put option is
$11.25 “in-the-money”.
Remember: a put option is in the money by the amount that the stock is
trading BELOW the strike price. A call option is in the money by the
amount that the stock is trading ABOVE the strike price.

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Options Trading Simplified 2008
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4. Time value is the premium (price of the option) minus the intrinsic value
($12.25 - $11.25.) So the time value is $1.00.
5. The option had about 5 months before expiration. I recommended the
put option on October 21, 2005 and the expiration month was March.
Remember: options always expire on the third Friday of each month
(except if it falls on a holiday in which case options expiration is on
Thursday.)

-My recommended purchase price for this option was $12.25.


-The stock was actually trading at about $58.75 at the time.
-Remember: we will profit if the stock trades lower.

You should notice a couple of key points here:

1. On this trade I had a very short-term time frame. You’ll notice that in the
Trade Alert (see below), I spoke about the negative technical picture of the
stock and the negative trend that the computer sector as a whole was in.

But you will also see that I mentioned that the company was scheduled to
report earnings in a week.

It is important to notice that, although I had a short-term time frame on this


trade, I still recommended that The Trend Rider members buy the put
options that expire in 5 months. This way, I would have a nice pillow of
time for the stock to do what I wanted, in case my timing was off.

2. 2) Once again, I recommended put options that were deep in-the-money,


so that the time value would be minimal. I hate to see time decay ruin a
good trade. In this example, the put option only had 1 point of time value.
That means the most that I could lose due to time passing was $1.00.

Now take a quick look for a minute at the actual trade alert that I sent to my
members:

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Options Trading Simplified 2008
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Options Trading Simplified 2008
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Watch what happened here …

Here’s what the stock’s chart looked like when I made the recommendation:

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Options Trading Simplified 2008
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And here’s what ended up happening:

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Options Trading Simplified 2008
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VERY IMPORTANT NOTE:

When you think that a stock will trade lower, these are two ways that you can try
to make a profit.

1. You can short the stock: Here you are putting up at least ½ of the entire
dollar amount of the transaction. In other words, if you wanted to short
1,000 shares of CAI at $58.75, you would have to put up $29,375.00
minimum, or the full $58,750.00.

That isn’t even the bad part. When you BUY a stock, you know that the
worst thing that can happen is it goes to zero. Your risk is limited to the
dollar amount that you have invested.

But the reason that most people shy away from shorting a stock, is that
you have an unlimited risk!

That’s right. For every dollar that the stock trades higher (when you are
short 1,000 shares) you are losing $1,000.00. What if the stock is Wall-
Mart in 1997, or Microsoft in 1990? You could end up with a disaster on
your hands.

When you short a stock, if you are wrong and the stock trades much
higher, you could end up owing your firm money, and your broker could
sell out your other positions to cover the debt in the account!

Okay, maybe that’s a little extreme. Even if you didn’t happen to short
today’s 1990 Microsoft – what if you shorted CAI at $58.75 and they got
acquired by another company at $85 the next day? You would lose
$26.25 per share, or $26,250.00.

2. The alternative is buying a put option (to open): In our case, CAI worked
the way we wanted it to. It traded lower. We made about 32.2%, over 3
times the percentage returns that we would have made by shorting the
stock.

What if the stock went the wrong way? At least we know that our risk is
limited to the dollar amount that we had invested (in this case $12.25.)

There is one more major benefit to trading options that I’ll show you, and then I
have to get back to researching more trades for our members.

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Options Trading Simplified 2008
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COVERED CALLS
The seller (aka the writer) of covered calls is generally interested in capturing the
premium income of the call option, and is willing to give up the stock at the
exercise price if the buyer of the call chooses to exercise the contract and take
the stock.

First, think about what the average stock trader does in this example:

Say you are the average stockholder who doesn’t sell covered calls. You buy
1,000 shares of “Bob’s car wash” (BOBC) at $50.00 per share.

The stock trades eight points higher, to $58.00 per share.

You say to yourself “if this stock gets to $60.00 per share, I’m going to sell it!”

So far you are up $8,000.00. There are four possibilities:

1. BOBC trades to $60.00+, and you net a profit of $10,000.00 HORRAY!


2. BOBC trades down and you watch your $8,000.00 profit shrink –
FOOWEY!
3. BOBC doesn’t trade up or down, but sideways – ZZZZZZZZZZZZZZZZ.
4. BOBC trades somewhere between $58 and $59.99 and you sit there biting
your nails wondering what your fate will be. Will you be rewarded for
standing your ground, or will you be swimming in regret, after seeing your
profit dwindle away?

Guess what! Either way you slice it, you have just left money on the table!!!

When you sell covered calls, you are grabbing that extra money off the table and
putting it in your pocket. You are increasing your potential profit, and you are
reducing your risk.

So why doesn’t everyone sell covered calls?

… No, I’m asking you, because I really don’t know the answer.

Let’s look at the example again. You bought BOBC at $50. The stock has
traded up to $58.

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Options Trading Simplified 2008
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You can either decide not to sell covered calls and say “if it gets to $60 I’ll sell it
and make 10 points, OR – you can sell someone the right to buy your stock at
$60.00 and receive a few extra bucks by selling a call option contract on BOBC.

If you don’t sell covered calls, then you are basically going to do what most
people do: If the stock hits your target, you’re going to sell the stock at $60.00
(free of charge).

What you could have done is have someone pay you money, if you promise that
they can be the one to buy your stock at $60.00 … and yes, this is legal!

For instance: Imagine that after buying BOBC at $50, it traded up to $58.

Since you can see that the stock is approaching your intended sell price of
$60.00/share, you sell the June 60 call for $2.00/share (to open.) - Notice that
when you sell (or “write”) covered calls, you will sell the call to open. Some
anonymous investor basically pays you money for the right to buy BOBC from
you at $60.00/share.

If the stock keeps trading higher, and continues past $60.00, then chances are
that your stock will be “called away” or sold at $60.00 at some point (when the
stock is trading at a price higher than $60.00).

Note: Keep in mind that the person who bought the call option from you has the
right, and not the obligation, to buy your stock at $60.00. The only time that your
stock is guaranteed to be called away from you is on expiration day, as long as
the stock is in-the-money by 25 cents or more.

Comparison

Regular Stock Trade: Stock trades from $50-$60

$60.00 on sale of BOBC


-$50.00 on purchase price
$10.00 total profit

Covered Call Stock Trade: Stock trades from $50-$60

$60.00 on sale of BOBC


-$50.00 on purchase price
$10.00 profit
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Options Trading Simplified 2008
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+ $2.00 profit on sale of June 60 call option
$12.00 total profit

If you do sell someone the RIGHT to buy your stock at $60 (which is what
happens when you sell covered calls), then you are being paid extra money!

Why on earth would someone PAY you for the right to buy your stock at $60, if
the stock is only at $58.00?

Why would someone give you extra money, so that they have the ability to buy
your stock at a higher price? Sound crazy?

Let’s use an example from the point of view of the buyer of the call option:

Forget about selling covered calls for a minute. Let’s pretend that instead of
being the seller of the BOBC call option contract, you are the buyer.

You have bought the BOBC June 60 calls at $2.00 (to open.) (You’re a dice
rolling, risk taking, gun slinging cowboy/cowgirl!)

That means you have purchased (at $2.00/share) the right to buy BOBC at
$60.00 per share at some point before the call option expires on the third Friday
of June (remember: options always expire on the third Friday of the month.)

As the buyer/owner of the call option, you are hoping that the stock continues to
trade higher, from its current price of $58, up to (let’s say) $70.00 per share.

If that happens, then the call option that you bought at $2.00 will trade to over
$10.00, which will be over 400% in profit!

But if the stock stays around $58.00 per share, and never trades over $60.00, the
call option will expire worthless in June (on the third Friday).

You are basically risking the entire $2.00 for the chance to make an $8.00 profit.
It’s a huge risk for a huge reward.

Now let’s test your memory:

Do you remember the difference between “intrinsic value” and “time value”?

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Always Remember: When you buy options that are out of the money, you are
taking a big risk, because the entire amount that you are paying for the option is
“time value.” Time value is at the mercy of time decay.

The BOBC June 60 call gives you the right to buy BOBC at $60.

Since the stock is not trading over $60.00 per share (it’s at $58,) the BOBC June
60 call option contract that you bought for $2.00 (to open), has zero intrinsic
value.

When an option is “in-the-money,” it has intrinsic value. When an option is “out-


of-the-money,” it has zero intrinsic value, and is 100% time value.

In this case, the entire $2.00 premium is time value.

Time value is prone to time decay. Intrinsic value is not affected by time decay.
So as time passes, the time value of the call option in our example will
deteriorate. If you recall, the time decay actually accelerates in the last 3 months
and especially in the last 30 days.

(See “time decay” chart below)

A Side Note: One of the most common mistakes that I see options beginners
make (even options veterans for that matter) is buying out-of-the-money options,
without realizing the level of risk that they are taking.

What’s worse is that they buy out-of-the-money options that are going to expire
within the next 1-3 months! Talk about stacking the odds against you!

This is the difference between buying options that are “cheap” and buying
options that are inexpensive.

Here’s a picture of the BOBC June $60 call. Its two points out of the money
(BOBC is at $58) so the entire “premium” (price of the option) is time value, and
will be affected by “time-decay!”

Watch what will happen to the premium if the stock simply trades flat (at $58.00):

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Options Trading Simplified 2008
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Why does a casino make so much money?

Because there are millions of people who are okay with taking bets, even when
they know that the odds are against them. Every now and again, the casino
loses and the gambler wins!

But does the casino ever really lose? I mean, is the casino really gambling at
all?

The guest, of the casino is doing all of the gambling. The casino is simply
running a business. The casino knows that every now and again they will have
to pay up. But the amount that they pay out once in a while is dwarfed by the
amount that they collect from most of the other guests. Everyone knows that!

But when you are the buyer of short-term, out of the money options, you might
not realize that you are the same guy as the gambling casino guest.

When you are the person who is selling (aka writing) covered calls, YOU
are the casino!

You are the one who is accepting payment after payment after payment,
from the guy who wants to see his $2.00 BOBC call option trade up to
$10.00.

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Once you have sold a covered call and received your payment, either you will
keep the premium and your stock position, or else you will keep your premium,
and you will sell your stock. BIG DEAL! Just be sure to only sell covered calls if
you are willing to sell your stock at the strike price.

Ideally, you want to sell calls with a strike price that’s slightly higher than the
stock’s current price. It’s also okay to sell calls with a strike price that’s at-the-
money (the same as the stock’s current price) or slightly in-the-money (slightly
lower than the stock’s price. The idea is to profit from the decaying time value of
the option that you have sold.

Ideally, you also want to sell calls that will expire in 30-45 days because that is
when time value will decay most rapidly.

Now for the comparison:

Let’s say you are NOT that average stockholder (who never sells covered calls).

Instead, you have taken the time to learn about covered calls, and you now have
the advantage of an easily acquired education on the benefits of covered call
writing …

You buy 1,000 shares of Bob’s car wash” BOBC at $50.00 per share.

The stock now trades to $58.00 per share.

You say to yourself: “I would be willing to sell my stock at $60.00. Let’s see what
the BOBC June 60 call options are trading at,” because you know that someone
is willing to pay something for the right to buy your BOBC at $60.00.

You find out that you can sell the BOBC June 60 calls for $2.00.

Again, the stock is at $58.00, and so far you are up $8,000.00 on your stock
position...

Remember these two keys:

1. Each option contract represents 100 shares. 10 option contracts


represent 1,000 shares. So if you own 1,000 shares of BOBC, and you
want to sell someone the right to BUY your 1,000 shares of BOBC, then
you would sell 10 call options (to open,) because 10 options represents
1,000 shares.
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2. Some people get confused about selling first and buying second.
Traditionally people are trained to only understand buying something first,
and selling it second. But when you write an option contract (or sell an
option contract), then you are essentially “short” the option contract. You
can first sell an option contract at $10 (to open), and THEN buy the option
3 weeks later at $6 (to close) for a 4 point profit.

So again, BOBC has traded from $50.00 to $58.00 per share.

This time you sell 10 June 60 call options (to open), and you receive an extra
$2.00.

That part of the transaction is now done. You now have an extra $2,000.00 in
the bank, no matter what happens to the stock.

(Now take a look at the difference)

There are four possibilities:

1. BOBC trades to $60.00+. Your BOBC is called away (sold) at $60.00 per
share, and instead of $10,000.00, you net a profit of $12,000.00. ($10k on
the stock and $2k on the option that you sold.)

Special note: Your stock will not necessarily be sold at $60.00 just
because it trades over $60.00. Your stock may or may not be called away
at any time before expiration. If, at 4:00 p.m. on expiration day, the stock
is 25 cents in-the-money, or more (which means BOBC would be at
$60.25 or higher), the call that you sold will automatically be exercised,
and your stock will automatically be called away (sold).

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Here is a quick picture of what this would look like …

2. BOBC trades down. You don’t feel so bad because you picked up that
extra $2,000.00. If you didn’t sell that call option, BOBC would have still
traded lower, but your account would be worth $2,000.00 less than it is
worth right now! Whatever dollar amount the stock trades down by, the
decline in value is reduced by $2,000.00.

For instance: If, after you take in that $2.00 premium, your stock trades
from $58 down to $55, then instead of losing $3,000.00 in value, your
1,000 shares of BOBC would lose $1,000.00 in value since you will have
been paid $2,000.00 for the call option that you sold.

(If the stock trades down 3 points, you really only lose 1 point in value,
because while the stock lost 3 points, you made 2 points by selling the call
option.)

At least you take in an extra $2,000.00, and you will be free of any future
obligation once the option contract expires. (Or else you can just close
out the call option position by buying the same call back (to close) at its
current lower price (see below).

Now here’s a fun twist: You actually have two choices if your stock
trades lower.

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a) You can do nothing and maintain both the “long” stock position,
as well as the “short” call option position until the option contract
expires.

b) You can simply buy the option contract (that you previously sold
at $2.00) at a cheaper price. Imagine selling a gold watch for
$2,000.00 and then buying it back from the person that you sold it
to for $300.00. Not bad. That’s a $1,700.00 profit.

As the stock trades lower, the call option that you sold also trades lower.
That means that if the stock trades lower, you can always buy the call
option (that you’ve sold), at a cheaper price than what you received for it
when you sold it. This is a profit on the option trade that will reduce the
loss incurred on your stock position.

For example: If BOBC trades from $58.00 down to $55.00, then the call
option that you sold at $2.00 (to open) may trade down to 30 cents. You
can now buy the call option at 30 cents (to close). That’s a difference of
$1.70. Since you originally sold (or shorted) that call option at $2.00, that
$1.70 difference is a profit.

Said differently, if BOBC traded from $58.00 to $55.00 the stock position
lost $3.00 in value. But since the call option that you sold at $2.00 (to
open) is now at 30 cents, you have a profit of $1.70.

So the net result is that, instead of your position losing $3.00 in value, it
really only lost $1.30 in value.

Stock lost $3.00


Option gained $1.70
Total loss is $1.30

OR – as I said originally, you can let the option expire worthless and
realize the entire $2.00 gain on the call. In this case, if the stock traded
from $58-$55, then your entire position would have lost $1.00 in value
instead of $3.00.

Stock lost $3.00


Option gained $2.00
Total loss is $1.00

After the option expires, you are free of you obligation. If you wish
to do so, you can sell another call option and start the process over
again.
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If you were to repeat the process over again, here is a picture of what it
might look like …

If BOBC fluctuates up and down between $55.00 and $60.00 all year long,
you can sell new covered calls every month or two, and take in extra
premiums over and over again throughout the year!

3. BOBC doesn’t trade up or down, but sideways. GREAT! As time


passes, the call option that you sold (to open) is losing its time value.
Since you are “short” the call option, this is a good thing for you.
Basically, as time goes by with the stock trading flat, you are making
money as the call option loses value due to time decay.

If the stock pretty much trades flat until the option expires, even though
the stock did absolutely nothing, you made an extra $2,000.00. This is
awesome! Even though the stock never got to $60.00 per share, you still
made $10,000.00 as you had originally hoped for! (You made $8,000.00
on the stock and $2,000.00 on the call option that you sold.)

Meanwhile, there is someone out there who was in the same position as
you, but since they didn’t sell covered calls, they are sitting on a $58.00
stock, wondering whether or not it will trade to their target price of $60, so
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that they can make the $10,000.00 that you just made with zero
movement in the stock.

The call option expires worthless, you now have two choices: You could
either: sell BOBC at $58 and skip down the street thinking about how cool
you are for making $10,000.00 on a stock that only traded up 8 points, or
you could sell another call (to open) that expires the following month or
two out. Maybe you can sell the July 60 call (to open), or the August 60
call (to open) and take in yet another extra premium.

4. BOBC trades somewhere between $58 and $59.99. GREAT! I can’t


wait to brag!

Let’s say, for example, the option expires worthless, and BOBC is at
$59.00 at the time. That means that you made $2,000.00 by selling the
call option (you had sold that casino guest the right to buy your BOBC at
$60), and you are also up 9 points on the stock. If my calculations are
correct, you are now up $11,000.00, and the stock never even hit your
price target of $60.00!

So the moral of the story is this:

When you are long the option contract (said differently: when you are the
owner/buyer of the option contract), Time Decay is your worst enemy, because
as time passes, your option loses value.

When you are “short” the option contract (said differently: when you are the
writer/seller of the option contract), Time Decay is your best friend, because as
time passes, the option that you sold (to open) to someone else, loses value.
You can either buy the option back (to close) cheaper, which will result in a
profitable option trade (offsetting your stock’s loss of value), or you can let the
option expire … which will also result in a profitable trade.

If this covered call lesson has helped you learn something new, then you are
probably anxious to get out there and write some covered calls on stock that you
own, and start grabbing all of that extra money that you have been leaving on the
table each month. But before you do, first consider this last possible outcome …

What would happen, and how do you think you would feel, if you wrote a covered
call on BOBC, which obligates you to sell BOBC at $60.00 per share, but 2
weeks later BOBC traded up to $90.00 per share? Hmm.

Before you read any further, think about that for a minute. Do you know what
would have to happen in that case?

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Well here it is: You would have to sell BOBC to someone at $60.00, even though
it is selling at $90.00 in the stock market. Now, that might drive you crazy, even
though your original plan was to sell at $60.00 anyway.

Ask yourself, how much of a loser would you feel like if you sold someone the
promise that they could buy your stock at $60, only to see it trade to $90, 2
weeks later?

Answer: You should feel like as much of a loser as the casino feels like when
someone puts $2.00 in a slot machine and wins $30.00.

The reason a casino is happy to give up a profit every once in a while is because
they make so much more in the long run.

I hope that I have given you a clearer picture of why options can be used as a
way to gamble, but also as a conservative way to reduce risk.

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Important Tips and Terms
Tip 1:

Always look at the bid and the offer, not the last trade.

I have had many people ask me how an underlying stock had fluctuated up or
down by a few points, but the price of the options contracts that are related to
that stock didn’t move at all.

Usually the problem was that when they looked at the option quote, they were
looking at the “last trade” instead of looking at the Bid and Asking price of the
option.

Think about this: You may look at an option quote that looks like the one circled
below, and make the mistake of thinking that you would only receive $5.60 by
selling this call option.

I circled in red a call option that has a bid of $6.00 (which is what you would get if
you were to sell the call at its current “market” price), and an asking price of
$6.20 (which is what you would pay if you were to buy the call at its current
“market” price).

So why does the “last trade” say $5.60? Simple: Because the last trade was
executed at $5.60. That trade may have happened a week ago for all we know.
Maybe the trade happened during the same day, but the option has since
fluctuated in price.
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When looking to see what you would pay for an option, or what you could get for
the sale of an option, always refer to the bid and ask (not the last trade).

It seems simple enough, but I hear this question all the time!

Tip 2:

Buy deep in-the-money options.

You may notice that some of the options that I used as examples in this report
only traded 38% higher, or 120% higher. But what about those 900% and
2300% returns that you heard can be made on options? Isn’t this a high risk,
high return strategy?

The answer is that options have a reputation of being “high risk, high reward” but
the truth is that it doesn’t have to be that way at all. It’s like the saying goes: “It
isn’t only black or white. There are all sorts of shades in between.”

Check out the “Knowledge Center” at The Trend Rider website


(http://www.thetrendrider.com/view_service_knowledgecenter.asp), specifically
the two articles titled “In the Money – Part 1 & Part 2.”

At The Trend Rider, instead of trading the options that either get you a 920%
return, or a 100% loss, we buy and sell options in a way that is much more
conservative … by trading options with lots of intrinsic value.

Buy purchasing deep in-the-money options, you reduce your risk greatly, but you
can still achieve profits that are much greater than a stock will show you.

Important Terms

At this point in our “lesson,” let me take you back a bit to make sure that nothing
got by you. In other words, don’t try to trade options before you understand
these terms:

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Premium: Price of the option

Selling an Option: Writing an option contract.

Just remember: When you sell an option contract (put/call), you are selling a
promise. Imagine literally making a promise and accepting payment to write it
down on a piece of paper and signing the paper. You are writing a contract and
selling that contract.

In the world of options trading, when referring to options contracts, the words –
“Writing” and “Selling” mean the same thing.

Opening Transaction & Closing Transaction

When opening a new options trade, you must specify that you are doing so
by using the term “to open”. When you are closing out an existing options
trade, you must specify that you are doing so by using the term “to close”.

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Remember: Just as you can “Short” a stock, by selling the stock first and
anticipating that you will buy it back in the future, you can also “short” an options
contract.

You can either: buy an option today and sell it tomorrow, or you can sell an
option today, and buy it back tomorrow.

With that in mind, just remember that whichever transaction you do first, that will
be your opening transaction, and should be marked “to open.”

Naturally, whichever transaction you do second, that will be your closing


transaction, and should be marked “to close.”

The Bottom Line on Covered Calls

When selling covered calls, the idea is to sell short-term calls (that expire in no
more than 60 days), that have lots of time value. The reason is because you
want the call option that you sold to lose value quickly.

If you sell calls that have lots of time value, then time decay will work in your
favor. Even if your stock trades flat, the call option that you have sold (shorted)
will trade lower.

Remember, when you sell a call option, you have the choice of buying the call
option back for a profit.

So you can: Sell IBM January 50 calls to open at $10.00/contract, on June 17,
2006.

Then, you can buy the same IBM January 50 calls to close at $8.00/contract, on
June 25, 2006.That would net you a $2.00 profit. ($10.00 - $8.00 = $2.00 profit.)

I hope that this helps, that you have had fun, and that you are ready to start
making some more money!

Chris Rowe
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How to Get Started Trading Options
An Invitation From Chris Rowe

I hope you enjoyed this guide to trading options, and that it has given you the
confidence and motivation to get involved in trading options.

But you may be asking yourself, “What next? How do I get started?”

I have the answer for you, and I’ll share it with you below, but first I want to share
a few rules of thumb that you need to take to heart if you’re just getting started
with trading options:

1. Don't Ever Be Afraid to Make Mistakes


The only lessons that really stick, in my opinion, are lessons that hurt a
little bit. Just do your best to limit the pain. When you start trading
options, the best way to do that is to make sure you learn as much as you
can and "start small." Don't pour all your money into any single trade,
start with some "phantom" trades, and only play with money that you can
afford to lose.

2. Good Things Come to Those Who Work


There's a lot of hype out there ... a lot of noise about how "easy" it is to
make money. Tune all of that out and be wary of anyone offering you
easy money.

I got to where I am today through hard work and self-discipline. Sure, I try
to make it as easy as possible for my members to have success with their
investments, but at the same time I'm a strong proponent of education and
discipline.

3. It Never Hurts to Have a Mentor


I wouldn't be half the trader I am today if I hadn't been lucky enough to
have a man named Mark Rosenberg take me under his wing in my early
days on Wall Street.

When I was just getting started, he "held my hand" for months and months
until I hit my stride. I'll always be thankful to him for making the
complicated simple, for questioning my decisions at every turn, and for
sharing some of his tried and true strategies with me.
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In my trading service, TheTrendRider.com, I find myself patterning my advice
after how Mark taught me. I try to picture a little bit of me in all of the Trend Rider
members, and I try to "hold hands" with my members to make sure they
understand everything I recommend.

So, on one hand, I make sure that my members have a very easy time trading
the service. I want it to be like they're trading right alongside me at my desk.

On the other hand, I always want to challenge Trend Rider members to improve
their own skills. Who knows ... maybe a few years from now one of them will be
writing to people talking about me like I was Mark Rosenberg.

I Chris Rowe, Hereby Volunteer to Be YOUR Mentor …

No, I can’t fly out to your house and sit in front of the computer with you while you
learn the ins and outs of trading options. But I can come close to doing just that.
I do it for hundreds of people just like you – every day – as CIO of
TheTrendRider.com.

Good News and Bad News

The Bad News:


Membership to TheTrendRider.com is very hard to come by these days.

Recently, demand for the service became so great; I decided to close the service
to new members for all but one week out of each month. Even when it's open, I'm
being very careful not to let more than 100 new people on board in any given
month.

The Good News:


You don’t need a membership to my trading service to receive professional
options advice from me! That’s right; you can read my weekly articles on options
in TheTycoonReport.com for FREE!

However, if you are interested in a Trend Rider membership, I can “sneak” you to
the front of the line through this special offer. The 100 memberships usually go
very quickly.

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Remember: You can read my weekly articles on
trading options FREE in TheTycoonReport.com
However, joining The Trend Rider has these major advantages:

Unmatched Advice, Winning Recommendations: You'll get the benefit of the best investment
experience money can buy in 60 weekly issues of The Trend Rider. Once you get my emails, simply call
your broker or place your trade online.

Urgent Flash Alerts: Sometimes the market moves too quickly for a regular trading schedule. When I
see an important event that changes the landscape of any of my recommendations, or when I see a
new trading opportunity in the middle of the week, I won't hesitate to send you a flash alert.

Winning Recommendations: An incredible near 80% of closed Trend Rider trades have been
profitable … a mind boggling success rate for any trader, let alone an options trader!

A World-Class Education: You already know by now that you’ll never have to worry if I’ll
conveniently “forget” trades I recommended that didn’t work out as planned. I treat you like I want to
be treated, which is why you get an honest and in-depth analysis of all my trades – regardless of the
result!

Special Reports: Free special reports such as “Options Made Simple,” which are packed with easy-to-
understand lessons on the do’s and don’ts of option trading.

Profit Protection: Demand for The Trend Riderhas become so strong that I decided to close the
service to the general public and only accept a limited amount of new members each month – just to
protect your trading profits from excess trading!

NEW Monthly Webinars: With the recent economic turmoil I wanted to make myself directly
accessible to my Trend Rider members so that I can personally answer their questions. In these Live
Webinars we will discuss our open positions as well as answer member questions. These Webinars will
also be available for members to download from The Trend Rider website.

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DISCLAIMER
1. Tycoon Publishing, LLC, publisher of, TheTrendRider.com, and PointandProfit.com, is strictly a
research publishing firm and falls within the publisher’s exemption of the definition of an
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The information we provide and publish is based on our opinions plus our statistical and financial
data and independent research. They do not reflect the views or opinions of any registered
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2. We are a financial publisher and do not provide personalized trading or investment advice. Again,
we are a financial publisher. We publish information regarding companies in which we believe our
subscribers may be interested and our reports reflect our sincere opinions. However, the
information in our publications is not intended to be personalized recommendations to buy, hold, or
sell securities. As a financial publisher, we are not legally permitted to offer personalized trading or
investment advice to our subscribers. If a subscriber chooses to engage in trading or investing that
he or she does not fully understand, we may not advise the subscriber on what to do to salvage a
position gone wrong. We also may not address winning positions or personal trading or investing
ideas with subscribers. Therefore, subscribers will need to depend on their own mastery of the
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the consultation of their own brokers and advisors as they deem appropriate.
3. Profits can be lost if they are not taken at the right time. Subscribers are advised to take profits at
whatever point they deem optimal, regardless of the profit target set in any given recommendation.
Publications such as those we offer provide recommendations. Subscribers are free to follow the
recommendation, follow it in part, or ignore it altogether. If a subscriber believes a given profit is at
risk, the subscriber should take the profit. Similarly, if a subscriber feels a position is likely to lose
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4. TheTrendRider.com publishes a model portfolio of stocks and options chosen by its author/s in
accordance with their investment strategy. Your actual results may differ from results reported for
the model portfolio for many reasons, including, without limitation: (I) performance results for the
model portfolio do not reflect actual trading commissions that you may incur; (ii) performance
results for the model portfolio do not account for the impact, if any, of certain market factors, such
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prices at the time such stocks or options were chosen for inclusion in the model portfolio. Past
results are not indicative of future performance/results.
5. The Trend Rider, and any educational material created by Christopher Rowe including, but not
limited to “Options Trading Simplified” contains Mr. Rowe’s own opinions, and none of the
information contained therein constitutes a recommendation by Mr. Rowe or TheTrendRider.com
that any particular security, portfolio of securities, transaction, or investment strategy is suitable for
any specific person. You further understand that Mr. Rowe will not advise you personally
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transaction, investment strategy or other matter. To the extent any of the information contained in
TheTrendRider.com may be deemed to be investment advice, such information is impersonal and
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necessarily indicative of future performance. PLEASE DO NOT EMAIL MR. ROWE SEEKING
PERSONALIZED INVESTMENT ADVICE. THIS IS NOT SOMETHING THAT HE CAN PROVIDE.
6. All securities trading, whether in stocks, options, or other investment vehicles, is speculative in
nature and involves substantial risk of loss. You may lose money trading and investing. Trading
and investing in securities is always risky. For that reason, you should trade or invest only "risk
capital" -- money you can afford to lose
7. To the maximum extent permitted by law, the Editor, the publisher and their respective affiliates
disclaim any and all liability in the event any information, commentary, analysis, opinions, advice

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and/or recommendations in the Newsletter prove to be inaccurate, incomplete or unreliable, or
result in any investment or other losses.
8. Neither the Editor, the publisher, nor any of their respective affiliates is responsible for any errors or
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10. The information provided in our Newsletters and Trading Services contain material which is
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11. Our Newsletters, Trading Services and Educational material are not a solicitation or offer to buy or
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13. Any subscriber who would like a copy of these “Disclaimers and Disclosures” may request a copy
by calling 877-4-TYCOON or writing to Tycoon Publishing, LLC, 110 East Atlantic Avenue, Suite
230, Delray Beach, FL. 33444, Attention: Disclosure (whereupon a copy will be mailed or faxed to
such subscriber.)

Don't enter any trade without fully understanding the worst-case scenarios of that trade. Trading securities
like stock options can be extremely complicated, so make sure you understand these trades before entering
into them. For example, aggressive positions in options have a greater probability of losing, while less
aggressive positions are less likely to yield substantial profits. Similarly, far out-of-the-money options are
unlikely to finish in the
money, and options purchased close to their expiration dates are very high risk and, thus, likely to win big or
lose big very quickly. Don't enter any trade without fully understanding the worst-case scenarios of that
trade.

RISKS WHICH ARE SPECIFIC TO STOCK OPTIONS TRADING

When you open a stock option account, you should receive a booklet entitled "Characteristics and Risks of
Standardized Options," which is also available on the Chicago Board Options Exchange website at
http://www.cboe.com/resources/intro.asp. This booklet contains an in-depth discussion of the characteristics
and risks associated with stock options trading. We strongly encourage you to carefully read and understand
this information.

4. Assignment of exercise to writers. As a writer of a stock option, you may be assigned an exercise
at any time from the date of sale through approximately two days after the date of expiration. The
consequences of being assigned an exercise depend upon whether the writer of a call is covered
or uncovered, as discussed below. Since an option writer may not be informed of the assignment of
exercise until up to two days after expiration, special risks can come into play. For example, an
option writer who sells out their underlying position upon expiration may find out the next day that
they have to surrender stock they do not now own.

5. Risk of unlimited losses for uncovered writers of call options. A "naked" or uncovered writer of a call
option is at substantial risk should the value of the underlying stock move unfavorably against the
position. For a naked call writer, the risk of loss is theoretically unlimited. The obligation of a naked
writer that is not secured by cash to meet applicable margin requirements creates additional risks.
A harsh adverse move in stock prices can create steep margin call scenarios in which a brokerage
firm may liquidate other holdings in the writer's account(s) to cover the option. Since pricing of
options tends to be magnified relative to the underlying stock, the naked writer may be at
significantly greater risk than a short seller of the underlying stock.

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6. Deep out-of-the-money options carry high risk of loss. Although purchasing stock options at strike
prices significantly above or below the current market price can be very inexpensive, you are at
high risk of losing your money. There are two versions of deep out-of-the-money options: A deep
out-of-the-money call is an option to purchase 100 shares of stock at a price far above the current
market price. A deep out-of-the-money put is an option to sell 100 shares of stock at a price far
below the current market price. Although these options seem inexpensive, the chances of making a
profit on such transactions are extremely low. Therefore, novice traders should avoid buying deep
out-of-the-money options.

7. Out-of-the-money options near their expiration date carry a high risk of loss. The closer you buy an
out-of-the-money option to its expiration date, the less likely it is to end up profitable. Although
these options are cheap, in order to win in such situations, you will need precise timing and the
occurrence of a major event that significantly moves the underlying future in your favor. Therefore,
the risk associated with these options is high and you are likely to lose your entire investment in
these positions.

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110 East Atlantic Avenue Suite 210
Delray Beach, FL 33444 USA

Web Site: www.TheTycoonReport.com

Copyright © 2008 Tycoon Publishing, LLC. All rights reserved.

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