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Understanding Options

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Introduction ............................................................................................................................... 4
Option Contracts ....................................................................................................................... 4
Call Options ................................................................................................................................. 5
Put Options ................................................................................................................................. 6
Using Leverage........................................................................................................................... 7
Pricing An Option...................................................................................................................... 8
Learning the Basics ............................................................................................................... 10
Understanding the Bid/Ask Spread ................................................................................ 13
Changing Sides ........................................................................................................................ 15
Buying Vs. Selling ................................................................................................................... 15
Managing Positions at Expiration .................................................................................. 177
American Vs. European ....................................................................................................... 17
Cash Vs. Share Settlement ................................................................................................. 177
Avoiding Major Pitfalls ...................................................................................................... 211
Choosing Your Position ..................................................................................................... 211
Understanding Implied Volatility .................................................................................... 23
Giving Up Your Edge on Entries ........................................................................................ 27
Fibonacci Ratios ................................................................................................................... 288
Closing Statements ................................................................................................................ 29

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Introduction
For many newcomers to the stock market, the possibility of making money by
trading from the convenience of a laptop is intriguing, dangerous, and exciting.
When the markets are closed, take the time to learn the facts presented in this
collaboration.
This collaboration specifically tells newcomers to the business how to use and
understand option contracts. For those just entering the field, moving into the world
of options can be somewhat daunting.
For those coming from a stock background, the most simplistic form of
understanding these methods would be buy low and sell high. In theory, this idea
breaks it down so even the newest members can understand, but that doesnt mean
it is always so simple.
With options, however, there are many working parts which make the machine, as a
whole, more difficult to understand, and even harder to master.
That said, trading still invites newcomers to compete along-side lifelong
professionals, unlike sports, where, for example, one could not sign up for the
Masters after learning a basic golf swing, nor could an individual compete as a
professional racecar driver after simply learning how to operate a manual
transmission.
If you feel like youve just set foot inside the Endeavour spaceship, where hundreds
of lights, buttons, and screens blink and beep in your direction, a sense of
overwhelming tension can creep up, causing a clear disadvantage in the market.
We overcome this disadvantage with a clear understanding of the market were
participating in, with a foundational knowledge of how each part works. This
foundation begins by understanding what an option contract is, how it works, and
how you can implement it into your specific trading techniques.
For those who already feel overwhelmed, remember to take each working part one
step at a time, breaking them down into pieces one-by-one, much like learning a
dance, step-by-step, slowly mastering the entire process.

Option Contracts
An option contract, also known as an option, is defined as a promise that meets
the requirements for the formation of a contract. Essentially, this is a binding
contract between two parties.

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An option simply means that the buyer has certain rights. The buyer is the optionee,
or beneficiary, of the contract. This individual has rights, but not necessary an
obligation, to long (or short) a stock from a predetermined price. There is a date
until which this contract is good for called an expiration date.
There are two types of options contracts calls and puts.

Call Options
Call options give the buyer a guarantee that the person who sold the option, will sell
those shares at a predetermined price. That predetermined price is also known as
the strike price. As a bullish bet, it is likely to go up in value. Bullish means that
an investor believes a stock price will increase over time; similarly, investors
who purchase calls are bullish on the underlying stock. Conversely, bearish
indicates that an investor believes that the stock will decrease in value.
A call option is a bet that the stock is going to increase in value. For instance, if
one predicted that Apples stock was on the verge of rising, that person would
buy a call option. The higher Apples stock climbs, the more the call option
appreciates.
The risk with options is that the option could expire worthless. If Apples stock
were hovering at $500 and one bought a $510 call, it would expire worthless
and the premium paid would be lost by that unfortunate investor. What that
seller managed to do is called writing an option. If a stock were going to go
lower, one could sell those options to a third party who believes it will go
higher. That is called writing premium, or collecting premium.
Writing call options is among the riskiest of trade strategies. A particularly
unfortunate scenario was illustrated when one individual sold hundreds of a
$50 call option for approximately one dollar; when the stock price was $48.
The call ended up expiring worthless, but that person had initially thought he
would make $25,000 on the trade. The next day he received the news that the
stock was up over $50 a share, as it was being bought out. The money he had
invested was unable to be recovered. That is the risk associated with writing
call options.
When one purchases a call option, it offers the right to buy a given asset at a
fixed price, also known as the strike price. If a call option is purchased at $5
and the underlying asset increases in value, the call will increase in value as
well. At any time before the specified expiration date, the option writer
(namely, the individual who created the option purchased) has a legal
obligation to sell the asset at the strike price. Call options that have a strike
price below the current market price of the underlying asset are said to be in

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the money. If Apple were at $500, a $450 call option would be considered to
be in the money, while a $550 call option would be out of the money. Those
acronyms are common: ITM, OTM, and ATM, or at the money. Put options
(discussed below) are the inverse of this.
It is also critical to remember that an option price consists of both the
intrinsic value and the time value. The former is the amount that the option is
in the money. For example, if Apples price was at $500 and there was a $490
call, $10 of that option price is intrinsic. Extrinsic (time) value has several
variables that create that dollar value.
Buying a call option is the least amount of risk that one could take. Selling a
naked call option, on the other hand, is the riskiest endeavor. The downside is
essentially unlimited. However, this should not indicate that buying will offer
a constant stream of income; if one purchases the wrong stock option, no
money shall be made. For instance, if a stock trades at $520 and there are
options available at a strike price of $570, this would indicate a tidy profit if
the stock were to rise in price. However, the stock could trade sideways, which
would leave the trader with nothing as the option expires worthless.
As an example, if Apples March $515 call option was priced $23.10. The
option buyer had the right to purchase 100 shares of Apple stock at a strike
price of $515 per share any time prior to the expiration date. If Apple was at
$520 and one bought the $515 call option, and the price might rose to $550.
Then an instant profit could be made because the stock is actually trading at
$550.
However, there is still the option of buying the stock at the price of $515.
Some experts discourage the purchasing (assigning) of stock, which is
uncommon but not unheard of. Generally the option is either bought or sold.

Put Options
Put options are the opposite of call options, and again, one can buy or sell a put
option in the same manner as a call option. If Apples stock were going to go
down, one would buy a put option because as that stock descends, the put
option will increase in value. These options give you the right to sell shares at a
given strike price.
Selling naked put options is a popular income strategy. For instance, if stocks
keep rising, like days when Apple continues to rally, one would sell naked put
options. If the stock keeps rallying and the put options expire worthless, the
premium received could be kept as income. This is a more conservative option
than selling naked call options because a stock can only fall to zero, and the

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difference between the option strike and zero would be the maximum loss.
One can also mitigate the risk by utilizing credit spreads. (more on this
technique later)
As mentioned earlier with an option being in or out of the money, with put
options, the inverse holds true: if put options have a strike price above the
current market value of the underlying asset, those would be considered to be
in the money. If the strike price were below the current market value, those
would be out of the money.
The purchase of put contracts gives the buyer a bearish outlook on the market;
meaning that they hope the value will actually go down. Therefore, we buy puts
when we expect a market to drop and buy calls when we expect it to rise.
While it seems that we could merely buy stocks rather than options, there is one
reason why options are so important: leverage.
Leverage means that a small amount of work can move a large force. Imagine using
a pulley system to lift a heavy object, or using a crow bar to open a jammed door.
Leverage can help small individuals move large objects. The leverage of options can
help build a powerful portfolio.

Using Leverage
Leverage can actually allow traders with small accounts to grow exponentially while
also allowing traders with large accounts to free up excess capital. It is imperative
to maintain several different accounts with which to work. Some traders keep
multiple accounts, each engineered for different work: short-term, long-term,
day trading futures, swing trading options (swing means holding for more
than 1 day), among others.
Consider the example of RAX. Currently, RAX is trading for $31.76 in the market. A
typical order of RAX may be 100 shares, for a total of $3,176.00.
$31.76 x 100 = $3,176.00
A delta 1.00 call option (delta meaning the rate of change for an options price,
relative to a one-unit change in the price of an underlying asset) will give you
the exact same price movement as the 100 shares of stock, but it will only cost the
buyer $800, rather than a price over three grand. Generally, one should aim for a
delta value of 70 or higher. Gamma, additionally, is the rate of change of the
delta. (more on this later)

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In both of these examples, the buyer will receive $100 for every $1 that RAX
increases. If both of these scenarios give the same movement, why not trade option
to save on capital?
Usually when something is too good to be true, it is. In this particular scenario, its
important to discuss the other moving parts that make the machine operate.
Leverage does not come without a cost. Traders who overleverage themselves may
not truly understand the risk involved. Imagine giving a fulcrum to children, or even
adults who havent been trained in operate the device, and then asking them to
move a large object; risk is involved.

Pricing An Option
In terms of our machines moving parts, this really only refers to how an option is
priced. The most common method is the Black-Scholes Option Pricing Formula,
which has been the premier method of valuating options since Fischer Black
and Myron Scholes published their theorem regarding the subject in 1973:

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To be fair, the formula above is a little overbearing and most traders will never
actually have to use it. Its included, however, for those who would like to
understand the fundamentals of trading.
Specifically, this formula emphasizes the point that your options price is a moving
target. Exercise comes back to being the buyer vs the seller. If youre long the option
you can exercise [buy the stock] at any time. For beginners, the following variables
should be noted from the formula above:
1.
2.
3.
4.

Stock Price
Strike Price
Time Until Expiration
Volatility

Of the four variables listed above, volatility is perhaps the most critical.
Implied volatility (IV) is one of the most important concepts for options traders to
understand for two reasons: First, it shows how volatile the market might be in the
future. Second, implied volatility can help you calculate probability. There are
various indexes to watch on a daily basis: NASDAQ 100 options (the
continental benchmark for securities and technology stocks), ETFs (exchangetraded funds), SPDRs (as said before, an abbreviated version of Standard &
Poors depositary receipt), and others. There are even reverse-ETFs, in which
an exchange-traded fund, which is made by utilizing various derivatives, leads
to a profit from a decline in the value of an underlying benchmark. These are
ideal for traders who feel comfortable doing shorter-term work.
Some individuals believe that market internals, or hourly updates from within
the market itself, provide valuable information. While they do offer
information and help situate a trader before buying or selling, the data is not
the benchmark from which someone should measure. If the trading is to be
done on SPDRs, then market internals will be valuable. Other times, market
internals will indicate an overall downward trend while individual stocks are
rising.
With that in mind, IV can be measured as a deviation or variance between several
returns within a security or market index. Essentially, the higher the volatility, the
more risk involved.

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Learning the Basics


The image below can come off as a little daunting to newcomers, but remember to
take each piece one at a time, and you will soon learn the entire puzzle.

From left to right, each of the four working parts is presented above. Time Until
Expiration is on the left, in red. On the upper right, Stock Price is listed with Strike
Price and Implied Volatility sit underneath.
This specific example comes from ThinkOrSwim.com, so not all programs will be
designed, or presented in this exact way.
1.
2.
3.
4.

Stock Price
Strike Price
Time Until Expiration
Volatility

In this example, the Time Until Expiration is presented in red, with exception to the
third option. When red (in this example), these are generally weekly options.
The strike price points to different numbers. These strike prices relate directly to
the underline stock price. With options, its important to understand what the stocks
may be worth upon option expiration, to know if these stocks or bearish or bullish.

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Its important to think of where the stock is trading. In many cases, 90 percent of
lower priced options will not lead to success and will expire worthless. Instead,
take time to study those options that sit within the money.
In addition, think about options from their intrinsic standpoint.
Implied volatility is the next step to study. Take a look at the numbers presented
here, listed in black font on blue background near the Implied Volatility bubble.
In this example, the numbers are relativity the same until April 14. When you see
something like this (a jump from 15 to 25), this usually signals an earnings period
for the company.
Market makers (traders on the other side of your position) price the option to cover
their risks. Essentially, rather than take the chance of losing any money, the price
simply rises during earnings periods to make sure the stock doesnt take any large
jumps or falls.
Now, take a look at the four black rectangles.
Apple is bullish, but its also important to know when/how the stock might move.
For example, if you expect the stock to move within 48 hours, you can examine how
the stock has moved in the past. If the numbers will not add up in 48 hours, consider
giving yourself seven days for the stock to move, knowing you will only pay an
additional two dollars overall.
In April 5, many of these numbers nearly double (presented in lower portion of
graph). This is a direct impact of the Implied Volatility. This is crucial and relates
back to the intrinsic value.
For example, take a look at the 540 call. Take a look at the beige colors on the left
side of the chart above (page 7). For this particular example, the beige strikes are in
the money and the white strikes are out of the money.
While the 540 call is in the money, its only worth $2.55, with the remainder of the
value being the juiced up volatility along with the premium, making profit difficult
to attain.
When an option expires in the money, it will be worth however far it is in the
money. Meaning, if these options expired on Friday, then they would only be worth
$2.55. When purchasing directional calls, timing is everything.
Also, despite these numbers being presented in the form of decimal dollars, when
buying, they actually represent hundreds of dollars. For example, if you were to
purchase a 2.55 stock, this is actually $255.00 and not $2.55, in real dollars.

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This all comes down to intrinsic value, versus extrinsic valueknowing what that
option will be worth upon expiration.
Imagine buying the 540 call, and doing so for only $15. Now, where will that set
your break-even price? Paying 15 up front means that Apple will have to be sitting
at 555 on the expiration date just for the buyer to break even.
If the call was only $10, but sat at 550, then the stock would have to increase all the
way to 560 just for the buyer to break even. For those not paying close attention, in
this scenario, its possible to take a large hit, losing money upon expiration.
Once again, if this seems overwhelming, take some time to digest the chart above,
allowing for the information to sink in. These four variables will come back again
and again.

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Understanding the Bid/Ask Spread


Presented in red next to the stock price, the Bid/Ask spread is presented as two
numbers. Unlike all other purchases, there is not a listed price. At your local grocery
store, all items are priced and there is nothing more to discuss. The Bid/Ask
Spread itself is the amount of money by which the ask price actually exceeds
the bid.
With trading, there is always a negotiation that takes place, much like how buying
used to take place in the market place. The negotiation exists between the buyer and
seller, along with hedge funds, floor traders, and those trading online.
Using a Bid/Ask, there is no set price, but a variable that needs to be agreed upon.
Lets take a look back at the Black-Scholes model to understand more.

With theoretical pricing, take a look at the Mark, Volume, Open, Bid, and Ask. In the
example above, using Theoretical Pricing, there is no Stock Price Adjustment or
Volume Adjustment, which means that stock should (theoretically) trade at 8.27.
The Bid/Ask spread, indicated by the fifth and sixth columns, is 35 wide, sitting
between 8.15 and 8.40. In this sample, there were over 3,000 sold (Volume).
The Bid is 8.15 and the Ask is 8.40, so (theoretically), the bid rests somewhere in the
middle, in the case at 8.27, with sellers asking for more and buyers asking for less.
When searching for equilibrium between the two, a sell can be made.
Lets look at another example.

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This option is not nearly as liquid as the previous option.


Auto Zone traded 232,723 options that day, which is relatively thin. In this scenario,
that will affect the numbers. Specifically, AZO doesnt trade weeklys (or weekly
options, for which premiums can be extremely high; when dealing in weekly
options, it is best to be a seller as opposed to a buyer), but they do trade
monthlys, meaning there is not an option to sell a spread the following week.
Lower volume stocks do not have weeklys. In this example, the Bid/Ask rests
between 10.60 and 11.40. For newcomers, its best to focus on liquid markets, such
as the one illustrated in the first example.
In the example above, looking under volume on the chart, only 1 single option was
traded that day, on an interest of 88. That means that only 88 people have come into
to purchase a fresh interest in the stock.
The Bid/Ask spread specifically relates to what the market maker will ask for and
what the buyer will pay. Much like an asking price at a car dealership, there is a
sticker price (MSRP is theo price), but there is some leniency until the two parties
reach an agreement. The agreed-upon price is the last price traded, or last.
Keep it simple: an option is only worth what a buyer is willing to pay.

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Changing Sides
Once these ideas have become more understandable, buyers are more comfortable
thinking of themselves as the market makers, or sellers. Imagine buying a car from a
dealership, and then becoming an independent dealer. As a seller, you want to find
the highest bidder in order to make the most money.
Buying an option versus selling one is also a key factor in how the Greeks will affect
your position. The main three to focus on are delta, theta, and vega (theta meaning
the measure of premium decay, and vega indicating the measure of how much
an options premium will increase or decrease given a change in volatility).

Buying Vs. Selling


Selling options can give you an edge in the market.
Take a look at the 535 calls in Apple (APPL).

In this scenario, we see a delta of .56, theta of -.22 and a Vega of .43.
Disregard the positive and negative values until you actually take a position. This
can be especially confusing when one number is negative and the other two positive.
If we come in as the buyer of the option, then we will be focusing on the bid and the
theo price.
Once we enter our position, the Greeks will take a positive or negative stance.

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In this example, we have one loan option that has fourteen days before expiration.
The market price is 538 and the market change is -4. There are long deltas, which
rest at 57.37, meaning that as APPL rises, the market will rise at that value.
However, each day theta will fall -21.88, as theta moves exponentially rather than
linearly, which is different from delta and vega. This means that if APPL opens up at
538 and doesnt move a penny, the buyer will still lose 21 dollars due to leverage.
Therefore, our contract will react each day as we move forward in time, to each
dollar the underlying rallies and how much the contract will gain or lose for each 1
percent change in the volatility of the underlying asset.
If the seller of the option focuses on ask and theo price, then the Greeks will take
their corrective positive or negative stances upon the position.

In the above example, the stock was sold, reversing the values of the Greeks. So, if
the individual sells, the seller will lose 57 dollars. Whatever hurts the buyer will
help the seller.
This occurs because theta is the only Greek that will absolutely move forward.
Short options carry more risk (leverage), but it puts the constant variable of time in
your favorthe only real truth within the formula. It is always important (and
always worth the investment) to pay more for time. Without time, the market
will work the trader instead the trader working the market.

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Managing Positions at Expiration


The third Friday of each month is the monthly expiration.
This is where all standard monthly equity options will stop trading and the
buyer/seller will have to determine whether or not they are in or out of the money
and what that value means to their overall portfolio.
Some index options will vary on their expiration, but there are ways to better
understand those issues.
Remember; take options and their expirations one step at a time.

American Vs. European


American style options (MSFT, APPL) can be exercised anytime on or before the
date of expiration. With European options (RUT, NDX), these can only be exercised
at expiration.

Cash Vs. Share Settlement


Cash settled options mean that there is no way for the buyer/seller to be assigned
shares of an underlying at expiration. The strike of the contract will be compared to
its moneyness and the different will arrive in the account.
If an individual expires in the money with APPL, for example, its possible to be
forced to take the shares, depending on the size of the account in question.
If the stock opens flat, meaning it can be flipped on the same day to meet margin
requirements, there is no harm. However, if there is a heavy margin, its possible to
take a loss, putting the individual back to square one.

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One way to remind your-self, or verify that a market would be cash settled, is to look
the volume for that ticker. In the case of SPX, this is cash settled because there are
no actual shares of SPX or trade. It is simply a measure of the S&P 500 that gives us
another instrument or trade.
As the buyer, there is more flexibility than the seller, which is why most people
begin as a buyer rather than a seller. As a buyer, there is no risk when action is not
taken, which is untrue in the case of sellers.
Note: in this example, the No Volume option has been presented using the Think or
Swim website, which presents a flat-line for study.

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In these two images, there is a different between SPX, with SPX expiring early. Make
note of the days left showing in your trading platform. These two images specifically
show the difference of SPX against NDX, with NDX expiring a day earlier.
These were taken together to show that NDX has already expired. These platforms
can actually take a great deal of the difficult work out of the equation.

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Avoiding Major Pitfalls


First, choose your position size and manage risk accordingly. Understanding and
managing risk based on the initial investment is perhaps the most important
aspect in trading.
Understanding implied volatility is another aspect of avoiding pitfalls. With
earnings, the market will make an example of you if your actions arent performed
correctly, using all known information.
Much like covering a spread, many buyers will assume that APPL will make money
during earnings, which they usually do. However, even if they make money, they
may not make enough for the buyer to make a profit, or even break even.
This will lead to these buyers feeling as if market makers took advantage of them,
when the truth is that they didnt understand the inner workings of the system.
Finally, giving up your edge on entries is the last mistake to avoid.

Choosing Your Position


With options, there are countless variables to consider. Make sure to understand
those variables, giving each their fair share of understanding.
This will differ for everyone and is something each person must learn in order to
make progress in the market. This will also vary depending on what type of goals
each person has within their own specific portfolios.
Many people do not understand the risk because they assume they are choosing a
winner. Like gambling, do not risk more than you can afford to lose.
As an example, lets say youre trading on a $100,000 account and youre focused on
steady income and would like to limit drastic swings in the account. Meaning, you
will sit around the 2 percent range, which is $2,000 to risk.
While $100,000 may seem steep at first, its a solid number for providing examples.
Feel free to scale this number to better fit your needs after understanding the basics
of the formulas.
Sizing up a 2 percent risk ($2,000), will differ depending on the strategy being used.
Directional calls are easiest to measure in this case since it is a debit transaction,
meaning you can add up contracts until you reach your limit of $2,000.

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For example, if an option is $5.00, you can buy 4, because that $5.00 actually equals
$500, and four would equal $2,000.
Situations where you sell a spread are different, but your risk has been defined.
If youre selling a spread that is $5.00 wide and you take a $2.50 as a credit that
means you have $2.50 of risk ($5.00 - $2.50 = $2.50).
Then, using the max value, divide it by the dollar amount, meaning you could sell 8
of these options at $250 x 8 = $20.00.
For smaller accounts, focus on doing longer-term, directional plays. Buy options
around 100 days out. When selling spreads, you must take into account the larger
risk, or loss, possible.
Look at risk with the attitude: What is the absolute worst case scenario for my
position, and how much would I lose if that came to pass?
Using this kind of risk control for your account does several things to help
newcomers to the world of trading.
First of all, youre never going to blow an entire account on a single trade, though
there might be some considerable damage. There are certain traders who feel
that the market (or the world) is against them. With this mindset, poor performance
becomes acceptable, which is wrong. Know your risks.
Next, you will have a more objective outlook on your position rather than being
stuck focusing on the P/L (profit and loss). Put on the spread and know how much
you are risking by keeping a strict limit on what you can afford to lose.
Do not find yourself in a deer in the headlights situation, or, in a trade you cant
handle. Meaning, do not tense up due to exceeding your risk.

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Understanding Implied Volatility


Implied Volatility is one of the Greeks previously discussed and is an enormous
factor to give an edge in options trading. This is a computed value that has to do
with the option itself rather than the underlying asset. Simply put, this states
that the intrinsic portion of an option will always remain the same. The
premium portion of that option, however, has the ability to change drastically
depending on surrounding circumstances. If the stock is right before earnings,
there might be an extra $20 of premium since the implied volatility jumps up
100%.
The above is why some traders have trouble with straddles prior to
earnings, which is an options strategy that has the investing holding a position
in both a call and put, with the same expiration date and strike price.
The first way to understand this is to look at a direct comparison with basic implied
volatility. This indicator can be found on most trading platforms.

Here, we have the clean price option and the basic implied volatility. In this example,
we can see earnings as they arrive over the span of a year. These same earnings,
which seem positive, can crush newcomers who do not understand earnings. If the
implied volatility is approximately 20% or anything up to 40%, that is a deal
that is safe and worth considering. If a deal is anywhere in the upper range
anywhere near 80% or higherone should be extremely careful. There will
be a large premium attached to that deal.

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Take a look at the small icon on the upper graph. As APPL earnings arise, the lower
graph falls tremendously. Buying high volatility in this example caused a big loss.
While the numbers do arise towards the day of earnings, it will then fall and the
pattern will continue to repeat itself.
Now, lets split the implied volatility into thirds. While these values arent exact, they
can be used for traders as a general measure on whether they should be buying or
selling options.

The volatility analysis can help decide whether the numbers will rise or fall. By
splitting these numbers into thirds, traders can compare the results of APPL to other
numbers along the same line.
Many traders will examine the results of Apple and then compare those numbers to
Google, which is like comparing apples and oranges. Instead, use the graph above to
compare Apples numbers to Apple, extended over a period of time.
This visual graph shows the highs and lows to better help traders understand the
range. Draw a line at the highest point and the lowest point. Then, begin to think
about your individual contract, helping decide when and how to trade.
For Think or Swim users, there is also another way to analyze this value.

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Check the Trade tab in Todays Options Statistics. This is essentially the same
numbers as presented on the graph, but rather than an image, there is a numerical
value assigned to each point.
Therefore, when examining the two graphs, notice that the 17 percent represents
the end of the green line of the graph above Todays Options Statistics. Meaning,
Implied Volatility is at a low point, when compared to the possibility of 100 percent,
which would be the highest point that the green line reached.
The percentage comes from the highest and lowest point of the graph.

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On this bar graph, its time to once again consider the rule of thirds. The Buy Options
represents 0-33 percent. The Buy or Sell represents the middle of the range,
providing options to traders. With Sell Options, the IV range (or implied volatility
range) is the highest.
When the IV range is in the upper portion of Sell Options, its not possible to buy
options.
Play volatility as its own independent trading instrument.
With the spread, buy a long contract with the hope of not having to use it. Much like
putting insurance on a home, it is something for safety that you hope not to use.

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Giving Up Your Edge on Entries


This is a lesson on discipline.
With options, if you give up your edge, you can lose. When you first start trading
options, or trading in general, theres a tendency to wait to get in until things look
good.
The problem with this is once you think things look good, so does everyone else.
This is typically where professionals are waiting to unload their positions (selling
them at the ask in the most lucrative examples) giving buyers a bad buy.
To avoid these situations, just remember if it feels like you are chasing, then you are.
Step back and wait for retracement. Know what you are willing to buy and if prices
dont meet that point, wait for the next opportunity.
Also, do not buy extensions. In regards to extension, prices above 100 percent of a
given swing, typically 127.2 percent and 161.8 percent, these swing ratios are
beyond this text, but simple enough to understand to get an edge in options.
For those unsure of whether or not they are chasing, focus on extensions.

Looking at SYK, the closing bar notes a new 52-week high, giving a bullish
appearance to the chart above. This also depends on the amount of data pulled
(meaning for ten days, it would be the high of ten days).

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This feature is especially useful to find a 1-year high or 5-year high. This data can
help traders known when and how to make a purchase.

However, on this chart, when these new highs are compared to the 127.2 percent
extension, traders can see that the risk to reward ratio is incomprehensible.
These results from Fibonacci ratios and their existence in the market.

Fibonacci Ratios
Fibonacci ratios are a tool that technical traders use to identify key numbers.
Developed from mathematician Leonardo Fibonacci, the sequence of numbers
results in extreme points on a given graph. After levels have been identified, a
horizontal line identifies support and resistance levels, as presented above.
In the example above (page 23), the extreme high to the extreme low (swing high to
swing low), the horizontal line represents 100 percent. The point at the end of the
graph, the point represents 127.2 percent, as it sits above the swing high.
While fundamentals are important, the buy and hold era is coming to an end, so
these ratios are crucial when it comes to risk and profit.

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Meaning, in this example, if you choose to buy at 84.12, this essentially means that
you can make a dollar, but you are willing to risk six dollars, which is foolish. We are
trying to predict what will occur in the future, taking as little risk as possible.
When everyone is trying to buy, the higher-ups are most likely about to dump,
which can cause a loss to many newcomers within the market.

Closing Statements
Most individuals who trade options lose money. This is because the only
approach utilized is that of purchasing options. There need to be other option
strategies in place, and players need to remember that 80% to 90% of options
expire worthless. The general public will buy options without paying attention
to the fair value of the option and the implied volatility. This can lead to
buying overpriced options and losing even more money. There are many
beginners mistakes that can ensnare the unsuspecting trader, such as not
diversifying strategies and not chasing out of the money options. However, a
trader simply needs to purchase delta 70 options with an implied volatility
that has not skyrocketed. Furthermore, do not chase a big move with an out of
the money option.
With a bit of time, practice and patience, sticking to this fundamental outline will
increase returns, lower stress, and hopefully give you a relatively gentle
introduction into the world of options.
To learn more about options you need to bring theory into the real world. At
Simpler Options we have a nightly options trading video newsletter service that will
prepare you for the next trading day. Normally this is $79 per month, but as a
reader of this e-book the first 30 days is only $7. If you would like to continue this
Journey with Simpler Options for 30 days for only $7 visit us at:
www.SimplerOptions.com/7

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