Liha OT CNA aR Minimize your riskand Learn from step-by-step jj Use technical analysis maximize your odds for __ instructions and sample to build your investment ern Ne pena eratesNo one likes a know-it-all. Most of us realize there's no such thing— how could there be? The world is far too complicated for someone to understand everything there is to know. So when you come across a know-it-all, you smile to yourself as they ramble on because you know better. ‘You understand that the quest for knowledge is a never-ending one, and you're okay with that. You have no desire to know everything, just the next thing. You know what you don’t know, you're confident enough to admit it, and you're motivated to do something about it. At Idiot's Guides, we, too, know what we don't know, and we make it our business to find out. We find really smart people who are experts in their fields and then we roll up our sleeves and get to work, asking lots of questions and thinking long and hard about how best, to pass along their knowledge to you in the easiest, most-accessible way possible. After all, that's our promise—to make whatever you want to learn “As Easy as It Gets.” That means giving you a well-organized design that seamlessly and effortlessly guides you from page to page, topic to topic. It means controlling the pace you're asked to absorb new information— not too much at once but just what you need to know right now. It means giving you a clear progression from easy to more difficult. It means giving you more instructional steps wherever necessary to really explain the details. And it means giving you fewer words and more illustrations wherever it's better to show rather than tell. So here you are, at the start of something new. The next chapter in your quest. It can be an intimidating place to be, but you've been here before and so have we. Clear your mind and turn the page. By the end of this book, you won't be a know-it-all, but your world will be a little less complicated than it was before. And we'll be sure your journey is as easy as it gets. TOE Sendra Mike Sanders Publisher, Idiot's GuidesAS EASY AS IT GETS! Options Trading www.ebook3000.comPenguin Random House Publisher: Mike Sanders Associate Publisher: Billy Fields Senior Acquisitions Editor: Brook Farting Book Designer: William Thomas ‘Ayana Lacey ‘Amy Borrelli Indexer: Tonya Heard As always, to Rik and Drew. First American Edition, 2016 Published in the United States by DK Publishing 6081 E, 82nd Street, Indianapolis, Indiana 46250 Copyright © 2016 Dorling Kinderstey Limited ’A Penguin Random House Company wv we W987 6 5327 01-285168-SEPTEMBERZD'6 All rights reserved Without limiting the rights under the copyright reserved above, no part of this publication may be reproduced, stored in or intraduced into a retrieval system, or transmitted, in any form, or by any means (electronic, mechanical, photocopying, recording, or otherwisel, without the priar written permission af the copyright owner. Published in the United States by Dorling Kindersley Limited. IDIOT'S GUIDES and Design are trademarks of Penguin Random House LLC ISBN: 9781615648627 Library of Congress Catalog Card Number: 2015948695 Note: This publication contains the opinions and ideas of its authors}. I is intended to provide helpful and informative material on the subject matter covered. It is sold with the understanding that the author|s] and publisher are not engaged in rendering professional services in the book. Ifthe reader requires personal assistance or advice, a competent professional should be consulted. The author{s} and publisher ‘specifically disclaim any responsibility for any liability, loss, or risk, personal or otherwise, which is incurred as a consequence, directly or indirectly af the use and ‘application of any of the contents ofthis book. ‘Trademarks: All terms mentioned in this book that are knowin to be ar are suspected ‘of being trademarks or service marks have been appropriately capitalized. Alpha Books, DK, and Penguin Rendom House LLC cannot attest to the accuracy of this, information. Use of a term in this book should not be regarded as affecting the validity of any trademark or service mark DK books are available at special discounts when purehased in bulk far sales prometions, premiums, fund-raising, or educational use. For details, contact: DK Publishing Special Markets, 345 Hudson Street, New York, New York 10014 or ‘SpecialSales@dk.com, Printed and bound in the United States of America Idiotsguides.comContents Part 1: Introduction to Options Trading 1 All About Options What Are Options>..— Why Options Exist Insuratin Leven Speciation = = 7 Basic Options Terminology emeereneenn neni 8 Pat td Call al Bid and Ath ad ang and Sb 9 Strike Price ou - W Expiration Datecnonnnnnnns -2 American and Europea Option sense? Underlying Securities. mene Comnidity Options... weed Equity Option nee 3 Index Options. B Imerest Rate Options. _ - s 4 Miscellaneous Options co How Options Work. Reading the QUOteS enn sn Is ee Option Traneactions.. Basie Order Typ am Advanced Order Types. Foor Exec Marking to Market and Margitsno-1n-nsenmnne Money n€3§ enn ‘Open Titres iene tion and Exercise... ESP Exercte. - 27 Delivery and Settoment.. eT Extrinsic and Intrinsic Vale mww-nennnnennns Relationships Among Options Options Cycle www.ebook3000.comiv Idiot's Guides: Options Trading 3 Exchanges, Brokers, and Other Market Institution Pricing and Trading Structures for Options... ‘The Role of Market Maker. The Order of Tre en Price improvement. Where to Trade Options Opvions Exchanges inthe United States: Over-the-Counter Option Finding a Broker... Commissions and Trade Execution... Position Litto Choasing a Sofizare Platform... Fasures Commission Merebantr. Signing the Options Agreement... Other Institutions in the Options Game Options Clearing Corporation Options Iaductry Council The Reger oon cc 4 The Greeks Delta Delta in Pictures. a 46 ae canst! Gamma. co (Other First Derivatives on Vega Bier How to Use the Greeks Part 2: Options Valuation and Trading Strategie: 5 The Basics of Options Valuation.. Put-Call Patty sonnei onan Basics of Valuation enone marae 59 Understanding Pricing with the Binomial Option Model wnnnonnnnenennnn 60 Pricing in Detail with the Black-Scholes Model ce Vale of the Under it. _ Time Valu... - - Interest Rate - moVoll cn tS American or European ‘The Effet of Divided anon ns 66 Paating Together the Black-Scholes Mot cnn Heston Volatility Model on nne-nninnnnnnnninnnnnnnnnninnin? The VIX and Other Market Indicators. Working with Volatility, Implied and Otherwise eunow-newnnnennnnninnT® Sentiment nen 7 Prt Call Rati oe ” Pat and Call Volume Indicator on 73 Premium Levelnucnnnnnn a Confidence Index. Implied Volare... he VIX ncn Calealatng the VIX. ce Using the VIX on er Extending the VIN Concept aft Using Indicators sac icra . 7 Batis Strategies 7 Neutral Sravegis. arenes TD Bears Strategies cen TS Beginning Options Trading... How to Open an Account... The Options Agreement 80 Margin Acco so Accounting in Your Account. a8 What Do You Want 10 Do? oaonne- ce 81 Simple Speculative Strategies. .nu- a 2 Covered Cline sc 82 Playing a Hunch with Weeklye and Binary Options. 8 Writing Deep Out-of-tbe- Money Pat. Reducing Transaction Carts with the Whee Trade... Hedging. (Closing Out Your Postion enn nn Ofietting Trades. Expiring Worthen Essence and Acsignment. eS What About Employee Stock Options?... www.ebook3000.comIdiot's Guides: Options Trading 8 10 Call Strategies Basic Uses of Calls. Why Use Long Calle... Being Short @ Call ‘The Call and ts Premio Call Strategies ones - Writing Care Call nnn Writing Naked Calle... Replacement ThePApy nnn Call Spreads... Butterfly Spree. ss Cid nnn How t0 Think About Cl. Put Strategies. Basic Uses Of PUS nnn Long Pat Stratton Sore Pet Strategies nnn The Patan the Preto Put Strategies... Protective Pat. Nabe Pat nnn Co Married Pt. Butterflies Condor. How to Think About Puts Christmas Tree Spread. Ba Spt Seraddles and Strangle... Stride Short Straddle _ Sirgen Iron Busterfliee and Iron Conder Collars and Fences enews Rolls, Jelly and Plain.Part 3: Advanced and Synthetic Strategies. 1 12 Serips and Straps. on AM Repair Strategies. ee Option Repair. a a 134 Stock Reiter a oe 38 Futures, Forwards, and Related Derivatives. Defining Furures.onn-ow-nennm “Types of Futures Contract. a) Options om Futures. ut Forward Contracts Hi Environmental Credits... 4 Swaps... ss as cna Ww ns’ Interest Rate S220pcm nnn nnn FB Commity S849 eel S Staptions dE Collateralized Deb Obligations... ns M3 Credit Defaule Swaps... a 3 Repurchase Agreements nnn a iA LEAPS and Weeklys. Synthetic Securities .. Serting Up Synthetics... A Si a aD Long Synthetic Stock... us Short Synthetic Stock... 150 Synthetic Options... 431 A Symbetic Call. 132 Long Somber Cal 152 Sbort Synthetic Cal 13 A Synrtie Pan 154 Long Synthetic Pat... 15 Sbort Synthetic Pate 156 ‘The Role of ler xnnnnnennnnenniennine ST A Reminder About Volatility oo 158 Syrabetes and Moneynesnnnennn acsmemareemeal T What's the Doronside er www.ebook3000.comIdiot's Guides: Options Trading 3 14 Wohy and How to Use Synthetics. it Barrer Shares to Short. [No Exchange-Traded Product. co intents BD) Greater Efficiency on Some Hedges... Arbitrage.. The Law of One PriC€ ews cca Arbitrage Strategies. Simple Arbitron Option Arbitrage... Sealping.. Synthetic Securities... Comcerson Arbitrage. Reve7 hen Bas Spreads. Interete Rate Arbitrage... Indes: Arbitrage Merger Arbitrage faxes, and Other Considerations... 2 Commss0nS nnn Dividende.. Commission Inter. Taser. Problems and Deronsides of Arbitrage a serait High-Frequency Trding.nnnnnnnens a”, Technical Analysis. ‘The Basics of Technical Amaly¥8..-ean-nnnnen need Intermediate Technical Analysis, —— seems lT8 Trend en Moving Averages Breakott Volatility... Revert Basie Chart Patterns. Pennants aud Flag. Head-and-Shoulders.‘Theories of Technical An: 88 Bibonacei and Eliott Wa. an 89 Candlestick Carton co 190 Ga eel Parting Ie All Together vn-newnn-ennnnnninninnennnneninn 1 15 Fundamental Analysis Why Analysis MatterSoo Starting with the MacroeconomY .-wminennnnnnnennnnnennnnen OM US. Data Sante om cee EIS Global Data Source. nl Analyzing the Underlying Asset... onc . 196 Single-Stoc Options a 196 Financial Product. . - 197 Commodities on - ol Looking at che Calendar... 199 Fundamental Analysis in Options Trading. 200 Putting Ie All Together... 201 16 _ Research Services.. Determining Your Needs... 204 Your Trading Sth. OM What Drives Your Market. — nen 205 Hore You Lethe 205 Research Relative to Perfor Mee ener sc “Types of Research Sct ViCCS se ennnneennnennnnennnennn 25 Data. co 28 Research and Analytic. — 207 Find eR ou co 208 ition 2 a 208 Evaluating the Services mvwnn-nnnnennnn en 209 Running Some Backeround Checb-- ane 209 Are They Rusming a Service ora Sales Pte. cen 210 Using Your Br ne Buyer Beware. Part 4: The Business of Trading 17 Trade Planning. Pick Your Markers... ick Your ‘Timeframe... www.ebook3000.comIdiot's Guides: Options Trading 18 Set Your Goals... - Are You Beginning or Advanced. Are You Speculating or Hedging Return Targets. ‘The Probability of Ruin. Risk Limite Time and Attention Cash Management... Fixed Fractional. Five Rat. Gann.. Kelly Criterion... Martingale Value at Ric. Cost OF Cat2Y enn Plan Your Trade sso Hore Much Money? Why Trade For Hoss Lang. and Trade Your Plan.. One Exe Sticking Your Limits. Keep a Trade Diary.. Managing Your Profits... Compounding Returns sith the Same Strategy. Pyramid. Taking Moncy Off the Table... Taxes Income and Capital Gains... ce Proceeds and Basis. sicsciemimteast sree How Options Affect the Tax BaSi¢S nro minal 82 ‘The Tax Rates, Applied. Dividends. Capital Gain... Interest Income Closing an Option Position... Using an Offeting Pato Assignment or Exercise Call Editon. Assignment or Exercise: Put Edition. Worthless Expiration.19 20 Contents 238 238 The Esplenation orn - oss 238 Antistraddie and Offet Rule Exempt ou anne dD Who Are You, Anyway? nm. - svn 3D I. 005 nn aaa eceaaas HD Dele nn ena! Traders ce : piercer itBO) Options in Retirement Accounts... 2 Deducting Investment ExpenseS.0-enonnonnninnnennnnnnn 2 Research and Advice. ne Hrs to Handle Commistots os cen Investment Interest smi ‘The One Expense You Can't Ded. 243 1 7 a nna Types of Tat Abi enn ond Special Considerations for Trader. a State Tavera 2a Evaluating Performance. 247 Learn About Options, Nor Strategies. ctnceS ‘Testing Before You Trade. cen AB Backering. cen Simalation an 250 ‘Tracking Trades eon | A Sinple Trading Ditton sven ausi5 Spreadsbet nan 7 eit ct Seating Up a PSL... 282 Calculating Overall Performance. 252 “Types of Rewrn. — 282 Rik Caen nn . 255 Benclmarking Performance sis One Final Note... 256 Training Your Brain.. 259 Controlling Your Emotion e-wn=ennnnnnniinnnninnnnnnnnn260 apames2B0) a") ene Bb Overcenfidenctn 282 Aner. 262 www.ebook3000.comAppendixes OPE OR Depression. Importance of a Trading Plan... ‘Trading as a Thought Endeavor. Balt Your Plato Learaing, Without Emotion. Having an Outlet. Balancing Life A Walk oy Ftd If You Have a Problems Glossary ResourcesIntroduction Options are powerful tools for managing financial assets. They can be used to manage risk, generate income, and make money. They're also complicated. Let's get that upfront. As a result, 100 many investors shy away from options because they confuse “complication” with “risk” Others are led astray by advisers who take advantage of the complication to recommend high- commission, low-return strategies. I's unfortunate, but it happens. Because options are complicated, though, they are an ideal topic for a book like this. Here, I break down the terminology and function of options to help you understand how you can use them to manage risk and to make money. An option is a contract that gives you the right to buy or sell something at a predetermined price on a predetermined future date, You are not obligated to exercise the contract, so you won't unless it is to your advantage to do so. Most options are nor exercised. It sounds like a goofy thing, doesn't it? It sounds like something that’s not quite real, not quite practical, and possibly sketchy, doesn’t it? Perhaps it sounds like something that’s used by finan cial people just to confuse the rest of us, However, options have real value. ‘Suppose you think about an option in another way: as insurance. Your car insurance policy gives you the right, but nor the obligation, to file an accident claim up to the amount of value of the car while the policy is in force. You don't have to file a claim, and it might not be worth your while to even file it if you do have @ minor accident that will cost less to repair than to cover your deductible. And yer, that policy has real value to you even if it expi ss unused. An option is a form of insurance. It is written on the value of an underlying asset, such as a share of stock, a market index, or a foreign currency. Some people buy options to insure against an unfavorable price change. Some people sell options to bet that the price change won't be favorable. They are not bad people. Instead, they are providing the insurance. In a same way, your car insurance company is betting that you won't get into an accident so that it can keep the premiums you pay each month. ‘The more likely you are to get into an accident, the higher car insurance costs. Parents of newly licensed teenage drivers know this well! And the more likely an option is to be exercised, the higher its cose will be. ‘Traders who buy options for their insurance value are known as hedgers. Those who provide the insurance are known as speculators who are looking to profit from price changes in the options Speculators aren’t bad folks because they want to profit. The presence of speculators ensures that there's a healthy market for options. That, in turn, ensures that prices are fair. All this trading www.ebook3000.com