Employee Stock Options and Trading Strategy

Option Trading Topic: Employee Stock Options

Dear Options Trading FAQ:

I have a couple of questions on long-term options given as employee benefits. Particularly, 10-year options that are issued with a strike price that is equal to the current price.

How should they be valued? They can't be sold, so perhaps Black-Scholes isn't appropriate. What about looking at them as a 10-year, interest-free, tax-deferred loan that is invested in the stock?

If you are worried about a fall in the stock price (or non- movement in the next, say 1-2 years) after a big run-up, what should you do with these options? What about exercising them, putting the stock in a margin account, and then selling covered call options that are out of the money (or even in the money).

If you exercise the options and buy the stock, then you must hold for 1 year before you can sell (for capital gains purposes), or if you sell within 1 year, then it is taxed as ordinary income. Is there an options strategy (selling short against the box perhaps, although I don't exactly know what this is) that could allow you to take (or lock in) profit, without realizing the gain for a year?

Concerned About Dad's Stock Options

Dear Keeping an Eye on Dad's Dough:

This is a real sub-specialty that some brokers are experts in. If your dad wants professional advice, he should ask around his office to see who the others know and trust.

Basically, the question your dad needs to think about is: How long term a play do I want this to be? If he is a long term bull on his company's prospects (and why wouldn't he be?), he should consider just holding his options as they are. Why would he need to convert it to stock? Currently, he has a long-term bullish play at no capital requirement. Can't beat that.

If his take on the stock is grim, then he should not only cash in but brush off his resume too! As for cashing in, that is an area to get help in. Ask around. There are various ways to approach it depending on the tax consequences and such. Also, when the options come due, does he want to continue betting on the rise of the stock, cash it all in, or diversify his holdings? Lots of questions to think about.

There are many in the group who have stock options as a benefit (very common in high-tech companies). Maybe we'll get some input from them. Will pass on any info. Stay tuned, dear options trader.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Employee Stock Options, Options Valuation, Options Pricing

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

Backwardation of Option Pricing

Options Trading Topic: Backwardation of Option Pricing

Dear Options Trading FAQ:

Perhaps you can explain two recent closing option prices that just don't seem to make sense to me. I noticed that the last transaction for SIII Dec. 20 call options was $1.00. The closing price on the same day for the Jan 20 calls was 7/16. Why in the world would there not be a greater premium on the farther out January call option?

Thought Time was Precious with Options

Dear Option Timer:

I think the key words in your question are: LAST TRANSACTION. In talking about options, we really must look at last bid/asks and not closing prices. In inactively traded options (i.e. options other than OEX and SPX) or strikes, there is often a drastic difference between the last transaction price and the current bid and ask.

In your particular example, I would guess that the January call options have not traded for a while. If you look at the closing bids, you'll see prices that make more sense.

There actually are instances where the option with a shorter time to expiration will trade for more than one with a longer contract life. Every once in a while, I'll see a question about this.

The last time it was brought up, it was seen in far-out-in-time, deep-in-the-money SPX options. How can this be? As you point out, shouldn't the extra time mean something? Well, this phenomenon (known colloquially as backwardation) has to do with the cost of carry of these pricey options. Certain strategies will call for purchase of nearer term options and this greater demand will actually leave a inversion in the normal relationship. An interesting oddity - maybe it can be exploited.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Pricing, Options Valuation

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Go options!

Swinging Option Spread Trading

Option traders: Welcome back from the Thanksgiving break, all you option traders. Hope all had a good time. Mine was wonderful, except for the food poisioning. Thanks Ma!

Options Trading Topic: Swinging Option Spread Trading

Dear Options Trading FAQ:

In the past year I've played many bull spreads, several times buying back the short options when the stock bottoms and reselling it when the stock is back up. I use bull spreads mainly to handle such unexpected drops such as the one that happened to MSFT, dropping from 100 to 81. I established the MSFT Jan 100, Jan 110 call debit spread when MSFT was around 96 (Buying the 100 Call options and Selling the 110 Call options for a net debit amount). When the stock dropped to 81, I bought back the Jan 110 to close the position. I then sold the Jan 110 back out to open when MSFT went back up to 100 and my exposure is now much less.

What do you think of this option strategy? Can I do this over and over? I know this only works for volatile stocks and also with low commissions.

Busy Option Spreader
Dear Maybe a Little too Busy with the option trading:

Just one question - when the short call falls in price so that you want to buy it back, doesn't the long side fall in value too? In your example, you bought to close the 110 call option when the stock hit 81. What was the value then of the 100 call that you were long? Not much, I would guess. The paper loss at that time must have been severe. It was a good play to close out the short side because the stock rebounded, putting good premium back into the long 100 call.

At this point many would have chosen to sell out the long side, flattening the position and salvaging the trade. That would be an example of a classic successful legging out of a troubled spread.

Here though you choose to re-spread the whole affair by selling the 110 call option again. I suppose it is because your original bullish outlook on the stock has been restored, but aren't you asking for a bit of trouble? In the time it took for all this to transpire, haven't you lost a bit of premium from your long call? Wouldn't a simple stop strategy have meant much less exposure from the start? If the stock had not come back, the spread would have been a complete loss.

It sounds like you're caught a little bit in the fact that you can make some short term money in the short side of the spread. Don't forget that in this and all spread strategies, you are "supposed to" lose money on one side. Don't fall into the trap of trying to make both sides profitable. It seems like you are cheering for the short side to come down so that you can buy it back to sell it again later. Well, don't wish for that because, theoretically, your debit spread in calls demands a swift, strong upmove.

I have a client who loves to try to make money on both sides of an option spread. An eternal optimist with his positions, he doesn't care which way he is spread, bullish or bearish. First he'll root for the net long side and then break the spread to cheer for the other side. Action is his game - he'll take it in whatever fashion it happens to appear in.

Let's try to be a little more controlled than he. I think you sense the concerns I've voiced, because you allude to needing low commissions and an active stock.

Just don't get carried away. If you want to play swings in the stock, use simpler strategies - buy plain calls for a rally and puts for a decline.
Often times the simplest things work the best.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Option Spreads, Options Strategy

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

Option Margin Requirements for a Buy-Write

Options Trading Topic: Margin Requirements for a Buy-Write

Folks, Here is an exchange of letters with a reader which you may find interesting if you've done buy-writes. It illustrates the not-as-simple-as-it-seems nature of the buy-write margin calculation.

Dear Options Trading FAQ:

Here's another discount broker horror story you can add to your horror story "portfolio". I tried doing a buy-write today. I knew it was going to be difficult going in, but I didn't expect them to flub it THIS badly!

I was trying to buy 100 shares of MU at 50 1/2, and sell the Jan 1998 50 call at 18. The margin requirement for this is an incredibly low $725 (yes, I realize there could be a margin call if it goes down), due to very inflated premiums and the use of a 2-year LEAP. The buy-write gives me downside protection of 25%, to about 38, and the return on margin is 149% if called, and 163% if unchanged. I realize now that I would rather have sold the 55 calls which give me 5 more points to the upside for only 1 point less protection on the downside. Maybe this worked out for the good, since I will have to attempt the trade again tomorrow - read on...

Well, first the LEAP threw them. Even though I was very clear in saying "January, 1998 50 calls" AND gave them the symbol, they insisted on quoting me the January 1996 calls. I also had to explain several times what I was doing. They thought I wanted to buy both the stock and the options. I got switched over to another broker, who seemed to understand buy-writes. He gave me a new quote, and it looked like we were ready to roll. Until... "you will be bringing in a check for $3600, right?".

After several more minutes, I still hadn't gotten through to him. I had at least convinced him that the margin requirement couldn't POSSIBLY be higher than $2525, if I were simply buying the stock, and forget about selling the option! I wrangled him down to $1800, but that was it. I got his name, muttered "I'm going to hold you to this trade", and hung up.

Next, I placed a call to their margin clerk. I left him a voice mail, and didn't expect to hear from him till the next morning. Well, actually, I heard from him about 5 minutes later, as apparently he'd been brought the trade from order-taker #2. I was very polite and said that perhaps I'm wrong, let's just go through this step by step... We both quickly agreed that the broker had incorrectly used the effective price of the stock instead of the market value in calculating the margin requirement. Yes, it did cost me $33 a share, but it's WORTH $50! Doh!
By this time it was 1:02 (4:02 eastern). (I first called at 12:45). He asked me if I wanted him to "drop the ticket". I was skeptical of the time (glancing at my atomic clock - well, it's synched to my Internet provider, anyway...) but I said "yes". He seemed to think there was time. Of course, there actually was enough time, since I'd placed a market order, giving up any hope that they could successfully do a contingent order. They could have still sold the option - there were 8 minutes left - and they could have easily picked up the stock in the after-hours market.

When I called back to check on my order, there was again much confusion. I finally got a call back from the head trader who explained that it had been too late (OptionFool, you DO have a big clock where everyone can see it, right?) but that he could put it in "first thing in the morning". He also reiterated my suspicion that the order could have gone through anyway - "this could have just been a market order". Yep, it sure could have, since that's the way I placed it! Anyway, I decided to look at the numbers again in the morning and start all over. (Hopefully, head honcho will have a little talk with the troops in the meantime...)
How about that?

Know More Than They Do

Dear You Know More Than I Do Too!

Now I feel really stupid. Glancing at the figures in your "horror story", I don't see where some of the numbers mentioned come from. What is the 725, 3,600 and the 1,800? How do you figure the 725? Why wouldn't it be calculated like this?:
Buy the stock at 50 1/2 Sell option at 18 _________ net debit = 32 1/2 x 100sh = 3,250
At 50% initial margin, the cash req is 1,625

The concept is this: Buy the stock and offset the purchase requirement by bringing in usable cash from a covered option sale.

The Options Trading FAQ

Dear Option FAQ:

I’m disappointed in you! You're figuring it the same way my broker did. Guess brokers just think that way. :)

The margin guy at Jack White agreed with me. Now, if it turns out that I'm wrong (I will allow for the possibility, but remember, now you're fighting both me AND Larry McMillan...) then JW is *really* hosed-up, and I'd sure like to know so I can toss McMillan and find another bible.

I explain below where the $725 figure comes from. $1800 is, of course, how much the sale of the option brings in. I still can't figure where the $3600 came from. It's just a number the broker pulled out of thin air.

The net debit isn't the right calculation. Here's why. Let's do a question and answer:

Q. How much is the stock worth?
A. It's worth $5050.

Q. How much can you borrow against it?
A. $2525 - wait a minute - I see where this is going - you're trying to trick me!

Q. No, I'm not. :) How much cash do you have to put up to buy the stock?
A. $2525.

Q. Right. Now, I'm selling an option for $1800. What I get when I sell the option sure looks like cash! So, after crediting the $1800 - cash - I receive for the option, how much more margin do I owe?

A. $2525 - $1800 = $725 Damn! Don't ever let em' count their own change!
Q. You're still skeptical, I can tell. OK, tell you what: I'll just put up the full $2550 margin for the stock.

A. Now you're talking!
Q. Now, about that option premium... It brought in $1800. I've been eyeing that big-screen TV down at the Appliance Mart. Mind mailing me a check?

A. Wait a minute - you're going to send me $2550, and I'm going to send you $1800... Oh.... Doh!

At first glance, net debit appears to be the right basis for the margin calculation. But it's wrong. The reason it's wrong is that it values the stock (for loan purposes) at the effective cost, rather than the market value. Looking at it yet another way, using the net debit disallows part of the current market value of the stock - in fact, 2 times the option premium - from the loan value of the stock. What? Because I only paid $39 for it, it's only worth that? :) In the case of LEAPS, and in particular 2-year LEAPS on a highly volatile stock - 2X the option premium is a very significant percentage (more than half) of the price of the stock.

I believe that the sequence of calculations in McMillan is the correct one.
Actually, the requirement is 766.50. Here's the calculation. I made an excel spreadsheet with the calculations from McMillan (2'nd edition - pp 43-45). I've attached the output from the spreadsheet.

Margin interest rate 9.00 % Margin rate (regulation T) 50.00 %
STOCK PURCHASE stock price 50.75 shares purchased 100.00 commission 36.00 Annual dividend/share 0.20 Annual dividend 20.00
OPTION SALE option price 18.25 contracts sold 1.00 commission 36.00 strike price 50.00 Months to expiration 25.75
NET INVESTMENT REQUIRED stock cost 5,075.00 plus commissions 36.00 net stock cost 5,111.00 x margin rate 50.00 equity required 2,555.50 less premium received (1,825.00) plus option commission 36.00 net margin investment 766.50
DEBIT BALANCE Net stock cost 5,111.00 Less equity (2,537.50) Debit balance 2,573.50 At 50.00 % margin
RETURN IF EXERCISED Stock sales proceeds 5,000.00 Less stock commissions (36.00) Plus dividends 42.92 Less margin interest (546.00) Less debit balance (2,573.50) Less net margin investment (766.50) Net profit - margin 1,120.92 Return % 146.24 % Net yearly return 68.15 %
RETURN IF UNCHANGED Unchanged stock value 5,075.00 Plus dividends 42.92 Less margin interest (546.00) Less debit balance (2,573.50) Less net margin investment (766.50) Net profit - unchanged 1,231.92 Return 160.72 % Net yearly return - unchanged 74.90 %
BREAK-EVEN POINT Net margin investment 766.50 Plus debit balance 2,573.50 Less dividends (42.92) Plus margin interest charges 546.00 Total stock cost to expiration 3,843.08 / shares held 100.00 Break-even point 38.43 :
PERCENT DOWNSIDE PROTECTION Initial stock price 50.75 Less break-even point (38.43) Points of protection 12.32 % downside protection 24.27 %

How about that, Options Trading FAQ?

Love, Me and McMillan

Dear M&M:

I give up! I now dub thee Sir OPTION TRADER. - You can take over the column, I’m staying out on an extended Thanksgiving holiday! Actually, I spoke with my margin clerk, and this is what I learned (I think ):

There are two applicable calculations: 1) the fed call requirement and, 2) the house call calculation. The first is as you have calculated: 50 1/2 for the stock times 100 shares at 50% initial margin is $2525. Then subtract the full proceeds of the option sale (1800) Requirement is $725. So, on the day of the sale, you are correct, only the 725 is needed. Then, after that, (as you have alluded to earlier), the house calculation applies as follows: 30% of the stock (that is when they’ll issue a call), but using the exercise price instead of the current stock price if the option is in the money. This is known as Pegging the stock (to account for the terms of the outstanding contract).

Also, the clerk replied (rather haughtily, I thought) that, for protection, each firm can set their own requirements higher than the minimums set by the exchanges.
Good Work. Now I’ve learned something from this forum too! I’ve got a question for you. Looking to jump into this internet craze, I bought calls in... ;D

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Broker, Options Order, Options Margin

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

Options Trading FAQ Thanksgiving List 1995

An Options Trading FAQ Thanksgiving List for 1995

This year, the Options Trading FAQ is thankful for:

1) The Dow Jones hitting the 5,000 mark. It takes a dramatic all time high in the market to get the equity in my trading account back to only mildly shameful losses.

2)The zealousness of the new products departments at the option exchanges. I’ve got great new indices to trade such as the Internet, Forest & Paper, REIT, Latin, and Global Telecom. Was getting tired of losing money in the same old things.

3) Alexander Graham Bell’s mom and dad. Without their friskiness, I wouldn’t get any of those dinner time stockbroker calls. It gets lonely and boring with just the old lady and my 14 kids. Five hotshot brokers, and I still can’t get a share of the Netscape IPO!

4) That ole demon time decay. Nothing like it to remind us to enjoy each moment to the fullest. All I need do is to call up a quote on the options I own to see how precious time is.

5) The ever-vigilant SEC. May you always be around to keep a level playing field for us little guys. Unless, of course, I’m the one with the inside info. If that’s the case, hassle someone else, pig.

6) My fellow geeks on the Internet. Without the incessant rumor mongering on the stock boards, I would have missed losing money in such gems as AKSEF, URT, CAML, and the Voisey Bay nonsense.

7) The hotshot tricksters at Barings and Daiwa. See, Santa? This old scamster looks like a cub scout next to those guys.

8) Those daily credit card offers in my mailbox. Your convenience checks are great! My margin guy accepts them just as if they were actually worth something.

9) Orange County’s derivative losses. I needed the company. As I told my wife, - See? The big boys got snookered in this derivatives stuff too. So, I’m not as unique a fool as you think. Her reply - Yeah, but who do you get to sue? Yourself?

10) The dear readers of THE OPTIONS TRADING FAQ. Without your stimulating questions and unflagging support, 1995 would not have been nearly as enjoyable. (This one was not a joke! - See ya’s on the ‘net!!)

HAVE A HAPPY, HAPPY THANKSGIVING!


Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Traders

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

Any Option Brokers Out There?

Options Trading Topic: Any Option Brokerage Firms Out There?

Dear Options Trading FAQ:

I would like to join your option trading membership list. Additionally, I have a question - do you know of any brokerage houses that specialize in option accounts, and/or any brokerage which does discount option trades? The traditional discount brokerage houses seem to have particularly non-discounted option commissions. Thanks. Great options trading stuff by the way!

Paying Too Much in Commissions:

Dear Commission Conscious:

It is my feeling that in option brokerage service, you get what you pay for. If you are satisfied with the deep discounter's option service, then stay with them by all means. The commissions can be outrageously low. This is great for the very small trader where commissions can be a huge percentage of the trading stake. But if you trade seriously, or in size, you may be better serviced at a firm specializing in options.

The bit of money you save on the commission with "El super cheapo" won't mean much if you suffer below-par executions, aggravating service, or can't get them to pick up the phone. You don't have to pay full service prices for top notch work, though. Many options trading firm's commissions, for instance, are competitively structured. Look for a good balance between the price you pay and the service you get.

It's a question of immediate access to floor information (how many contracts ahead of you on the floor, who is bidding in size, etc.) and in the competence of the person who picks up the phone. In checking for a broker, ask what the order procedure is. How are the executions? Who are you speaking to? An inexperienced order clerk, or a savvy Registered Options Principal (series 4)? If you are a serious option player, the last thing you need to do is to spend your time educating an order clerk. Have you ever tried explaining the difference between a debit spread and credit spread to a newbie clerk? Or how about asking for an explanation of a margin requirement?

As for particular brokers, the best route is to get recommendations from people you know and trust. Ask around. Sometimes it is difficult because option trading can be such a lonely pursuit. In that case, call all the firms you can and carefully go over the materials they send you. What sort of orders do they accept? Stops? Contingents? OCO's? You can open up a small trial account to see how things go. How easy are they to work with? Is the style of the desk something you would be ok with? If you've placed orders with seasoned professionals, you'll really miss it when you move to a mass market firm discounter.

Speaking of placing orders, many have asked about the right way to give an order. I'll discuss this in an upcoming letter. How you deal with the broker on the phone can mean the difference between a successful execution and a poor or missed fill.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Broker, Options Commissions

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

Options Expiration Pricing

Topic: Yipes! Getting Close to Expiration.

Dear Options Trading FAQ:

If I hold an option, and it is getting close to expiration, what are my alternatives? Do all options that are in the money get exercised? That is, the day before my option expires (and it is in-the-money), who on earth would be willing to buy my option (unless they want to buy the shares, and then why wouldn't they just buy in the market)? It could be that I am completely missing something here, but can you explain exactly what happens in aggregate with open positions when options expire?

Confused on Option Expiration

Dear Confused Option Trader:

You can (and usually should) offset your long option position at any time by selling the contracts in the open market. As long as there is a bid quoted, your broker can execute the sale. Matching off the aggregate buy/sell, open/close option positions is one of the responsibilities of the Option Clearing Corp.
Most contracts are not ultimately exercised, but are rather offset in the open option market. Prior sellers need to buy to close and prior buyers (like you) need to sell to close their positions. The options that settle in or at the money get exercised/assigned. This entails actual purchases and sales of the underlying stock. Index options would be cash settled.

As for who would buy the option, there are a thousand and one reasons why someone would do it. Here's a dramatization of a famous and extreme example: It is 4:00 in New York on expiration day and Gerber has just closed for the day. Trader X hears something very interesting from a reliable source. He rushes to the phone to call his option broker, knowing that the Gerber call contracts trade until 4:10pm.

The broker takes Trader X's breathless order to buy 200 out-of-the-money options at the market. The order for a worthless, about to expire, option is strange, but the broker promptly executes it, knowing that Trader X has unusual sources of information. The contracts are bought for 1/16 and then expire, seemingly worthless. Trader X calls his broker to make sure the options are exercised. Puzzled but compliant, the brokerage house does so. The rest is history as the Gerber takeover is announced late Friday. The fat takeover premium gives Trader X a huge score. Not bad for a few minutes work and a $1,250 investment!

PS. Trader X is still dodging the SEC inquiry into the situation.
Best wishes and watch out for the federales!

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Expiration, Options Valuation, Options Pricing

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

Secrets of the Option Specialist

Options Trading Topic: Secrets of the Options Specialist

Dear Options Trading FAQ:

Are there any books that describe in detail what an option specialist does? I think having a better model of how the specialists think and behave would help out my wallet. What option books do specialists read to learn how to do their job?

Here are some other things I'm wondering about:

How does the specialist protect himself from option traders who have inside information? What does he do to limit his risk exposure?

Is the specialist for a stock also the specialist for options on that stock, or are they separate?

What else should I be asking about option specialists that I haven't thought of yet?

Ultimately I'd like to be able to develop a computer simulation of the market that includes the operation of the specialists as an integral part.

PS: I realize that I'm asking a lot of questions, but since you're offering such valuable information at such a low price I'd be a fool not to ask! :-)

Option Trader Full of Questions

Dear Inquisitive Option Strategist:

Great questions! First off, call the stock and option exchanges for materials explaining their option specialist systems. Some of the option floors feature different procedures so be sure to ask all around.

Yes, the option specialist is different from the stock specialist Trading for each occurs at different floors. There is some general information on how stock specialists function but little on what goes on with the option specialists. The function of each is similar: to ensure a ready and orderly market in their security, stepping up with bids or offers with their own money if necessary. The reward is making a steady income off the spread differential. The risk is not managing the hedging properly (staying delta neutral) and getting bagged the wrong way with the stock running against you.

Traders with inside information can really sock it to the options specialist. The delta neutral positions can get smacked out of kilter on news induced gap openings from which it is difficult to recover. You ask about books on the subject. I have heard that Jack Schwager's New Market Wizards has an interview dealing with the dangers from traders possessing inside information. Haven't read it myself yet.

There really aren't many books dealing in depth with the subject of options specialists. For most, it remains a black art and the specialists themselves prefer to keep it that way.

Once in a while, some journalist plays up the "unholy" advantage they supposedly have, but the rewards come with great risk. How about the ulcers from the Crash of 87? Specialist assignments go only to the very well capitalized.
On the stock exchanges, the specialist function is a time-honored family affair, with knowledge passed from grandfather to dad to son. The tradition continues today.

The primary concern to the option specialist is how to hedge himself from market movement. The usual goal of the option specialist is to stay neutral. That is, to make money dealing the spread and not to speculate on the direction of the stock. An option order that the specialist fills himself will get hedged by buying or shorting the common stock.

Here is a little known fact: The need to hedge with the common explains why fills can be poor in the 10 minute time frame between the close of the common stock and the close of the equity option markets. If the specialist can't lay off the risk with stock done in the aftermarket, he'll factor in a little extra room in the option spreads.

There is so much to say on this subject that I can't do it any justice. Check the specialty (stock market) book mail order companies for literature on the matter.

Other questions to look into: How do they determine the opening prices? And in time of a panic, or big news? What specialist systems/public order book procedures do the different option exchanges use? How does it exactly work?

What is the role of the market maker on the option floor? What is a DPM (Designated Primary Market Maker) on the CBOE? Why am I asking the questions? Am I not supposed to be answering them?

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Broker, Options Specialist, Options Floor

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Option Pricing Valuation

Options Trading Topic: Option Pricing

Dear Options Trading FAQ:

Can you explain any popular wisdom on option prices to a novice trader? I've noticed that the prices of options are *not* linearly proportional to how much they are in or out of the money. Is the best bargain usually bought just in or out of the money?

Also: I've only watched stocks in the $70 range--is an option that is $5 in the money proportionally more expensive for a cheaper stock since the percentage gain for stockholders is proportionally more? Or does the price "roll off"?

Trying to Figure Out Option Pricing

Dear Go Figure:

I note your use of "popular wisdom". Careful! This can be deadly depending on who you are listening to. Generally speaking, the speculative option account is considered a contrarian indicator. It is very important to try to distinguish between smart and dumb option money. With the right tools, the small but savvy individual trader can do well in discerning which option money flows to follow. As long term readers can tell you, that is one of my favorite subjects.

More in the future on options trading.

You pose some thoughtful questions which can be addressed from two perspectives: theoretical (Black Scholes) and empirical (market savvy). First the textbook discussion and then on to the real world stuff.

As discussed a couple of weeks ago, the mathematics of the option valuation formula is not linearly based, and so, far from intuitive. The intrinsic value is but one of the inputs. Of course, in a deep in-the-money option, it can be the primary source of its value. However, as you point out, the stock's prices swings in terms of real ticks and as a percentage of its value depends on the price of the stock. This will be addressed in the volatility portion of the formula, but, as we said, it is the most difficult component value to assign.

As in many areas, the intuitive sense of a human trader can be more sensitive than any program you come up with. Ask any tape reader what a certain option with such and such time remaining is worth and he'll often surprise you with a very close answer. Of course such a feel for what is right or wrong with a certain option's premium takes quite a bit of time and devotion to develop.

A factor the savvy trader takes into account that formulas miss is the extra "speculative" demand caused by option traders. The most famous example is the secular rise in OEX put premiums since the Crash. Portfolio hedgers and Black October Aficionados are fond of bidding up puts as a whole for protection. Also, because of the swell in the ranks of new, "little guy" option accounts, the out- of-the-monies are more popular than ever. Have you checked out the premiums of the way-out strikes of these tech and net stocks lately? Or how about the extra pressure caused by media reports like Dorfman? Option shooters will bid up the strike or two above the current price where as more controlled players will target the at- the-money series.

The general advice we tend to give is to stay close to the current stock price. Usually the far out strikes are pure crap shots. You'll find more value in the very near or at the money options. They may cost more, but can be well worth it. They help when you turn out to be wrong - they'll hopefully retain value much longer than the real speculative strikes. While your at it, try to pay for that extra month, too. How many times would have an option worked out if you had that extra month? Also, as mentioned, value players will gravitate to these options and may not be quick to sell in a downdraft. The more shaky holders of the out-of-the-money options, on the other hand, may be very quick to panic out of their positions, leaving you holding the bag.

Did I get around to answering your question? I don't know, but I'll sign off before hogging up any more bandwidth ;)

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Pricing, Options Valuation

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Extraordinary Options Trading Techniques

Options Trading Topic: Extraordinary Techniques for the Ordinary Investor

Dear Options Trading FAQ:

An options trading friend forwarded me your discussion on option volatility. As someone who has played options on a part-time basis (no way to grow old gracefully), I can appreciate the difficulty of playing the game properly. Can you please tell me how the ordinary investor would have access to the transaction information required to know if option contract purchases were naked or part of a spread? Or, more importantly, are you really saying that one shouldn't play options (at least short-term) without the battery of information you imply is required? My gut (and also my wallet) tell me that this is probably the case.

Concerned Option Trader

Dear Concerned (about your wallet, or your gut?):

There are basically two types of options traders: gunslingers and researchers. The fast and loose style of the former is loud, boisterous and a lot of fun. Does it make the option gunslinger rich? Occasionally, but these traders are usually in it for the heady action. Gut reactions and hunches rule. Other than a source of market information, not much is needed in terms of research materials. An informal sense of trend formation allows the shooter to spot and ride a developing situation. For a small entry fee, one can be part of the fireworks of an incredible move (Who owned Internet Index calls this week?). With a group of other similarly minded traders gathered around a real time quote feed, it’s a blast. Just don’t lose your cool - if you treat the option game as a casino, act accordingly.

The researcher type of options trader, in contrast, may prefer to work alone so that he can concentrate on picking the right entry and exit spots. Of course plenty of research allows him to become intimately familiar with the options he deals with. This type of trader patiently waits for those times when something falls out of line. Because of his dutiful study, these situations are readily apparent and he feels comfortable with taking action at that time to capitalize on it.

Does it cost and arm and a leg to set yourself up for proper options research? Do you need to spend thousands on some sort of rocket science package? Even if money was no object, where does the little guy get access to the secrets of the street?

You would be amazed at some of the option trading folks I have met over the years. With very little in the way of "street connections" and money to spend, some traders have put together amazing systems and databases.

I think the secret is to start with a very small area of study. Choose a few stocks or even just one and watch its options closely. Get a feel for the trading style of the contracts. Pick up the Investors Business Daily during the week and Barron’s on Saturday. Learn how to read the listings properly. Start logs of the open interest statistics you’ll see there. Use your stock broker or quote machine correctly. If you see the option volume jump drastically, find out if it was in a few huge chunks or by a steady pick. The Time and Sales screen of the quote machine will list whether the trades were done as part of a spread or a stand alone purchase. The next day, check the open interest to see if the transactions were closing or opening. Write all this down and track it through a few expiration cycles. You’ll get a sense of things unmatched by all except the specialist.

There are plenty of little things such as these one can do for zero or very little cost that will add up to an expert understanding of the option situation. I suppose that the trick is to learn about these procedures in the first place. Many of them I have never seen discussed in books or how-to manuals. They can be learned by word of mouth and in forums such as this one. Information is king so stay tuned. I aim to dispense as much "secret" information in this e-mail list as possible. The problem is that I keep taking certain things done on Wall Street as routine. It doesn’t occur to me that others wouldn’t intuitively know to look at something in the way I, or my colleagues do. That’s why your questions are so important - keep them coming!!

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Strategy

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Option Trading Wash Sales

Options Trading Topic: Wash Sales

Dear Options Trading FAQ:

Your questions and answers about options trading strategy are really apreciated by this eager stock options trader. Thanks for the education on options trading. I posted the following question on the internet but didn't get a response. Wondering if you can answer. I sold a Oct 85 call option on HWP ( unfortunately ) for $3. On expiration day I rolled over to the Jan 85 call options as follows: Buy Oct 85 to close at $7, Sell Jan 85 to open at $9

Can I claim a short term capital loss on the Oct 85 option trade for $4? The Jan 85 trade will be closed in January and I'll claim its profit/loss depending on the situation at that time. Or are there any wash sale rules that can apply for this situation?

Wondering About Wash Sales on Options

Dear Wishy Washy Options Trader:

My friends will claim that I'm the least reliable source of tax-related information they know. And judging by its correspondence, the IRS tends to agree. So take what I'm about to tell you with a grain of salt and consult a competent tax advisor. Perhaps you bean counters out there can also shed some light on this topic and correct me if I am wrong.

I would think that the $4 loss must be taken immediately. The two option contracts are different securities by virtue of the terms of their expiration (or can it be argued otherwise?), so wash rules don't apply. In the tax codes, reference to options as substantially similar securities usually refers to options as compared to the underlying stock (i.e. selling the stock for a loss, but buying a call contract). In your case, the two contracts are separate entities. If they were the exact same contract, and you trade in and out of them short term, the accounting may be different. What does the IRS want us to do in that case? Defer losses until the end of the trading series and adjust cost basis then? I don't know. I guess we'll have to ask an expert. I'd look at the code, but it's just gibberish to me. Hey, I know - let's call the IRS help line! Just kidding.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Option Profits

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Option or Stock-Which Moved First?

Option Trading Topic: Which Moved First, the Option or the Stock?

Dear Options Trading FAQ:

Ok, intuitively, it makes sense that option activity has an effect on the stock prices, but when I try to figure out exactly what the effects are, and why, I get confused quickly. For example, suppose stock XXX is trading at 42 and Jan 40 call options are going for 2.75. Now say I buy 100 calls at 2.75, what effect will this tend to have on the price of the underlying stock, and why?

Eager to Learn more about Options Trading:

Dear Eager Beaver Option Trader:

Good options question. The fact that this issue is on your mind shows that you are well on your way to properly using option pricing as an analytical tool. Here is the concept in a nutshell. Then, I’ll get into the mathematics behind it.

First, let’s assume that because of the fantastic leverage inherent in the options, someone with advance inside information will seek to profit by it through playing the calls or puts. Because they have the scoop in terms of expected price movement and timing, they will move into specific options instead of blanketing the entire call side or put side. This makes for characteristic cash flows that experienced option trackers will recognize as smart money moving in.

Now for the theory part. For those that have experience working the Black Scholes theoretical option valuation model, you know that the volatility factor is the hardest input to deal with. If you simply take some sort of historical average (10, 30, 60, etc. time periods, weighted or unweighted), it is not satisfactory in that the result won’t jive with the up-to-the-minute floor analysis. So the pros use the formula backwards to come up with an implied volatility figure. That is, enter the current market price along with the other factors and solve for volatility. We are letting the current trading price of the option imply the volatility.

Do this on an ongoing basis and you can track the expectations for the stock through the volatilities implied by its options.

If the implied volatility jumps all of a sudden without any stock news, pay attention! Someone is bidding up the options. Perhaps they know something?

This, combined with study of volume trends, can tip you off that something is going on in the stock. For example, if you notice that today’s number of call options traded is double the average total daily volume of all contracts, pay attention! If this occurs without any news on the underlying stock, suspect that news is upcoming.

In your example, the call option purchase will raise some eyebrows if 100 contracts is unusually big. Do large option blocks usually occur in this issue?

What is the average volume of options traded? Is there news on the stock? Is it a volatile stock with lots of interest? Option analysts have a whole list of things to look at in determining the import of your purchase. The underlying question is whether your trade represents smart money that should be followed.

Typically, the option watchers will check to see if the trade was a straight purchase or part of a spread. Also, they will look for accompanying volume in other strikes and months. Usually, 100 contracts is not considered a lot, but if persistent volume follows, the analysts will be interested. Of course, your purchase (and any subsequent others) will push the bid/ask up and that will show up on everyone’s theoretical valuation model. The implied volatility will increase, signaling an alert to option fanatics around the world. If deemed significant, the trade will serve to put the stock on many players’ watch lists.

Some may buy the stock right away on a hunch, driving up the stock price a bit.

So, you see that in the case of a stock that has no news, a significant option purchase will move the stock up. The option purchaser is considered to be ahead of the stock in terms of anticipating possible good news.

This is just the rudimentary approach to option tracking. The experts will also run screens based on comparisons of today’s option price against all sorts of historical averages and stats. The field is a complex one with many opportunities for innovation.

PS. I fondly remember the antics of one wealthy options client who used to drive the analysts absolutely batty. On nothing more than a hunch, he would place an order for 1,000 HWP Calls, 1,500 MOT Puts, or worse yet, 1,200 Calls on some thinly traded issue on one knew about. The floor people would call asking if we knew if something was about to happen with the stock. The option analysis screens would spit out alerts based on our own buying. I suppose all sorts of panic ensued all around the country based these option volume swells. It just goes to show. When a system based on logic meets the unpredictable workings of the human mind, not everything is what it seems. Be careful!

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Valuation, Options Pricing

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Options on Internet Index Netscape

Topic: Any Netscape Options? / The IIX: Internet Index

Dear Options Trading FAQ:

Might you expand on an issue raised in your previous response? What are your thoughts on when NSCP options might appear? Won't this be an absolute bonanza for brokers? I would think trading in NSCP options would be at an absolutely furious pace, given the high profile of the stock and its volatility.

Can't Wait for Netscape

Dear Waiting for Godot:

Well, you don't have to wait for Netscape options. How about looking into the Interactive Week Internet Index? Developed by the AMEX and Interactive Week Magazine, the index is designed to measure a selection of companies involved in providing digital interactive services, developing and marketing digital interactive software and manufacturing digital interactive hardware (This from the Contract Specifications sheet available at 1(800) THE AMEX). As you see from the list below, Netscape is indeed a component. Also keep in mind that this index is market capitalization weighted, that is, the Index value is based on the sum of the market value (i.e. share price x number of shares outstanding) of the components. That means that as NSCP grows in value, its effect on the Index grows as well.

List of 37 Components

3Com Corp
Acclaim Ent
Activision
Adobe Sys
America Online
Avid Tech Bolt
Beranek & Newman
Broadband Tech
Broderbund Software
C-Cube
Microsys
Cabletron Sys
Cisco Sys
Compression Labs
CUC International
Davidson & Assoc
Electronic Arts
FTP Software
H&R Block
Metricom
Microtouch Sys
Netcom Online Comm
NetManage
Netscape Comm
Newbridge Networks
Novell
NTN Comm
Optical Data Sys
Performance Sys
PictureTel Corp
Qualcomm
Sierra On-line
Silicon Graphics
Spectrum HoloByte
Spyglass
Stratacom
Sun Microsystems
UUNET Tech

Other bits to keep in mind: Expiration cycle of 3 consecutive near term months plus 2 additional further term months in the Jan cycle. LEAPS to be introduced. European style exercise. Cash settlement based on final settlement valuation symbol IIV. Margin for naked writers is 20% due to narrow based index makeup.

Definitely call the AMEX for further details on this index.

Sub-sector indices such as this one have historically not caught on particularly well. As a result, liquidity can be poor with the low volume. Witness the industry indices of the past such as the biotech, banking, oil etc. Indeed, some on the street use the introduction of such an index as a reverse indicator. The biotech index, for example, was brought out at the height of the biotech craze, only to crash with the inevitable cooling off of the sector. This one, however, may prove different as the rate of growth of the internet seems vastly greater than many realize. We will see.

As for NSCP options themselves, you won't have too much longer to wait. A fellow I spoke with at the CBOE says that investor requests for NSCP options have been coming in heavily. The exchange is working on the project.

Unofficially, he thinks within a couple of weeks maybe. And, yes, it will be a bonanza for the floor. Getting the specialist assignments for hot issues is a real windfall for the firms involved.

Note: The abovemention of equity and index options is NOT a solicitation to invest. Study up on new products before speculating.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Products, Index Options

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use.

Which Stocks Have Options?

Option Trading Topic: Which Stocks Become Optionable? Why do only some stocks have options?

Dear Options Trading FAQ:

While searching Investor's Business Daily for options and leaps on various stocks, I wondered what it takes for a certain stock to be "optionable" and then what volume it would take for it to be listed in the various newspapers that list option prices?

It is very confusing, since DRI (Darden Restaurants, Inc.), which spun off from GIS (General Mills), has options even though it is a relatively "new" company, but NSCP (Netscape) does not appear to be a stock which has options, even though it is very volatile. Can you shed some light on this? I want my stock options.

Curiously yours, Need More Options

Dear Can't Get Enough...Options, that is!:

This is an interesting question that many ask but no one seems to know the exact answer. The rules are set by each exchange but are usually similar.

Here are the requirements for the Chicago Board of Options Exchange (CBOE):

Listing Requirements:
1) Minimum of 7 million shares out that are owned by folks not required to report their holdings.
2) Minimum of 2,000 shareholders
3) Full compliance of security laws (SEC1933, etc)
4) Trading volume of 2.4 million shares in the preceding 12 months
5) Market price of at least 7 1/2 in the three previous months.

Exchanges definitely respond to public demand. If you have a stock that meets the requirements, give the option product department a call!

As for which options get listed in the financial papers, I guess that is set by the papers. Long time readers will know how poor I think the news coverage is for option prices. Many folks enter orders based on prices in the paper which in no way reflect reality. Because last sales (and not bids) are listed, the quotes do not take into account when the option last traded. Inactive options may be bid at a price far away from the last print. Always ask for bid-ask quotes before placing an options order. This also has the additional benefit of forcing the order clerk to double check that he is entering the right order for you.

Other tips in dealing with order clerks will be featured in an upcoming issue.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Exchange, Options Order

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Successful Option Trading in the Long Term

Option Trading Topic: And we have an option trading winner!

Dear Options Trading FAQ:

Everywhere I read that option trading is a deadly game and a losing one. I have been trading options since Jan 95 and have been successful since April 95. I am currently up 205% for the year in my options portfolio. What am I missing? Is this all going to come tumbling down on top of me?

I do thorough options research and only buy options on top quality companies. I have been successful with my options 85% of the time and am making a killing. I keep looking for the monster that is going to jump me and take everything away. Am I blind and this is all going to disappear in one fell swoop? I buy in or at-the-money options usually six months out after doing extensive study.

Doing Great with Options Trading

Dear Doing Great in Options (for now):

It is nice to hear an options trading success story such as yours. I am very happy for you. It seems that you corrected whatever was wrong the first few months and really got on a roll. Here are a few observations as to what you may be doing right:

Buying at or in the money options - Many are tempted to maximize leverage by chasing only out of the money (sometimes WAY out!) options. This makes it a real crap shoot.

Buying six months time - It may cost a little more, but this is often a real life saver. Much more conservative than always playing the current month options.

Research and staying with Top Companies - Oftentimes options players play from the gut - hopping on a quick trend with out the due diligence that they would sink into a stock purchase. Also, with the quick introduction of options on OTC speculative type issues, the quality of the underlying stock is not top-rate. The more casual paced investor may not react in time to the quick swings in this type of stock.

To balance things out, here are a few warnings about options trading:

You have done well for six months. Realize before you quit your day job that you will need to extend this streak to decades if you want to retire from it. Can you keep up the pace? The experience is a heady one now, but can you keep up the energy when some losing option trades show up?

I have gone through hot spells where anything I trade spells $. These periods inevitably cool off as does my passion for options. At these points, one must fall back to other areas of interest such as stocks, bonds, baseball cards. Do you have a well-rounded trading repertoire?

If you hit a slump in your option trading (and, sorry to say, you will), can your constitution and bankroll take it? Can you limp along until you once again hit your stride?

I assume the trading has been from the call option side so far. We have been in a bull market that is unbelievable to many savvy traders. They have been too smart for their own good. It has been the novice that does not know to be afraid that has been raking in the cash.

When the market turns (perhaps dramatically) will you recognize the need to switch to the short side? Having trained yourself to expect good things from call options, do you now have an up-market bias? The truly versatile trader can recognize a trending market and play it regardless of direction. Will you graduate to this level of sophistication? Or will you suffer with the rest until you run into a similar market again? As they say: Do not confuse brains with a bull market!

Enough of the lecturing. Continue with your lucky streak and thanks for the story. It gives the rest of us hope. Enjoy your option wins while they last!

PS. I’m reminded of an old client who would take his wife on a super deluxe extended vacation at the height of every hot streak trading options. When I commented on it, he told me that he had learned over the years to enjoy the fruits while he had them. As he said about a trip to France: The markets can take my money away next time, but they will never take this trip away from me.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Strategy

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.

Options Trading Software

Options Trading Topic: Option Trading and Analysis Software Packages

Dear Options Trading FAQ:

I enjoy very much reading your comments on options trading. Since I am doing option trading without a computerized analysis program, I think I am handicapped in this battlefield. Could you recommend some affordable software packages that are good to analyze options? Thanks,

Handicapped Option Trader

Dear Handy Options,

Sometimes it’s better not to have the computer around to mislead you. From what I read in the ads, all I need do is to buy the package, run it and make tons of cash. I guess all the others buying the package will do just as well, but there is plenty to go around, isn’t there? ;) Seasoned players will agree on several points about computerized packages and trading systems.

The options trading systems that do really work, only do so until they are discovered. When enough people pile onto any system, the self-defeating factors set in. It is at that point that the cash flow of the program’s originators switch from trading to selling the system. The old Wall Street axiom is that if a system really works, why would someone be willing to sell it to you? They would be jealously guarding the secrets of it for themselves.

There are basically two types of systems that you’ll be looking at: 1) The open system and 2) The Mystery Box. Serious players will put up money only when they can see and understand the theory behind the signals that are generated. This type of open system would include the technical packages that flash buys and sells when certain parameters are hit. As a user, you will know in advance just what triggers the bells and whistles. The amateur trader is more fond of the simple magic box formula. A guru or his software will generate trading signals which you are to blindly follow. The exact parameters behind the thinking is secret. A stellar track record is usually supplied with the demo package which, along with the guru’s reputation successfully sells the package to the trader looking for big gains with little effort.

I would personally favor the first type of package over the latter. I feel better knowing that it is the Wilder RSI flashing the sell signal, rather than the mood of the so called expert. But then again, their track records are much better than mine, so maybe I shouldn’t be so skeptical .

I’ve gotten off the track - you actually asked about option valuation tools, not trading systems. Sorry.

Getting down to particulars, I recommend various packages depending on what you want to do. Are you looking to analyze the underlying stocks themselves or their options? For stock trends, the champ is METASTOCK. I was a beta tester for the windows version, so I’m partial to the program, but many have told me good things about it. Warning: This may be more than you want to spend. It will entail securing a source of data as well. I used DIAL DATA with it. They are a great value compared to some other larger name sources.

As for options analysis, all the programs run some variant of Black Scholes or compare the current premiums to the theoretical value. There are quote packages that incorporate this as well. Again they may be too expensive. A popular outfit for option valuation studies is OPTIONVUE. You can call and ask for a demo disk or download it from their WWW site. They have an OPSCAN service available from their bbs which lets you program filtering screens based on factors you select (e.g. Show me all stocks whose options today exceeded twice their average trading volume). We use this a lot and is highly recommended.

The CBOE just came out with THE OPTIONS TOOLBOX which lets you construct and test option strategies. I haven’t looked at it yet but it seems interesting. Inexpensive, too, at $29.95. Call 1(800) OPTIONS.

There really are so many resources for you to look into. All sorts of price ranges and depth of detail. I’ll let the others suggest some of their favorites.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Software

The Options Trading FAQ is a reprint of the ground-breaking work done at the dawn of the web age. The generation of option traders that learned the ins and outs of option trading from the usenet will remember these posts fondly.

Copyright 1996 This is copyrighted material about trading options. Do not reuse this text in any manner without permission. This option trading strategy information is valuable and monitored for unauthorized use. Think about your options.