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On the Third Day of Christmas – US Options Trading Part 1

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On the Third Day of Christmas My True Love Gave to Me, $1,200 Credited Into My Bank Account Last Night!

I’m very excited to be able to write about this today! I initially had ‘US Stock Options Trading’ as the 6th Day of Christmas to keep you in suspense, but last night’s windfall was too much to contain!

Online MoneyOne of my Free World income stream experiments is US Options Trading. It’s one of the online streams of income that doesn’t involve blogging, building a reputation, getting subscribers or trying to sell anything. The results are based on you and you alone and is one of the primary ‘location independent’ revenue opportunities.

So this isn’t going to be a get-rich-quick scheme, there’s nothing to sell you at the end, but the idea is to show you what I’ve been tinkering with on the options market and that I’ve been able to make some small (but significant %) profits. (And that you can too)

I’ll explain a bit about Options Trading (it’s not daunting, don’t worry) and then about how to find profitable stocks and what tools you can use to kick things into gear. There’ll be a few links at the end of sites you can check out, sign-up for free online brokers and do some ‘virtual’ trading on your own. (not real money, but it uses the real results from the stock market).

Things might get a bit confusing as we go along, but I made $1,200 last night without lifting a finger so it’s worth you getting a cup of tea, having a good read once or twice, following the links, and if anything doesn’t make sense then either drop a comment or send me an email. If you’re viewing this post via the email subscription or RSS feed, it’s probably better to head to the site as some of the images enlarge if you click on them.

Introduction to Stocks & Options

daily email - thumbLate last year I attended a seminar on shares, options and CFD’s (ignore the last one). This piqued my interest so I read a few more books and found that most of the information was readily available for free in books, none of the theories were new or top secret and what wasn’t available in books was available online. I got hold of a good course of DVD’s and CD’s and studied away, eventually starting up a free account and experimenting, reading more books and found that the whole game was about learning, getting some experience, risk management and not putting all your money on the table at once.

It doesn’t matter if you don’t know anything about the stock market, stocks or shares and all that jazz. The words ‘company’, ‘shares’ & ‘stocks’ all represent the same thing, if Ford Motor Company came out tomorrow with the flying car then their share price/stocks/company would increase in value. If their flying car crashed when you drove it then their share price/stocks/company value would decrease.

What is an Option?

So anyway, what are these options I keep going on about? An ‘option’ is based on a stock. An option has three components; time value, a premium and a strike price. Confused much?

Time Value

Like car insurance, you buy an option to last for a set amount of time; one month, two months, six months, a year, it varies. (Consequently the more time you buy, the more it costs) You’re not actually buying the ’stock’, in essence you’re taking out a policy that will give you the ‘option’ of buying the stock at a set price further down the track.

Premium

This is the ‘premium’ you pay for the option, similar to the cost of your car insurance. The backbone of options is that the premium is more often than not only about 10% of the cost of buying the actual stock. (Think about it, $10 stock that you control for $1, if it goes up to $12, you’ve made 100%).

It’s worth jumping in here to give you the textbook definition of an option to help clear things up; “An option gives the buyer have the right, but not the obligation, to buy or sell the underlying stock at a specified price (strike price) until the 3rd Friday of their expiration month (Time Value).”

Strike Price

From above, the ‘strike price’ is the price at which the buyer can buy the stock for. So if you buy an option on a $10 stock for $1, and your stock moves to $15, you have the right to buy that stock at $10 (and here you’d have $5 profit as the stock has moved to $15).

Hopefully you’ve just had a light bulb moment from the above paragraph and probably asked as I did “surely that’s not possible?” I probably haven’t done the greatest job at explaining all of this so head here when you’ve got the chance to read up on it.

Sales Pitch

So if you do a few google searches or even attend a seminar or two, you’ll hear/read a few of those gimmicky sales pitch catch cries to reel you in. Here’s a few I’ve put together that ARE true and should make you stand up and want to get into this for yourself;

  • Automatic Profit Email!Options Trading will take a whopping 15 minutes of your time per day
  • You can double or triple your money rather easily
  • You can profit hugely from stock going down
  • You can make money if stock goes sideways (neither up or down)
  • You don’t have to know which way the stock is going to make money

Ok that’s the gimmicky sales pitch crap out of the way, and I’m not even trying to sell you anything!

The whole options trading thing is full of strategies, you can; buy, sell, make money on stock going down, all sorts of stuff, but to ease you into it I’ll work through some real examples that I’ve used myself.

If you missed the two screen shots within this post scroll back up and check them out. The first screenshot is of the daily account email I receive which outlines my overall position and the second screenshot is when one of my orders gets filled and I make a profit! If you want to learn some more right away you can google ‘options trading’ or go to one of the many online brokers and sign up for a virtual trading account, I’ve used optionsxpress and they were fine.

In US Options Trading – Part 2 I’ll show you a behind-the-scene’s look at how I find trades (companies), what to do with them once you’ve found them, and how to place trades.

Receive the Twelve Days of Christmas (and Part 2 of Options Trading) delivered directly to your inbox here. If you’ve got twitter it’d be great if you would retweet the article. :)   retweet

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Written by Andrew

December 16th, 2009 at 1:02 pm

Posted in Improve Yourself, Personal Finance

Tagged with , , , ,

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  • grantrnieddu
    BAM! Solid stuff, Andrew!

    My first forray into the free world was when I leapt into options. It took me 6 months to save the initial investment...then I lost it by the bell!

    BUT, more important, I learned how to do whatever it takes to invest! And I was introduced to the leverage of options.

    The sad part is that I didn't keep up with it. Knock it dead! and keep pressing.

    Grant Nieddu
  • Hey Grant,

    What went wrong with your forray into Options? Would you give it another go? I'm still fairly 'new' to it all myself but have a few decent rules in place to stop me from risking it all.


    Any major reason why you didn't stick with it? I'm thinking it's about taking small wins often and hopefully overtime building up the trading bank.

    Interested to read about your experiences?
  • Maybe this is already slated for Part II, but I'm interested to hear what books you've read on the topic. I read a zillion before starting a hedge fund a few years ago (before I was put out of business by new *expensive* regulations), but the only great author on the trading I can bring to mind is Van Tharp. At least two of his are in my list of faves, but it's been a while.

    I'm assuming you're leaning more toward technical analysis than fundamentals? Yeah yeah... maybe this is already schedule for Part 2. :)

    The key to trading to me was always the psychology behind it. Our minds are heavily biased to make "common sense" decisions that are actually harmful to long-term trading success... especially from a risk management perspective.
  • Hmm, good idea, I wasn't going to suggest any reading. I've got a few good books I'd recommend. Next time I'm back at my place I'll jot down a list.

    I've read Van Tharp's, they were quite good.

    I make a point of doing all of my analysis, setting stops, Break Even's and Profits before I place a trade, so it 'sort of' takes the psychology out of it once it's all live.

    At the moment I'm focusing on Fundamentals, good companies that have crashed or are under valued, I haven't entered the mine field of technical analysis just yet. My trades are placed on 3 - 6 month options so it gives the company a bit of time to sort themselves out.
  • well done!!

    i'm doing a degree in Actuarial Science so swimming in this stuff.

    ever read a book called "fooled by randomness"?

    highly recommended.
  • Ah nice. I'm a firm believer that this whole game is all about risk management and probability. Not the ability to pick winners, but the ability to preserve capital until your winner shows up. The best thing about options and the leverage they afford is that you can have a string of trades that go down, hit your stop loss and you're out, then your one winning trade makes 300%.

    Haven't read 'fooled by randomness', I seem to have an ever growing 'to-read' list these days!

    Keep checking the blog as the next post I do on options will have a few good screen shots & example of stock screeners I use to sift through companies. The amount of financial data out there is amazing.
  • I've always been intrigued by trading options or day trading but have never had the time to really figure it out or feel comfortable putting my money up. The sheer excitement of it has got to be worth a few (small) losses. I am looking forward to seeing more from you on trading Andrew.
  • Hey Royce,

    I played with the Virtual Trading Platform on optionsXpress for months before I committed any real money. Figured out how strategies work and how the profits/losses worked. It was really helpful (and is totally free).

    I've got an option at the moment that cost me $0.99 on a $9.40 stock, the stock has moved to $11.30 and my option premium is now worth $1.80. So for a 20% move in the stock price I got an 80% move in my option premium. The leverage of options is the most exciting part!
  • Congratulations for your results! Keep working on them ;)
  • You nailed the lightboxes.

    So, how do you *lose* money on this stuff?

    There's got to be a catch...
  • Losing money? Quite easily! :P A fundamental analysis of companies might reveal 10 companies that have good fundamentals but their stock is low, you might put trades on 5 of them with tight stop losses, all 5 companies could go down instead of up and you'll lose 10% of the premium (or whatever your stop loss is).

    In part 2 I'll detail one of my big losses (decent lesson learnt). Also the age old human greed thing, I only commit 30% of my trading bank onto the market at a time and 7.5% on any one trade, so i'm fairly restricted by my own risk management rules.
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