The Options Course Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding The Wiley Trading series features books by traders who have survived the market’s ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics Whether a novice trader, professional, or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future For a list of available titles, visit our web site at www.WileyFinance.com The Options Course High Profit & Low Stress Trading Methods Second Edition GEORGE A FONTANILLS John Wiley & Sons, Inc Copyright © 2005 by George A Fontanills and Richard Cawood All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201748-6011, fax 201-748-6008 Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our web site at www.wiley.com Library of Congress Cataloging-in-Publication Data: Fontanills, George The options course : high profit & low stress trading methods / George A Fontanills.—2nd ed p cm Includes index ISBN 0-471-66851-6 (cloth) Options (Finance) I Title HG6024.A3F66 2005 332.64'53—dc22 2004028852 Printed in the United States of America 10 To Charlene Fontanills— the one true love of my life Contents Preface ix Acknowledgments xiii About the Author xv Introduction CHAPTER Options Trading: A Primer CHAPTER The Big Picture 16 CHAPTER Option Basics 42 CHAPTER Basic Trading Strategies 76 CHAPTER Introducing Vertical Spreads 130 CHAPTER Demystifying Delta 164 CHAPTER The Other Greeks 175 CHAPTER Straddles, Strangles, and Synthetics 187 CHAPTER Advanced Delta Neutral Strategies 234 CHAPTER 10 Trading Techniques for Range-Bound Markets 265 CHAPTER 11 Increasing Your Profits with Adjustments 311 vii viii CONTENTS CHAPTER 12 Choosing the Right Broker 330 CHAPTER 13 Processing Your Trade 347 CHAPTER 14 Margin and Risk 371 CHAPTER 15 A Short Course in Economic Analyses 382 CHAPTER 16 Mastering the Market 403 CHAPTER 17 How to Spot Explosive Opportunities 415 CHAPTER 18 Tools of the Trade 453 CHAPTER 19 Final Summary 466 APPENDIX A Trading Resources 485 APPENDIX B Important Charts and Tables 503 APPENDIX C Strategy Reviews 511 APPENDIX D Success Guides 527 Glossary 533 Index 557 Preface An investment in knowledge always pays the best interest —Benjamin Franklin M ost new investors and traders, whether they are beginners or professionals, usually lose money for two reasons First, they not have a grasp of how the markets really work Second, they are under too much stress when they trade because they fear losing money Many times, traders liquidate good trades too quickly or have no idea when to take profits But learning to trade successfully is not an impossible task This book is designed to build your knowledge base of the markets to a professional level and to provide you with strategies that make money in the marketplace My trading program is the result of many years of trading experience, as well as many years of research and development, all in the pursuit of developing the optimal methodologies to trade the stock, options, and futures markets Students often ask me how I got started as a full-time investor Perhaps like you, I was looking for an opportunity that would allow me to achieve my financial dreams after a long road of despair After attending high school in Miami, I felt a college career was necessary to become successful Although I questioned what success really meant to me and whether college would bring me that success, I settled on the University of Florida in Gainesville for the wrong reasons It was close to home and all my friends were going there One day, after just a few semesters, I woke up having difficulty breathing I went to the university clinic and was told I had a mild case of pneumonia After a week of useless medications, my breathing troubles increased Finally X-rays were taken, and at the age of 18, I was diagnosed with Hodgkin’s disease, a form of cancer There is no news that can be more devastating to a young person and his family Perhaps the hardest thing I had to face was the loss of my physical prowess Until that time, I was in exceptional shape, working out every day and participating in lots of sports Over the next year, I was hospitalized ix x PREFACE and had to undergo chemotherapy treatments and radiation therapy Throughout this dark time, I continued my studies at a community college At this point, I realized that life was too short to waste time, and that I needed to work as hard as I could to achieve everything I wanted to As my resolve to succeed took flight, I coined the phrase, “Out of adversity comes inspiration.” I slowly recovered and went on to attend New York University, graduating with honors with a bachelor’s degree in accounting I subsequently earned my CPA license and joined a large accounting firm However, after spending several years in public accounting, I once again felt disillusioned I needed something more I applied and, to my surprise, was accepted at Harvard Business School After two grueling years (but something I would again without hesitation), I graduated Here I was, a bright and energetic young man with an MBA from the finest business school in the world with countless job offers others would never dream of turning down But somehow I just couldn’t get excited about any of the positions, no matter what they paid me I had already traveled down that road and knew that it led to a dead end Instead, I decided to go into business for myself Driven by my need for a more rewarding career, I started my first business It failed Strike one Undaunted, I started a second business, which never even got off the ground Strike two On my third attempt—an attempt to strike gold in the real estate business—I realized that I could actually be good at something Working with some wealthy individuals in Massachusetts, I was just able to keep my head above water I would find great real estate deals and they would put up the money to buy them Subsequently, I would get a small piece of each deal Unfortunately, I forgot one thing: I needed to eat and pay the rent without the benefit of a consistent salary Finally, the day came when my landlord (one of my partners) came to collect my rent and I had no money to pay it I hedged as best I could and asked him to give me a little more time He turned me down, adding that he was going to throw me out regardless of how much money I made him in the past I was shocked At first I thought he was kidding around But with a stern look on his face, he proved me wrong, stating unequivocally, “One day you will thank me for teaching you this lesson.” At the time, I cockily replied that I’d be much happier with a wheelbarrow full of money In hindsight, I realize that he was probably referring to my favorite personal proverb about finding inspiration in adversity However, he is still waiting for me to thank him Crushed and downhearted, I went to my parents to borrow money to eat and live Being a Harvard MBA and having to borrow money from your parents is very demoralizing Having to listen to “Why don’t you get a real 562 Delta, see Delta neutral trading characteristics of, 68, 166–169, 171–172, 176–177, 186, 454 value, 504 variable, 312–313 Delta-based adjustments, 316 Delta neutral trading: advanced strategies, see Advanced delta neutral strategies combining stocks with options, 190–193 long straddles, 189, 193–202, 225–227, 519 long strangles, 207–211, 227–228, 520 long synthetic straddles, 215–225, 228–232, 521 mechanics of, 187–190 optimal trades, 165 overview of, 11–12, 76–77, 165–166, 231–232 position adjustments, 174, 468 short straddles, 202–207, 519 short strangles, 211–215, 520 time frame, 172–173 volatility, 169–174 Demand-pull inflation, 395 Derivatives, international, 29 Diagonal spread: bearish, 289 breakeven, 288–289, 292, 306, 526 bullish, 289 case study, 289–292 defined, 472 example of, 287 exit strategies, 287–288, 306 market opportunity, 289, 292, 526 overview of, 180–181, 286–287, 289, 292, 512, 526 risk graph, 290 risk/profit profile, 289, 292, 306, 526 strategy road map, 305–307 Direct-access firms, 340 Direction, significance of, 14–15 INDEX Discipline, importance of, 40–41, 468–469, 481 Discount brokers, 331, 342–343 Dividends, 18, 20–21, 30, 45, 47, 120, 126, 428 Dot-coms, 1, 393 Dow, Charles, 21, 23 Dow Jones Diamonds (DIA), 32 Dow Jones Industrial Average (DJIA), 21, 23, 30, 76, 183, 353, 428, 442 Dow Jones Railroad Average, 33 Dow Jones Transportation Average, 33, 354 Dow Jones Utility Average, 354 Down market, Downtrends, 87, 422 Duration of contract, significance of, 14–15, 47–48 Earnings, generally: announcements, 199 estimates, 17–18 reports, 190, 445 significance of, 171 Eastman Kodak (EK), 237–238 eBay (EBAY), 248–249 Economic analyses, components of: bonds, 384–387, 401 economic data, 387–391 federal funds rate, 397–398 Federal Reserve, role of, 388, 391–393, 401–402 inflation, 395–397 interest rates, 384–387, 401–402 overview of, 382–384 Securities and Exchange Commission (SEC), 393–395 stocks, 384–387, 401 U.S dollar, 399–400 Economic indicators, 387–391, 401–402 Economic news, market impact, 25 Economic recovery, Economic theory, 384 Index EDGAR Online, 417 Edgetrade, 340 Educational web sites, 495–496 Ego, dealing with, 479–480 Electronic communication networks (ECNs), 339–340, 358–359 Electronic trading, delta-based, 316 Elliott wave, 402 Embezzlement, 340 Employment cost index (ECI), as economic indicator, 389, 392 Employment report, 194, 389 Energy markets, 182 Enron, 394 Envy, 479 Equities market, 25 eSignal, 492 E*Trade, 333, 343 E*Trade Professional, 340 Eurodollars, 27–29 Euronext.life, 29 European-style options, 33, 72 Euro Stoxx 50, 31 Event-based adjustments, 316–317 Event-driven markets, 435–436 Exchange-traded funds (ETFs), 32–33, 48–49, 506 Exchanges, contact information, 496–497 Exercise order, 363 Exercise price, 64 Exercising options, 33–35, 37 Exit points, 83, 407–408 See also Exit strategies Exit strategies, see specific types of trades exercising, 70–71 importance of, 40, 69–70, 451, 463–464 offsetting, 70–71 Expensive options, 15 Expiration, see Expiration date cycles, 47–48, 62–65 Greeks and, 178–179 563 implications of, 47, 227, 232 triple witching, 48 Expiration date, 34, 36, 43, 45, 47–48, 56–58, 120, 123, 125, 157–159, 161 Expiration month codes, 503 Extrinsic value, see Time value Factory orders, as economic indicator, 391 Fair dealing, 345 Fair value, 38 Fast-moving market, 263 Fear factor, 423, 428 February expiration cycle, 47, 63–64 Federal funds rate, 397–398 Federal Open Market Committee (FOMC), 392, 397–398 Federal Reserve, 87, 383, 388, 391–393, 396–397, 401–403 Fill or kill order, 361 Financial commodities: characteristics of, 26–27 currency markets, 28–29 debt instruments, 27–28 exchange-traded funds (ETFs), 32–33 index markets, 30–32 single stock futures (SSFs), 29–30 Financial markets, influential factors, 194 Financial security, as motivation, 8–9 Financial services sector, 24 Financial statements, 416–417 Financial television programs, 440–442, 454 Financial Times Stock Exchange (FTSE) Index, 31 Fixed income securities, 406 Fixed life, 47 Flexible investment plan, development of, 12–13 Flight to quality, 401 Floor broker, 355 564 Floor traders, 12, 46, 164–165, 173, 311, 356, 369 Forecasting, 469–470 FOREX, 348–350 Forward volatility skew, 250, 261 Four-letter stocks, 60 Front running, 340 Full-service broker, functions of, 331–332, 363 Full-service firms, 342 Fundamental analysis, 83, 416–421, 480 Futures, generally: characteristics of, 26–27 financial commodities, 27–33 margin/margin requirements, 74, 374–375, 377 options distinguished from, 34 physical commodities, 27 ratio put spreads, 239 Gamma, 176–180, 185–186 Gates, Bill, 446 General Electric (GE), 58, 240–242 Gentile, Tom, 40 Global commerce, 399–400 Going long, 13, 55, 81–82 Gold futures, 36–37 Good till canceled (GTC) orders, 336, 362 Government bonds, 27 Government securities, 406 Greed, 341, 414, 423, 479 Greeks: applications, 185–186 charting, 462 defined, 175–176 delta, 68, 176–177, 185, 454 gamma, 176–180, 185 risk assessment, 176, 179–180 theta, 69, 176, 178–180, 185, 314, 454 time decay and, 180–181, 185 vega, 176, 178–181, 185–186 volatility and, 181–185 INDEX Green stocks, 20, 22 Greenspan, Alan, 388, 393–394, 402 Gross domestic product (GDP), 390, 392 Gross national product (GNP), 399 Growth stocks, 20, 22 Health-related sectors, 24 Hedge funds, 350 Hedgers, characteristics of, 26–27 Hedges/hedging, 28, 173, 311, 372, 429 Hedge wrappers, 310 High-grade stocks, 103 High-low-close (HLC) chart, 455–457 Highs/lows, implications of, 450 High-volatility market, 125 Historical volatility, 39–40, 170, 178, 184, 199 Holding Company Depositary Receipts (HOLDRS), 32, 219 Home Depot (HD), 205–207 Hot tips, 434 Housing starts, as economic indicator, 390 Huzienga, Wayne, 446 IBM, 18, 29, 35, 43–44, 51, 53, 58, 60, 65–66, 73, 168, 265–266, 274–275, 279–280, 377 Illiquid markets, 39 Implied volatility (IV): charting, 462–464 defined, 473 implications of, 40, 96–97, 107, 120, 123, 125, 155, 159, 161, 170–171, 180–184, 199, 225, 229, 243, 255, 258–259, 261, 286, 288, 292, 298, 300–301, 307, 309, 428–429, 454 investment strategies, overview of, 474 trade selection and, 470–473 Implied volatility indicator (VXN), 431–432 Index Import/exports, as economic indicator, 389, 399–400 Incentive programs, 62 Inco Limited (N), 145–146 Income statement, 418–419 Income stocks, 20, 22 Indexes, listing of, 509 Index markets, 30–32 Individual investors, 46, 410 Individual retirement account (IRA), Industrial production index, as economic indicator, 391 Inflation, 383, 387–388, 395–397, 401 Information resources: data service providers, 491–493 Internet sites, 493–502 trading media sources, 485–491 types of, generally, 39, 62, 67, 163, 183, 200, 377 Initial public offerings (IPOs), 24–26, 411 Insider trader, 345 Installment debt indicator, 387 Institute of Supply Management (ISM), 387–388, 390, 401 Intel (INTC), 24, 92–94, 253–254 Interbank, FOREX market, 348–349 Interest income, 406 Interest rates: implications of, 27, 45, 47, 383–387, 401–403, 435 margin accounts, 374 International derivatives, 29 International Securities Exchange (ISE), 352, 354, 496 Internet, as information resource, 163, 200 See also Web sites Internet bubble, 1, 393 Internet stock, 326–327 In-the-money (ITM) options: assignment, 71–73 calls, 50–51 565 characteristics of, generally, 44, 101–102 credit spreads, 148 deep, 68 delta, 178 delta neutral trades, 166–167, 169, 172–173, 188, 244, 251–252, 257–258, 260–261, 263, 317 exercising, 71 expiration cycle, 48 Greeks and, 179–180 intrinsic value, 65, 68 long call strategy, 92 offsetting, 70 order placement, 363 puts, 54–55 range-bound market, 267, 271–272, 291 vertical spreads, 131 Intrinsic value, 65–68, 100, 131, 176, 265, 307 Investing, characteristics of, 6–7 Investment Advisers Act of 1940, 394 Investment capital, 406–407 Investment Company Act of 1940, 394 Investment Company Institute (ICI), 426 Investment criteria: computerized trading systems, 412–413 exit points, 407–408 high potential returns, 405 importance of, 406, 414 investment capital constraints, 406–407 low risk, 404 risk profile, 404–405 risk tolerance, 406 time requirements, 405 trade personality, 406 Investment maxims, 473–478 566 Investment opportunities, components of: contrarians, 433 fundamental analysis, 416–421 implied volatility indicator (VXN), 431–432 nonanalytical methods, 433–434 sentimental analysis, 424–430 technical analysis, 421–423 trading filter, 434–451 Volatility Index (VIX), 430–431 Investment philosophy, see Successful traders, advice from Investor confidence, 394–395, 451 Investor sentiment, 429 Investor’s Business Daily, 39, 67, 183, 426, 442–443, 489–491, 499 January expiration cycle, 47, 63–64 Japanese candlestick chart, 455, 457–458, 460–461 Japanese yen, 298, 399 Johnson & Johnson (JNJ), 29, 284–285, 289–290, 475 Journal entries, guidelines for, 15, 119, 121, 124, 155, 157, 159, 161, 226, 228–229, 257–258, 260, 262, 299–300, 302, 304, 308, 366 Kansas City Board of Trade, 348 Key employees, 62 Kickbacks, 340 Knight/Trimark, 339 Knowledge base, importance of, 12–14, 453–455 See also Information resources; Investment criteria Knowledge management, LEAPS, see Long-Term Equity Anticipation Securities (LEAPS) Leeson, Nick, 434 Lehman Brothers (LEH), 461–464 Leverage/leveraging, 3, 94, 129, 349 Levitt, Arthur, 339 INDEX Limit orders, 123, 127, 162, 228, 230, 257, 259–260, 262, 299, 302, 304, 355, 361 Line chart, 456 Liquidity, 38, 59, 120, 122, 124–126, 155, 157, 226, 229, 259, 261, 298, 300–301, 307, 355 London Financial Futures and Options Exchange, 29 Long butterfly: breakeven, 268–269, 271, 299, 524 case study, 268–271 exit strategies, 268, 299 iron, see Long iron butterfly margin, 269 market opportunity, 269, 271, 523 mechanics of, 267 overview of, 266–267, 269, 271, 512, 524 risk graph, 267, 270 risk/profit profile, 269, 271, 299, 523 strategy road map, 298–299 Long call: breakeven, 91–94, 119–120, 514 case study, 92–94 exit strategies, 91–92, 120 long stock compared with, 94 margin, 92, 94, 120 market opportunity, 92, 94, 514 mechanics of, 90–91 overview of, 89–90, 92, 94, 128, 511, 514 risk graph, 90, 93 risk/profit profile, 92, 94, 119, 514 spread, see Bull call spread strategy road map, 119–120 Long condor: breakeven, 272–273, 275–276, 300–301, 524 case study, 274–275 exit strategies, 272, 300–301 margin, 273, 276 market opportunity, 273, 276, 524 mechanics of, 272 Index overview of, 271–273, 275, 512, 524 risk graph, 273–275 risk/profit profile, 273, 275–276, 300, 524 strategy road map, 300–301 Long futures, delta neutral trades, 166 Long iron butterfly: breakeven, 276–279, 281, 302–303, 525 case study, 279–281 defined, 472 exit strategies, 277, 279, 302 margin, 278, 281 market opportunity, 278, 281, 525 mechanics of, 277 overview of, 276–278, 281, 512, 525 risk graph, 278, 280 risk/profit profile, 278, 281, 525 strategy road map, 301–303 Long option, 162 Long put: breakeven, 108–109, 124, 515 case study, 109–110 delta neutral trades, 166 exit strategies, 108, 124 margin, 108–109 market opportunity, 108–109, 515 mechanics of, 107 overview of, 106–109, 511, 515 risk graph, 110–111 risk/profit profile, 106, 108–109, 124, 128, 515 strategy road map, 123–124 Long stock: breakeven, 78, 83, 85, 513 case study, 83–84 characteristics of, 81–92, 128 delta neutral trades, 166 exiting position, 83 margin, 83, 85 market opportunity, 83, 85, 513 mechanics of, 82 overview, 83, 85, 94, 513 profitability, 83 567 risk graph, 84 risk/profit profile, 78, 83, 85, 513 Long straddle: breakeven, 195–197, 199–200, 226–227, 519 case study, 196–198 defined, 472 exit strategies, 196, 199, 226–227 market opportunity, 196–197, 519 mechanics of, 194–197 overview of, 193–194, 511, 519 risk graph, 192, 195, 198, 226 risk/profit profile, 195–197, 226 selection tactics, 198–200 strategy road map, 225–227 synthetic, see Long synthetic straddle time decay, 226 Long strangle: breakeven, 208–210, 227–228, 520 case study, 209–210 defined, 472 exit strategies, 209, 228 margin, 210 market opportunity, 209, 520 mechanics of, 208–209 overview of, 207–208, 210, 511, 520 risk graph, 208, 210–211, 228 risk/profit profile, 209–210, 228, 520 strategy road map, 227–228 Long strike, 139, 144, 147–148, 156, 158, 160, 162 Long synthetic straddle: adjustments, 317–322 breakeven, 217–218, 221, 223–225, 229–230, 521 case studies, 218–219, 223–225 defined, 191 exit strategies, 217–218, 222, 229–230 market opportunity, 218, 221, 223, 522 order placement, 364–365 568 Long synthetic straddle (Continued) overview of, 191–192, 215–216, 221, 228–229, 319 risk graph, 191–192, 217, 221–224, 229 risk/profit profile, 218, 221, 223–225, 229 strategy road map, 228–231 using calls, 220–225, 229–230, 512, 521 using puts, 216–221, 230, 512, 521 Long-Term Equity Anticipation Securities (LEAPS): bull call spreads, 155 calendar spreads, 282 call ratio backspreads, 259 characteristics of, 56–58 collar spreads, 293 defined, 14–15 diagonal spreads, 307 expiration, 47, 56–58, 63, 263, 328 long straddle, 225–226 long synthetic straddle, 229 option symbols, 60 put ratio backspreads, 251 Long-term options, 57, 101 Long-term trades, 76 Losing stock/option trades, repair strategies, 326–327 Losses, dealing with, 129 Low-priced shares trade, 446–447 Low-risk/high-profit options, 40 Low-risk trades/trading, 9, 193 Lynch, Peter, 34, 475–476 Magellan Fund, 434 Magnitude, significance of, 14–15 Managerial changes, 199 March expiration cycle, 47, 63–64 Margin, generally: characteristics of, 85, 125 defined, 74, 373–376 in futures, 30 requirements, 89, 376–378 trades, 73, 373 INDEX Margin account, 73–74, 87, 374–376 Margin call, 74, 87, 374 Market acronyms, 530–532 Market analysis, components of, 383 Market capitalization, 19 Market conditions/environment, 170, 182–183 Market-if-touched (MIT) order, 363 Market makers, 152, 339 Market orders, 127, 361 Market personality, 406, 467 Market psychology, 46 Market research, 40, 341, 414, 454, 467 Market reversal, 138, 263 Market valuation, 46 Market value, 88 Merrill Lynch, 346 Micro-cap stocks, 19 Microsoft (MSFT), 29, 58–60, 456–457 Mid-cap stocks, 19 Midwest Stock Exchange, 353 Momentum indicator, 422–423 Momentum investing, 447–450 Monetary policy, 388, 397–398 Money-fund balances, 427 Money management, importance of, 40, 483 Moneyness, 44, 46, 51 Money supply, 396–397 Monster Worldwide, 149–150 Monthly statements, 414 Morgan Stanley Dean Witter, 346 Morgan Stanley Oil Service Index, 33 Mortgage interest, 396 Motivation, sources of, 7–8 Moving average, 380, 422 Moving average convergence/divergence (MACD), 309, 402 Mutual funds, 1, 427 Index Naked options, 96, 113, 378 Narrow-based indexes, 38 Nasdaq Composite Index, 31 Nasdaq ETFs, 32–33 Nasdaq 100 Index, 26, 31–33 Nasdaq 100 QQQ Index (QQQ), 32–33, 41, 44, 109–110, 352 Nasdaq 100 Trust (QQQ), 84–85, 88, 214 National Association of Securities Dealers Automated Quotations (NASDAQ), 17, 31, 348, 355, 496 National Futures Association (NFA), 348 Near-term options, 101 Near-the-money call option, 286 Negative delta, 166–167, 188, 318 Net credit, 239–240, 242, 245–246, 257, 262, 276–280, 471 Net debit, 239–240, 242, 245, 257, 262, 267, 273, 299, 302, 304, 471 Neutral collar, 310 Neutral strategies, 474 See also Delta neutral trading New Market Wizards, The (Schwager), 478 New product development, 446 News events, market impact, 17, 46, 199 News media, as information resource, 440–444, 454, 498–501 Newspapers, as information resource, 442–444 New York Mercantile Exchange (NYMEX), 39, 348 New York Stock Exchange (NYSE), 17, 23, 347, 355, 497 Nikkei 225, 31 Nortel Systems (NT), 323–326 Northrup Grumman (NOC), 98 NYSE Composite Index, 31 Odd-lot trading, 426–427 Offered down, 17 569 Off-floor traders, 12, 164, 234, 311, 394 Offsetting transactions, 50, 70–71 Oil Service HOLDRS (OIH), 201–202, 219, 223–225 OneChicago, 29–30 Online brokerage firms, 58, 332–334 Open, 50 Open-high-low-close (OHLC) chart, 455–456, 459 Open interest, 59, 171, 429 Opportunity cost, 94 Option chains, 49, 58–60 Option contract, Option Delta Values chart, 169 Optionetics approach, 64, 326–327, 411, 482–484 Optionetics.com: features of, 58, 62, 69, 163, 263, 493–494 Platinum site, 78–79, 158, 161, 167, 186, 200, 334, 459–462 Option pricing model, 40 See also specific option pricing models Options, generally: characteristics of, 34–37, 48–50 defined, 43–44 exchange-traded funds, 37–38 exercising, 34–35, 37 expiration cycles, 62–65 expiration date, 34, 36, 43, 45, 47–48 futures distinguished from, 34 futures options, 36–37 historical perspective, 351–352 on indexes, 37–38 liquidity, 38–39 margin on, 377–378 mechanics of, 50–56 price determinants, 44–47 stock, 36, 72–73 stop-loss orders, 379–380 strike price, 35, 37, 43–45 symbols, 60–62 types of, 34–38, 43 570 Options, generally (Continued) underlying assets, 44 versatility of, 33–34 volatility, 39–40 Options account: characteristics of, 343–344 margin requirements, 336 opening procedures, 341–343 size requirements, 335–336 Options Clearing Corporation (OCC), 30, 70–72, 351–352 Options Course, The, development of, Options Industry Council (OIC), 352 Options trading, generally: characteristics of, 5–8 discipline, 40–41, 468–469 strategy selection factors, 469–470 success factors, 8–9 OptionsXpress, 334 Option symbols, 59–62 Order confirmation, 345, 355–356 Order flow, 339–340, 356 Order fulfillment, 355 Order placement, 127 Organization of Petroleum Exporting Countries (OPEC), 27 OTC relative volume, 428 Out-of-the-money (OTM) options: calls, 50–51 characteristics of, generally, 38, 44, 71, 101 delta neutral trades, 167, 169, 171, 173, 188, 207–209, 211, 219, 227, 231, 235, 244, 258, 260–261, 318 Greeks, 178, 183, 185 intrinsic value, 65–67 long call strategy, 92–93 puts, 55 range-bound markets, 267, 271, 276, 293, 301, 307 vertical spreads, 131 volatility and, 183 INDEX Over-the-counter (OTC) market, 28, 355 Overpriced options, 125, 225, 229, 243, 256, 259, 261, 307 Pacific Stock Exchange (PCX), 348, 351, 354, 497 Panic selling, 424–425 Paper trades/trading, 11, 163, 264 Patience, importance of, 10–11, 40 Penny stocks, 19 Perfectionism, 478–479 Personal improvement strategies, Personal income, as economic indicator, 391–392 Philadelphia Stock Exchange (PHLX): functions of, generally, 33, 348, 351, 354, 497 Semiconductor Index ($SOX), 218 Physical commodities, 27 Positive delta, 166–167, 188, 313, 318 Preferred stock, 19–21 Premium(s), 13, 40, 45–47, 68, 89, 92, 97, 107, 113, 120, 122–123, 125–127, 129, 157–158, 161, 168 Price determinants: overview of, 44–45 premium, 45–47 Price-earnings ratio, 409–410, 428 Price movement, Greeks and, 176–182 Price trends, 120, 122, 125–126, 155, 157, 225, 229, 259, 261, 298, 300–301, 305, 307 Prime rate, 386–387 Print media, as information resource, 485–491 Producer Price Index (PPI), 194, 388, 390, 392, 401 Profitability, 67, 186, 195 Profits, 165 ProfitSource, 459–460 Protective collar, 292 Protective puts, 343–344 Index Prudential, 346 Psychological influences: crowd psychology, 428, 481 ego, 479–480 envy, 479 fear, 423, 428 greed, 341, 414, 423, 479 investor confidence, 394–395, 451 investor sentiment, 429 panic, 424–425 Put butterfly spread, defined, 472 Put calendar spread, defined, 472 Put/call ratio, 425, 427 Put option(s): at-the-money (ATM), 171 defined, 34–35, 37, 471 delta neutral trades, 191 exercising, 70 in-the-money (ITM), 44 intrinsic value, 65, 68 long, 106–110 long synthetic straddles, 216–219 mechanics of, 54–56 out-of-the-money (OTM), 44, 171 protective, 343–344 short, 110–114 Put ratio backspread: breakeven, 253–254, 262, 523 case study, 253–254 defined, 472 example of, 366 exit strategy, 255, 262 market opportunity, 253–254, 523 mechanics of, 251–253 overview of, 249–251, 512, 523 risk graph, 254 risk/profit profile, 253–254, 262, 523 strategy road map, 261–262 Put time value, 72 Qs (QQQ), 32 Quiet period, 345 Quote terms, 505 Quotes, information resources, 497–498 571 Rambus (RMBS), 104–105, 117 Range-bound markets, trading techniques: calendar spread, 281–285, 303–305, 525 collar spread, 292–298, 307–308, 310, 526 diagonal spread, 286–292, 305–307, 527 long butterfly, 266–271, 298–299, 526 long condor, 271–276, 300–301, 524 long iron butterfly, 276–281, 301–303, 525 overview of, 265–266 strategy road maps, 298–308 volatility skews, 285–286 Range-bound stock, 100 Raschke, Linda Bradford, 477–478 Ratio backspreads: call, 243–250, 259–261, 263, 523 example of, 464 exit strategies for, 255 overview, 472 popularity of, 263 put, 249–255, 261–263, 523 Ratio call spread: breakeven, 235–237, 257, 522 case study, 237 exit strategies, 242, 257 margin, 237 market opportunity, 236–237, 522 mechanics of, 235–236 overview, 234–235, 512, 522 risk graph, 236–237 risk/profit profile, 236–237, 257, 522 strategy road map, 256–257 Ratio put spread: breakeven, 239–240, 242, 258–259, 522 case study, 240–242 exit strategies, 242, 259 margin, 242 market opportunity, 240, 242, 522 572 Ratio put spread (Continued) mechanics of, 239 overview of, 238–239, 512, 522 risk graph, 239–241 risk/profit profile, 240, 242, 258 strategy road map, 258–259 Ratio spreads: call, 234–238, 256–257, 512, 522 exit strategies, 242 put, 238–242, 258–259, 512, 522 Recession, 383 Recordkeeping guidelines, 341, 414 See also Journal entries, guidelines for Red Candle + Doji chart, 461 Resistance level, 100 See also Support and resistance level Retail sales, as economic indicator, 388, 390, 401 Retail sector, 24 Retail stores, as information resource, 436–437 Return on assets, 419 Reverse volatility skew, 161, 256, 259–260, 263 Risk, generally: assessment techniques, 176, 179–180 context of, 372–373 control and balance, 172, 378–381 defined, 13 perceptions of, 11 Risk curve, 78–80 Risk graphs, see specific types of trades delta neutral trading, 11 features of, 78–81 Risk management, 1, 3, 6–7, 171, 372 Risk minimization, 165 Risk mitigation, 28 Risk profiles, 77–81, 186 See also specific types of trades Risk/reward profile, 78 See also specific types of trading strategies INDEX Risk/reward ratios, 58 Risk tolerance, 406 Rule 101, 345 S&P, 183 See also Standard & Poor’s 500 S&P Depositary Receipts (SPY), 32 S&P 100 Index (OEX), 31, 33, 351–352 Sarbanes-Oxley legislation, 394 Scholes, Myron, 184, 351 Schwab, Charles, 477 Sears, 60 Seasonal markets, 435–436 Sector indexes, 23 Securities Act of 1933, 393 Securities and Exchange Commission (SEC), 74, 190, 339, 346, 351, 353, 377, 393–395 Securities Exchange Act of 1934, 393–394 Selectnet (SNET), 360 Sellers, characteristics of, 17 Selling options, 34–35, 49 Sell-offs, 234, 402 Sell on opening order, 363 Sell stop order, 363 Semiconductor HOLDRS (SMH), 135–136, 218–220 Semiconductors, 24 Sentimental analysis, 424–430 Series of options, 53 Short call: breakeven, 96–99, 121, 514 case study, 97–99 delta neutral trades, 166 exit strategies, 97, 121 margin, 97, 99 market opportunity, 97, 99, 514 mechanics of, 96 overview of, 95–97, 99, 128, 511, 514 risk graph, 95, 98 risk/profit profile, 97, 99, 121, 514 strategy road map, 120–121 Index Short futures, delta neutral trades, 166 Short interest, 427 Short put: breakeven, 110, 112–114, 125, 515 case study, 112–114 exit strategies, 112, 125–126 margin, 113–114, 125 market opportunity, 113–114, 515 mechanics of, 112 overview of, 110–112, 128, 511, 519 risk graph, 114–115 risk/profit profile, 110–114, 125, 515 strategy road map, 125–126 Short sales: characteristics of, 427 restrictions, 345 Short sellers, 216 Short selling stocks, margin on, 377 Short stock: breakeven, 87, 89, 513 case study, 87–89 delta neutral trades, 166 exit strategies, 87 margin, 87, 89 market opportunity, 87, 89, 513 mechanics of, 86–87 overview of, 85–87, 89, 128, 513 risk graph, 88 risk/profit profile, 87, 89, 154 Short straddle: breakeven, 203–205, 207, 519 case study, 205–207 exit strategies, 204 margin, 207 market opportunity, 205, 207, 519 mechanics of, 203 overview of, 202, 519 risk graph, 203–204, 206 risk/profit profile, 205, 207, 519 synthetic, 192 573 Short strangle: breakeven, 212–214, 520 case study, 213–215 example of, 212 exit strategies, 212 margin, 214 market opportunity, 213–214, 520 overview of, 211–212, 520 risk graph, 212, 215 risk/profit profile, 213–214, 520 Short strike, 103, 139, 143, 148, 156, 158, 160, 162 Short-term at-the-money call, 286 Short-term options, 57 Short-term trades, 15 Shorting options, 34 Shorting stocks, 74 Shorting the market, 13, 54, 70 Sideways market, 2, 266, 300–301, 309–310, 422 Sideways-moving stock, 231 Sideways trades, 206 Single stock futures (SSFs), 29–30 Small-cap stocks, 19 Small investments, 450 Small order execution system (SOES), 359–360 Small trades, 12 Socially conscious investing, 22 Socially responsible stocks, 20 Specialists, functions of, 355 Specialist trading/specialization, 13, 427 Speculation/speculators, 26–27, 29, 244 Spiders (SPY), 32 Spreads, implications of, 113 See also specific types of spreads Spreadsheet programs, 79 Standard & Poor’s 100 Index (SOEX), 352 Standard & Poor’s 500 (S&P 500) Index (SPX), 12, 23, 26, 30, 33, 48, 76, 352 574 Standard & Poor’s 500 Cash Index (S&P 500 Cash Index), 442 Statement of cash flows, 420 Statistical volatility, 39, 178–179, 184–185, 429, 472 Stewart, Martha, 394 Stock(s), generally: characteristics of, 16–18 classification of, 20–21 common, 19–21 dividends, 18, 20–21 IPO system, 24–26 market capitalization, 19 preferred, 19–21 sectors, 21, 23–24 splits, 64, 199 types of, 22 Stock exchanges, 17 Stock investors, characteristics of, Stock market, generally: characteristics of, 384–387, 401 crash of 1987, 251 historical perspective, 507–509 Stock options, 36, 72–73 Stock reversals, 209 Stop-loss orders, 93, 380 Stop-loss rules, 379–380 Stops, 13 Straddles: adjustment strategies, 313–315 long, 189, 193–202, 225–227, 473, 511, 519 long synthetic, 191–192, 215–224, 228–231, 317–322, 522 order placement, 364 short, 202–207, 519 short synthetic, 192 success factors, 190 Strangles: long, 207–211, 227–228, 520 short, 211–215, 520 Strategic trades, 76 Strategy reference guide, 511–513 Stress level, reduction of, 12–14, 129 INDEX Strike price: codes, 503 implications of, 35, 37, 43–45, 49, 53, 56–57, 62, 64, 69–70, 92, 95, 102, 107, 112, 116, 121–123, 125–127, 133–134, 155, 157–159, 161, 227 Successful traders, advice from, 473, 475–478 Success guides: nine-step formula, 527–529 rules for success, 529–530 trading tips, 480–481 Support and resistance level, 100, 298, 300, 310, 467 Support level, 100 Swiss franc, 28 Synthetic straddle: long, 215–226, 228–231 order placement, 367–368 SyQuest Technology, Inc., 449 Systematic approach, 10 Takeovers, 199 Taxation, margin accounts, 375 Technical analysis, 380, 421–423, 444, 448, 455, 480 Technical Analysis of Stocks & Commodities, 500 Technicians, defined, 421 Technology sector, 24 Technology stocks, 65 Templeton, Sir John, 476 10-K/10-Q statement, 417 Terrorist attack (9/11), economic impact, 1–2 Theta, 69, 176, 178–180, 314, 454 Thinkorswim, 334 Tick, 168 Tick-by-tick traders, 173 Time-based adjustments, 316 Time decay, 45, 57–58, 68–69, 159, 180–181, 185, 210, 226, 230, 232, 265, 306, 311 Time erosion, 270, 281 Index Time frame, 470 Time horizon, 405 Time stop-loss, 380 Time value, generally: decay, 199 implications of, 65–68, 73, 176, 232, 265, 288 premium, 69 Trade balance, 399–400 Trade execution, 6, 338–340 Trade process: delta neutral trades, 364–366 electronic order routing systems, 358–360 exchanges, 347–348 FOREX market, 348–350 futures (commodity) orders, 355–357 ordering mistakes, avoidance of, 366–368 order mechanics, 360–364 order placement, 357–358, 368–369 stock market order process, 354–355 Traders, investors distinguished from, 6–7 Trading capital, 9–10 Trading desk, 397–398 Trading filter, components of, 434–451 Trading opportunities, recognition of, 6, 10 Trading plan, importance of, 480–481 Trading resources, see Information resources Trading strategies: covered call, 99–106, 122–123, 128, 516 covered put, 115–119, 126–128, 516 long call, 89–94, 119–120, 128, 514 long put, 106–110, 123–124, 128, 515 long stock, 81–85, 128, 513 overview of, 76–77 short call, 95–99, 120–121, 128, 514 575 short put, 110–114, 125–126, 128, 517 short stock, 85–89, 128, 514 strategy road maps, 119–127 Trading systems, computerized, 412–413 Trading volume, 64–65, 429, 458–459 Transportation sector, 24 Treasury bills (T-bills), 28 Treasury bonds (T-bonds), 28, 382 Treasury notes (T-notes), 28 TRIN, 428 Triple witching, 48 Trust Indenture Act of 1939, 394 Turnaround stocks, 22 200-day moving average, 89 Uncertainty, 169, 171–172, 479 Underlying assets, 172 Underlying security, 46, 49, 93, 102 Underlying stock, 43, 62, 68–69, 156 Underpriced options, 259 Undervalued options, 125, 225, 229, 256, 261, 307 Unemployment report, 388 U.S dollar, 27–29, 383, 399–400 U.S Treasuries, 353 U.S Treasury bond, 382 Unit of trade, 57 Up/down volume, 427 Up market, Uptick, 190 Uptrends, 422 Utilities sector, 20 Vacation trading, 243, 263 Value Line, 426 Vega, 176, 178–181, 185–186 Vertical spreads: bear call spread, 130–132, 146–151, 161–163, 518 bear put spread, 130, 132, 137–141, 156–158, 163, 517 bid-ask spread, 152–154 576 Vertical spreads (Continued) bull call spread, 130, 132–137, 154–156, 163, 518 bull put spread, 130–132, 141–146, 158–160, 163 mechanics of, 131–132 order fulfillment, 151–152 overview of, 130–131 strategy road maps, 154–162 VIX (CBOE Volatility Index), 352, 430–431 Volatile markets, characteristics of, 128–129 Volatility, see specific types of volatility charting, 458–459 delta neutral trading, 169–174, 189–190, 263 forward volatility skew, 250, 261 Greeks, generally, 181–185 impact of, generally, 15, 36, 45, 47, 311 information resources, 200 long call strategy and, 91 price skews, 286 reverse volatility skew, 161, 256, 259–260, 263 skew, 183, 255–256, 263–264, 285–286, 292 time skews, 286 types of, 183–185 Volatility Course, The (Fontanills/Gentile), 40 Volatility Index (VIX), 430–431 Volume, implications of, see Trading volume INDEX Voting rights, 21 VXN, 431–432 WallStreet*E, 334 Wall Street Journal, The, as information resource, 21, 39, 163, 183, 442–443, 489, 501 Wal-Mart Stores (WMT), 78–81 Wasting assets, 45, 68 Wealth accumulation, Wealth creation, 25 Web sites, as information resource: analysis tools, 501 charts and quotes, 497–498 educational, 495–496 exchanges, 496–497 informative sites, generally, 58, 62, 64, 163, 377, 501–502 news sources, 498–501 Optionetics.com, 493–494 Whipsawed traders, 433 Wholesale trade, as economic indicator, 389 Wilder, Welles, 200 Willpower, importance of, Wilshire 5000, 31 Wings, long butterfly spread, 266 WorldCom, 394 World events, economic impact, 1–2 Writers, defined, 34, 46 Writing options, 34 Yahoo! (YHOO), 152 Y2K, 393 ... Cataloging-in-Publication Data: Fontanills, George The options course : high profit & low stress trading methods / George A Fontanills. ? ?2nd ed p cm Includes index ISBN 0-4 7 1-6 685 1-6 (cloth) Options. .. gyrations since the first edition of The Options Course was released back in 1998 We have lived through the boom of the Internet along with the subsequent bust— when the dot-com became the dot-bomb During... Course and Trade Options Online, and co-written with his partner, Tom Gentile, two others: The Stock Market Course and The Volatility Course These “definitive guides to trading? ?? have added to his