Section 3 Option Buying doc

Section 3 Option Buying [...]... DO” APPROACH TO SELECTING OPTION STRATEGIES Secret 28 ANALYZE YOUR OPTION POSITION Beware of the “any horse in a barn” approach to option buying Ninety percent of all option buyers approach the option markets totally wrong They think a stock or futures will move up or down and randomly select any option they can find on that stock or futures without carefully analyzing the option position and determining... always set a time limit on how long you will hold an OPTION BUYING option If nothing happens within that time period, exit the position With more expensive options and in-the-money options, I usually set a three week hold period After three weeks, I am out of that position 72 Secret 24 AVOID AN OPTION S LAST MONTH As a general rule, I avoid holding options in their last month before expiration They depreciate... picture before entering a position OPTION BUYING The beauty with options is that you can mathematically measure what an option is worth and what your probability of profit will be In fact, the mathematical model for measuring the real worth of an option won a Nobel Prize in Economics in 1997 We will discuss option analysis in future chapters, but the process of option analysis is easier than you think... totally unrealistic expectations There is a tremendous amount of hype about how much you can make buying options Many option experts promise 100% and even 1000% returns each year Unfortunately, most option investors lose, and most get discouraged very quickly when their dream of quick riches vanishes Option buying is a very tough game that requires tremendous patience Your goal should be to make a profit,... good value for your options However, never take a huge position Make sure any option position is less than 5% of your total option buying portfolio Also, if you find a super bargain, forget about scaling and take what you can get! Scaling out of a position is the secret to never losing a good paper profit Gradually take profits as the option position moves in your direction Sell a few options when they... made by option buyers is to see the underlying stock, index or futures move the way they have predicted but to purchase an underlying option that does not increase in value at all One option buyer bought a call with a strike price of 20 for a price of 1 when the stock was 13 The stock did rise to 20 at expiration, but the option never rose above the price paid for it and expired worthless Options have... and so on, leaving just a few options for a potential super spectacular move OPTION BUYING Scaling out is one way to insure that you will not lose the profits already in your position Scaling, of course, requires that you buy more than one option to a position Try to buy at least three options to each position you take 76 Secret 26 BEWARE OF DELUSIONS OF GRANDEUR Most option buyers have totally unrealistic... to know as you compare options in order to select the best one to buy: 1 The fair price of an option 2 The probability of profit 3 The delta How do you use this information? Try to buy options where the option is under the fair price Know that the higher the probability of profit and the higher the delta, the better the play But, what is the delta? The delta tells you how the option will move if the... the stock or futures increases 1 point For example, if the delta is 30 and if the stock increases 1 point, the option will increase 30 % of a point or 30 There are many computer programs that will provide this output, including Option Master®, which also works on a Palm system If these three items do not look good, look for another option or create a strategy that has a good risk-reward picture, (to... fastest rate during that last month In fact, in some cases the option premiums absolutely collapse One reason such depreciation may occur is because option investors sell (write) options the last month before expiration In fact, I write options a day or two before the last month begins (expiration of the previous month) Nevertheless, sometimes I buy options with one month or less before expiration if they . Section 3 Option Buying