The Secrets of Options Trading

- Vladimir Furman

You have probably heard that trading Options is a “very risky” business, and you may even know people who have lost money by trading Options. It's also possible that you know people who regularly make money by trading Options, and you may think it's “Lady Luck” more than anything else that makes them winners in this seemingly hazardous occupation. So what is it that makes some Options traders “Lucky”? What do these traders have that others don't? The answer in fact, is really very simple. As a group, successful traders have two things in common: First, they have adopted sound and sensible methods for analyzing Options. Second, they have acquired the proper tools for undertaking accurate analysis in support of their strategies. If that's called Luck, so be it! In the articles that follow, I want to show you my own fast and easy route to this elite group of “Lucky” traders. This series of articles will show you step by step how to build profitable trades. I will not use any complicated formulas to define any subjects. I will try to explain in plain English all correlations between different parameters and how they reflect on the final results. I spoke to a lot of traders who wanted to be options traders, but was scared to death after reading some options series of articles with complicated mathematical stuff in it. They are thinking that all these “options stuff” is above their heads and too risky to be involved with. And it is hard to blame them for this, because people usually afraid doing something that they could not comprehend the basics of. In reality options trading is far from rocket science. It is pretty simple after you learn the basics and understand relationship between the main components. I am strongly believe that option trading does not required knowledge of standard deviation or normal distribution and especially how to calculate some of them. Now days with the Internet and PC at your disposal you do not have to have scientific calculator and equations to perform calculations. You can easily find all these on the Internet. What I think each option trader must know is how to build and analyze trades. What market conditions to look for and how to take advantage of them by using appropriate option strategy. I am a mathematician and I enjoy all maths behind option trading. I think option trading is more structured and more science than stock trading that I consider more art than science. Look at the market “gurus” that you can sea on TV or read in the newspapers. How many times you witness the situation where their analysis and predictions for the same company were going into two different directions. I do not want to criticize them for this. I just want to emphasize that their fundamental and technical analysis is more Art than Science. It based on their subjective interpretation of the facts and not supported by real scientific analysis. There is a big difference in the way you trade underlying stocks and commodities than Options. When you trade the underlying you are trying to predict the direction in which the underlying will go. Many novice Option traders use the same attitudes in Option trading, trying to Buy Calls or Puts based on their assumption of market direction. This is the main reason most people lose money by trading Options. Let me explain why they are loosing money. From mathematical (scientific) stand point there is a 50% probability that underlying price will go up or down, unless you have some “inside information” on it. Any option has so called “time value”. We will learn about this and other component of option price later in this series of articles, but for right now let me define it as a price that option buyer agrees to pay for this option above its real (intrinsic) value. Now lets analyze your probability of success in “option trade”, where you are trying to buy Call option on a stock that you think will go up. Your profit zone will start at least at current Stock price plus “Time value” you paid for this option (in many cases it will be even further from the stock price, if you bought out-of-the-money option) What it means from the probability stand point? It is 50% chance that stock will move up and, let say, it is 10% probability that stock will move from its current price into your profit zone. The simple calculation is showing that you have only 40% to be profitable. When you are trying to buy Call (Put) you have to predict not only the direction of the move, but also its magnitude. Option trading is a completely different “ball game”. In many cases you do not care which direction the underlying will go. You are only looking for a big move in the underlying price. In Option trading there is also a way to build Option strategies with 80% or more probability of success and positive expected profit/loss (we will talk about this parameter a lot later in the series of articles). If you are in a market for just a couple trades and want to employ “Hit and Run” tactic this series of articles is not for you, because I do not know scientific way to succeed in this type of trading. For me it is combination of Art and truly luck. But if you want to be in the market for a long time and be profitable that is something I can teach you how to do. I do not promises you will always win, but I can guarantee if you follow my steps, you will be overall profitable. Las Vegas is a living and prospering example, which makes me so confident in this basic idea. Casinos are using the same mathematical theory of playing odds and expected profit/loss to pull money from their guests, as I will teach you. You probably know the only way to make money in casino is to own the casino. I will show you how to “build” your own casino, where You are setting the odds in your favor and than playing against the other traders (your casino guests). Volatility analysis is the critical key to Options trading. It has been written about and discussed in hundreds of series of books and manuals. Recognized professional traders and brokers know this and it is the goal of my series of articles to unlock this key to Options trading.