Best Way to Learn Options Trading?

[ERD50]

There are many online video tutorials on TD Ameritrade. They also have a good trading platform for options: thinkorswim But keep in mind that 80% of the money made by option trading are done by investors who write calls and puts not the one's buying them.

Interesting assertion. The implication is that calls are consistently overpriced relative to their risk. Do you have a link or a citation to back this statement up?

I'm busy now, will try to expand on this later, but...

I would agree with Freedom56's assertion. Instead of zero-sum game, think of it as insurance. We should know that when we purchase insurance, or place a bet in a casino, we should expect to lose on average. Otherwise, the insurance companies and the casinos would be out of business.

But we don't say that insurance or roulette wheels are mis-priced, we just acknowledge the house has to make a profit. And we place the bet to protect assets, or for a chance to win big

edit/add: I posted before seeing NW-Bound's post - he covers much the same territory, and I agree with what he says about the statistics. I found much the same info (or lack of it), and came to the same conclusions.

-ERD50

 

[NW-Bound]

One important thing I must add: in order to be the casino house, you need to limit your risk the same way they do.

I never sell naked calls, only covered calls. If the option gets exercised, that does not result in a loss, and only limits my gain. The drawback here is that I let go of a good stock too early, compared to a buy-and-hold investor. For that reason, I never sell options on all of my shares at once. And if a stock jumps up because of a good news on its fundamental, I would watch to buy it back, either outright or via a cash-covered put.

And regarding cash-covered puts, I usually do this to buy back stocks that I "lost" via selling covered calls. The net is I try to have some gains over a buy-and-holder.

In order to be the house, I need to spread out my risks. And I make many small bets to have the statistics on my side. Again, using my stocks and cash as capital, I aim to make only a few percent a year, not to get rich.

 

[Freedom56]

Interesting assertion. The implication is that calls are consistently overpriced relative to their risk. Do you have a link or a citation to back this statement up?

A long time ago, TD Ameritrade provided investment seminars (for free) and the instructor gave us those statistics. Most options expire worthless or are closed before expiration for pennies prior to expiration by the option writer. I rarely made money buying options (usually bought speculating on a merger) but always made money writing out of the money naked puts on SPY. It's actually an okay way of generating extra income if your are holding cash/money market in your account to cover the risk. I never wrote puts more than 6 weeks out or on an individual stock.

 

[NW-Bound]

It is looking like all of the options I wrote for Aug 16 are going to expire worthless. They were already out-of-the-money when I sold them, and they are hopelessly so now. Some did become in-the-money after I sold, but in just a couple of days turned south and headed into oblivion.

I may still lose money overall this month of August, but losing $10K less with these options. If I just sold the stocks, I would do better. Not getting rich here.

 

[dtbach]

Just keep in mind that you will go from being an "investor" to being a "bettor". I did well on a few options but seemed to lose more than win. Best of luck.

 

[NW-Bound]

Investors are bettors too. They bet that in the long run, things will go always go up.

I am a stock holder, but I am also willing to bet that things are not always as rosy as other guys think. Hence, I am often willing to let them have my stocks at an even higher price than they are now, by the end of the month.

In other words, while I believe stocks are good, I don't think they are "that good". Stocks go down, we both lose money, but I lose less than the other guy. That's my consolation prize.

 

[jldavid47]

Hard statistics on options are not easy to find.

An analogy is that option buyers are like casino gamblers, while option sellers are like the house. In the long run, the house has a net gain.

Yeah, tell that to Long Term Capital Management and at least 15 other hedge funds. They all sold options naked, WAY out of the money and all went bankrupt because in the long run their luck ran out. You can lose years of gains in a matter of hours when an alleged "10 sigma" move happens. And those happen far more often than would be predicted by options models so either the market is wrong or the models are wrong. Since the market is never wrong...


And it's a bad analogy because a casino has table limits and can't go broke. There is no "table limit" in the financial markets.

 

[NW-Bound]

Yeah, tell that to Long Term Capital Management and at least 15 other hedge funds. They all sold options naked...

I highlighted the keywords above.

I only sell calls on stocks that I have. And I already have gains on these shares, and am willing to limit my potential gain by selling out-of-the-money calls to people who bet that they will go even higher in a short time such as a month.

These LTCM guys were looking to get rich. I am just trying to hedge. Huge difference.

PS. In contrast with these guys, I set my own table limit. I know what happens when I am completely wrong.

 

[NW-Bound]

Here's an example for people who are not familiar with this.

Let's say I have a stock that moves from $90 to $100 in a short time. Even though the stock is good, I don't believe it can keep on going up like Jack's beanstalk. So, I sold an option to people who are willing to pay $103 for it at the end of the month. And they pay me $2 additionally right now for the privilege. So, I take their $2.

1) If the stock shoots up to $110, I only get $105 for my stocks. I get less than I would otherwise. I miss out on $5. The other side gets $110 stock, while paying $105. They put $2 at stake in order to get $5 back, for a net gain of $3.

2) If the stock goes up but less than $103, the option buyer will not buy it from me at $103. I keep the $2. They lose $2.

3) If the stock drops back to $90, I still have my stock and also the $2. And I will say "Darn, I should have sold it at $100", instead of having $92 now.

In all cases, I do not go bankrupt. I am willing to limit my potential gain, in order to have a smaller but surer gain.

 

[NW-Bound]

And here's how I use put options.

Stock drops bad, going from $100 to $90 in a short time. I think of buying, but decide to sell a put instead to people who bet that it would go even lower.

I sell them the option for them to sell it to me at $85 a month from now. They give me $2 so I can guarantee them that they will not get any less than $85.

1) Stock turns around and goes back up to $100. The other side will not sell it to me for $85. I keep their $2. I miss out on gaining $10, if I just buy the stock at $90.

2) Stock drops badly to $80. I have to buy it from them at $85, but with the $2, that's effectively paying $83 for something worth only $80. I have lost $3. But if I bought the stock outright, I would have lost $10.

Again, I am willing to limit my gain, in exchange for something smaller but more certain.

 

[jldavid47]

I highlighted the keywords above.

These LTCM guys were looking to get rich. I am just trying to hedge. Huge difference.

There sure is and you are using options the way most retail clients should. What one needs to be aware of is that having a covered call position is identical (from a risk/reward perspective) to writing a cash secured put (at same strike, same expiration). The only difference is that with the covered call you already own the shares. With a cash secured put, you are willing to own the shares at the strike price minus the premium collected. Cash secured puts is one of Warren Buffet's stock accumulation strategies but he knows what he wants to own and why first.

 

[Big_Hitter]

How did YOU learn?

watching people lose money at it

 

[cyber888]

I just sold a $335 Put option for Boeing for next week, and pocketed $6.60 in premium ($660). Boeing has dip from $380 a few days ago, due to the software problem with their 737 which I'm sure they will resolve soon. Anyway, I think I'm ok owning Boeing at $335. Break-even is around $328.40 (335 - 6.60) . it was $342-$347 before Trump declared the tariffs on China goods. If it goes down a lot, I may roll it to a future Put date .. we'll see.

And here's how I use put options.

Stock drops bad, going from $100 to $90 in a short time. I think of buying, but decide to sell a put instead to people who bet that it would go even lower.

I sell them the option for them to sell it to me at $85 a month from now. They give me $2 so I can guarantee them that they will not get any less than $85.

1) Stock turns around and goes back up to $100. The other side will not sell it to me for $85. I keep their $2. I miss out on gaining $10, if I just buy the stock at $90.

2) Stock drops badly to $80. I have to buy it from them at $85, but with the $2, that's effectively paying $83 for something worth only $80. I have lost $3. But if I bought the stock outright, I would have lost $10.

Again, I am willing to limit my gain, in exchange for something smaller but more certain.

 

[NW-Bound]

... that having a covered call position is identical (from a risk/reward perspective) to writing a cash secured put (at same strike, same expiration)...

At the same point in time, yes.

Being a market timer, I like to write out-of-the-money covered calls when I think the market is topping out, or a stock that I have is overrunning the market.

Conversely, I like to sell out-of-the-money cash-covered puts when I think the market is bottoming out.

Doing the above, I try to keep my stocks and cash constant, and make some money on the side.

I often wonder if I should be a more daring market timer and sell/buy the stocks outright. But of course, the risk is higher for the more reward.

 

[ERD50]

OK, I'll expand on my previous post.

Shortly after I retired, I decided I should take the time to understand these "option thingees", as I knew little about them. I read this book from cover to cover:


Options as a Strategic Investment: Fifth Edition 5th Edition
by Lawrence G. McMillan (Author)

https://www.amazon.com/Options-as-Strategic-Investment-Fifth/dp/0735204659

Well, not exactly ( Hardcover: 1072 pages)

But I did read a few of the opening chapters, and took notes to make sure I understood the basics. Once I had that down, most of the rest of the book became fluff, and I just skimmed lightly.

It all boils down to 4 simple curves. There are PUTS and there are CALLS. You can buy them, or sell them. That is 4 curves, that's it. All those crazy terms like Condors, Iron Butterflies, Collars, etc, are just combinations of those 4 things. Study those 4 curves, and that is really all you need to know.

Here's what options can do for you, that plain-jane stock investing cannot - you can pre-define your limits for maximum gain and/or loss. Pretty cool. Two examples, with $10,000 investment:

A) I trade some options such that my maximum possible loss is $1,000 (I'm left with $9,000), and my maximum possible gain is $9,000 (I'm left with $19,000).

B) I trade some options such that my maximum possible loss is $9,000 (I'm left with $1,000), and my maximum possible gain is $1,000 (I'm left with $11,000).

Remember, there is always someone on the other side of that trade, and they are not stupid (or if they are, their stupidity gets arbitraged out before you can access it, but that really doesn't happen to any large degree, the bid-ask on widely traded stocks/indexes is pretty narrow). The other person is either trying to profit, or buying some insurance for protection. No one is giving anything away.

Common sense then tells us that since the gain/loss ratio looks so much better in example A compared to B, that the odds of making that gain are far lower in A than in B. Similar to a roulette wheel, the odds for Red/Black are the same as for a single number. In the long run, they will have the same pay out. But you will win almost half the time betting Red/Black, you will win only occasionally betting a single number. But in the long run, it's all the same.

IMO, anyone selling a program for this can't tell you any more than I just did, but they will make it look impressive to have some "sizzle" to sell.

But - CAN YOU MAKE MONEY IN OPTIONS? There's the crux of the biscuit. And outside of what I will say is luck, yes, I think you can - but not a killing (or others would do it and the opportunity would be gone).

If you sell to people looking for insurance, or to the speculators/gamblers (you are the house), then yes, I think you can make a small gain. This is what NW-Bound is doing with covered calls. It makes sense, just like casinos and insurance companies make money on average.

I did this for a while, pretty aggressively, and I actually did quite well for a while, then it seemed like the averages caught up with me, and I decided to get out while I was still a good amount ahead. Since you are trying to take a small slice off the top, for it to work you need to do it across many trades for the averages to work out. You can do well for a while like I did, or maybe do poorly for a while. There did not seem to be enough movement in large indexes, so this meant I had to use individual stocks, and that meant I was reducing my diversification. I just decided the effort and tracking and reduced diversification was not worth it to me. One stock falling off a cliff takes a lot of little profits along with it. If you buy some protection against that, your potential profit margins are reduced.

-ERD50

 

[NW-Bound]

I just sold a $335 Put option for Boeing for next week, and pocketed $6.60 in premium ($660). Boeing has dip from $380 a few days ago, due to the software problem with their 737 which I'm sure they will resolve soon. Anyway, I think I'm ok owning Boeing at $335. Break-even is around $328.40 (335 - 6.60) . it was $342-$347 before Trump declared the tariffs on China goods. If it goes down a lot, I may roll it to a future Put date .. we'll see.

Yes. I only sell puts on stocks at a price that I feel comfortable owning. I have 2x more stock and cash, therefore I tend to write covered calls more often.

While I usually pick a price to avoid assignment, I have been tightening it in order to use assignment to reduce AA in some growth stock, then use cash to move to more defensive stocks.

 

[Rianne]

My experience with options is watching DBI day trade, options, stocks and short selling. ERD50 mentioned someone stupid on the other end of the trade, he lost in the neighborhood of $200K in approx. a month. Reminds me of Dirty Harry quote "Do you feel lucky?" I'll add "Do you feel lucky but happen to be stupid?"

 

[cyber888]

Yes. I only sell puts on stocks at a price that I feel comfortable owning. I have 2x more stock and cash, therefore I tend to write covered calls more often.

While I usually pick a price to avoid assignment, I have been tightening it in order to use assignment to reduce AA in some growth stock, then use cash to move to more defensive stocks.

Yes in most cases I try to avoid assignment. I made great $ on selling Puts on Beyond Meat since it was $70 until it hit $233 and I'm out for a while.

 

[NW-Bound]

If you sell to people looking for insurance, or to the speculators/gamblers (you are the house), then yes, I think you can make a small gain. This is what NW-Bound is doing with covered calls. It makes sense, just like casinos and insurance companies make money on average.

I did this for a while, pretty aggressively, and I actually did quite well for a while, then it seemed like the averages caught up with me, and I decided to get out while I was still a good amount ahead. Since you are trying to take a small slice off the top, for it to work you need to do it across many trades for the averages to work out. You can do well for a while like I did, or maybe do poorly for a while. There did not seem to be enough movement in large indexes, so this meant I had to use individual stocks, and that meant I was reducing my diversification. I just decided the effort and tracking and reduced diversification was not worth it to me. One stock falling off a cliff takes a lot of little profits along with it. If you buy some protection against that, your potential profit margins are reduced.

-ERD50

This does take a bit of work, but I enjoy it still. I like to watch my stocks and the market, so might as well try to make a few bucks. My WR is only a few %, so the premium from the options is enough for that.

If I were a more daring market timer, would trade the stocks directly, but am still afraid of being wrong. With my style of option trading, the cost of being wrong is much less.

No freebie in life.

 

[Ready-4-ER-at-14]

how did I learn:

I took some classes from options industry council and was actually in options pit for a mock trading session. Even had my own trading badge during it.

I read some books.

I took some classes from Optionetics.

I placed first trades with a broker "holding my hand".

Typos can be really expensive since each contract is for 100 shares worth...
1 vs 11 is a big deal..

Main thing I learned: Buying gives rights.. Selling creates obligations that might be way more than you expected.

 

[NW-Bound]

Options are extremely volatile because when the price of the underlying stock bounces around the strike price, the price of the options can swing between many dollars a share to zero. Here's an example of a trade I made.

On 6/26/2019, I bought some additional shares of MU (Micron Technology) to add to the existing shares that I held long term. I paid $39.2/share.

On 7/11/2019, MU went up to $43. I decided to take a possible quick gain, and sold Aug 2 call option at $45 for $1. This means the most I get for these shares is $46, which is OK with me for a gain of almost $7 in just 6 weeks.

MU continued to climb faster than I could expect. It got to $48 on 7/24. The call option I sold went as high as $4. This means the guy who bought my option got a gain of 3x his purchase. It looks like I will have to sell some shares at $45, and have my gain limited.

There was suddenly talk of more tariffs on Chinese imports 2 days ago. Semiconductor stocks are particularly vulnerable to this, because of all the electronic manufacturing that is done in China.

MU closed just now on Aug 2 at $44.08, below my $45 strike price. The option just expired worthless.

Does that mean the guy who bought my option for $1 lost it all? Not necessarily. He could be a good timer, and sold his contract to another guy at $2 or $3 in the past 6 weeks. It might have changed hand a few times on its path from $1 to $4 then back down to $0, who knows? One thing for sure is that the last guy who probably bought it for $0.25 yesterday hoping it to turn into $0.50 or $1 lost his $0.25.

PS.

So, am I happy that the option expires worthless? Not necessarily.

I have more MU shares than I sold contracts on. I would rather the shares stayed at their high price of $48 than to pull back to $44. I would have more money that way. I would have reduced my holdings of MU if the contract got assigned. I always want to stay diversified.

But as it is, I got some extra cash because I was willing to limit my potential gain in exchange for that cash. Either way it works out, I am OK with the outcome.

 

[Doribe]

You learn by doing. Start small, with only what you can afford to lose.

I do options more for defensive reasons and not to get rich quick. Risk and reward go together. I do low risk/low reward.

I have been doing options for close to 20 years, but did not become really active until 2 years ago. My objective is to pick up a couple percent of extra return each year compared to doing nothing.

I don't buy but sell covered calls and cash-covered puts. The few times I bought options, I lost 9 out of 10 times, so I stopped.

When selling options, I try to pick the strike prices far enough so that the options will expire worthless, but not too far that the premium is too little.

+1

 

[NW-Bound]

Main thing I learned: Buying gives rights..

The rights often become worthless. But they can become 10x more valuable, and that's what people think they can get.

Selling creates obligations that might be way more than you expected.

That happens when you sell naked calls. Suppose a stock is at $100, and you say no way it can get to $110 in a month. So you sell several contracts at that price, expecting them to expire worthless. The stock goes crazy and gets to $120. Now you have to buy shares that you do not have and pay $120 in order to sell at $110.

If you actually own the shares, which you bought at $90, it's different. You gain on the sales, but not as much as you could have without the contract.

You can run into a similar trouble selling puts. Basically, it happens when people get greedy.

I only do it to get a few percents of extra return each year. Typically, when the market goes crazy whether up or down, I sell about 20 to 30 contracts each month, collecting premium of $200 to $500 each. When it is calm, there's not much money to be made.

 

[Running_Man]

http://www.early-retirement.org/forums/f44/so-i-bought-s-and-p-500-2500-puts-94093.html

I have a different take on purchasing options, I believe in identifying market turns and only reacting to what a market turn indicates. NW-Bound strategy is very sound and what he is good at but that is not what I am good at. This thread back in October I think identifies my thought process pretty well, though it was misinterpreted from the start:
My basic Thesis was:
One) CAPE 10 showed market grossly overvalued - I use CAPE 10 as one measure to gauge to judge the stock market valuation and it was in extreme overvaluation.

TWO) Complacency was very high, I find this to be on of the the best uses of this board as a means of gauging fear/optimism.

Three) There was a significant change in a component of valuation that got no initial reaction - interest rates moved up surpassing long term averages for the first time and years and most thought it would not change the valuation of the market when simple math showed interest rates going up 2 percent as the FED indicated they would decline long term values by 22 percent. So I took a risk with the part of my portfolio I could afford to lose without effecting me much to see what I could gain.

Comments were interesting as most thought it an impossibility and that even if I identified the top I could never identify the bottom and when to get back in, even though I did not sell any stocks. There was a fixation to know the specific options selected as if that would impart knowledge somehow instead of judging the strategy. The Cape 10 was questioned as why to use that for timing the stock market, when I was using as a valuation. As it turned out I bought in early October @2900 and sold in December between 2450 and 2350, selling my last options on the morning of the very bottom of the market. The observable notion that most did not understand the thought process eliminates the idea that if anything was a good idea everyone would see it, the facts were clear to see but until the FED raised rates in December there had not been a valuation adjustment in stock holders minds of the average investor.

Why did I sell at the point I sold? There had been only a few times in history with a pattern the same as what occurred during the Powell panic and a 12% daily gain was not out of the question. Large one way moves frequently exhausts the remaining oversupply of either buyers or sellers. Indeed the stock market drop so scarred the FED they announced they were changing policy and to this day have dropped any pretense of having economic goals for interest rates and instead talk of preemptive moves.

So in general I like to have a take on the overall value of the market and if we are near a peak or large bottom with a big change that effects valuations options provide a very inexpensive method in which to bet on a change in trend.

Presently I think we are equally overvalued however the interest rates are on a downward path which continues to increase their relative value and inhibits selling. I have targets that would change my mind but for now I am expecting rates to go to zero and the Central Banks to hold up US equities with all their might.

 

[OldShooter]

Hard statistics on options are not easy to find.

It's a fact that a majority of options (75%) expires worthless, which means the option buyers get nothing and the option sellers pocket the premium for nothing.

However, those are the options that are held to expiration. Of all options that are opened, about 3/4 are closed out prior to expiration by the buyers selling them. Do they sell at a loss or a gain? I have not found a statistics on the average gain or loss.

One thing is sure though. The time value decay works in favor of the option sellers, not the buyers. That works for both call and put options.

If so, who would buy options? People buy put options for the same reason as they buy vehicle crash insurance and home fire insurance. Most of the time, nothing bad happens, and the insurance companies pocket the premium. And people buy call options the same way people buy lottery tickets. The potential loss is finite (the cost of the ticket or the call premium), but the potential gain can be very large.

An analogy is that option buyers are like casino gamblers, while option sellers are like the house. In the long run, the house has a net gain.

@NW-Bound, I'm going to argue with a couple of your points but not just picking on you -- several other posters have made the same implicit points.

First, lets start with volume. Millions of equity options are traded every day. This is not trading done by little pipsqueek investors like us. This is professionals for whom the Black-Scholes model is kindergarten math.

So, conclusion #1: This is not a market of little guys thinking that they are buying the equivalent of car insurance. This is a market of traders with vast access to information, placing bets on what are essentially random variables -- the stock prices themselves.

And, conclusion #2: This is not an inefficient market where there is money just lying around for the picking up because risk is improperly priced. There are too many sophisticated players in the game. Simple schemes have little chance of making money for us pipsqueeks. Remember the old poker rule: "If you look around the table and can't figure out who the sucker is, it's you."