One infrequently discussed topic important to understand in becoming familiar with the mechanics of learning to trade options is that of the various settlement issues. Many option traders limit their universe of option trading to two broad categories of underlyings. One group consists of individual equity issues and the similar group of exchange traded funds (ETF). The other group is composed of the various broad based index products. These two groups are not entirely mutually exclusive since a number of very similar products exist in both categories, for example the broad based SPX index and its corresponding ETF, the SPY.
The first category, the individual equities and ETFs, trade until the close of market on the third Friday of each month for the monthly series contracts. These days there are many ETFs and equities that also have weekly settlements too. These contracts are of American type and as such can be exercised by the owner of the contracts for any reason whatsoever at any time until their expiration. If the contract is in-the-money at expiration by just one cent, clearing firms will also exercise these automatically for the owners unless specifically instructed not to do so. The settlement price against which these decisions are made is the price of the underlying at the close of the life of the option contract.
When this first group we are discussing settles, it is by the act of buying or selling shares of the underlying equity/ETF at the particular strike price. As such, the trader owning a long call will acquire a long position in the underlying and the owner of a put a short position. Conversely, the trader short these options will incur the offsetting action in his account. Obviously, existing additional positions in the equity/ETF itself may result in different final net positions.
The second category, the broad based index underlyings, are also termed “cash settled index options”. This category would include a number of indices, for example RUT and SPX. As the name implies, these series settle by movement of cash into and out of the trader’s account. The last day to trade these options is the Thursday before the third Friday; they settle at prices determined during that Friday morning. Like ETFs and equities, these index options also have weekly settlements as well.
One critically important fact with which the trader needs to be familiar with is the unusual method of determining the settlement price of many of the underlyings; it is NOT the same as settlement described above. Settlement for this category of underlyings has the following two characteristics important for the trader to understand: 1.The settlement value is a calculated value published by the exchange and is determined from a calculation of the Friday opening prices of the various individual equities, and 2. This value has no obligate relationship to the Thursday closing value for the underlying.
Many option traders choose never to allow settlement for the options they hold, either long or short. For those who do allow positions to settle, careful evaluation of the potential impact on capital requirements of the account must be a routinely monitored to avoid unpleasant or mysterious surprises.
With the holidays in full swing and trading volume falling off, it might be a good time to give yourself a mental break and reflect on your trading. Are you the great options trader you thought you would be by now or have you ever wondered what truly makes a great options trader? I mean not a options trader that does pretty well, but one that you envy and want to be? Are great options traders just born that way? Does being smarter necessarily give you an advantage in options trading? Is studying charts until you are bleary-eyed from looking at them the secret; or is it just dumb luck on who succeeds and who fails? How does one learn to trade options?
The qualities that you will need to succeed in my opinion are a commitment to success, having a options trading plan and the most important, mastering your emotions—or the psychology of options trading. I believe that options trading is the hardest job in the world (quite possibly the best, but the hardest). That’s why it will probably take you a lot longer than you think before you really get a solid grip on it.
So let’s first talk about your commitment to success. This essentially sounds like the easiest of the three qualities to master doesn’t it? Why does anyone want to become a options trader in the first place? Probably, because they want to become wealthy and very successful. Who isn’t committed to that, right? All you need is some money, charts, and a platform and you are on your way. Almost everyone says they are committed but most people are not because when they find out options trading is work—and it is. They tend to lose their focus and their original goals when the going gets though.
If you are committed to success then you must be committed to reaching your goals. The most important part of having goals is to write them down. If you never write them down they are simply just dreams. We don’t want to dream we are a great trader we want to realize that we are! Only about 2% of Americans write down their goals. Is it really shocking to know that most people never achieve what they want out of life? As “corny” as it may seem, when you write something down no matter what, your thoughts are transformed from the subconscious to the conscious and are now tangible. Your goals have become something you can see and say out loud. If you never write them down they never exist outside of your thoughts.
Let me leave you with this before I end this introduction on how we are going to build a great options trader out of you. I think everyone can agree whether you are a beginning options trader or a more experienced options trader that there are several key components you will need to do to become a standout. Having said this I also know that most of you will not be committed to do this at first. I know I wasn’t. I thought to myself I am too smart and I know how to options trade. I knew it would not be easy but I was unprepared for the results that followed. I’ll give you a hint, they weren’t good. After I decided to fully commit myself and write down my goals did my results finally change. Let’s face it; options trading is a realm like no other. Options trading looks easy and which in turn makes you lazy to work at it. Be committed to your success and write down your goals right from the start will only help you achieve the success you are after that much quicker.
Looking for an options trading system to give to someone in need or for yourself this Holiday Season? Let the Market Taker Mentoring Trading Path be your options trading guide.
The MTM Trading Path
The MTM Trading Path is a simple, but powerful proprietary options trading system designed to be a veritable options trading guide that outlines a step-by-step a plan for options trading. There are a total of eleven steps in this options trading system which begins with observing the market and discovering opportunities.
Options trading is, of course, more involved than stock trading. Specifically, there are two steps in this options trading guide that are not in a conventional trading plan. These steps center around analyzing volatility and selecting among the various strategies.
The important thing here is discipline. Having a guide to follow to avoid missing important steps is the key to any options trading plan. The Trading Path is central to my Options Coaching program, Dan’s Online Options Education Series and my Group Options Coaching. I encourage my options coaching students and students in Dan’s options seminars alike to closely follow this option trading guide for all their trades.
It makes the perfect gift because it is a gift that can keep on giving!
One of the bullish strategies in the arsenal of an options trader is that of selling puts. Many traders have have heard of this strategy but are unfamiliar with the nuances and need more options education before possibly implementing them. The sale can be accomplished either as naked sales (aka selling “cash secured” puts when cash is set aside for potentially buying the stock in the event of assignment) or as one of two legs of a vertical credit spread (aka a bull put spread, a put credit spread, or simply selling a put spread).
The requirement of this position is that of being short puts. As a result of the short put position, the trader has fundamentally taken the position of an insurance broker and sold a contract to insure the counter party against a decline of in the price of the underlying. The magnitude of the “deductible” for the policy is determined by the strike price the trader has sold.
Here is an example using AAPL whose recent sell-off has sparked interest in puts. A trader who sells a December 555 strike put to another trader holding an underlying currently trading at $550 has essentially sold an insurance policy indemnifying the purchaser of that put for any losses incurred as a result of the underlying trading below the strike price for the term of the option contract purchased. To continue the insurance analogy, the purchaser of the put would have a $5 deductible. In return for issuing this insurance policy (known as “writing” the contract), the seller receives a premium which is credited to his account.
Naked put sales refer to simply selling the put as a single legged option trade without any additional hedging positions. The naked put seller has no rights whatsoever and has the non-negotiable obligation to purchase the stock for the strike price should a request be made. This one position encumbers a variable degree of trading capital in order to ensure that the trader would reasonably be able to fulfill his obligation to purchase the stock should the owner of the put elect to exercise the contract he has purchased. In absolute risk terms, also known as “Black Swan” risk, the total risk is from the strike price sold to zero less the initial credit received.
Another commonly used and more conservative strategy is to sell a put spread. When a trader sells a put spread, the fundamental profit is still short sale of the put at the selected strike price. However, as contrasted to the naked put sale, an additional position is taken to lower the risk and to reduce the margin. The additional position is to buy the same number of put contracts at a lower strike price than those sold in the same expiration. Since the higher put strike will always sell for more premium than the lower strike price costs to buy, this constitutes a credit spread. In this case, the Black Swan risk is crisply defined to the difference between the strike prices less the initial credit received.
For traders who focus on the yield of a position, a successfully executed put credit spread will almost always result in a higher trade yield than the naked put sale because of the dramatically lower margin. However, investment-oriented option traders will often use unhedged naked put sales to initiate long stock positions in stock they wish to own at a cost basis lower than the current price since the assigned price will be the strike price sold less the initial credit received.
The potential use of option strategies for the knowledgeable trader allows an almost limitless array of choices of trade structure. This is why a fundamental and comprehensive knowledge of the nuances of strategies is so valuable.
Options involve risk and are not suitable for all investors. Before trading options, please read Characteristics and Risks of Standardized Option (ODD) which can be obtained from your broker; by calling (888) OPTIONS; or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, IL 60606. The content on this site is intended to be educational and/or informative in nature. No statement on this site is intended to be a recommendation or solicitation to buy or sell any security or to provide trading or investment advice. Traders and investors considering options should consult a professional tax advisor as to how taxes may affect the outcome of contemplated options transactions.