the secret of options trading

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From Zero To Options

Build a Trading System for Passive Income that Lasts for a Lifetime

HOW TO MAKE A PROFIT EITHER THE MARKET RISES OR CRASHES WITH OPTIONS TRADING

From Zero To Options

This SPECIAL REPORT is Copyright 2011 Flavian Barrett and may not be redistributed/shared/sold without prior written consent of the author. In order to let others know of this Report, please direct them to www.FromZeroToOptions.com. To contact the author, please email: [email protected]

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

TABLE OF CONTENT
Introduction…………..…………………………………………………………………………………..……………3 Content Structure……………………………………………………………………………………………………4 SECTION 1 - Call Options and Put Options Unique Risk Profile…………………………….…6 Stock Options Made Easy……………………………………………………………………….…………………6 Call Options Explained……..……………………………………………………………………….…………..…7 Put Options Explained……..………………………………………………………………………….……………8 Rights and Obligations……..……………………………………………………………………….………..……9 The Unique Options Risk Profile……..…………………………………………………………………….….9 Introducing Delta Neutral Strategies……..…………………………………………………….………...12 Delta Neutral Strategies - The Straddle……..……………………………………………………………12 Delta Mechanics on Option Neutral Strategies…………………………………….…………………13 How to Set up a Delta Neutral Trade……..…………………………………………………..….………15 Real Trade - Example……..…………………………………………………………………………….……..…16 SECTION 2 - Top 10 Factors Impacting on Delta Neutral Strategies………………………23 Overall Market Picture…..……………………………………………………………………………….………24 Upcoming News Events…..……………………………………………………………………………..………24 Earnings Reports…..………………………………………………………………….……………….……………25 Strike Prices, Expiration Dates and Time Decay…………..……………………………………….…26 Potential Profit, Potential Loss and Commissions……………………..……………………………27

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

1

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Implied Volatility (IV) related to the Underlying…………………………….…..……………..……28 Implied Volatility (IV) related to Options………………………………………..…………………….…28 Underlying and options liquidity…..……………………………………….…….…………………………30 Risk profile and risk graphs…..…………………………………………………………..……………………30 Price trends, Timeframe, Entry and Exit Plan…..………………………………………..……………31 Conclusions…..……………………………………………………………………………………….………………32 Additional Resources…..……………………………………………………………………..…………………33

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

2

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

INTRODUCTION
This special report has the purpose to demonstrate how today’s volatile financial markets offer the chance to make a profit either when the market goes up or down. Now I know this may sound as a strong claim to newbie and people who approaches the financial markets for the first time. If that were true you may be wondering why investors around the world struggle and why when markets collapse people collect huge losses. The reason for my statement is that most people fail because they do not build the required knowledge and treat investing and trading as gambling and not as a business. This is a business and with the right knowledge and a little bit of effort you can learn financial instruments and investing strategies that can make a difference for your everyday life. More experienced traders know this truth and usually they keep it for themselves. The good news is that you need neither a financial background nor to get a degree to be able to use these strategies. Moreover you can even get started with a small account so that money is not a problem too. Anyone can learn how to make a living through the market if they put in determination and hard work.

How can be possible to make a profit even when the market crashes? This is the main point of my exclusive report

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

3

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

CONTENT STRUCTURE
This Report is structured in 2 sections so as to meet the needs of readers with different knowledge.

SECTION 1 - Beginners The first section is built for newcomers, those who do not have much experience about the market and particularly about stock options, but are curious about trading online and serious in learning how to make a new source of income with options. More experienced traders may decide to skip this section or read only some paragraphs.

SECTION 2 - Experienced Traders The second section is built for more experienced traders, those who have a certain knowledge of the market and know the basics of options trading. Below is introduced for those traders an invaluable investing strategy that can allow them to get a profit either the market goes up or down. With this purpose, in section 2 I unveil the Top 10 factors impacting on a delta neutral strategy that banks and floor traders do not want you to know. A fully understanding of those key factors can make the difference between a very profitable trader and a loser. I truly hope you enjoy the information provided in this free report. If you need further details, visit my website at www.FromZeroToOptions.com where you will find more resources stock options related.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

4

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

I must advice you that trading and investing are risky activities and may not be suitable for everyone. Before starting trading in a real market, you should always be aware of all the risks involved in stocks and options trading. For that reason if you are serious about online trading, I encourage you on investing time and some money on your education by attending seminars or courses and being always open to share information with other traders. Online trading is very fascinating because can give you the freedom to work from wherever you are in the world and make decisions for yourself. Once mastered, trading becomes very rewarding and definitely the best profession out there. I believe that anyone starting from scratch can build that knowledge as I did just a few years ago. However, it takes time to learn the necessary skills to trade successfully and a big effort from your part. With my report I want to help you to get off the ground by understanding the potential of options trading. Then, if you are determined about investing your money online, but you do not know from where to start I can recommend you the Option Income System. I started with this online course and I am delighted I did because it gave to me all the answers I was looking for.

For any enquiries, feel free to drop me a line at [email protected].

Happy Trading, Flavian Barrett

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

5

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

SECTION 1 Understanding Call Options and Put Options Unique Risk Profile
Stock options are usually regarded as a very risky investment or even as a kind of gambling activity. While it is an undeniable fact that they involve a certain degree of risk, it also true that most people are not willing to spend time on learning how these tools work. Newcomers and beginners approach the options world just because of the easy cash they hope to lock in. Does this sound familiar to you? This is absolutely the wrong approach! This is the “gambling mentality” that can just bring to get broke. To make stock options work for you and become a professional trader, you must go step by step understanding how stock options work and the consequent rights and obligations that these instruments involve for buyers and sellers.

Stock Options Made Easy
A stock option is a bidding contract giving the buyer the right to trade a particular financial product called “underlying asset”. There are two types of stock options: call and put options. An American-style call option is a contract that gives the holder the right and not the obligation to buy 100 shares of the underlying stock at a certain price and within or at a certain date. As a result, the option owner will get an advantage from a rise of the underlying asset within the expiration date.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

6

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

An American-style put option is a contract that gives the holder the right and not the obligation to sell 100 shares of the underlying stock at a certain price and within or at a certain date. As a result, the option owner will get an advantage from a decrease of the underlying asset within the expiration date. It is significant to remark that option buyers have no obligation to exercise the right within their options, but they can just let the expiration date go without taking any action.

Call Options Explained
Options can be explained by using two useful analogies. From one side, call options may be seen as the bidding agreement (call option) used for the purchase of a home (underlying asset). Before buying a house, the buyer has to sign in a bidding contract which contains the price and all the contract details. Imagine that the total price of the home to purchase is $100.000. The owner agreed to let you pay $10.000 in advance (the 10% of the price) and the remaining $90.000 within a certain date written on the contract (e.g. eight months in the future). Over this time the price is blocked and nobody else is allowed to purchase the house. The contract works exactly as a call option does: the holder has the right, but not the obligation, to purchase that house at the agreed price within eight months. During this time or/and at the end of the contract there may be three scenarios: 1) The value of the house rises and the contract holder makes a profit. The buyer can either decide to sell the contract for a quick profit or decide to purchase the house and manage the asset to have a subsequent opportunity to make a profit. 2) The value of the house decreases and the contract holder collects a loss. The buyer may even think not to exercise the contract and subsequently collecting a loss equal to $10.000 (premium paid).

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

7

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

3) The value of the house does not change during the life of the contract. The buyer has the right to exercise its contract collecting the asset without experiencing either a loss or a profit.

Put Options Explained
On the other side, put options may be seen as the premium of an insurance policy on your car purchased in case a certain event occurs. Imagine you purchase a car worth $10.000 and decide to draw up an insurance policy for its whole value. The insurance company agrees to assure your asset and ask you to pay a premium of $500 for the duration of the contract (put option). The policy holder owns the right to get back the amount of $10,000 if the assured event occurs within a certain period of time. In a certain way it is like the premium paid gave the contract owner the right to sell back the asset assured in case the expected event occurs. The assurance contract works exactly as a put option does: the holder has the right, but not the obligation, to sell the assured asset at the agreed price within expiration. During this time or/and at the end of the contract there may be three scenarios: 1) The event assured occurs and the contract holder exercises the right within the contract and makes a profit. 2) The event assured does not occur and the contract holder makes a loss equal to the premium paid. 3) The event assured partially occurs and the contract holder has the right, but not the obligation to partially exercise the right within the contract making a profit or collecting a loss depending on the entity of the event.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

8

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Rights and Obligations
From one side there are options buyers who purchase the rights within their contracts. It is the option holder’s choice to exercise or not that right. On the other side, there are options sellers (writers) who are willing to sell the rights within the contract for a reward. As a change for that reward they get some obligations in the future in order to satisfy the buyers’ rights in case some circumstances occur. A word of caution: Actually, option sellers have obligations only if they initiate the position by selling options. In this case, sellers are called “short sellers”, because they are selling contracts they do not own getting cash. We must distinguish between the following two scenarios:


Flat position, when you at first buy a stock option and then, in a later date, sell that same contract. In such a case, you will have no contracts in your account. A flat position does not involve any obligation for the seller. Short position, when you at first sell an option contract without owing the underlying asset. You will receive cash today in exchange for accepting an obligation in the future.



The Unique Options Risk Profile
Understanding options is very important because these financial instruments allow you to create complex risk profiles. In chart n. 1 is represented in ThinkorSwim the risk graph of a long stock (General Electric Corporation - GE), where the stock price is showed on the x-axis and the profit/loss on the y-axis.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

9

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Looking at the chart, you can see how stocks have unlimited profit potential, but are exposed also to unlimited loss (when the stock price drops to 0). Purchasing shares of stock, you make dollars for dollars if they rise, but you also risk dollars for dollars if they fall.

On the other hand, if you buy a call option (chart n. 2) your risk profile changes dramatically as showed in the chart below. Investing in stock options, while still maintaining potential unlimited profit, the majority of the downside risk is eliminated as the maximum loss is limited to the premium paid.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

10

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

In chart n. 3 below is represented the risk graph of a short stock (GE). Looking at the chart, you can see how stocks are exposed to unlimited loss on the upside, while having limited profit potential on the downside (the stock price can only fall to 0).

On the other hand, in chart n. 4 is showed the risk graph of a long put and, as you can see, your risk profile changes dramatically if compared to a short stock. Once again, by investing in stock options traders eliminate the majority of the downside risk as the maximum loss is limited to the premium paid.

To summarize, by simply buying or selling call and put options and creating different risk profiles, you can change your exposure to the market as conditions change.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

11

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Making a Profit Either Way The Market Moves
Introducing Delta Neutral Strategies
What delta neutral strategies are? Delta neutral strategies are considered as those investments in which the direction of the trade is not important. This occurs because traders can gain the knowledge to manage their positions as to collect a profit either way the market moves. Here I am going to introduce you how to trade option neutral strategies giving you an insight into the fundamental concept of delta.

Delta Neutral Strategies - The Straddle
Delta neutral traders must be able to find the optimal relationship among options strikes, implied volatility and the effect of time decay. Traders’ goal is to create positions with the highest probability of success regardless of the market direction. As difficult it may sound, this is something anybody can do with patience and making a little bit of effort. You can achieve such result by planning and assessing in advance all possible reactions to market moves. There are two different kinds of straddles traders can perform:  Long straddles, that involve buying both ATM calls and puts with the same strike price and the same expiration date.  Short straddles, that involve selling both ATM calls and puts with the same strike price and the same expiration date.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

12

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Short straddles are not within the purpose of this report as they are a very risky strategies involving unlimited potential risk. They are not suited for inexperienced traders and usually are not recommended even to more experienced ones. On the other side, long straddles are one of the most traded delta neutral strategies amongst professional traders. Why? Because this strategy allows traders to get a profit either way the market moves involving only a limited potential risk and an unlimited potential reward.

Delta Mechanics on Option Neutral Strategies
Creating a neutral option strategy imply putting together different options so as to hedge your overall position by making it delta 0. To achieve this result it is necessary that you deeply understand what delta is and how it is calculated for stocks, options and futures. Delta is a measure of how much the price of a financial instrument (stocks, options and futures) will change given a $1 change in the underlying. It is essential to know that stocks and futures have always delta equal to 1 if you are a buyer and -1 if you are a seller. As a consequence, when you buy 100 stocks or one futures contract, you are +100 deltas; when you sell 100 stocks or one futures contract, you are -100 deltas. Deltas are a little more complicated for options than they are for stocks and futures. For options, the delta is always a number between -1 and +1. Long options positions can only have positive delta, which is a number between 0 and +1, whilst short options positions can only have a negative delta, a number between -1 and 0.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

13

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

The closer is the delta of options to 1 or -1; the highest will be the connection with the respective underlying security and, consequently, the impact of the stock movement on the option price. The delta depends on the kind of options traded (calls or puts), the chosen strikes and the relationship with the price of the underlying. In other words, the delta of options is strictly related to the fact that options might be ATM (at-the-money), ITM (in-the-money) or OTM (out-of-the-money). Such classification of options is known as option’s moneyness. More in detail, on the basis of their moneyness options can be:  At-the-money (ATM); the options strike price of both calls and puts is at the closing price of the underlying or very close to it. In such a case, the delta will be around +.50 for long call options and -0.50 for long put options.  In-the-money (ITM); the strike price of call options is below the closing price of the underlying, while the strike price of put options is above the closing price. ITM long call options will have deltas between +0.50 and 1, while ITM long put options will have deltas between -0.50 and -1.  Out-of-the-money (OTM); the strike price of call options is above the closing price of the underlying, while the strike price of put options is below that some closing price. OTM long call options will have deltas between 0 and +0.50, while OTM long put options will have deltas between -0.50 and 0. In the case of short calls and puts, ITM and OTM values will be absolutely in the other way around:  ITM short call options will have deltas between -0.50 and -1, while ITM long put options will have deltas between +0.50 and 1.  OTM short call options will have deltas between 0 and -0.50, while OTM short put options will have deltas between 0 and +0.50.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

14

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

How to Set up a Delta Neutral Trade
Let us try to create together a delta neutral strategy. If you buy 100 shares of stock, you will be positive 100 deltas (+100). As your purpose is to get a delta 0 position, you need to find financial instruments which carry -100 deltas. You can decide to buy two ATM put options or to short two ATM call options (ATM puts have something in the region of -0.50 deltas, while ATM calls something in the region of +0.50 deltas). As each option’s contract gives the right to control 100 shares, you will have roughly -100 deltas and your position will be balanced. In analytics terms, there may be four scenarios: Scenario 1 - Long stocks and puts Buy 100 stocks Buy 2 ATM puts +100 deltas (-0.50*2)*100= -100 deltas

Scenario 2 - Long stocks and short calls Buy 100 stocks Sell 2 ATM calls +100 deltas (-0.50*2)*100= -100 deltas

Scenario 3 - Short stocks and long calls Sell 100 stocks Buy 2 ATM calls -100 deltas (+0.50*2)*100= 100 deltas

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

15

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Scenario 4 - long puts and calls Buy 2 ATM calls Buy 2 ATM puts (+0.50*2)*100= +100 deltas (-0.50*2)*100= -100 deltas

As you may notice in the fourth scenario, a long straddle involves buying several contracts of ATM calls and puts. In a delta neutral strategy, it is very important to keep the delta as much close to 0 as possible in order not to be influenced by the stock direction. Once into the trade, if the underlying start moving far from the entry point making your overall delta position positive or negative, you may need to carefully adjust your position in order to keep it delta neutral and not be affected by the market direction. As a rule of thumb, a straddle is required to be delta neutral not only when the position is open, but also throughout the trade and until a certain and awaited catalyst event (e.g. earnings release) occurs.

REAL TRADE - EXAMPLE
In order to make you understand how powerful can be a straddle, let’s have a look at a real trade I did recently. After having done all my analysis, the 6 July 2011 I decided to enter a straddle on Cisco System Incorporation - CSCO (Table n. 1). As you can see, I performed the straddle explained in scenario 4 where a position is made up of both calls and puts. I decided to enter the trade by making some considerations and analysis on the basis of the top 10 factors impacting on a straddle that I am going to outline in section 2.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

16

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

The trade is performed exactly 35 days before the earnings release expected for the following 10th August with the purpose to open a delta neutral trade (delta close to 0) and benefit from a strong movement of the underlying either upwards or downwards. My main aim was to hold the position until the earnings release to try to benefit from a strong move that such event may involve. With the underlying being traded at 15.56, in order to be delta neutral I chose to buy 5 ATM calls and 4 ATM put options (whose strike prices are very close to the underlying price) with strike 16. You can check all these data in the tables and charts below. Straddle Risk profile: Maximum (Limited) Risk: Maximum (Limited) Reward: Days to Expiration: Delta: $800 $Unlimited 107 1.56 (Neutral)

Table 1 - Cisco Corporation (CSCO) Analytical Risk Profile at the opening day (Source: Optionetics)

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

17

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime The trade produced a risk graph as showed below in the chart n. 1. On the left hand side there is the CSCO chart, while on the right hand side is showed my straddle. As you should notice, the stock is being traded exactly in the middle of the position. If the stock moves upwards we make a profit, if the stock moves downwards we still make a profit. The only risk is if the stock doesn’t move at all, in such a case we collect a loss due to the passage of time that erode the options time value.

Chart 1 - Stock Chart and Straddle Risk Profile at the opening (Source: Optionetics)

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

18

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

You need to check the position every day and manage it according to your plan. You must always be cautious, check all parameters and make adjustments whenever the position requires it. After 34 days, one day before the earnings release the underlying had dropped almost two points from 15.56 to 13.73. On the table n. 2 you can see that the trade has already earned a substantial profit ($475, more than 50% profit) from the stock moving downward.

Table 2 - Analytical Risk Profile the day before the earnings release (Source: Optionetics)

The risk graph below shows clearly the profit that the straddle has collected. At this point we need to do something. In fact the day after there will be the earnings announcement that is the catalyst event we were waiting for in the first place.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

19

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Chart 2 - Stock Chart and Straddle Risk Profile a day before earnings (Source: Optionetics)

We need to make an adjustment to our straddle in order to bring it back to delta 0 (neutral) before the earnings. Without doing the necessary adjustments you may risk to lose what just earned and more. As we do not want to give away our profit, but want to maximize it we need to take action. I decided to buy 3 more ATM call options with strike 14 and become again delta neutral. On the table n. 3 you can see the new analytical risk profile. With more options purchased, the entry debit becomes $1112 while our maximum loss is $512.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

20

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Table 3 - Table 2 - Analytical Risk Profile on the day of the earnings release (Source: Optionetics)

Chart 3 - Stock Chart and Straddle Risk Profile on the day of earnings (Source: Optionetics)

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

21

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

In the earnings day, the stock jumped up to 15.92 allowing us to collect additional cash and close the trade out with $503 profit (approximately 60%). A word of caution: The trade above mentioned is showed just as an example of the potential of options and delta neutral strategies. I must warn you that not always this kind of trades is profitable and that there are too many variables to analyze that cannot be covered all here. Two of the main factors to consider when trading a straddle are the effect of implied volatility and time decay. I am going to say more about these in the next section.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

22

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

SECTION 2 Top 10 Factors Impacting on Straddles and Delta Neutral Strategies
Before trading a delta neutral strategy such as a long straddle, traders should be fully aware of the main factors impacting on the position. In a nutshell, they are:  Overall Market Picture;  Upcoming News Events;  Earnings Reports,  Strike Prices, Expiration Dates and Time Decay;  Potential Profit, Potential Loss and Commissions;  Implied Volatility (IV) related to the Underlying;  Implied Volatility (IV) related to Options;  Underlying and options liquidity;  Risk Profile and risk graphs;  Price trends, Timeframe, Entry and Exit Plan.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

23

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

1. Overall Market Picture - Market Overview
Looking at the world financial market as a whole to get the big picture is the most important point to successfully start trading. Check news and analyze charts of the most recognized indexes and corporations to pick the general market trend. Yahoo Finance, The Wall Street Journal, Reuters and the CNBC live are just some of the sources that can provide you with updated information and market insight 24 hours a day. Analyze the S&P500 (SPX), Dow Jones Industrial Average (DOW) and NASDAQ indexes (NDX) to verify the overall market condition trying to catch market trends and volatility patterns.

2. Upcoming News Events Related to the Underlying
Look for underlying securities which, historically, have moved consistently with important news incoming. There are several kinds of news that usually have a remarkable impact on stocks and can cause huge moves. Below are highlighted some of the most important news:  Earnings release;  Management turnover;  Lunch of new products;  Entry in new markets;  CEOs and Presidents speeches;  Acquisition of new companies.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

24

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

When one of this news is going to come, be aware that the related underlying security might have a substantial rise in volumes and, as a result, move in an unpredictable way. This occurs because such news can have a considerable impact for two main reasons: The expectations that this event generate on investors; The significant move in the implied volatility of the underlying. In fact, strong expectations towards relevant news can cause a quick rise in implied volatility and, usually, the market anticipates important news with explosive moves. Rule of thumb: consider trading a delta neutral strategy if are expected relevant news impacting on the underlying.

3. Earnings Reports
An earnings release is an event that can involve a huge and unpredictable move in the underlying and, consequently, increase dramatically the likelihood to get a profit on a delta neutral strategy. Before trading a straddle, you should always make sure that the earnings release is going to come. In fact, differently from other events difficult to predict such as management turnover, lunch of new products, entry in new markets and acquisition of new companies, the earnings release is the only event that occurs at a specified time (quarterly).

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This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

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From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Suggestion: Try to enter a delta neutral trade around 30 days before the earnings announcement (conference call) in order to benefit from an increasing implied volatility. You can check such events on the website www.earnings.com or directly on the ThinkorSwim Trading Platform. Make sure you get out from the trade after the stock conference call occurs. Rule of thumb: trade a delta neutral strategy only if the earnings release or other relevant events are announced within the expiration date.

4. Strike Prices, Expiration Dates and Time Decay
As you buy ATM options, the major value of their premium is made up of time. This time value reflects the probability that options may expire in-the-money (ITM) by the end of their life. Now, this value decreases as options get closer to their expiration date, resulting in a relating reduction of options’ premium. That is why the value of your straddle decreases in value as options approach expiration. Such process, known as time decay, increases substantially in the last 30 days within the expiration date and gets at its fastest rate in the last 15 days determining the full erosion of all time value remaining on the options’ premium. Taking into consideration this effect, you must select very carefully the options to pick. Considerations: At first, looking at the time decay effect, it might seem reasonable to buy options with further expiration dates (200 days, 300 or more days before expiration). Unfortunately, long straddles are recognized as a quite expensive debit strategy since traders need to invest a relative high quantity of money to buy both ATM calls and puts.

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This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

26

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

For this reason, picking longer term options such as Leaps to trade a long straddle appears to be not convenient from an economical point of view and may be not affordable to most traders. Considering such cost, the key to make a long straddle feasible locking in an adequate profit is to be able to find underlying which are about to make an explosive move. In fact, to make a profit either if the stock rises or plummets the movement of the underlying should be enough to cover the cost of the trade. Suggestion: Preferably trade options with about 120 or 90 days left before expiration to keep the cost of the trade low and the expiration date reasonably far. Close out your straddle when the awaited event occurs and in any case at least 30 days before expiration.

5. Potential Profit, Potential Loss and Commissions
A straddle is a debit strategy in which the potential profit is substantially unlimited and the maximum loss is equal to the sum of premiums paid to buy the ATM options. It is important to stress the point that to be profitable a straddle needs a big move of the underlying. It is a relatively expensive option strategy in which is necessary a trade-off between cost of the trade, potential move of the underlying and time decay effect. You need a considerable move of the stock within a short amount of time. In fact, the overall position collects a loss either if the stock doesn’t move at all or doesn’t move enough. Conversely, in order to get a profit the underlying should move above the upside breakeven or below the downside breakeven. Within the breakeven points the position collects the maximum loss at expiration.

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This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

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From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

In addition, try to keep commission low. You don’t want to pay too high commission if compared with the likelihood to get a reward.

6. Implied Volatility related to the Underlying
When trading long straddles, you should always consider you are substantially buying ATM options paying a net debit for that. As the implied volatility (IV) is a main part of the options price and your goal is to minimize the premium paid, before getting into the position you want the IV to be as lower as possible. You need to look for underlying with low IV. Look at the IV charts in any trading platform (e.g. ThinkorSwim by TD Ameritrade) and carry out the following actions for each underlying security you would like to trade: a) Compare the IV of the last trading day with the average IV of the previous year or more to understand if that value may be considered high or low. b) Compare the implied volatility (IV) with the historical volatility (HV). Have a look at the IV chart and the HV chart simultaneously. If the IV is lower than the HV for that particular time, then the options may be considered cheap and so convenient to buy.

7. Implied Volatility related to Options
As you are buying ATM calls and puts, you should try to buy as economic options as you can in the first place. In fact, trading a long straddle involves taking the so called Vega risk, meaning that you may face a consistent loss if the implied volatility (IV) of the options declined.

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This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

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From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

For this reason, it is very important to anticipate an incoming rise of implied volatility getting into the trade when the IV is about to increase. Usually, the IV increases when relevant or unexpected news are on the verge of coming. In order to purchase options with low IV, you should consider looking at options volatility charts (the firm Optionetics offers good IV charts, but you must pay a yearly fee to get access to that) and/or options volatility values (IV values for each option are provided by ThinkorSwim - TD Ameritrade) and perform the following actions: A. Compare the IV of each option with the IV of the underlying. If the option has lower IV than the stock it may be suitable for a long straddle. B. Compare the options’ IV of the last trading day with the average IV of the previous six months or more. The IV of options is more difficult to analyze since it’s not easy to find these kinds of data. One way could be to manually check the average options’ volatility over a period of time for a few underlying in your watch list. This activity may appear tedious to most, but, if performed constantly, can produce unbelievable results making you understand if options are overpriced or underpriced. To avoid spending too much time, make sure to pick only underlying with a catalyst event approaching within a month and towards which there are strong expectations from investors. In fact, these are the ones that have the highest likelihood of an explosive move upward or downward in the short time. Rule of thumb: trade a long straddle only if you are able to find low priced options (low IV values) that are likely to increase in value due to an upcoming event.

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This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

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From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

8. Underlying and Options Liquidity
It is important to trade only underlying and options with high liquidity values. This statement is true not only for trading a straddle, but for any kind of investment in the markets. Basically, there are two main reasons why you should trade only high liquidity financial instruments: 1. Flexibility. You want to have the chance to get into the trade and close your position out quickly. 2. Cost. You want to keep the Bid/Ask spread as much lower as possible. In fact, this is a relevant component of the cost of a straddle. In order to investigate liquidity, you must check and analyze the volume figures over the past year or two years. You must search for: a) Underlying or stocks with high liquidity, at least 500,000 Average Daily Volume (ADV), but preferably over 1,000,000 ADV. b) Stock options with high liquidity, at least 100 open interest, but preferably over 500.

9. Risk Profile and Risk Graphs
Determine graphically the trade’s feasibility by creating a risk profile. ThinkorSwim by TD Ameritrade offers for free, to all its customers, an invaluable tool to analyze risk graphs, called the “Analyze Tab”.

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This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

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From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

In a Straddle, your risk profile can be summarized as follows: Maximum (Limited) Risk: Maximum (Limited) Reward: Breakeven Point Up: Breakeven Point Down: Return on Investment (ROI): Net Debit Paid (options premiums) Unlimited ATM Strike + Net Debit ATM Strike - Net Debit Reward/Risk Ratio

10. Price trends , Timeframe, Entry and Exit Plan
Investigate price trends of the stock by reading charts and identifying whether in the previous one or two years the underlying has experienced consolidating price patterns and explosive moves when relevant news occurred. Keep in your mind that in a long straddle you are neutral about the direction of the trend, meaning that you get a profit either if the underlying goes up or down, while you get a loss if the stock price doesn’t move at all. You must always enter a straddle having in mind the timeframe of your investment. You should be in the position for no more than 30/35 days and always closing out the trade in the day (or at least the day after) in which the catalyst event occurs.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

31

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Furthermore, to effectively trade a straddle traders must have clear in their mind an entry and exit plan before entering a position. Below are outlined 7 steps to follow:  Prepare a detailed trading journal;  Write your strategy down;  Look for ATM call and put options;  Focus on underlying securities with catalyst events such as earnings reports about to occur within a month;  Identify a consolidating price pattern;  Make an exit plan based upon the price movement of the underlying stock and set your stop losses;  Do not hold a long straddle into the last month before expiration.

Conclusions
The positive aspect about straddles is that if the underlying doesn’t produce the expected movement, one can get out from the trade without experiencing a significant loss as long as the options are not held until expiration. In fact, the effect of time decay is very small when options are months away from expiration. To be successful in the trading business, you should plan your very next moves as to know exactly what to do in different market scenarios. A tool that can help you in gaining awareness of the impact of different market prices is the Price Slices in the ThinkorSwim Analyze Tab.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

32

From Zero to Options
Make a Start Trading Options with ThinkorSwim! Build a Trading System for Passive Income that Lasts for a Lifetime

Additional Resources
Thank you for taking the time to read through this report. I truly hope you enjoyed the information provided. If you need further details, visit my website at www.FromZeroToOptions.com where you will find more resources stock options related. If you are truly interested in option trading consider giving a try to the complete online course the Option Income System. This course provides instant access to over 40 videos and more than 20 hours of training. These videos will show you an extraordinary way to trade options for income including a collection of little known additional option cash flow strategies that can be traded to generate income - spending as little as 15 minutes a day.

For further information, send me an email at the address below or visit my website.

Happy Trading, Flavian Barrett [email protected]

DISCLAIMER Anything written into this report does not represent an incentive or a suggestion to make any sort of investment. Stocks and Options Trading are a risky activity and are not suitable for all people. We decline any responsibility for losses could occur during your trading activity.

Want To Learn the Art and Science of Options Trading Faster? Click Here To See a Series of Articles and Video Tutorial on Options Trading www.FromZeroToOptions.com
This Special Report is Copyright 2011 Flavian Barrett - From Zero to Options - All rights reserved worldwide

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