Options Trading for the Conservative Investor: Increasing Profits Without Increasing Your Risk

271 Pages·2010·1.647 MB·English

by  Thomsett, Michael C

OPTIONS
TRADING FOR THE
CONSERVATIVE
INVESTOR
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OPTIONS
TRADING FOR THE
CONSERVATIVE
INVESTOR
INCREASING PROFITS
WITHOUT INCREASING
YOUR RISK
Michael C. Thomsett
Vice President,Publisher:Tim Moore
Associate Publisher and Director ofMarketing:Amy Neidlinger
Executive Editor:Jim Boyd
Editorial Assistant:Pamela Boland
Operations Manager:Gina Kanouse
Senior Marketing Manager:Julie Phifer
Publicity Manager:Laura Czaja
Assistant Marketing Manager:Megan Colvin
Cover Designer:Alan Clements
Managing Editor:Kristy Hart
Project Editors: Julie Anderson and Jovana San Nicolas-Shirley
Copy Editor:Karen Gill
Proofreader:Dan Knott
Indexer:Michael C.Thomsett
Senior Compositor:Gloria Schurick
Manufacturing Buyer:Dan Uhrig
©2010 by Pearson Education,Inc.
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Printed in the United States ofAmerica
First Printing January 2010
ISBN-10:0-13-704200-0
ISBN-13:978-0-13-704200-5
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Library ofCongress Cataloging-in-Publication Data
Thomsett,Michael C.
Options trading for the conservative investor :increasing profits without increasing your risk /
Michael C.Thomsett.— 2nd ed.
p.cm.
Includes bibliographical references and index.
ISBN 978-0-13-704200-5 (hardback :alk.paper) 1. Stock options.2. Options (Finance) 3.
Investments.4. Risk management. I.Title.
HG6042.T462 2010
332.63’2283—dc22
2009036159
CONTENTS
ACKNOWLEDGMENTS . . . . . . . . . . . .xi
ABOUT THE AUTHOR . . . . . . . . . . . .xii
PREFACE . . . . . . . . . . . . . . . . . . . . . . .xiii
CHAPTER 1:SETTING THE GROUND RULES . . . .1
The Ground Rules . . . . . . . . . . . . . . .2
A Model Portfolio . . . . . . . . . . . . . . .4
CHAPTER 2:OPTION BASICS . . . . . . . . . . . . . . . . . .7
The Workings of Option
Contracts . . . . . . . . . . . . . . . . . . . . .8
Long and Short . . . . . . . . . . . . . . . .13
Calls and Call Strategies . . . . . . . . .17
Puts and Put Strategies . . . . . . . . . .22
Listed Options and LEAPS
Options . . . . . . . . . . . . . . . . . . . . . .28
Coordinating Strategies with
Portfolio Goals . . . . . . . . . . . . . . . .32
Option and Stock Volatility:
The Central Element of Risk . . . .35
v
Trading Costs in the Option
Analysis . . . . . . . . . . . . . . . . . . . . . .46
Tax Rules for Options:
An Overview . . . . . . . . . . . . . . . . . .47
The Importance of Professional
Advice and Tax Planning . . . . . . . .48
CHAPTER 3:OPTIONS IN CONTEXT . . . . . . . . . . .51
The Nature of Risk and Reward . . .52
Perceptions about Options . . . . . . .60
Short Positions: Naked or
Covered . . . . . . . . . . . . . . . . . . . . . .63
Margin Requirements and
Trading Restrictions . . . . . . . . . . .68
Return Calculations: Seeking
Valid Comparisons . . . . . . . . . . . . .70
Long-Term Goals as a
Guiding Force . . . . . . . . . . . . . . . . .80
Exercise as a Desirable Outcome . .82
CHAPTER 4:MANAGING PROFITS
AND LOSSES . . . . . . . . . . . . . . . . . . . . .85
Your Conservative Dilemma . . . . . .87
Managing Profits with Options . . .89
Overcoming the Profit-Taking
Problem . . . . . . . . . . . . . . . . . . . . .92
vi
OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
Managing the Inertia Problem . . . .99
Taxes and Profits . . . . . . . . . . . . . .102
CHAPTER 5:OPTIONS AS CASH
GENERATORS . . . . . . . . . . . . . . . . . .107
The Covered Call Concept . . . . . .108
Examples: Ten Stocks and
Covered Calls . . . . . . . . . . . . . . . .110
Smart Conservative Ground
Rules . . . . . . . . . . . . . . . . . . . . . . .115
A Conservative Approach . . . . . . .121
Tax Ramifications of
Covered Calls . . . . . . . . . . . . . . . .125
Rolling Forward and Up:
Exercise Avoidance . . . . . . . . . . . .130
The Exercise Acceptance
Strategy . . . . . . . . . . . . . . . . . . . . .131
CHAPTER 6:ALTERNATIVES TO STOCK
PURCHASE . . . . . . . . . . . . . . . . . . . .133
Leverage and Options . . . . . . . . . .134
The Long-Call Contingent-
Purchase Strategy . . . . . . . . . . . . .137
The Covered Long Call . . . . . . . . .140
Short Puts and Contingent
Purchase . . . . . . . . . . . . . . . . . . . .144
vii
Contents
Rescue Strategy Using Calls . . . . .148
Rescue Strategy Using Puts . . . . . .154
Covered Calls for
Contingent Sale . . . . . . . . . . . . . .155
CHAPTER 7:OPTION STRATEGIES IN DOWN
MARKETS . . . . . . . . . . . . . . . . . . . . . .157
Thinking Outside the
Market Box . . . . . . . . . . . . . . . . . .158
The Long Put:
The Overlooked Option . . . . . . .161
Short Puts: A Variety of
Strategies . . . . . . . . . . . . . . . . . . . .165
Comparing Rates of Return for
Dissimilar Strike Prices . . . . . . . .170
Using Calls in Down Markets . . . .172
Evaluating Your Stock Positions . .175
Stock Positions and Risk
Evaluation . . . . . . . . . . . . . . . . . . .180
Options and Downside Risk . . . . .182
Option Planning with
Loss Carryover . . . . . . . . . . . . . . .185
CHAPTER 8:COMBINATION CONSERVATIVE
TECHNIQUES . . . . . . . . . . . . . . . . . .189
Spread Techniques . . . . . . . . . . . . .190
viii
OPTIONS TRADING FOR THE CONSERVATIVE INVESTOR
Straddle Techniques . . . . . . . . . . . .192
Long or Short Positions . . . . . . . . .194
Theory Versus Practice . . . . . . . . .196
Tax Problems with Combination
Strategies . . . . . . . . . . . . . . . . . . . .199
The Ultimate High-Return
Strategy . . . . . . . . . . . . . . . . . . . . .200
Examples of the Strategy in
Practice . . . . . . . . . . . . . . . . . . . . .202
Outcome Scenarios . . . . . . . . . . . .211
The Augmented Strategy:
A Short Straddle . . . . . . . . . . . . . .213
Rescue Strategies . . . . . . . . . . . . . .218
CHAPTER 9:STOCK SELECTION AND THE
OPTION CONTRACT . . . . . . . . . . .221
Remembering Your Conservative
Profile as a Priority . . . . . . . . . . . .223
Dangers and Pitfalls in Using
Options . . . . . . . . . . . . . . . . . . . . .224
Temptation to Select Most
Volatile Stocks . . . . . . . . . . . . . . .226
Creating Sensible Conservative
Standards . . . . . . . . . . . . . . . . . . .228
Maintaining Fundamental
Clarity . . . . . . . . . . . . . . . . . . . . . .232
ix
Contents