Title : Get Rich With Options: Four Winning Strategies Straight from the Exchange Floor
Author : Lee Lowell
List Price: $39.95
Street Price : ~$26.00 ~ $28.00

Starting with the title of this book, I was not happy. The title sounds too much like a 2am infomercial than a good book on options trading. At first , you think maybe just the title is ‘hype-y’, but here is a quote from inside the flap:

Lowell explains the only four options trading strategies that actually work: buying deep-in-the-money call options, selling naked puts, selling option credit spreads, and selling covered calls.

He gave a fifth “bonus strategy” which is ratio spreads.

Really? The only strategies that make money? I don’t know a lot of professional option would use these strategies. Oh wait, there is one I know who used those strategies. Niederhoffer. He sold naked puts ( which is the same as covered calls ). We all know what happened to him.

Now the book was not all ‘hype-y’. The author did do a good job of simplifying options, and gave some good tips on trading options. But claiming these are the only four option strategies that work, was a little over the top for me. I should mention that covered calls and naked puts have the same return profile so it is only three strategies anyway.

The thing to remember is that this guy traded commodity options on the floor of the New York Mercantile Exchange (NYMEX) , which are a different beast than equity options. He was pretty light on the money/risk management side of things. I do give him credit for talking about DITM calls which is not really discussed in options literature.

Bottom Line : Cannot recommend this book other than light reading for an option trader. If you are starting out, there are much better books. If you already know what you are doing, this book will not teach you much.

I have been saying things like this ( Short vega, etc ) for so long, I should realize that on the surface it does not make too much sense.

What I am talking about is how your current position reacts to one of the greeks. Let’s take short vega as an example, also called negative vega and short volatility they mean the same thing. Your position makes money if if volatility decreases.

[EDITED - Thanks Michael . Man, I need to find a proofreading 101 class]

Long Theta is a little bit stranger. Long theta means your position makes money as time passes. Time usually moves forward, so we pretty much know long theta will help our position. How much it help depends on other factors.

SO here is an example. The Mar 08 250 BIDU put closed at 16.90 ( 2/15/08 ) with BIDU closing at $259.10. The position is short theta in that it loses money over time. The amount it loses increases every day, with the rate increasing the most in the last 30 days.

Using a option calculator, and advancing the date to Monday ( 2/18/08 ) , we have a price of $16.03. A loss of about ~$29 a day. Now, this is if implied volatility and price of the stock do not change. Both of these are unlikely, since the implied volatility on Fridays gets messed around.

So the BIDU 250 PUT is short theta in that the option is losing $29 a day.

Personally, I like long theta trades. IF / WHEN you are wrong in your equity selection, you have time to adjust your trade without have to pay the “vig” everyday.

~ squid

I like writing again. Maybe I will start doing book reviews or something.

So just some thoughts on volatility contraction ( or crush ). One of the inputs to option pricing models is something called ‘volatility’. This is the only unknown input into option pricing formulas. It is a prediction of how volatile the stock WILL be in the future. Since we do not know what the future price of the stock is, this volatility is a ‘guess’.

I want to use Michael’s BIDU call as an example. Michael Trader bought a Mar08 250 Put. Today it closed at $21.50. Since the put is out of the money, the price is heavily influenced by the pricing model which is determined by the future volatility, or rather the guess of the future volatility.

So what does this mean for the price of Michael’s put ? BIDU’s earnings were after the close and they came inline with expectations. Well, since during the trading day, we could not predict what the earnings would be ( or what the market reaction would be ) traders charged a higher premium ( higher volatility ) to sell options to cover their a$$’es in the case of a huge move. So now after earnings, option sellers would not charge such a high premium for options.

So after earnings, even if the stock price does not change, the price of the option will probably fall. There are lots of other things that could happen, but I would not go into those here. We can expect , all things being equal, Michael’s put opening lower. Sometimes the volatility crush can be huge, sometimes not that great. But that is the nature of trading.

And to Michael , dude, we have all been there. Good luck.

Since Michael was kind enough to write about my blog, I decided to take time to write about his. I will use Michael Trader because I still find the R word offensive.

I don’t post on this blog much because my trading is , frankly boring. I do the same type of trades for the most part day in and day out. Very few speculative trades. Maybe I will start posting option book reviews or something, but for now, I have something to post.

I want to say that when I first started trading options, I traded like a drunken monkey also. I started out with 5K , coincidentally, to learn how to trade. I ran that $5K up to $12K in something like 6 weeks with just a couple of trades. I was really just guessing. I did not have a defined edge, I did not have a plan. I just traded on hope. I would buy options and just hope the stock would go my way ( hope was my trading plan ). After I lost all the money I made and more in the next four weeks, I took some time off, and figured out what my edge was and I have been much more successful since that time. I think blowing out your account CAN be a good learning experience, although an expensive one.

So anyway, back to the post.

As for trading outside your size, position sizing is important. Mainly to keep you in the game. To really make a lot of money , you can swing for the fences, but you have to realize that you will strike out more. None of us can predict the market 100%. We all will have losses and drawdowns as you pointed out. The point with position sizing is so that you will be able to take a few losses in a row and still have enough money to trade. Lose 20, 30 or 40% percent of your account, makes it that much harder to come back and profit. Position sizing does not mean not trading the money in your account, but it does make you spread out your trades over different stocks. I am almost never 100% in the market, I have gotten close a few times. I usually leave some in my account so I have cash to adjust positions. I will have as many positions as my position sizing allows.

A trading plan has a lot to do with psychology. We all trade for profit of course, but a trading plan for your trades help keep you sane before and during the trade. When I enter a trade, I write down my objective & reason for the trade. Then I write the reasons to exit. What happens during a trade is you get all wound up in the emotion of trading and it makes it hard to trade with disciple. By writing down why I entered the trade and what my exit strategy is, I don’t start flip-flopping on my decisions mid way through the trade.

As for your BIDU trade , I think it was a good trade on picking the direction. BIDU is in a downtrend, and has some support at the $240 level which it looks like it has passed on the downside. IMHO, I would be first looking at at vertical spreads because of the high implied volatility and earning due this week.

( click to enlarge, 11.FEB.2008 before the open )

If you notice, the volatility falls after earnings, which affects the price of the options. Vertical spreads help you counter the effects of volatility contraction and theta. In a vertical spread such as a bear put spread, you have two options One long and one short at different strikes for the same expiration. Say the volatility of the option falls and the option you purchased falls in price. The option you sold would also fall in price, reducing the effect of volatility contraction. On the theta side, you would gain some from the option that you sold, and lose some from the option that you purchased.

I don’t trade vertical spreads that often, it is not my style, I mainly trade time spreads. I do take trades like this on a more speculative basis every blue moon. Now, if you are looking at a large quick move ( I assume south ) on BIDU, cheap OTM options would be great because of the leverage. If you expect a small move ITM options would be better. You picked an ITM options, so I assume you are expecting the stock to move lower but not plummet after earnings. The delta on your put is 53.5% ( as of Monday morning ), so a $10 move in BIDU, produces $5.35 ( roughly ) for you.

( click to enlarge, 11.FEB.2008 before the open )

The implied volatility will probably decrease after earnings ( 2/13 after the close ) so the price of the 250 BIDU option you purchased may decrease even if the stock price does not move.

Oh, and as for the 100K , that is not realistic in your case. It was just a number off the top of my head. You can get deals less than 100K of equity. Since your commissions will come down a lot when you start trading larger sizes, and no pattern day trader rule ( which stops at 25K equity ) it makes it a lot easier.

All said and done, I am 75% an income trader, and you will not get from $5K to $100K in a year income trading. So go swing for the fences, and I hope you make it.

~squid

P.S. I did play D&D in my early teens, but that was put to an end by the acquisition of a drivers license.