It starts with understanding a rather long set of symbols that looks something like this:
This code is simply the ticker symbol for your option. And once you break it down, you'll find that it holds a wealth of information, including all the "standardized" terms we talked about in this article.
The first three or four letters are just the stock ticker for the specific underlying stock, in this case, Google Inc. (NasdaqGS: GOOG):
The next two digits tell you the year the option expires. This is necessary because long-term options last as far out as 30 months, so you may need to know what year is in play. In this case, the Google option is a 2012 contract:
The next four digits reveal the month and the standard expiration date. The expiration date does not vary. It's always the third Saturday of the month. And the last trading day is always the last trading day before that Saturday, usually the third Friday (unless you run up against a holiday). In this case, you've got a March contract (03). And the third Saturday of March 2012 is the 17th.
Now you'll see either a C or a P, to tell you what kind of option you're dealing with - a call or a put. This one happens to be a put:
After that comes the fixed strike price, which is 600:
Finally, any fractional portion of the strike is shown at the end. This comes up only as the result of a stock split, where a previous strike is broken down to become a strike not divisible by 100:
Now that you're a pro, let's take it a step further.
Don't let the red tape hold you back.
A lot of experienced and sophisticated investors shy away from anything that involves paperwork.
They think they're not qualified or ready, or simply that it's not worth the trouble.
Don't be one of them.
Yes, you will have to fill out an options application with your broker, but it's easy.
In fact, you had to file a similar form just to open your trading account in the first place. Now, if you want to upgrade your account to be "options approved," it's just another small step away.
Admittedly, the application may look intimidating at first glance. It is full of disclosures, legal qualifications and the kind of small print that is worrisome.
Yet the purpose of the application is simple enough.
Your broker just wants you to state that you know enough about options to make your own trading decisions.
And not to worry... It's not a quiz.
The disclosures are designed to gauge your level of experience. But their real goal is to let the brokerage firm off the hook in case things go terribly wrong. Of course, that's not going to happen to you.
But if a broker lets anyone trade without at least appearing to check them out first, they could be liable for your losses. And no one wants that.
Because options are by definition speculative, the New York Stock Exchange (NYSE), Financial Industry Regulatory Authority (FINRA), and National Association of Securities Dealers (NASD) all have rules and policies about "suitability."
That's the real reason you have to go through this (very small) hoop.
So you'll fill out the application. They file it away into the "just in case" drawer and you're ready to trade.
What's on the Options Trading Application?
The options application will ask some questions you would expect: Name, address, employment and employer name, annual income and all sources of income. They also want to know your net worth and liquid net worth, marital status and number of dependents.
Then there are a few questions you might not expect.
Even so-called "experts" struggle with options. It gets even uglier when they attempt to bring it down to earth for their readers.
Yet, if anyone can do it, I can.
I've written six books about options, and have been trading options myself for more than 35 years.
It means that I have already made every mistake in the book so you don't have to.
So why should you learn about and invest in options?
Done right, you can use options to create a virtual cash cow - often quickly, and often with very little risk.
Options Trading in ActionConsider the case of the SPDR Gold Trust (NYSEArca: GLD). A year ago, GLD shares were trading for about $130.
Say you felt pretty confident GLD was going to go up in the next 12 months. You could have gone "long" GLD by buying 100 shares.
Of course, you'd have to be ready to plunk down about $13,000 for them. But if you had that kind of cash you would have done pretty well.
A year later, GLD was trading at $160, and your 100 GLD shares were worth $16,000. That's a nice 23.7% gain.
But you would have done even better if you had used options.
Let's say, instead, you bought one $135 call. (A "call" is just a bet on the price of GLD going up from $130; the same thing you're betting on when you buy the stock.)
A year ago, GLD calls were trading at $9.00. So you would have spent about $900 to initiate the trade. Yet by the expiration month, the price of the calls had risen to $28.00.
That means the price of the option "contract" you bought was now worth $2,800-giving you a 300% gain on the very same price move in GLD.
Now where I come from, 300% is much better that 23.7%. That's the power of options.
And there's more...
If so, they could be perfect candidates for a low-cost, low-risk options trading strategy that could pay off big time if we get another move like last Friday's 169-point Dow plunge.
The strategy is called a "calendar put spread," and it works like this:
- You sell a slightly out-of-the-money put option with a strike price just below the current market price of the underlying stock - with a near-term expiration date.
- You then simultaneously buy a put option with the same strike price but with a more distant expiration date.
It may sound complicated, but it's not once you understand how to employ this bearish options trading strategy.
Options Trading Primer: A Potential 900% Gain in Six WeeksHere's how a bearish calendar spread might work with Exxon Mobil Corp. (NYSE: XOM), which has held up better than many other oil stocks in recent weeks, closing last Friday at $84.57, barely $3.00 off its 52-week high:
To be specific, stocks - as measured by the Standard & Poor's 500 Index - rose from 1,204.00 at the close on Monday, Dec. 19, to 1,257.60 on Friday, Dec. 30, then jumped to 1,280.15 at midday yesterday (Monday), a gain of 6.32% in just three weeks. The Dow Jones Industrial Average did almost as well, climbing from 11,751.96 on Dec. 19 to 12,398.29 in Monday trading, a 21-day gain of 5.50%.
While those short-term moves are certainly impressive, they're hardly unique in today's volatile market environment. Three similar advances have occurred in the past five months alone - in late August, early October and late November - but each was followed by a sharp short-term pullback that wiped out much of the value gained in the rallies.
And, while few things in the market are certain, there's a strong probability this current market advance will also be followed by a sizeable retracement in the very near future.
So, how do you protect your most recent gains?
One answer is to turn to the options market.
A Defensive Options PlayAs veteran Money Morning readers know, two of the most effective and often-used strategies involving options are writing covered calls to bring in added income and buying put options as "insurance" against possible price pullbacks.
As such, investors would typically look to the latter strategy - buying puts - for protection in the present market situation. However, there are times when unusual conditions can force investors to take an alternative approach to option strategies - and that has certainly been the case recently, thanks to the market's extreme short-term volatility.
If a firm like Goldman will sit idly by while a client eats about $1 billion on a single investment, where do you think you and your portfolio land on Wall Street's list of priorities?
The message here is simple: You can't trust Wall Street - not with a $10,000 investment, a $100,000 investment, a $1 million investment, and especially not with $1 billion investment.
Goldman Sachs claims that the Libyans were picking the derivatives trades themselves. But that's exactly what they would say.
After all, if it got around that Goldman's ace traders were capable of losing virtually all of their clients' money, bonuses would fly out of the window along with most of the business. I'm sure the Libyan government would have offered a rebuttal if it weren't being toppled in a civil war.
The Libyans no doubt did much of the investment decision-making themselves, but the real problem is that there was no basis of comparison for the prices of the derivatives products they were being given.
And that's where there's a lesson to be learned. As a retail investor, you have to be able to determine a two-way price quote for whatever investment you buy.
The investment landscape is littered with the wreckage of failed structured investments.
Between 2008 and 2010 already-strapped cities and states had to pay Wall Street $4 billion in termination fees to get out of various interest rate products that had gone wrong.
For example, there's the exciting 2007 "Abacus" deal by Goldman Sachs trader "Fabulous Fab" Tourre, which lost European banks a total of $1 billion.
The investors in Fabulous Fab's Abacus deal had no independent means of assessing the value of the subprime mortgages in the pool. These were large, "sophisticated" banks, but they deluded themselves with the risk/reward tradeoff they were taking on.
Losses are not confined to the notoriously murky derivatives investments, either. I would bet that the special Goldman clients who earlier this year bought privately offered shares of Facebook Inc. at a $60 billion valuation will end up losing big on their investment as well.
As investors, most of us are not rich enough to get Wall Street's attention, but we should stay informed about how these firms are luring their clients into spectacularly bad deals.
That way we'll all know what to avoid.
In other words, stock prices have historically tended to fall faster - and further - when investors are running scared than they rise when investors get a pleasant surprise.
Lately, however, with Treasury yields still near all-time lows, commodity prices hovering near record highs, and little else offering significant potential, there's a lot of money out there in mutual funds, exchange-traded funds (ETFs), retirement accounts and other institutional portfolios that's looking for a place to go.
And thanks to renewed inflation fears and the growing unrest in Egypt, Libya and other Middle Eastern nations, most forecasters believe the "yellow metal" still has lots of room to run.
But if you watched gold struggle during January 2011, you may also be worried about keeping those hard-won profits - even with the rebound and run to record highs that gold prices have made.