Table of Contents
Acknowledgments xi
Introduction xiii
Part 1 The Foundations of Options Trading 1
Chapter 1 Option Basics 3
Definitions of Calls and Puts 3
Are You Long or Short? 4
Option Contract Size 4
Is My Option In- or Out-of-the-Money? 5
Option Trade Orders 5
Option Expiration 6
LEAPS Options 7
Option Settlement 7
Options Cycles 8
Chapter 2 Probability Distributions 11
The Gaussian Distribution 11
Application to the Real World 12
Risk-Adjusted Returns 15
High-Probability Trading 17
Low-Probability Trading 18
Options Trading Myths 20
What Is a Conservative Trade? 21
Exercises 22
Chapter 3 Options Pricing and Implied Volatility 25
The Black-Scholes Pricing Model 25
The Greeks 26
Implied Volatility 27
Building the Price of an Option 28
A Closer Look at the Greeks 29
How Will We Use the Greeks? 31
Exercises 32
Chapter 4 Vertical Spreads 33
Building the Vertical Spread 33
Effects of Implied Volatility 35
Early Exercise 41
Expiration and Exercise 43
Margin Requirements 44
Application of Probability Calculations 45
Risk/Reward and Probability of Success 46
Exercises 47
Part 2 Options Strategies for Income Generation 49
Chapter 5 Using Options to Boost Income in a Stock Portfolio 51
The Classic Covered Call Strategy 52
Strategic Considerations 53
The Notorious Selling Naked Puts Strategy 53
Selling Naked Puts for Income 54
Buying Stocks at a Discount 56
Combining the Covered Call with Selling Naked Puts 56
Early Exercise 58
Risk Management 60
The Achilles’ Heel of Directional Strategies 61
Exercises 62
Chapter 6 Calendar and Double Calendar Spreads 63
Vega Risk and Calendar Spreads 66
Volatility Skews 67
Searching for Calendar Candidates 70
Entering and Managing the Trade 71
Early Exercise 71
Adjustments 72
Out-of-the-Money Calendar Spreads 73
Double Calendar Spreads 73
Determining the Optimal Strike Prices 76
Trade Management and Adjustments 82
Multiple Calendar Spread Positions 83
Exercises 83
Chapter 7 Double Diagonal Spreads 85
Diagonal Spreads 85
Double Diagonal Spreads 87
Managing the Trade 90
Double Diagonals vs. Double Calendars 91
Exercises 92
Chapter 8 Butterfly Spreads 95
At-the-Money and Out-of-the-Money Butterfly Spreads 95
Iron Butterfly Spreads 99
The Broken-Wing Butterfly 99
Margin Requirements 101
Trade Management 103
Closing Butterfly Spreads 106
Butterfly Spreads as Adjustments 111
Exercises 112
Chapter 9 Condor Spreads 113
The Basic Condor Spread 113
The Opportunistic Model 116
The Insurance Model 119
Iron Condor Spreads 121
Vega Risk and the Condor 124
The Short-Term Iron Condor 128
The Long-Term Iron Condor 129
Capital Management 131
Risk Management 131
Adjustment Techniques 132
Adjustment Pros and Cons 134
Adjustment Case Studies 135
Managing the Iron Condor with the Greeks 138
Advanced Adjustment Techniques 140
Iron Condor Trading Systems 140
Butterflies and Condors are Cousins 144
Exercises 146
Chapter 10 Delta-Neutral Trading Strategies 149
Risk Management Systems 151
Challenging Markets for the Delta-Neutral Trader 152
Two Distinct Trading Philosophies 153
The “Secret” of Success 155
Chapter 11 Make Your Trading a Business 157
Getting Started 157
Managing Losses 159
The Trading Plan 159
Money Management 160
The Psychology of Trading 161
Living with the Two-Headed Monster 163
Required Tools for This Business 164
What’s Next? 165
Appendix: Answers to the Chapter Exercises 169
Glossary 185
Index 193
