Outline: Part I - Basics

"You underestimate the power of the Dark Side. If you will not fight, then you will meet your destiny."

- Darth Vader to Luke Skywalker, Episode VI

The first part will be a quick overview of equity basics followed by option fundamentals. I'll explain what options are and why one would use them. Then I'll emphasize how risky they are if you aren't using a strategy or you don't understand its risks!

Part I will be composed of four chapters. Here's a list plus a few topics that will be covered in each:

1. Equity Basics: Quick run through of what is a stock, index, ETF, and financial derivative.
2. Option Basics: What is an option?, Long/short call, long/short put
3. Fundamentals: Strikes, premium, moneyness, expiration, exercise, assignment
4. Classifying Options and Strategies: Directional assumption, profits and losses, debits and credits, volatility assumption

The first two chapters are just to bring everyone to an equal footing. Ideally one would already have some of this knowledge. Chapter three may need to be switched or merged with chapter two since you need to know about this to explain options. The last chapter is just some ways to categorize the different strategies. I'll be explaining what they mean here.

Draft Foreword

"A long time ago in a galaxy far, far away...."

- Star Wars opening craw

Although this may be a bit early, I decided to draft a foreword. I feel like usually the foreword is one of the last things you write, but in this case I wrote it to give a sense to myself as to why I doing this. Without further ado, here it is:

Learning about options has been an interesting and enjoyable process for the most part. It definitely wasn’t a smooth journey and I still wouldn’t call myself any sort of an expert. I have no formal qualifications related to finance – everything I know I learned in my spare time. I will admit that I started off by using options as a get-rich-quick plan. After figuratively throwing some of my money into the garbage, I realized that nothing is really that easy in life. At that point I rededicated my efforts to understanding options and how they could be employed.

Options can be like a good friend if used correctly – more good times than bad. But without careful planning they can also easily turn on you and wipe out your account. Keep in mind that the informed trader is the wise trader.

This text is not so much for you as it is for me – the best way to master something is to try to teach it. I expect that I will make errors and mistakenly inject my opinions into this piece. I hope that you, the reader, have a cautious mindset while reading this and are open to informing me of any mistakes. If you benefit at all from this book, all I ask is that you let me know. If you took the time to read any of it and found you didn’t appreciate it, I too ask that you let me know – but specifically on what can be improved upon. Please send all e-mails related to errors and/or suggestions to <e-mail 1 here>.

The current plan is for this to be a companion reference for options, not an instructional text. I will release it in stages as my progress permits, so please be patient with its perpetual “work in progress” status. For more general comments <e-mail 2 here> is where I can be reached.

May the odds be ever in your favour and the force always with you,

The Author
September 23rd, 2015

Yes, I have had that draft sitting around for two and a half weeks.

Trade Recap: First Short Put - Part 1

I've been watching a lot of tastytrade and I thought I'd try out a little of my newfound knowledge in action. The guys over there are always talking about limiting profits to improve profitability, which means selling instead of buying options and using probabilities. I decided to use SPY (SPDR S&P 500 ETF) as my underlying for 4 reasons:

1. It tracks an index so I don't have to worry about individual earnings or dividends - it moves with the market
2. Although the%  margin requirement is higher, it's about 10x cheaper to enter a position than using SPX (the actual S&P 500 index)
3. It trades above $100. It's actually closer to $200. This is important since commissions are high enough to set a minimum on the options I can trade. If the price is too low, then all my potential profits are going towards commissions.
4. It has high volume which means high liquidity - the bid-ask spreads aren't atrocious here compared to other choices.

Using their advice I looked at a Strangle with strikes at one standard deviation (SD). I entered the trade on September 18th when SPY was trading at $196.74 with an IV (implied volatility) of 19.45% on the October monthlies (October 16th expiration). I know the recommended DTE (days to expiration) is 45, but I November monthlies were too far out at that point. The strikes would be at $187 and $207 to be roughly one SD.

Looking at the bids, the Put would get me around $1.21 while the Call would give me $0.24. This worried me as entering a Strangle with those credits would give me a ~68.2% chance of max profit while having a 74.6% of any profit. Knowing that the Call side premium wasn't really high, I did the same calculation for just the Put. A short Put at $187 would have an 83.5% chance of max profit and am 86.3% chance of any profit. So by reducing my max profits by 15.4% ($1.43 to $1.21) I increased my chance of max profit by 15.3% and chance of any profit by 11.7%. Since I liked those odds, that's what I did.

To recap the trade I sold to open (STO):

• Trade date: Septeber 18, 2015
• SPY at $196.74
• DTE: 25
• October 16, 2015 monthly IV: 19.45%
• Trade: STO 1 October 16 SPY Put @ 1.30 (I ended up getting more than the number I used in my calculations)

Keep in mind that this is a naked position. If things go badly, my losses are only limited by the underlying's price. This did bother me which is why I only sold 1 contract (and the fact that you should always start off slowly when still learning). But I figured that I had done the math (although a Normal distribution of stock returns is not exact) and doing an Iron Condor or Bull Credit Spread (a.k.a. Put Credit Spread) would garner no profits (because of the comission). Next time I'll cover the rest of the trade to close (hint: this is posted before October 16th....)

General Outline

"This is some rescue! You came in here, but didn't you have a plan for getting out?"

 - Princess Leia, Episode IV

I've been drawing up an outline of what topics I should include in the text and I've divided them into 4 parts. Each part will be composed of multiple chapters, and each of those further sub-divided into sections. What I have in mind is:

1. Basics: A quick overview of equity basics followed by option fundamentals
2. Strategies: The bulk of this text. A comprehensive description and classification of option strategies
3. Adjunct Material (Needs a better name): More advanced material on options. Also includes case studies and lookup tables of strategies based on different criteria
4. Appendices: Support material

The first two parts are pretty self-explanatory for now - I will detail each part in future posts. Part III is really just a dumping ground for topics I think are good to know. This will include the Greeks and some math on probabilities. I'm also planning to put a few case studies, although that will be one of the last things to write. The Appendices is where the index and references will be. I will also be including a short guide on using Excel to calculate probabilities and such, Finally, I'll also include a list of learning materials that I learned from or found interesting.

Meta Update - First Post

 "Oh, Anakin's not a Jedi yet. He's still a padawan learner."

- Padmé Amidala, Episode II

Welcome to the first of my meta-posts about this blog. As you may be able to tell already, I am a Star Wars fan. My intention for these posts is to update you the reader on my plans for this blog.

This blog is to document my attempt to write an introductory to intermediate guide on option strategies. Although I have a vision for what this should be, I expect it will evolve as I write the text and get feedback. Soon I will begin posting various outlines, drafts, and excerpts from here. This mostly as a learning exercise for myself - as I write, I will learn at the same time. Since that's the goal, I don't intend to monetize this guide in any way. However, please keep in mind that I am not a financial professional nor expert, and have learned the material on my own.

A secondary goal is to document any interesting trades I think of. I might make or lose money so under no circumstances should you view this as trading advice - it is purely academic. In fact most of the trades will be paper trades - especially if they're risky!

Since I'm only able to work on this in my spare time, I think I'll schedule updates for Mondays. If I end up keeping a better pace, I may add another update per week.Or maybe I'll save the second weekly post to comment on my paper trades.