THE BASICS OF OPTIONS AND TRADING REPORT A Beginners Guide to the Wonderful World of Stock Options Trading

www.OptionMillionaires.com

TABLE OF CONTENTS

INTRODUCTION......................................................................................................................................... 1

WHAT ARE OPTIONS?............................................................................................................................... 4

TYPES OF OPTIONS................................................................................................................................... 7

OPTIONS TERMINOLOGY.......................................................................................................................10

OPTIONS: WHY WOULD YOU WANT TO USE THEM..........................................................................12

OPTIONS: HOW THEY ACTUALLY WORK.............................................................................................15

OPTIONS TRADING: THE REAL REALITY..............................................................................................17

THE PRICING OF OPTIONS.....................................................................................................................18

CATEGORIES OF OPTIONS......................................................................................................................20

OPTIONS TABLES: ADVICE ON LEARNING TO READ THEM.............................................................22

WRAP UP...................................................................................................................................................23

1

INTRODUCTION

There are many different kinds of investments available even to the most average of the

Average Joe investors out there, all of whom are looking to add the best investment

vehicles to portfolios buffeted by the market turmoil that seems to be a constant

companion of most investors since the Crash of 2008. Such investments include mutual

funds, bonds, stock and the like. All of these securities are fairly well-known to investors

large and small but there's another kind of investment vehicle that's perhaps less well-

known but which is also of such a high caliber character that many sophisticated

investors always make sure they dedicate a certain percentage of their portfolios to

them. Called an “option,” this class of investment vehicle can present a huge

opportunity for those investors willing to learn about them and then trade in them.

One of the most notable factors speaking for options as an investment vehicle is how

versatile they are when it comes to trading them. Holding options, you're able to adapt

your trading position or trading holdings or to adjust them in accordance with just

about any trading or market situation that develops, for one. If you're a daring and

adventurous trader, then options are perfect for you. But if you're very conservative

and don't like risk, then options are also perfect for you. How this can be so from one

investment vehicle is also why the power of options trading is so potentially lucrative

for those willing to learn how options work and how and why they're traded to such

great effect by investors savvy enough to master the ins and outs of investing and

trading in them.

A point to remember in all this happy talk about options, though, is that there are

potential costs to trading in them as well. Unlike most forms of stock, options are

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sometimes (okay, most of the time) among the more complex securities to trade and

they can be very risky to deal in.

In fact, when dealing with options trading brokerages and the like, there's inevitably a

pretty strong disclaimer presented that takes care to remember potential options

traders that dealing in options comes with risk and that they're certainly not for

everybody. At heart, options trading is speculative in nature, too, and comes with

SUBSTANTIAL risk of loss. When it comes to options trading, you should only do so with

what's called “risk capital,” or capital that you'd have no problem losing should your

options trading strategies not come to fruition.

Because options trading can be a complex business and because of their risky nature,

many investment experts advise those not familiar with how they work to avoid placing

them in an investment portfolio, at least until some time has been spent learning their

complexities. But with great risk comes great reward and options can be among the

most reward of investment vehicles available to the average investor. Given their

speculative nature, though, it's a foolish investor indeed that doesn't take the time to

learn as much about them as is reasonable before investing in them, and that's where

this report comes in. Use it to learn the basics of options before you jump into trading

them, for one. Just jumping into the options market and expecting to learn about them

as you trade in them is downright dangerous and it's the quickest route to losing all of

your investment capital.

Lastly, understand that most options traders have several years' worth of experience in

the ins and outs of options trading, which – by using this report – you'll be able to

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reduce in terms of the experience you yourself will need to develop before actively

trading them. Also, it's strongly recommended that you combine study of options

trading via something like this report with some sort of membership at one of the

better options trading website on the Internet nowadays.

There are a few exceptional sites where top options traders are willing to discuss the

right ways to go about trading in them, and they'll take person interested in this

fascinating trading sector from crawling to walking and then to running, so to speak, in

the options markets. Springing for a membership at one of these sites could be one of

the better investments in your options trading education that you're likely to see

relatively quickly, too.

One last thing: If you're new to options trading and you're also not sure you have a firm

grasp of the basics of the stock market and how stocks are traded then spend some

time boning up on your stocks basics before trying to tackle the more complex activities

that take place when dealing in options trading.

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WHAT ARE OPTIONS?

While investment vehicles like stocks, bonds, mutual funds and others are tangible

assets (or tangible losses when they decline in value) it's best to think of options as a

kind of contract. With an option you have the right but you don't have the obligation to

buy or sell what's called an “underlying asset” (see above for types of assets) at a

specific price or or before a certain specified date, which is mainly why these

investment instruments are called “options.” You have the “option” to buy or sell them,

in other words. Likes stocks and bonds, options are also classed as “securities,” which is

also a legal description for their character or as what they're looked at in the world of

investments. Never lose sight of the fact, when it comes to an option, that it's a legally

binding contract and that like most contracts it will come with very tightly defined

terms, conditions and properties. This is another reason why options can be complex

investment instruments. The below is a good workable example of how an option

would work:

Consider that you're in the market for a house and that you've found a great one. It's in

a nice neighborhood, with good schools, plenty of green space and a super low crime

rate. Plus the house has just been modernized. In other words, it's a potentially great

purchase with good long-term prospects for appreciation in price. However, you don't

have the money to purchase it outright right at this moment and it's going to take you a

few months to line up financing at any rate. The owner of the house, though, is willing

to work with you and will agree to a contract that gives you the option to buy the house

in two months, for example, at an agreed-upon purchase price at the end that two

months. For the privilege of having the option, but not the obligation, to buy that house

at that agreed-upon purchase price all you have to do is pay the owner $2,000, which

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he keeps regardless of whether or not you end up buying his house. Now, there are two

ways this option could play out.

One: In the intervening period between the time you and the owner enter into the

option a real estate boom kicks in and the house has tripled in worth and is now able to

command a sale price at a level far above what you and the owner agreed to when you

entered into the option agreement. Too bad for the owner, though, because he has to

sell you the house at the agreed-upon price should you exercise your option to

purchase it. That's good news for you, because you can exercise your option, purchase

the house, turn around and sell the house at its new market value and pocket a

handsome profit.

Two: In the intervening period between the time you and the owner enter into the

option, a market crash ensues, termites are found in the home and its value declines

sharply. You're now left with an option to purchase a home worth far less than its

original agreed-upon price and you know there's no way you'd want to buy it at this

point. Fortunately, because you're under no obligation to purchase the house – under

the terms of the option agreement – you're able to avoid a potentially perilous financial

situation. Of course, avoiding this situation by not exercising your option will come with

definite costs, those “costs” in this case being that you lose at least $2,000 dollars on

the deal, which is the price you paid to purchase the option to buy the house at the

mutually agreed-upon price. You're out two-grand, but you're not out $200,000, in

other words. This is where the risk equation when it comes to options is most evident.

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The above example perfectly illustrates a couple of characteristics when it comes to

options. First: When you purchase an option you have the right but you don't have an

obligation to do something. If you don't want to do that something – typically, this

involves purchase a block of stocks or some other underlying asset – simply let the

option period expire and walk away and be out only your option purchase price. In

some cases, this could be the smartest investment decision to make and losing 100% of

that investment money could save you lots more

money in the end. The second characteristic to remember is that options are nothing

but contracts that are supported by their underlying assets, such as stocks, bonds and

the like. For that reason, options are called “derivatives,” and they DERIVE their value

from the underlying asset, usually. In and of themselves, options have no redeemable

value whatsoever. In the vast majority of cases, the asset underlying an option is a stock

or some sort of index.

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TYPES OF OPTIONS

Options come in two types: Calls or Puts. A call option (if you're a poker player, you've

heard the term “I call,” right?) give the holder of the option the right purchase an asset

at a certain price and within a specified time period. If you know what stocks about,

think of call options as “going long” or taking a “long position” on a stock. When you

buy a call option, you're taking the position that the asset (typically a stock, in which

case the option would be known as a “stock option”) will appreciate in price or value

before the option expires. If it does, you exercise your option to buy, purchase it at the

lower price and then turn around and sell it at the new higher price, pocketing the

difference between the two prices as pure profit.

In the case of a put option, you're holding the right to sell an asset (typically a stock) at

a certain price and within a specified time period. Again, in the stock world, having a

put option would be like a stock investor who takes a short-term position on a stock.

Buying a put option would mean that you're expecting that the price of the asset (a

stock, say) will fall before the expiration of the option. You can then short-sell the asset

and pocket a handsome profit as well.

There are four, and only four, types of options market players (participants, really), and

having only four types makes it easy to understand just who's playing the options game.

One: Buyers of call options.

Two: Sellers of call options.

Three: Buyers of put options.

Four: Sellers of put options.

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If you're buying options you're also going to be known as a “holder” in the options

language used by all options traders. If you're selling options you're going to be known

as a “writer.” In all cases, holders (buyers) have long-term positions and writers (sellers)

have short-term positions, so never forget that when it comes to the buying and selling

of options. You buy or sell call options and you buy or sell put options. Holders are

“long” while writers are “short.” Here's the most important thing to remember about

holders and writers, though:

Call holders and put holders (buyers) don't have to buy or sell. They've got the right to

exercise the right to buy or sell if they so choose.

Call writers and put writers (sellers) must buy or sell. They can be required to make

good on a promise they make to buy or sell the assets underlying the options, in other

words.

After reading through the above you'll see it's easy to figure out why options trading

can be a bit complex, especially if you're dealing with options as seller, which is riskier

than being a buyer of options (though it can also be more financially rewarding). At

base, what you need to understand is that there are always two sides to an options

contract; buying and selling. Buying options is always easier to understand, so we'll

spend some time working our way through that aspect of options trading first.

Before proceeding any further with options, it's important to understand some of the

terminology a bit more thoroughly. Doing so will give you a level of comfort with the act

of options trading that will help prevent you being sucked into this or that unsteady or

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outright fraudulent options trading scam, for one. For another, understanding the

terminology that defines options will give you a higher level of competency in a shorter

length of time, thereby allowing you to more easily participate in options trading,

perhaps to your ultimate financial benefit.

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OPTIONS TERMINOLOGY

Strike Price: The price at which an underlying asset (for purposes of this report, we'll

use stocks) can be bought or sold. The strike price is the price must go above (for calls)

or go below (for puts) before you can exercise a position for a profit. Remember;

positions can be long or short. All of this activity has to occur, though, before the

option's expiration date or all bets are off and you're out, at minimum, your option

payment.

Listed Option: All options that are traded on a national options exchange (a well-known

one is the CBOE, or “Chicago Board Options Exchange”) are called “listed options.” Their

strike prices and their expiration dates are fixed and each option in them represents

100 shares of a company's stock, which is also known as a contract.

In-the-Money: For call options, when the share price is above the strike price, the call

option is said to be “in-the-money.” For put options, when the share price is below the

strike price the put put option is said to be “in-the-money.”

Intrinsic Value: Regardless of the type of option, call or put, the amount by which the

option is in-the-money is said to be that option's intrinsic value.

Premium: The price (its total cost) of an option is called its premium. That price is

arrived at through a number of means, including the stock price, its strike price, its

“time value” (the time remaining until the expiration of the option) and the volatility of

the option (some options are highly unstable or “volatile” while others a far less volatile

and, hence, far more stable and predictable). Figuring premiums on an option is very

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complicated, so if you're curious about how to figure such things we suggest advanced

study or time spent on just options premium determinations, which is a field of study

all its own.

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OPTIONS: WHY WOULD YOU WANT TO USE THEM?

For the most part, investors deal in options for two reasons: To speculate or to hedge.

At its core, speculation – at least when it comes to securities – is a bet on the

movement, one way or the other, of a security. The beauty of options, and one of the

major reasons why sophisticated investors trade in them, is that you're able to make a

profit – if you're good – on options not only when they go up in price (when their

market goes up) but you can also make a profit when they go down in price (their

market goes down) or even when their prices move sideways, neither up nor down. You

can realize profit on options in all three market conditions because options are so

inherently versatile just by nature. And if you're into the idea of making really big

money in securities, then options speculation is definitely where you want to be. Just

keep in mind, though, that options speculation is also where really big money can just

as easily be lost if you're not sophisticated or experienced enough to trade in options.

Speculating on options this way is precisely why they're known as being risky

investment vehicles, in fact. Reasons for why they're risky can be boiled down to the

following points:

When you buy an option you have to be right when it comes to the direction of the

stock's movement (up, down, or sideways). You also have to be correct on

the stock's magnitude of movement as well as also being correct on the timing of that

same movement. You'd have to: 1) Correctly predict whether a stock is going to go up

or down; 2) Be correct about just how much the price of the stock will change; and 3)

Be correct about the length of time (the time frame) in which all this will happen. Plus,

during all this activity you're also racking up commissions that will have to be paid to

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the broker executing all these options moves for you. Because of all these factors the

odds of you successfully speculating on an option generally tend to be against you

prevailing or making a profit. This would be discouraging except for the fact of what's

called “leverage.” Using leverage, which is an inherent feature of an option contract.

With you able to control, for example, 100 shares of a stock with just a single contract,

even a very small price movement can generate a substantial profit, in other words.

When it comes to hedging (you've heard the phrase “hedge your bets” before, right?),

what you're basically doing is purchasing an insurance policy. It's really no different

than taking out insurance on your car or on your home, and you can use options to

insure your investments against a market downturn. Many sophisticated investors are

disdainful of hedging because they think it's a way-too-safe (meaning, that with less risk

will come less reward) act that greatly limits the profit potential that can be realized

when one deals in a generally risky investment vehicle, which an option normally is. In

essence, if your stock pick makes you so unsure that you require a hedge against the

risk it present, then maybe you shouldn't make an investment in it in the first place, or

so goes the thinking of all the so-called “smart money” players and investors in the

options world.

However, the thing to keep in mind about hedging of options is that if it wasn't so

useful, in certain circumstances, then there wouldn't be a need for it. A good hedging

strategy to manage risk when it comes to options trading can make a

great deal of sense, even for the small individual investor (hedging is often seen among

large institutional investors, generally speaking). For an individual investor, hedging can

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help limit losses on a particular stock and you would do this by making use of options,

thereby restricting downside issues while taking full advantage of the upside movement

in a way that's most cost-effective. Hedging options can also get complicated, so take

some time to study up on what are called “married puts” as a way of limiting downside

risk when it comes to stock options.

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OPTIONS: HOW THEY ACTUALLY WORK

The best way to explain how options work is to provide an example of options in action.

For example, let's take a look at XYZ Company, a manufacturing firm of some note. On

the first of this month, stock in XYZ Company stood at $35 per share. The premium (its

cost) on a 100-share option on XYZ Company is $2.50 for an August 40 Call. The

preceding figures indicate that expiration of the option is for the 2nd Friday in August

and the strike price of the stock would be $40 per share. The total price of the option

contract would be $2.50 X 100 = $250 (broker commissions are also normally a part of

the price of an option contract, too). Remember that we also pointed out that an

option contract is for 100 shares of stock, which is why you multiply the contract by 100

to arrive at the price of the contract itself, being $250 in this particular case.

Take a look at the strike price in this example, which is $40. That means that the stock

price in XYZ Company must rise above $40 before a call (buy) option is worth anything.

And because this contract is $2.50 per share the “break-even price” would be $42.50

per contract. At this point, because the stock price is only at $35 per share, the option is

essentially worthless. And because you paid $250 to purchase this contract you're $250

negative or “in the hole.”

Let's say that a month later, stock in XYZ Company is now worth $45 per share. The

options contract has also moved up in price and is now worth $3.50 x 100, or $350.

Your profit in this case would be $100 ($350 - $250 = $100). If you wanted to, you could

“close your position” on this options contract by selling your contract and take your

profit. Or, you could hold onto the contract in expectation that the stock's price will

continue to rise, which is known as “letting it ride.” Unfortunately, by the expiration of

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the options contract, stock in XYZ Company has declined to $33 per share, two dollars

less than the $35 strike price and leaving you with a worthless contract yet again. You're

now down to your original investment of $250. As an example of leverage in this

example take a look at the price swing in the stock options contract, which went from a

low of $250 up to $350, which would have realized you a $100 profit just by controlling

100 shares of stock – via an options contract – in the company.

The above is a nice illustration of how a relatively small amount of money can control a

much larger amount of stock assets, potentially, without even really having to buy the

stock first. What you've invested in is a right to buy or sell some stock but not the stock

itself, in other words. If you've taken out an options contract on shares of XYZ stock at

$2.50 per share (remember, a contract is for 100 shares of stock) and the stock

increases in value before the expiration of the contract, thereby driving up the premium

on the contract to $3.50, you'll have made $100 on the option contract, and all without

having had to initially purchase the 100 shares in the first place! This is a major reason

why options trading can be so attractive, and options really are attractive under many

circumstances, especially if you're skilled enough to buy and sell them as the situation

dictates. Just remember the element of risk in them, as was pointed out in the story of

XYZ company, because there really is a measurable amount of risk in the trading of

them. It behooves you, then, to learn as much about trading them as you can before

actually getting into the options trading game in a big way, which is one reason why

you're reading this report.

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OPTIONS TRADING: THE “REAL REALITY”

Up to this point, the discussion on options trading has involved how they're bought and

sold (known as “exercising” your right to buy or sell the underlying asset), which in

most circumstances is a fairly cut-and-dried affair. However, most aren't normally

exercised at all. That's because options holders normally trade out – called “close out” –

their positions when it comes to these instruments or investment vehicles. What this

means is that holders mostly end up selling their positions in the market and writers

buy their positions back in order to close out. Research has shown that only about 10%

of all options contract are exercised, which is a low number indeed. Another 30% of all

options contracts are allowed to expire – with holders of those options losing the

money they used to purchase the options – while the remaining 60% of options

contracts are traded out, which is where the real money is options trading is made, of

course. If you're smart and you learn how to manipulate your options activities

correctly, the positions you take via your options trading activities can generate

lucrative income for you. But you'll really have to work at developing the faculties

necessary, as well as the access to all the data and information you'll need to trade in

options, before you can do well enough at them to realize consistent profits. Options

trading isn't for the faint of heart and if you can't tolerate a healthy amount of risk then

they may not be for you.

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THE PRICING OF OPTIONS

In the last section, we showed how the change in the premium, or price, of the option

moved from $2.50 all the way up to $3.50 (in reality, premiums can move in much

greater amounts over a short period of time, which is why seriously nice money can be

made from them). Why a premium on a stock option moves the way it does can be

ascribed to two factors: its intrinsic value and something called “time value.” Most

people who have even a small amount of interest in investing or saving have heard the

term “time value of money” and time value as it's applied to options trading is really no

different. In investing there's value in time and time in value, so to speak.

Keep in mind that when it comes to an option, the premium for that instrument is its

intrinsic value plus its time value. As we defined in the terms section “intrinsic value” is

the amount in-the-money which, if we're discussing a “call” option, means that the

price of the stock will equal its strike price. The concept of “time value” when it comes

to an option has to do with the POSSIBILITY of the option increasing in value over time.

Here's an example:

Premium (of a stock): $2.50

Intrinsic value: $2.00

Time value: $0.50

Out in the real investment world, options almost always trade above their intrinsic

value – which we observed previously is a complicated equation or calculation. How

options can work in real life can be somewhat more complicated, therefore, than what

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we've illustrated above, but it serves to show just how options traders size up an option

using a variety of measures of value and risk before they take a position on that option.

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CATEGORIES OF OPTIONS

Two types of options exist: American options, and European options, though location

(America or Europe) actually has nothing to do with why they're referred to so. Actually,

it has more to do with how they're traded than anything else. With American options,

they're able to be exercised at any point between the date of purchase and their

expiration. The XYZ Company example we highlighted earlier is an example of trading in

American options. If you decide to make use of what are called “exchange-traded

options” you'll probably be dealing in American options, for what it's worth. European

options, by contrast, can only be exercised at their expiration, which is the end of their

useful lives.

Another characteristic of options lies in how long they live, which we've only touched

upon in a broad sense. Most options traders, being people comfortable with greater

risk, tend to prefer shorter-term investment horizons, which the typical option contract

brings to the table. However, there actually are longer-term options available to the

options investor or trader. These types of longer-term options are called LEAPS, or

“long-term equity anticipation securities.” Most long-term options feature 1, 2 or even

3-year or longer holding times, which tends to appeal to those investors out there that

prefer long-term investing horizons. LEAPS aren't available on some options types but

they're almost always available on all the most widely held stock issues. LEAPS also

offer the opportunity to control or manage risk to a greater degree than is possible with

the typical short-term options contract and are almost identical to those shorter-term

investment vehicles, so they may make sense for you if you're not completely

comfortable with large options of risk.

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The last thing to understand when it comes to options types is that there are many,

many different variations, though most of the simple buy-sell/call-put/hold-write

options are often referred to as “plain vanilla options” there are an array of non-

standard options that traders call “exotic options.” For those just starting out in options

trading, plain vanilla options – which are very easy to understand, for the most part –

are most likely the options trading investment vehicles to take on, at least until you've

gained some experience and training in the ins and outs of trading in other variations of

options, including the exotic versions. It's these exotic options that present some truly

intricate variations on the payoff profiles of plain vanilla options or are even completely

different options with their optionality being the facet most thoroughly embedded

within them. What this means is that you'll probably need a fairly sophisticated

understanding of them before giving them a try. Exotic options come with so many

variables you'll need to pay close attention to them in order to effectively trade in

them, in other words.

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OPTIONS TABLES: ADVICE ON LEARNING TO READ THEM

One piece of advice to remember when it comes to trading in options is that you should

never do so until you have a basic familiarity with the various types of options table

published online these days. Though each website or source supplying an options table

may vary the content of the table slightly, almost all of the online versions carry much

of the same information that can be found in their competitor website options table

offerings. In addition, a number of quality options trading software programs populate

their options tables with an array of data that today's increasingly sophisticated and “in

the know” Average Joe options trader has learned to quickly grasp, which is why we

recommend spending some time learning the basics of how to read a typical options

table.

It's beyond the scope of this report to break down and then explain in some detail each

of the data boxes within an options table but it's a fact that you can, if you spend just a

small amount of time learning about facets of an option table such as “Delta Bid/Ask

(%)” or the “Open Interest” column or any of several other columns found on the table

that, if you understand what they're saying, will make you a much more confident – and

successful – options trader. There are a few top-quality options trading and options

trading education websites out there on the Internet that will gladly take the time to

explain the intricacies of the options table and it's definitely worth your time, if you

intend to make income from options trading, to explore them.

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WRAP UP

It's been said before, but it requires saying yet again: Options trading isn't for

everybody, mainly because they tend to be sophisticated trading tools and on a level of

investment above standard trading activities in stocks themselves. That's why it's

important that you gain an education and an understanding of how they're traded

before you invest any of your capital in them. Options come with measurable risk that's

sometimes quite high, as well, so never trade in them with capital that you're not

prepared to lose, if it comes to that. Keep the options trading review below in mind as

you contemplate becoming an active investor in them:

An option is a contract. It gives you the right, but doesn't require an obligation, to buy

or sell an underlying asset such as a stock at a specific price with you having to do so on

or before a specified date.

An option is considered a derivative, and trading in derivatives in typically considered as

trading in an exotic investment instrument. Options are called “derivatives” because

they DERIVE their value from the underlying asset, not from the mere fact of the

existences of the option itself.

When you “call” on an option, you have the right to buy, when you “put” on an option

you have the right to sell. There are also only four types of participants in the options

markets: Buyers of calls, sellers of calls, buyers of puts and sellers of puts. Buyers of

options are typically referred to as “holders,” while sellers of options are referred to as

“writers.” Lastly, the “strike price” of an option is price at which an underlying stock can

be purchased or sold.

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We can't emphasize enough that you spend the time and effort gaining a solid

grounding in options trading before you decide to engage in them. While extremely

potentially lucrative, if you trade them smartly, they can also be extremely risky if you

trade in them without having a complete understanding about what you're doing.

That's why we always recommend that you invest a little in a good pre-options-trading

course or a membership at one of the top options trading websites on the Internet,

where you can learn about options trading at your own pace, discuss in real-time and

with real options traders how options trading works and pore through all of the articles,

examples, videos and other education materials these options trading education

websites make available. Your initial monetary investment in one of those programs or

at one of those websites is likely to be repaid several times over with just your first

options trade if you conduct it smartly, which you'll be much more likely to do if you

first spend some time gaining crucial knowledge about options and about how to trade

them. Good luck in all your trading activities, both now and in the future!