By: Steve Smith
Today, I present a labor of love reading list for the options trading enthusiast.
With July 4th just around the corner, summertime offers an opportunity to lather on the tanning oil and brush up on your options trading knowledge. Not that I wouldn’t reach for the latest Jack Reacher novel, object to the suggestion of Grisham’s courtroom intrigue or deny the deal making put forth by Trump.
But as someone who writes about and actively trades options, I belong to the camp that believes options are a valuable investment tool that, when properly utilized, can both boost returns and reduce risk. So instead, impress your neighbors, annoy your family and study yourself into a well-deserved siesta with some of the best books and resources on options. It may lack the drama of reading about Greece or central banks’ interventionist policies, but I promise the long term benefits are greater.
That said, I acknowledge the validity of many of the arguments made against options trading. Perhaps pointing out the most common pitfalls, rather than proselytizing on the benefits, is the best approach to bring some evenhandedness to the subject.
I’ll tee up a few topics and offer some reading suggestions for those that want to delve deeper and don’t mind being spotted on the beach thumbing or swiping through an options book or tablet.
As with any tool, before using options, make sure you are familiar with the basic rules and guidelines that govern their behavior.
For starters, make sure you know the contract specifications the product you are trading. Items such as margin requirements (pay special attention to leverage), the exercise and settlement procedures, and what strikes and expirations are currently listed for trading are important to know.
For example, you should be aware that index options, such as for those on the S&P 500 or SPX, can only be exercised on expiration day and are cash settled; also note that SPX options actually cease trading on the third Thursday of the month, a day earlier than equity options, though they officially expire on the third Saturday.
By contrast, equity options, including those on the Spyder Trust (SPY), can be exercised at any time during the life of the contract. This is especially important when trading options on stocks that pay dividends.
A terrific book that covers all the basic concepts and strategies is Options as a Strategic Investment by Lawrence McMillan.
For more sophisticated techniques, try Option Volatility and Pricing: Advanced Trading Strategies and Techniques by Shelton Natenberg.
Dealing in Dividends
If you own in-the-money calls on Exxon (XOM), make sure you know when the ex-dividend date occurs — you will need to exercise your calls if you want to qualify for the payment. Likewise, if you are short an in-the-money call on a dividend-paying stock, be prepared for assignment and being short the actual shares the day before it goes ex-dividend.
Most ETFs pay dividends. Some, like the Spyders, pay out on a quarterly basis. For some reason, the ex-dividend date often falls on the Thursday prior to a quarterly expiration. Meaning many people have failed to exercise an ITM call and lose out on the dividend while others or are unwittingly assigned puts and forced to pay.
Others, like the Dow Jones Diamonds (DIA) make monthly distributions. The point is, knowing the basic rules by which the various vehicles operate will help you avoid surprises such as an early assignment on an in-the-money call.
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.
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