3 Trading Horizons Of Options Trading
Have you ever lost money trading stock options?
Chances are good that you tried to apply the 3 trading horizons of stock trading to options trading and then got yourself hurt real bad.
There are 3 time horizons or what we call trading horizons in stock trading and they are; Long Term, Mid Term and Short Term. Long term horizon in stock trading means the buying and holding of stocks for 3 to 5 years, or sometimes longer. This is ideal for value investing in the long term prospects of a company. Mid term investing in stock trading is the buying and holding of stocks for 6 months to a year or two. Most stock investors use a mid term view to invest in new growth stocks which are expected to perform well in the immediate year. Short term investing in stock trading is the buying and holding of stocks for 3 to 6 months. These are stocks of companies that are expected to make a breakthrough in their industries. However, do these notions of investing apply in
options trading? Not at all!
The truth is this: Stock Options are derivative instruments that have very short contractual lives! In fact, the longest expiration for exchange traded stock options rarely exceed 1 year! On top of that, the extrinsic value, or what we call time value, built into every stock options contract decays as expiration draws nearer, diminishing the value of your options even if the underlying stock remain stagnant. Due to these characteristics, stock options are trading instruments, not investing instruments, and have much shorter trading horizons than if you trade stocks. This is also why options trading is associated so closely with technical analysis these days because technical analysis is extremely useful in identifying short term trends or reversal of trends.
So, how is the long term, mid term and short term trading horizon defined for options trading?
In Options Trading, long term horizon is the buying of options with expiration of up to 1 year in order to speculate a long term rally or ditch in the underlying stock. Typically, long term charts on monthly time periods are used to identify such trends. Mid term horizon is the buying and holding of monthly options all the way to their expiration, each trade lasting no more than a month. Charts on weekly time periods are particularly useful for identifying mid term trading opportunities. Short term horizon lasts from 3 to 15 days in order to speculate a quick short term surge or ditch in the underlying stock and typically uses short term daily time period charts to identify trading opportunities.
From the above definitions, it is clear that stock options, as a short term trading or hedging instrument, is useless for anyone who is investing in the long term horizon defined for stock trading. Therefore, before you decide to completely replace your stock investing with options trading, first decide if trading
stock options allow you to trade the way you always have with stocks. If it doesn’t, it is time for you to either stick with stock investing or learn a trading system which is perfectly suited for options trading.
By Jason Ng
Jason Ng is the Founder and Chief Option Strategist of Masters 'O' Equity Asset Management (
MastersoEquity.com ) and author of
OptionTradingPedia.com . He is a fund manager specializing in options trading and his revolutionary Star Trading System has helped thousands.
3 Reasons Why Stocks Move
For years, I have been asked this same question over and over again, “Why does stocks move?”.
For most people, the reason why stocks move has been a mystery. In fact, there are people who believed that someone is controlling these movements behind the scene playing against them! There are even people who believe that stocks move mainly due to good fundamentals. Well, look at it this way, if there is this big institution playing against you and taking all your money away from you, why aren’t all the financial institutions making money year after year? Why are so many funds closed down every year? If stocks move just because the business fundamentals are good and that the business makes sense, then why do good stocks fall at all?
The truth is this; stocks do not move based on what is happening in the world right now but based on expectations of future events! These expectations create a temporary imbalance in the number of buyers and sellers, moving prices. When there are more buyers and fewer sellers, sellers will hold off selling until prices have been bid up higher. When there are more sellers than buyers, sellers will continuously lower their asking price in order to entice buyers to pick up their stocks. Those dynamics create the ups and downs in the stock market.
What do “expectations” in the stock market really mean? To put it simply, you would avoid driving along a road that is expected to be congested, right? You wouldn’t go all the way down the road and see the congestion before deciding what to do, will you? That is the same decision making dynamic in the stock markets. The real issue here is what kind of expectations drives that temporary imbalance in the number of buyers and sellers which moves stock prices? That brings us to the 3 reasons why stock prices move at all.
Reason 1: Earnings Expectation
Have you ever wondered why a lot of stocks actually fall after releasing good earnings? Well, that’s because along with every earnings release comes earnings guidance! Earnings guidance is the estimated earnings for the following quarter. If the next quarter is guided lower and the stock is expected to fall when the time comes, wouldn’t you start selling today while prices are still high? That’s the same theory behind the congested road scenario mentioned above. Similarly, if earnings guidance is great, the stock continues to move higher. This is what the stock market call “pricing in” the future earnings.
Reason 2: Dividends Expectation
Dividends are an extremely important reason to own stocks. For stocks that never pay a dividend, this is not really a concern but for stocks which have been paying a steady dividend, changes in the expected dividends yield can cast doubts on the future profitability of the company, thus resulting in a sell off today. Similarly, if expectations of future dividends are raised, future profitability of the company can be expected to be better, resulting in a rally today.
Reason 3: How Much Investor Are Willing To Pay For Those Earnings & Dividends
Yes, now that you know that earnings expectations and dividends expectations creates the conditions by which stock prices might change, the only question which remains is how much would such a change be? Just as you might wish to pay a different price for your burger down the street under different economic conditions, the amount of money investors are willing to pay for future earnings and dividends also differ under different economic conditions. When the economy is looking upbeat and everyone’s optimistic, you might be willing to pay a higher price for the same expected future earnings. Conversely, when the economy is looking sour and everyone’s pessimistic, you might want to pay a lower price for that same earnings outlook. All these are reflected in what the stock market call “multiples” or the full name being “Price Earnings Multiples” or “PE ratio”. The PE ratio tells you how many times above earnings is the current stock price and represents the amount of money investors are willing to pay for that earnings outlook. Under good economic conditions, investors may be willing to pay up to 100 times earnings while bad economic conditions may justify only a 50 times earnings.
When times are good and higher prices are justified for the same earnings, the stock market is in a period of “Multiples Expansion”. Conversely, when times are bad and lower prices are warranted for those same earnings, we call it a period of “Multiples Contraction”. Understanding which period the stock market is in will result in tremendous profitability trading
stock options which can profit both ways.
These 3 factors interact in the minds of traders and investors all the time. Sometimes when earnings guidance is higher for the next quarter in a poor economic condition, stock prices might still fall as investors may be willing to pay only a much lesser price for that earnings. So, next time you try to make sense of why stocks are moving the way they are, think in terms of these 3 factors and you will definitely see the light.
Discover The Danger Of Technical Analysis
Read about the
Danger Of Technical Analysis now!
After more than a decade as a professional option trader and hedge fund manager, I’ve had the honor of knowing many great option traders all over the world as well as the opportunity to learn from the mistakes of thousands of broke option traders.
From these great and brave option traders who dared go where no men has before, and from my personal option trading experience, I am quite awed to realize that there really isn’t much difference in the methods used by both profitable millionaire option traders and completely broke option traders. Both kinds of option traders used the appropriate option strategies corresponding to their opinion on the direction of the underlying asset. Most of these option traders even have the same opinion on the same underlying asset but ended up in dramatically different results.
I slowly understood that it takes more than just correct analysis and perfect option strategy execution to make it as a millionaire option trader. It takes a different breed of man! It takes a breed of man with qualities not naturally found in most people and who behaves and thinks very differently from an average person.
I have consolidated and listed here 5 outstanding qualities of real Millionaire Option Traders :
1. Cool Headed
While amplifying profits, option trading even greatly amplifies the effects of every tiny whipsaw on the underlying asset. What looks like a small, harmless whipsaw in the price of a stock will look like an earthquake on the price of its options. In the face of losing a lot of money very quickly due to whipsaws, a millionaire option trader remains cool headed and calm no matter what the trading value says. Too many option traders bail out and lose 50 to 60% of their money instantly due to such whipsaws, all due to their inability to stay cool in the face of such pressure. I was trading in the call options of a stock along with one of my option trading students in mid 2006. That particular stock went into a quick and deep whipsaw that took 50% from the value of our positions instantly. That option trading student of mine almost went crazy and then sold that position incurring a loss even though our stop loss point has yet to be hit (it was very close then). That position went on to make a profit of about 40% for me right after that whipsaw. Same trade, same opinion, different results.
2. Patient
The stock market is not an auto-teller machine where you simply go to withdraw money at will. No. The Stock market is like an ocean and all of us option traders are seafarers. All veteran seafarers know that there are seasons where one should not go out to sea at all. These are the seasons where the veterans seat back and watch the amateurs perish in the storms. A Millionaire Option Trader knows such seasons and is patient in waiting for the harvest season to come before making a move. Most amateurs option traders (yes, broke too) are more interested in making a lot of trades than to make profitable trades. Many of them will rush in and just trade something even if market conditions are too turbulent to result in a profitable trade. As we have mentioned before, option trading greatly amplifies every whipsaws made by the underlying asset. When you enter the market during very turbulent times, the whipsaws are enough to scare every option trader into making the wrong moves or to result in unnecessary tripping of stop loss points. A Millionaire Option Trader is like an eagle; He soars and glides peacefully and patiently, only when a clear opportunity turns up does he soar down mercilessly for the kill.
3. Systematic
A Millionaire Option Trader is systematic in identifying trading opportunities, systematic in trade and portfolio management, systematic in the execution of every trade, systematic in the stop loss of every trade, systematic in the profit taking of every trade, systematic with his or her lifestyle (in order to maintain a sound mind during trading hours), systematic in loss recovery, etc… Nothing is left to last minute decisions. Nobody can be trusted to make perfect decisions under pressure. A Millionaire Option Trader leaves no decision to be made during those times as every possibility and their corresponding action has been planned before hand. Unsystematic option traders, especially in the area of trade management, will often find themselves making huge losses and very small profits all the time.
4. Disciplined
Millionaire Option Traders are not only systematic, they are also highly disciplined traders. They stick to their trading plan, stop loss points and profit taking system with an iron clad discipline no matter how good or bad their position is doing. Being disciplined also mean that millionaire option traders are not driven by fear of loss or greed for profit. They have only one mission and that is to carry their trading methods to their ends. Unlike trading in stocks, the huge volatility in option trading often scare undisciplined traders into insensibly closing their positions at great losses before their stop loss points are hit and to greedily take profits off the table the very moment it is made even if their profit taking criteria are not fulfilled. This creates a situation again where option traders with the same opinion on the same stocks, executing the same option strategies end up with very different results.
5. Focused
Most amateur and often broke option traders jump from one method of trading to another like a lost bunny. They often go from long term option strategies into short term speculative trading just because they feel that there are money to be made there. It is like the man who ordered steak one minute, changed his order to pasta 5 minutes later and then changed his order to burger before the pasta arrived and then complained why his orders never came. All option trading strategies take time to produce results. A millionaire option trader is focused on the trading and investment objectives of his account and sticks to sensible strategies that fulfill those objectives.
There are many more differences in the qualities between a millionaire option trader and a mauled option trader but these are the main ones that I feel really make a difference. May this list help you reflect upon your own success or failures so that you can make internal changes that will show up as long term option trading success. For a free online trader psychometric test to help find out your suitable trading style, please visit
http://psychometric.mastersoequity.com and for free option trading education, please visit
http://www.optiontradingpedia.com .
Good luck on your journey to becoming the next Millionaire Option Trader.
4 Deadly Reasons Why Beginners Lose All Their Money In The Share Market...
1. Don't know how to choose the right share to buy
2. Don't know when to bail out of a losing share
3. Don't know when to take profit on a winning share
4. Don't Know how to construct a proper portfolio
1. Don't know how to choose the right share to buy... How does beginners choose what shares to buy amongst thousands of shares? You might choose to listen to your share broker, or listen to your "experienced" relative, or listen to free "share pick" on the internet...etc... and you will end up losing money.
Because individual share behavior is very complex, only the most professional full time traders have the right technology to make proper share pick decisions. Such experience and technology is simply not available especially to the beginner trader.
2. Don't know when to bail out of a losing share... The deadliest killer of beginner traders is not knowing when to get out of a losing share. Too many traders hold on to their shares until it is worth nothing. Most beginners will hold on hoping that the share will stage a rebound because you simply do not have the technology to tell if a share will ever rebound! The only way for a beginner to prevent losing everything is for an expert to tell them when to get out of a trade.
3. Don't know when to take profit on a winning share... How many times have you heard stories around you of people who hold on to shares which made them a lot of money until one day, the share turned around on them into a severe loss?
Too many people keep thinking that their winning shares will keep on winning forever and never knew when to take profit... until the shares crashed on them! The problem is again that telling when a share is losing upward momentum is extremely difficult.
4. Don't know how to construct a proper portfolio... Do you know that many shares actually move up and down together no matter what? Do you know that there are shares that totally move opposite to each other? Do you know that many shares actually move exactly opposite to the way the market is moving? Do you know that there are shares that do not ever move? Do you know that there are shares that are on the verge of getting delisted?
If you do not know the above, how would you ever be able to intelligently put different shares together so that you can make money? What if you put a share together with a share that moves exactly opposite to it? Would you ever make money?
That is why a lot of people are turning to trading a much more reliable and much more stable instrument; Market Index or Market Index ETF.
Read about how trading an index based strategy can help you overcome all these problems at
http://www.mastersoequity.com/MOE_ridetheflow.htm
This revelation had me surprised too. I was idly flipping through my old physics textbooks yesterday when it suddenly struck me. I was amazed to realize that Sir Issac Newton’s laws of physics points to so many profound and important rules in the stock markets today.
So, here we are… the physics of the stock markets.
Newton's First Law of Trading
“A Stock at rest tends to stay at rest and a Trending Stock tends to stay in trend unless acted upon by an equal and opposite reaction or an unbalanced force.”
This law teaches us the same thing the old commodity traders will… that the trend is your friend. If a stock is trending sideways, it tends to stay sideways until a powerful enough market force takes it out of its trend. If a stock is trending up or downwards, it will tend to stay moving up or downwards until drastic changes happen to the company or the market at large creating an “equal and opposite reaction”. We should therefore always trade in the direction of a trend and always be vigilant for signs of an
”equal and opposite reaction” or the “unbalanced force”. Such a force may take the form of a drastic change in the market sentiment at large or drastic change in the performance of the specific company in question.
Newton’s Second Law of Trading
“The acceleration of a stock as produced by a market consensus is directly proportional to the magnitude of that consensus, in the same direction as the consensus, and inversely proportional to the mass of the stock.”
This law teaches us that a stock moves up or down into a trend due to a force created by market consensus. How much a stock moves up or down that trend is determined by the magnitude of the market consensus and how “massive” a stock is. By “massive” we are talking about the price of a stock. The more expensive a stock is, the more well established the company has been and the lesser in percentage you will make out of the same move in absolute dollar versus a smaller, less massive stock.
The force of the market consensus is directly proportionate to the event that spurred it. If a company produces a breakthrough product on a worldwide patent, it creates an extremely strong market consensus that is likely to take a stock very far. If a company merely scores a marginally higher earning this quarter, it is unlikely to produce a market consensus that will go very far.
Newton teaches us to not only look at what the news is but also how well established the company is in order to determine how much momentum it will produce in a given trend. The same breakthrough that drives a small company’s shares up by hundreds of percentage points may perhaps move a big company’s shares only by a fraction of that percentage.
Newton’s Third Law of Trading
"For every action, there is an equal and opposite reaction."
No need to explain this one in much detail, do I?
For every buying or selling, there must be an equal amount of buyers or sellers on the other side. The stock market is a zero sum game. For every buyer, there must be a seller and for every seller, there must be a buyer. The real question is, who is profiting from each of their buying and selling. There is really no such thing as more buyers today than sellers or vice versa. Every trader needs to understand that you can be on the wrong side of the table at anytime and only a sensible portfolio management system can help you go in the long run.
I have traded actively in the stock markets for over a decade and survived with ancient wisdom such as what you have read here. There is indeed wisdom to be found in every corner of our life and if we care to look carefully, we will never be in a lack of guidance.
For more of the wisdom that have prospered me so far, please visit
http://www.MastersoEquity.com
Option Trading; Is it truly invincible?
Option trading is fast becoming one of the hypes of this generation. Option trading has been and still is being taught all over the world as the definitive investment instrument for entry to the fast track. Popular speakers like Robert Kiyosaki and Robert G Allen have fuelled this option trading hype in a very big way. The steadily rising number of option contracts that have been traded over the past years is evidence to the rising popularity of option trading.
While option trading is one of the most versatile investment vehicles that have ever been created, it does have fundamental limitations.
First of all, the number of optionable stocks in the markets is really quite limited. Only 2649 out of 7277 tradable securities in the US markets offer stock options. This represents only 36% of the universe of tradable securities. This percentage is even lesser in other markets in the world. This results in a fairly limited choice for investors to choose from.
Secondly, the liquidity of most stock options up for option trading is also pretty limited. In fact, only a handful of stocks have options with liquidity to handle a respectable fund size. The result of which is that it may be difficult for investors with bigger funds to participate as freely in option trading as they may in trading shares. In this respect, option trading may be more productive as a hedging instrument against a large portfolio of shares.
Thirdly, due to its liquidity and its leverage effects, option trading is fast becoming the favorite of small investors with only a very small fund to trade with. However, many of the complex spread strategies that are being taught by option trading speakers all over the world require an extremely high commission outlay that is much higher than if you trade stocks. These high commissions frequently eliminate any possible profits from these complex spread strategies.
With these in mind, I hope you will be able to make an even more informed decision when applying option trading as part of your overall investment strategy. If who you are learning from is just telling you all the pros and none of the cons, then it is time you change teacher to someone who teaches the truths.
