W. Edward Olmstead - Options for the Beginner and Beyond: Unlock the Opportunities and Minimize the Risks

Unlock the Opportunities and Minimize the Risks, Second Edition

W. Edward Olmstead

FT Press

Vice President, Publisher: Tim Moore
Associate Publisher and Director of Marketing: Amy Neidlinger
Executive Editor: Jim Boyd
Operations Specialist: Jodi Kemper
Marketing Manager: Megan Graue
Cover Designer: Chuti Prasertsith
Managing Editor: Kristy Hart
Project Editor: Elaine Wiley
Copy Editor: Apostrophe Editing Services
Proofreader: Kathy Ruiz
Indexer: Lisa Stumpf
Senior Compositor: Gloria Schurick
Manufacturing Buyer: Dan Uhrig

2013 by Pearson Education, Inc.
Publishing as FT Press
Upper Saddle River, New Jersey 07458

This book is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional services or advice by publishing this book. Each individual situation is unique. Thus, if legal or financial advice or other expert assistance is required in a specific situation, the services of a competent professional should be sought to ensure that the situation has been evaluated carefully and appropriately. The author and the publisher disclaim any liability, loss, or risk resulting directly or indirectly, from the use or application of any of the contents of this book.

FT Press offers excellent discounts on this book when ordered in quantity for bulk purchases or special sales. For more information, please contact U.S. Corporate and Government Sales, 1-800-382-3419, .

Company and product names mentioned herein are the trademarks or registered trademarks of their respective owners.

All rights reserved. No part of this book may be reproduced, in any form or by any means, without permission in writing from the publisher.

Printed in the United States of America
First Printing December 2012

ISBN-10: 0-13-265568-3
ISBN-13: 978-0-13-265568-2

Pearson Education LTD.
Pearson Education Australia PTY, Limited.
Pearson Education Singapore, Pte. Ltd.
Pearson Education Asia, Ltd.
Pearson Education Canada, Ltd.
Pearson Educacin de Mexico, S.A. de C.V.
Pearson EducationJapan Pearson Education Malaysia, Pte. Ltd.

Library of Congress Cataloging-in-Publication Data

Olmstead, W. Edward.
Options for the beginner and beyond : unlock the opportunities and mimimize the risks / W.
Edward Olmstead.
p. cm.
Previous ed.: 2006.
Includes index.
ISBN 978-0-13-265568-2 (hbk. : alk. paper)
1. Options (Finance) 2. Investment analysis. I. Title.
HG6024.A3O46 2013
332.6453--dc23
2012039841

To my wife Pandy,
who gleaned enough from the contents
herein to become a very proficient trader in her own right.
To my sons Hal and Randy,
who shared in my development
as an options trader.

I am most grateful to Gregory Spear and Kathy Butler of Independent Investor, Inc. for providing the opportunity and support to serve as Editor of The Options Professor newsletter, which was a primary source of material for the first edition of this book. I am also indebted to Jim Boyd of Pearson Education for his support during the preparation of the first edition, as well as for his encouragement to update the work for the present edition.

W. Edward Olmstead has a B.S. from Rice University and a Ph.D from Northwestern University, where he is currently Professor of Applied Mathematics in the McCormick School of Engineering and Applied Sciences. He has received several prestigious awards for teaching excellence including an endowed chair. His teaching activities include courses that cover both the theory of options pricing and practical strategies for trading options.

In the world of finance, Dr. Olmstead has more than fifteen years of experience in the trading of options. He holds a FINRA Series 65 license along with considerable experience as an options consultant. He has written various articles on options for the online media.

Dr. Olmstead was Editor of The Options Professor newsletter published by Independent Investor, Inc. during 2003-07. His consulting activities included service as an options analyst for Spear Capital Management. He also worked on an ultra short-term trading concept for a member firm of the Chicago Mercantile Exchange. Since 2010, he has utilized a proprietary options strategy in the management of funds for a group of private clients.

For more information about Dr. Olmsteads current options interests, go to www.olmsteadoptions.com.

This book is intended for people who are just starting to learn about options as well as for those who want to advance their basic knowledge to a higher level. Much of the material for the first edition of this book appeared in a series of articles written for The Options Professor, a monthly online newsletter about options trading, published by Independent Investor, Inc. Some of the material was originally developed by the author for a course on options pricing theory and applications taught at Northwestern University. The new material included in this revised version of the book is largely drawn from the authors trading experience during the past few years.

to fill some gaps in their knowledge.

. Each chapter in this section is devoted to a strategy that goes beyond the basic trade of owning a call or a put option. Some chapters are an advanced continuation of the strategy introduced in the preceding chapter. The advanced chapters are marked with an asterisk and can be passed over by beginners during their first reading of this book.

. Each chapter in this section covers a topic that is intended for people with options experience who want to develop a broader background. Some of these chapters include topics topics not covered in other books devoted to the trading of options. All of these chapters are marked with an asterisk, so this whole section can be passed over by beginners during their first reading of this book.

to fill some gaps in their knowledge.

Why should someone who invests or speculates in the market learn to use options? The simple answer is that options can greatly enhance your profit from stocks and provide the means to protect your portfolio. The goal of this chapter is to familiarize the beginner with call and put options, and demonstrate some of the basic ways to use options.

Suppose you buy a stock for $30 a share and it goes to $33. The stock price has risen by 10 percent and accordingly you have a 10 percent profit. Thats nice! If instead of buying the stock, you buy an appropriate option, you might make a 100 percent profit or even more for the same 10 percent rise in the stock price. Thats better than nice. Thats fantastic!

Of course, there are risks associated with options, just as there are risks with any investment. You need to understand the risks and the advantages of options to optimize your results.

Throughout this book, the use of call and put options are illustrated through a variety of examples. The examples concern options associated with either individual stocks or Exchange Traded Funds (ETFs). An ETF trades like an individual stock but represents a group of stocks that might be identified with an index such as the Dow 30 or might be identified with a financial industry such as semiconductors.

To understand the basic concept of options, start with a simplified look at how they work.

An