524 THE OPTIONS COURSE Long Butterfly Strategy: Buy lower strike option, sell 2 higher strike options, and buy a higher strike option with the same expiration date (all calls or all puts). Market Opportunity: Look for a range-bound market that is expected to stay between the breakeven points. Maximum Risk: Limited to the net debit paid. Maximum Profit: Limited. (Difference between strikes – net debit) × 100. Profit exists between breakevens. Upside Breakeven: Highest strike – net debit. Downside Breakeven: Lowest strike + net debit. FIGURE C.22 Long Butterfly Spread Long Condor Strategy: Buy lower strike option, sell higher strike option, sell an even higher strike option, and buy an even higher strike option with the same expiration date (all calls or all puts). Market Opportunity: Look for a range- bound market that is expected to stay be- tween the breakeven points. Maximum Risk: Limited to the net debit paid. Maximum Profit: Limited. (Difference between strikes – net debit) × 100. Profit exists between breakevens. Upside Breakeven: Highest strike – net debit. Downside Breakeven: Lowest strike + net debit. FIGURE C.23 Long Condor Spread ccc_fontanills_appc_511-526.qxd 12/17/04 4:45 PM Page 524 Strategy Reviews 525 Long Iron Butterfly Strategy: Buy a higher strike call, sell a lower strike call, sell a higher strike put, and buy a lower strike put with the same expiration date. Market Opportunity: Look for a range-bound market that you anticipate to stay between the breakeven points. Maximum Risk: Limited. (Difference between strikes × 100) – net credit. Maximum Profit: Limited to the net credit received. Profit occurs between the breakevens. Upside Breakeven: Strike price of middle short call + net credit. Downside Breakeven: Strike price of middle short put – net credit. FIGURE C.24 Long Iron Butterfly Spread Calendar Spread Strategy: Sell a short-term option and buy a long-term option using at-the-money options with as small a net debit as possible (use all calls or all puts). Calls can be used for a more bullish bias and puts can be used for a more bearish bias. Market Opportunity: Look for a range- bound market that is expected to stay be- tween the breakeven points for an extended period of time. Maximum Risk: Limited to the net debit paid. Maximum Profit: Limited. Use software for accurate calculation. Breakeven: Use options analysis software for accurate calculation. FIGURE C.25 Calendar Spread ccc_fontanills_appc_511-526.qxd 12/17/04 4:45 PM Page 525 526 THE OPTIONS COURSE Diagonal Spread Strategy: Sell a short-term option and buy a long-term option with different strikes and as small a net debit as possible (use all calls or all puts). •A bullish diagonal spread employs a long call with a distant expiration and a lower strike price, along with a short call with a closer expiration date and higher strike price. •A bearish diagonal spread combines a long put with a distant expi- ration date and a higher strike price along with a short put with a closer expiration date and lower strike price. Market Opportunity: Look for a range-bound market that is expected to stay between the breakeven points for an extended period of time. Maximum Risk: Limited to the net debit paid. Maximum Profit: Limited. Use software for accurate calculation. Breakevens: Use options analysis software for accurate calculation. FIGURE C.26 Diagonal Spread Collar Spread Strategy: Buy (or already own) 100 shares of stock, buy an ATM put, and sell an OTM call. Try to offset the cost of the put with the pre- mium from the short call. Market Opportunity: Protect a stock hold- ing from a sharp drop for a specific period of time and still participate in a modest increase in the stock price. Maximum Risk: Initial stock price – put strike + net debit (or – net credit). Maximum Profit: (Call strike – initial stock price) – net debit (or + net credit). Breakeven: Initial stock price + [(put premium – call premium) ÷ number of shares]. FIGURE C.27 Collar Spread ccc_fontanills_appc_511-526.qxd 12/17/04 4:45 PM Page 526 APPENDIX D Success Guides FIVE MINUTE SUCCESS FORMULA: A QUICK METHOD FOR FINDING PROMISING TRADES 1. Look for stocks that are up (+) or down (–) at least 30 percent in value for the day. • You are looking for good momentum trades (where fear and greed are really driving the market). 2. From these, choose those with volume greater than 300,000 shares for the day. • Greater than 1 million shares a day is better; 10 million is best. • Look for volume spikes (market moves generally begin or end on volume spikes). • Call your broker twice a day to check on potential movers (call a half hour after the market opens and 15 minutes prior to market close). 3. Try to find out/ask your broker why each of these stocks is moving. • Usually movement is based on really good news or really bad news, including: • Earnings releases. • Earnings upgrades/downgrades. • New product announcements. 527 ccc_fontanills_appd_527-532.qxd 12/17/04 4:45 PM Page 527 • New agency approvals. • Stock splits. • Merger announcements. • Friendly or hostile takeovers. • Litigation. • Accounting irregularities. • No news (can mean insider buying/selling). • Good reasons can indicate big moves. • Takeovers that are done deals produce little movement and are generally not good plays. 4. Determine which of these stocks has options. • Forget those stocks that don’t have any options. • Consider only those stocks that have liquid options available. • If none exist, try again tomorrow. 5. Choose a low cost/low risk strategy. • A good goal is to find trades that cost less than $100 for each position. • Cheapest play for an up move? Buy calls, bull call spreads, or call ratio backspreads. • Cheapest play for an down move? Buy puts, bear put spreads, or put ratio backspreads. • Cheapest play for a neutral move? Straddles, strangles, or long syn- thetic straddles. • Calculate the maximum risk, maximum reward, and upside and downside breakevens for each possible position to find the trade with the best probability of profitability. 6. Find out/ask your broker how many block trades (institu- tional trades of more than 5,000 shares in size) have traded in these stocks. • Choose only those stocks that have 10 or more block trades on a volume of greater than 300,000 shares for the day. 7. Find out/ask your broker how many blocks are trading on the upticks or downticks (i.e., how many institutions are buying or selling). • Blocks trading on upticks—stock is moving higher. • Blocks trading on downticks—stock is moving lower. 528 THE OPTIONS COURSE ccc_fontanills_appd_527-532.qxd 12/17/04 4:45 PM Page 528 8. Select your entry strategy. • Put the trade on in the last 15 minutes before the market closes (provides the best fills and prices). • Buy options with at least 90 days till expiration (six months or more is even better). • Consider multiple positions so that you can eventually create a free trade. • If you miss the first big move, try to position yourself for the rebound (wait for one “ugly” day, one reversal from the top or bottom, and then place the trade). 9. Select your exit strategy. • General Rule: You should exit the trade 30 days prior to expira- tion, unless the profit on the trade depends on a short option ex- piring OTM. • If you hold multiple positions, sell off half when they double in value to produce a free trade. Ride the free trade to maximize profits. • In an up move, if the stock breaks 20 percent in price from a new high, then close out the position. • In a down move, if the stock breaks 20 percent in price from a new low, then close out the position. RULES FOR TRADING SUCCESS 1. Use a reliable and knowledgeable broker who offers a balance between low commission rates and fast and accurate fills. 2. Research all aspects of a trade using your favorite techniques— fundamental and technical analysis—as well as sentiment and broad market analysis, and scheduled and breaking news. 3. Know what you are trying to do: Define your goals. Select your time frame and availability. Create a risk graph for your position. 4. Look for trades with a reward/risk ratio that is greater than 2 to 1. 5. Buy low volatility and sell high volatility. 6. Do not leg into or out of a spread. Place all sides of the trade at the same time as a single order 7. Write down all orders and read them to your broker to make sure you call your orders in correctly. Success Guides 529 ccc_fontanills_appd_527-532.qxd 12/17/04 4:45 PM Page 529 8. To get the price you want, the best time to place your order is at the end of the day about 15 minutes before the close. 9. Risk no more than 5 percent of your trading account on any one trade. 10. Risk no more than 50 percent of your total trading account at any one time. 11. Keep a record of all your trades and review them periodically. 12. Review all your trades every six months, especially the ones you lost money on; identify bad trading habits/patterns, and try not to repeat them! 530 THE OPTIONS COURSE TABLE D.1 Market Acronyms AAF—asset allocation fund AAGR—average annual growth rate AAR—average annual return ABS—automated bond system AD Line—advance/decline line ADR—American Depositary Receipt ADX—Average Directional Movement Index AGI—adjusted gross income AMEX—American Stock Exchange AMT—Alternative Minimum Tax AON—all or none APR—annual percentage rate APV—adjusted present value APY—annual percentage yield AR—accounts receivable ARM—adjustable rate mortgage ASX—Australian Stock Exchange ATM—at-the-money ATP—arbitrage trading program ATR—average true range BIC—bank investment contract BIS—Bank for International Settlements BOP—balance of payments BOT—balance of trade BP—basis point CAPEX—capital expenditure CAPM—capital asset pricing model CAPS—convertible adjustable preferred stock CBOE—Chicago Board Options Exchange CBOT—Chicago Board of Trade CCE—cash and cash equivalents CCI—Commodity Channel Index CD—certificate of deposit CEO—chief executive officer CFA—chartered financial analyst CFO—chief financial officer CFP—certified financial planner CFPS—cash flow per share CFTC—Commodity Futures Trading Commission COGS—cost of goods sold COO—chief operating officer CPA—certified public accountant CPI—consumer price index CPM—cost per thousand CSI—Commodity Selection Index CUSIP—Committee on Uniform Securities Identification Procedures DAT—direct-access trading DD—due diligence DI—disposable income DJIA—Dow Jones Industrial Average DJTA—Dow Jones Transportation Average DJUA—Dow Jones Utility Average DMI—Directional Movement Index DPSP—deferred profit sharing plan DRIP—dividend reinvestment plan EAFE—European, Australasian, Far East Equity Index EBIT—earnings before interest and taxes EBITDA—earnings before interest, taxes, depreciation, and amortization ECN—electronic communication network EDGAR—Electronic Data Gathering Analysis and Retrieval EMA—exponential moving average ccc_fontanills_appd_527-532.qxd 12/17/04 4:45 PM Page 530 Success Guides 531 TABLE D.1 (Continued) (continues) EPS—earnings per share ERISA—Employee Retirement Income Security Act ESO—employee stock option ETF—exchange-traded fund FAD—funds available for distribution FASB—Financial Accounting Standards Board FDIC—Federal Deposit Insurance Corporation FFO—funds from operations FIFO—first in, first out FHLMC—Federal Home Loan Mortgage Corporation (Freddie Mac) FNMA—Federal National Mortgage Association (Fannie Mae) FOMC—Federal Open Market Committee FRA—forward-rate agreement FRB—Federal Reserve Board FRS—Federal Reserve System GAAP—generally accepted accounting principles GARP—growth at a reasonable price GDP—gross domestic product GIC—guaranteed investment certificate GNMA—Government National Mortgage Association (Ginnie Mae) GO—general obligation bond GSE—government-sponsored enterprise GTC—good till canceled order HOLDRS—Holding Company Depositary Receipts HTML—hypertext markup language IFCI—International Finance Corporation Investable Index IPO—initial public offering IRA—individual retirement account IRR—internal rate of return ISO—International Organization for Standardization ITM—in-the-money IV—implied volatility JSE—Johannesburg Stock Exchange KCBT—Kansas City Board of Trade LBO—leveraged buyout LEAPS—long-term equity anticipation securities LIFO—last in, first out LLC—limited liability company LP—limited partnership MA—moving average MACD—moving average convergence/divergence MEM—maximum entropy method MER—management expense ratio MIPS—Monthly Income Preferred Securities MIT—market if touched MPT—modern portfolio theory MSCI—Morgan Stanley Capital International NASD—National Association of Securities Dealers NASDAQ—National Association of Securities Dealers Automated Quotations NAV—net asset value NMS—normal market size NOI—net operating income NPV—net present value NSO—nonqualified stock options NYSE—New York Stock Exchange OBV—on-balance volume OI—open interest OID—original issue discount OPEC—Organization of Petroleum Exporting Countries OTC—over-the-counter OTM—out-of-the-money PDF—portable document format P/E—price-earnings ratio PEG—price/earnings to growth POP—public offering price PPI—producer price index QQQ—ticker symbol for Nasdaq 100 Trust R&D—research and development REIT—real estate investment trust RIC—return on invested capital ROA—return on assets ROE—return on equity ROI—return on investment RPI—Retail Price Index RSI—Relative Strength Index SAI—Statement of Additional Information SAR—stop and reverse ccc_fontanills_appd_527-532.qxd 12/17/04 4:45 PM Page 531 532 THE OPTIONS COURSE TABLE D.1 (Continued) SEC—Securities and Exchange Commission SEMI—Semiconductor Equipment and Materials International SEP—simplified employee pension SIC—Standard Industrial Classification SIPC—Securities Investor Protection Corporation SMA—simple moving average SOES—small order execution system SOX—Philadelphia Semiconductor Index S&P—Standard & Poor’s SPDRs—Standard & Poor’s Depositary Receipts (ETF) SSR—sum of squared residuals SV—statistical volatility SWIFT—Society for Worldwide Interbank Financial Telecommunication TPO—time price opportunity TRIN—trading Index TSE—Toronto Stock Exchange UN—United Nations VIX—CBOE Market Volatility Index VPT—volume price trend VXN—Nasdaq Volatility Index WSE—Winnipeg Commodity Exchange XD—ex-dividend XR—ex-rights XY—ex-warrants YTD—year-to-date YTM—yield to maturity ccc_fontanills_appd_527-532.qxd 12/17/04 4:45 PM Page 532 Glossary ABC wave Elliott wave terminology for a three-wave countertrend price move- ment. Wave A is the first price wave against the trend of the market. Wave B is a corrective wave to Wave A. Wave C is the final price move to complete the coun- tertrend price action. adjustment The process of buying or selling instruments to bring a position delta back to zero and increase profits. All Ordinaries Index The major index of Australian stocks. This index repre- sents 280 of the most active listed companies or the majority of the equity capitalization (excluding foreign companies) listed on the Australian Stock Ex- change (ASX). American Stock Exchange (AMEX) A private, not-for-profit corporation, located in New York City, that handles approximately one-fifth of all securities trades within the United States. American-style option An option contract that can be exercised at any time be- tween the date of purchase and the expiration date. Most exchange-traded options are American-style. amortization The paying off of debt in regular installments over a period of time. analyst Employee of a brokerage or fund management house who studies com- panies and makes buy and sell recommendations on their stocks. Most specialize in a specific industry. annual earnings change (percent) The historical earnings change between the most recently reported fiscal year earnings and the preceding year earnings. annual net profit margin (percent) The percentage that the company earned from gross sales for the most recently reported fiscal year. annual percentage rate (APR) The cost of credit that the consumer pays, ex- pressed as a simple annual percentage. annual rate of return The simple rate of return earned by an investor for each year. 533 ccc_fontanills_glos_533-556.qxd 12/17/04 4:45 PM Page 533 [...]... “body” bounded by the open and close for the period and “shadows” which extend above and below the body to the high and low prices for the period When the “body” of the candlestick is dark (or red in color charts), the closing price was below the opening When the body of the candlestick is white (or green in color charts), the closing price was higher than the opening cancel (CXL) order An order is used... range The difference between the high and low price of a security in one trading day day order An order to buy or sell a security that expires if not filled by the end of the day day trade The purchase and sale of a position in the same day day trading An approach to trading in which the same position is entered and exited within one day debit spread The difference in value between two options, where the. .. patterns hedge Reducing the risk of loss on an outright directional move by taking a position through options or futures opposite to the current position held in the market high The highest price that was paid for a stock during a certain period high and low Refers to the high and low transaction prices that occur each trading day high ier A speculative high- priced stock that moves up and down sharply over... stopped falling and either moved sideways or reversed direction swings The measurement of price movement between extreme highs and lows synthetic long call A long put and a long stock or future synthetic long put A long call and a short stock or future synthetic long stock A short put and a long call synthetic short call A short put and a short stock or future synthetic short put A short call and a long... purchases, investments, and exports minus imports guts A strangle where the call and the put are in -the- money hammering the market The intense selling of stocks by speculators who think the market is about to drop because they believe prices are inflated head and shoulders (H&S) The head and shoulders pattern is probably one of the best-known, most reliable patterns The pattern resembles the silhouette of... spread The difference in value between two options, where the value of the short position exceeds the value of the long position cross rate The current exchange rate between differing currencies cycle The tendency for price action to repeat uptrends and downtrends in a relatively predictable fashion over a prescribed period of time Price cycles are measured low to low, high to high, or low to high Various... of the trade that is lost due to commissions and because of the spread between the bid price and ask price Traders try to keep slippage to a minimum, which can be done by using brokerage firms with low commissions and by sometimes placing orders between the bid and ask price small-cap stocks Up -and- comer companies that offer big rewards and higher risks They tend to cost less than mid-caps and have lower... days indicating the time for an immediate sale spread (1) The difference between the bid and the ask prices of a security Glossary 553 (2) A trading strategy in which a trader offsets the purchase of one trading unit against another Standard & Poor’s Corporation (S&P) A company that rates stocks and corporate and municipal bonds according to risk profiles and that produces and tracks the S&P indexes... security or commodity for a specified time bid and asked The bid (the highest price a buyer is prepared to pay for a trading asset) and the asked (the lowest price acceptable to a prospective seller of the same security) together comprise a quotation or quote bid-asked spread The difference between bid and asked prices bid up When demand for an asset drives up the price paid by buyers block trade A trade... represents the difference between two moving averages with differing time periods One is shorter (commonly 12 days) while the other is longer (commonly 26 days) The shorter one is referred to as the fast line while the longer one is termed the slow line When a stock is in an uptrend, the fast line will cross over the slow line If a stock is trending down, the fast line will cross under the slow line . the open and close for the period and “shadows” which extend above and below the body to the high and low prices for the period. When the “body” of the candlestick is dark (or red in color charts), the. are measured low to low, high to high, or low to high. Various types of measure- ments are possible. daily range The difference between the high and low price of a security in one trading day. day. during a certain period. high and low Refers to the high and low transaction prices that occur each trad- ing day. high ier A speculative high- priced stock that moves up and down sharply over a short