More Profitable Options in the Stock Market

The city of Chicago can be referred to as the center of the universe when it comes to trading options. That's because right there in the heart of the Windy City is the Chicago Board Options Exchange (CBOE); the leader in options volume and a fixture in Chicago since 1973. So when people ask me where to find the most trusted information on the markets worldwide, that's my online preferance.

I recommend bookmarking the following URL for quick reference: http://www.cboe.com/tradtool/webcast.aspx

Please exercise care when trading in this volatile bear market.

By Chuck Anthony

The SPDR S&P 500 ETF is Standard and Poor's Depository Reciepts trust that is involved in the financial services industry. S&P's holdings in this Exchange Traded Fund are comprised of the 500 stocks in the S&P 500 Index. The fund is designed to capture price performance of a large cross-section of equities publicly traded in the U.S. Stock Market. The ticker symbol for SPDR S&P 500 is SPY, sometimes referred to as "spiders."

As a dedicated options trader, I enjoy trading these types of index options because price and volume fluctuations are less of a factor than individual stocks, particularly in the style of technical trading that I like to use. Stock prices in general are heavily influenced by events such as rumors, earnings reports, management changes, etc., whereas an ETF such as SPY, while still affected by the news, market conditions, what have you, inplies a lower degree of uncertainty.

Another reason, i prefer trading options on SPY is that it is relatively inexpensive and I don't have to commit to purchasing the actual stock. I like to think of options trading as a way of "renting" stocks. For example, if I buy 1 contract on the SPY April 83 Call (Option Symbol SZCDE) for $3.20, I am actually controlling 100 shares of stock (multiply by 100) and my cost basis would be $320. If SPY advances in price the next day and the option price is now $3.80. I can decide to sell it at a profit of .60 cents or in other words, $60 when you do the math.

This example is an oversimplification of course, as there are expiration dates, risk tolerances, etc. to consider. We can discuss these in future articles, but for now, suffice to say that trading options on indexes such as SPY, QQQQ (Nasdaq) and DIA, (Dow) can be an great entre into the market when practice, care and due diligence are employed.

I think a key point to remember is also the fact that index options such as SPY are heavily traded and therefore show massive amounts of something called open interest. This benefits both the Trader and Market Maker. The shear volume of orders benefits the Market Maker as this enables them to "shorten the spread" between the "bid" and "ask" prices (on the option). The trader benefits because he or she can get in and out of the trade quickly just by targeting a .40 to .60 cent profit for example. So depending on the number of contracts bought, traders can pick up some nice gains in a relatively short period of time, provided they don't greedy! Incidentally, if the stock goes the wrong way, it's wise to have your stop-loss orders in place. Take my word for it, GREED can be the kiss of death when it comes to trading options.

The top ten components of SPY are as follows (stock symbol followed by company name):

1.) XOM, ExxonMobil Corporation
2.) GE, General Electric Company
3.) C, Citigroup, Inc.
4.) MSFT, Microsoft Corporation
5.) T, AT&T, Inc.
6.) BAC, Bank of America Corporation
7.) PG, Procter & Gamble Company
8.) JNJ, Johnson & Johnson
9.) PFE, Pfizer Inc.
10.) MO, Altria Group, Inc.

Try as they might, the gurus are stepping up to the plate to call a bottom. I'm hearing S&P 800, 700, even 420; Whoo ha, what a bear!

One thing's for sure, I'm not looking for a "V" shaped bottom -- don't think one has ever occcurred in these conditions where volatility (VIX) is at an all-time high. I'd rather subscribe to theory that the market will re-test these lows in December after the election. I attribute that to there being too much uncertainty and too much fear right now for any kind of sustained optimism.

But still, it's this same bearish sentiment that can give rise to an unprecedented countertrend rally; you know, those fast and furious ones. So, keep an eye out for that.

Update: February 27, 2009 -- Wll the S&P follow suit with the Dow and retest the lows of November 2008? Read The Bear Market Daily News on Squidoo.

A time-wasting asset, that is. Here's a quick example of how options on a stock can lose their value over time and assuming the stock price is moving in the opposite direction from your trade. Not a pleasant thought, I know... We'll look at "out of the money" options since these values decrease at an accelerated rate as the option's expiration date approaches. Since options are in fact, "wasting assets", these value declines are important because over time, as this out of the money option gets closer to expiration without being "in the money", the probability of its time value is reduced. We call this time decay.

This scenario makes a good case for using stop losses if you happen to be in a trade where the stock price is headed in the wrong direction.

Speaking of stop losses, a simpler way to explain options as wasting assets might be to share with you the plight of the Detroit Lions. Right now, the Lions are a winless professional football team at 0-7. Chances of the team finishing 9-7 over a 16-game schedule are becoming less likely. Therefore we can liken the Lions to our "out of the money" options play. Can they finish their season "in the money" at 9 vicories and 7 defeats? Sure, it can happen. But time value and time decay are not in their favor.

Update 11/13/2010: To all my friends in the Detriot, Michigan area, Glad to the Lions are doing better this year ;-)