Learning About the Markets While Social Distancing

Many people’s lives have been turned upside down by staying at home or sheltering in place — they are looking for diversions. 

And while it might be tough to watch the daily gyrations of the stock market, this could be a good opportunity to step back and use the extra free time to bone up on their financial education.  Especially in the area of options so when things return to normal you’ll have more investment tools at your disposal or when the next crisis emerges you’ll be better prepared.  

Operation Manual

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 of 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. 

This information and more can easily be found at exchange websites such as the Chicago Board of Options Exchange  (CBOE) page.  Another great source of education is the Options Industry Council. A terrific book that covers all the basic concepts and strategies is Options as a Strategic Investment by Lawrence McMillan.  

The next level is 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 short the actual shares the day before it goes ex-dividend. 

Most ETFs pay dividends. Some, like the “Spyders Trust (SPY)” payout on a quarterly basis and 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. 

Jargon Slashing

Options traders, like other professionals, love to use industry jargon. Talking the lingo serves several purposes: It connotes a high level of knowledge and expertise in one’s specific field, and accurately conveys complex concepts in a concise manner — and it just sounds so cool to say things like, “I’m long vol up the ying-yang and bleeding theta,” which basically means one owns options that are suffering from time decay. 

The downside of lingo is that sometimes it’s used to purposely conceal the true level of understanding, or is simply a means for the speaker to bolster his self-esteem and get the upper hand in a conversation or negotiation. 
This can be very off-putting to the layperson put in the position of deferring to the expert because he is reluctant to ask a “stupid question.”   So, with that in mind, while it’s not important to know all the jargon it is imperative to understand the concepts so as not to make a needless costly error.  

Or that scalping gamma is a fancy way of saying “I’m trying to buy low volatility and sell higher volatility as the price of the underlying stock moves back and forth within a trading range.” Some basic concepts of option pricing models such as Black-Scholes and what the “the greeks,” especially, delta and theta, mean and how they measure options’ value. 

For deeper dives into there are plenty of good books out there.  One of my favorites on harnessing Vega and Gamma is Options Volatility Trading: Strategies for Profiting from Market Swings by Adam Warner.  A great site for finding and analyzing current and historical volatility, along with an amazing amount of free tools, is iVolatlity.com 

Some of the best option books I’ve ever read, come Charles Cottle whom I’ve had the pleasure of sharing a panel with on several occasions. His Options Trading: The Hidden Reality blew my mind the first time that I had to go back and read it again. I still only understand only half of what he was saying. This one will both enlighten you and put you to sleep.  

Enjoy your distance. 

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SPY shares were trading at $252.62 per share on Friday afternoon, down $8.58 (-3.28%). Year-to-date, SPY has declined -21.05%, versus a % rise in the benchmark S&P 500 index during the same period.

About the Author: Steve Smith

Steve has more than 30 years of investment experience with an expertise in options trading. He’s written for TheStreet.com, Minyanville and currently for Option Sensei. Learn more about Steve’s background, along with links to his most recent articles. More…

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