Introduction to the 8th Edition
The options market has had a remarkable history since its inception in 1973. Every year, new records are set that vastly pass up previous record levels. This trend is going to continue into the future, because option trading makes sense on so many levels and for so many reasons.
In 1989, the year the first edition of Getting Started in Options was published, only 227 million options contracts traded during the entire year. In 2008, for the first time, total trading volume exceeded three billion contracts. That is considerable growth in only 20 years.
In the first year that listed options were traded (1973), only 1.1 million contracts traded. In those days of pre-Internet, pre-electronic trading, that was a lot of volume. However, the Internet has made the entire options market faster and more efficient and, most important, accessible to anyone with a computer.
In 2000, the Options Clearing Corporation (OCC) reduced its clearing fees by a record 41 percent, making options trading practical at bargain levels for the first time. Trading since then has grown at an amazing rate. In 1999, volume passed one-half billion contracts for the first time. Volume then moved over one billion in 2004 and over two billion in 2006. Even with the volatile and fast-changing market of 2008, the popularity—and for many, the necessity—of options continued to grow. In 2008, volume of contracts traded passed the three billion mark for the first time.
Why are options so popular and why is this popularity expanding? The answer involves several aspects:
1. The Internet has made options accessible to everyone. In the past, you had to telephone or visit a stockbroker, who had to then place a call to an exchange to get a quote and place an order. This cumbersome process meant that anyone who was not physically on the exchange floor missed many fleeting opportunities.
2. Costs have been vastly reduced. Since 2000, when clearing fees were reduced 41 percent, the cost of trading options is quite low. If you use an online discount broker, you can buy or sell contracts for about $10. That is a real bargain.
3. The use of options goes far beyond speculation. Many people think of options as high-risk and purely speculative instruments in which it is easier to lose than to win. However, many strategies are undertaken to hedge stock positions, insure paper profits, and take profits without having to sell stock. The many uses of options make them not only a valuable tool, but an essential tool in the modern portfolio. The flexibility of options is increasingly making them a vital strategy for portfolio management and risk reduction.
4. Expanded products have made options useful in many ways beyond options on shares of stock. Today, you can buy long-term options or options on futures, exchange-traded funds, indices, and even futures contracts. Options trading is also available internationally today, and many foreign exchanges and fully automated exchanges provide options trading. In other words, the universe of options trading has become quite mainstream.
5. Education has expanded along with ease of access through the Internet. The Chicago Board Options Exchange (CBOE) offers many online and live educational seminars on options trading; seminars, online courses and tutorials, articles, and books are easily found; and more and more stock investors are beginning to recognize the value of options as part of their portfolios.
Even with all of the improved access, lowered costs, and widespread availability, there remains a great deal of confusion about the market. Anyone new to options trading is easily confused and lost in the jargon and technical explanations of how options trading works. Many strategies have more than one name, making it even more difficult to master the complexities of advanced strategies. Many books on the topic are overly technical and do not carefully explain and define the field of information. In this book, the learning curve is made easier with the use of several tools. These include:
• Definitions in context. The complex terminology of the options market makes comprehension difficult and often overwhelming. In this book, as each important term is first introduced, it is defined in a shaded box on the applicable page. (Definitions are also summarized in the glossary at the end of the book.)
• Smart investor tips. These set-asides give you observations, resources, web links, or important points to bring home a main point. In fact, one of the most practical ways to use this book is to skim through it and read only the smart investor tips. Then, when you find an area of discussion especially interesting or relevant to your portfolio and trading strategy, you can focus on that section of the book.
• Examples. This book employs dozens of examples to show how a particular strategy works. These are straightforward and to the point, but detailed enough to clarify the discussion.
• Checklists. A lot of discussion in this book includes organization in a checklist or outline format. This makes it easier to absorb information logically.
• Illustrations. Much of what we learn is visual in nature, and all learning is easier when new ideas are presented graphically. Options trading can be complex, mathematical, and difficult to envision, so the use of ample visual aids makes the task much easier.
• Tables. Besides illustrations, tables are very useful in summarizing a lot of information, especially when a lot of dollar values are involved. This is most true for options strategies involving two or more offsetting positions. Tables make it possible to explain a strategy in text and demonstrate its potential in rows and columns of numbers.
As you go through this book, don’t expect yourself to grasp and master everything right away, or even with a first read. The nature of options is that it takes time to think about the strategies and to come to conclusions. This is why trying out strategies with paper trading (a technique of hypothetical trading) is valuable. It enables you to learn about how a specific trade works using real contracts and stocks, but without risking actual money.
Set a goal for yourself to learn how to best use this growing, exciting, but complex field, in four stages:
1. Master the terminology of the options field. Of course, you cannot simply memorize definitions without a context, which is why all of the terms you need are defined as they are introduced.
2. Be constantly aware of risk as you read this book. Options strategies are best defined and compared by their risk levels, so this is most important. You will also discover that options strategies cover the entire risk spectrum, from speculative through very conservative.
3. Watch the market and check trends in option values as well as stocks. Become familiar with how option values changes in relation to price movement in stocks, noting that these values do not always mirror the changes in stocks. This occurs for many reasons, and it is valuable to be aware of the variations between stock and option price levels.
4. Identify your personal risk tolerance level and decide how options are most appropriate for you. Everyone has a different set of goals, financial resources, and ability to tolerate loss, and this all defines how you can and should employ options as part of your portfolio. Try various strategies with paper trading before putting real money at risk (see Chapter 10). Only when you have a clear appreciation of the range of outcomes for any specific strategy will you be ready to proceed with confidence.
The John Wiley & Sons Getting Started in series is designed to provide people like you with a solid basis and understanding in a particular market or strategy. The use of many learning tools and carefully designed book layout make this series popular and successful in its many investment titles. Options and many other markets are highly technical, but one important premise to this series is the underlying belief that anyone can master a new idea. If information is provided and explained in a user-friendly format, you can acquire all of the skills you need to master a new field of investing. This ultimately improves your chances for success in the market.