The Complete Guide to Option Strategies

Important insights into effective option strategies

In The Complete Guide to Option Strategies, top-performing commodity trading advisor Michael Mullaney explains how to successfully employ a variety of option strategies, from the most risky--selling naked puts and calls--to more conservative strategies using covered positions. The author covers everything from options on stocks, exchange-traded funds, stock indexes, and stock index futures to essential information on risk management, option "Greeks," and order placement. The book provides numerous tables and graphs to benefit beginning and experienced traders. Written by a CTA who has successfully employed various options strategies to generate market-beating returns, The Complete Guide to Option Strategies will be an important addition to any trader's library.

Michael D. Mullaney (Jacksonville, FL) is a high-ranking commodity trading advisor who specializes in option selling strategies.

Preface xv

Acknowledgments xx

Part One Learning the Fundamentals 1

Chapter 1 Getting Ready to Trade 3

Why Trade Options? 3

Developing a Game Plan 4

What Is an Option? 8

Defining Key Terms 12

Final Thoughts 17

Chapter 2 Option Fundamentals 19

Overview 19

Opening and Closing Positions 19

Option Buying 20

Option Selling 22

Spreads 26

Bid/Ask Spread 26

Option Chain 27

Final Thoughts 28

Chapter 3 What Determines an Option’s Price? 31

Overview 31

Factors Affecting Option Pricing 33

Forecasting Option Prices 41

Final Thoughts 43

Chapter 4 Tools of the Trade — Greeks 45

Overview: Greek Basics 45

Position Greeks 54

Converting an Option Chain to Greeks 55

More on Delta 56

Final Thoughts 62

Chapter 5 Buying versus Selling 65

Overview 65

Comparing Long and Short Options 66

Option Buying 69

Option Selling 70

Bullish versus Bearish 73

Learning How to Roll 73

Final Thoughts 76

Chapter 6 Understanding Spread Terminology 77

What Is a Spread? 77

Spread Buying versus Selling 78

Spread Strategy Summary 83

Final Thoughts 86

Part Two The Four Basic Option Strategies 87

Chapter 7 Long Call 91

Overview 91

Strategy Examples 93

Beyond the Basics 104

Final Thoughts 107

Chapter 8 Long Put 109

Overview 109

Strategy Examples 111

Beyond the Basics 122

Final Thoughts 124

Chapter 9 Short Call 125

Overview 125

Strategy Examples 127

Beyond the Basics 139

Final Thoughts 140

Chapter 10 Short Put 141

Overview 141

Strategy Examples 143

Beyond the Basics 154

Final Thoughts 157

Part Three Spread Strategies 159

Chapter 11 Vertical Spread 161

Overview 161

Strategy Examples 163

Beyond the Basics 173

Final Thoughts 177

Chapter 12 Iron Condor 179

Overview 179

Strategy Examples 180

Beyond the Basics 188

Final Thoughts 189

Chapter 13 Unbalanced Spreads 191

Overview 191

Strategy Examples 192

Beyond the Basics 201

Final Thoughts 202

Chapter 14 Straddle and Strangle 205

Overview 205

Strategy Examples 207

Beyond the Basics 218

Final Thoughts 222

Chapter 15 Butterfly Spread 223

Overview 223

Strategy Examples 226

Beyond the Basics 238

Final Thoughts 240

Chapter 16 Condor Spread 243

Overview 243

Strategy Examples 246

Beyond the Basics 258

Final Thoughts 260

Chapter 17 Calendar Spread 263

Overview 263

Strategy Examples 266

Beyond the Basics 279

Final Thoughts 283

Chapter 18 Diagonal Spread 285

Overview 285

Strategy Examples 288

Beyond the Basics 298

Final Thoughts 299

Chapter 19 Covered Call 301

Overview 301

Strategy Example 302

Beyond the Basics 306

Final Thoughts 310

Chapter 20 Combination 313

Overview 313

Strategy Examples 316

Beyond the Basics 321

Final Thoughts 324

Chapter 21 Collar 327

Overview 327

Strategy Example 329

Beyond the Basics 332

Final Thoughts 334

Chapter 22 Covered Combination 335

Overview 335

Strategy Example 338

Beyond the Basics 341

Final Thoughts 342

Part Four Comparing Underlying Instruments 343

Chapter 23 Comparing Stocks, ETFs, Indexes, and Stock Index Futures 345

Overview 345

Size of Instrument 346

Exercise and Assignment 347

Margin 348

Commission and Bid/Ask 349

Taxes 351

Final Thoughts 351

Chapter 24 ETF Options 353

Overview 353

What Is an ETF? 353

ETF Options 354

Final Thoughts 362

Chapter 25 Stock Index Options 363

Overview 363

What Is a Stock Index? 364

Index Options 364

Index Volatility Skew 370

Index Time Decay 370

Final Thoughts 371

Chapter 26 Stock Index Futures Options 373

Overview 373

What Is a Futures Contract? 375

Stock Index Futures Option 379

Bonus Section 385

Final Thoughts 389

Part Five Advanced Topics 391

Chapter 27 Assessing Volatility 393

Overview 393

Comparison of Implied Volatilities 398

How to Compare Volatility 399

Response to Changing Conditions 401

Market Volatility Gauges 406

Volatility Skew 407

Delta-Neutral Volatility Trading 414

Consider Trading Volatility Index Options 415

Final Thoughts 416

Chapter 28 Exercise and Assignment 417

Overview 417

American-Style Exercise 420

European-Style Exercise 421

Cash Settlement 422

Automatic Exercise 423

Spread Risks 425

Likelihood of Exercise 427

Assignment Risk 429

Exercise and Assignment Procedures 430

Final Thoughts 431

Chapter 29 Risk Management 433

Run It Like a Business 433

Controlling Risk 438

Final Thoughts 448

Chapter 30 Margin 449

Overview 449

Stock, ETF, Index, and Futures Margin 450

Comparing Margin 459

Margin Planning 460

Interest 462

Cash Accounts and IRAs 462

Final Thoughts 464

Chapter 31 Placing an Order 465

Overview 465

Types of Option Orders 466

Strategy: The Multistep Order 471

Bid/Ask Spread 472

Commissions 475

Trading Platform 476

Clearing of Trades 476

Final Thoughts 476

Chapter 32 Taxation of Options 479

General Rules 479

Option Taxation 480

Tax Reduction for Broad-Based Index and Futures Options 482

Internal Revenue Service Circular 230 Notice 485

Final Thoughts 485

Appendix A Strategies at a Glance—ETFs 487

Bullish ETF Strategies 488

Bearish ETF Strategies 492

Trading outside a Range 497

Trading inside a Range 499

Appendix B Strategies at a Glance—Indexes 503

Bullish Index Strategies 503

Bearish Index Strategies 506

Trading outside a Range 508

Trading inside a Range 510

Appendix C Strategies at a Glance—Stock Index Futures 515

Bullish Stock Index Futures Strategies 515

Bearish Stock Index Futures Strategies 519

Trading outside a Range 523

Trading inside a Range 525

Glossary 529

About the Author 543

Index 545

MICHAEL D. MULLANEY has traded equity and futures options utilizing a broad range of strategies and instruments, including options on stocks, stock and bond ETFs, indexes, and stock index futures. Mullaney executes option buying and selling strategies but concentrates most of his efforts on writing far out-of-the-money options by using strategies that can profit in rising, declining, and sideways markets. Mullaney is a principal of a commodity trading advisor and a certified public accountant. He has been interviewed on national business radio, featured by national trading magazines, was formerly a partner at KPMG, vice president of a corporate tax department, instructor for a law school course, contributor to a book on taxation, and author of six articles on merger and acquisition issues. He can be contacted at mmullaney@miminvestments.com.

THE COMPLETE GUIDE TO OPTION STRATEGIES

In The Complete Guide to Option Strategies, author Mike Mullaney, an options expert, shares his insights in what is destined to become a classic among serious option traders. This comprehensive and informative guide covers hundreds of option strategies and is filled with in-depth insights and practical advice. It starts with the basics, moves up the educational ladder to the intermediate level, and then progresses to an advanced level. Mullaney describes the best limited-risk option-buying strategies and details how writing options can help you place the odds of success on your side. It provides you with the tools necessary to expand your horizons by profitably trading options on stocks, ETFs, indexes, and stock index futures.

The Complete Guide to Option Strategies is written in clear and straightforward language and is filled with examples, tables, and graphs. This guide provides step-by-step analyses so traders can understand even the most complex strategies.

Divided into five comprehensive parts, this reliable resource touches upon many topics:

Part One: Learning the Fundamentals covers getting ready to trade, option fundamentals, what determines an option's price, buying versus selling, understanding spread terminology, and the "Greeks"

Part Two: The Four Basic Option Strategies covers the core fundamental strategies of a long call, long put, short call, and short put

Part Three: Spread Strategies covers the vertical spread, iron condor, unbalanced spread, straddle and strangle, butterfly, condor, calendar, diagonal, covered call, combination, collar, and covered combination

Part Four: Comparing Underlying Instruments compares and contrasts trading options on stocks, ETFs, indexes, and stock index futures

Part Five: Advanced Topics covers volatility, exercise and assignment, risk management, margin, placing an order, and tax rules

Three Appendices illustrate many of the strategies covered throughout this book and present them according to whether the strategies are primarily bullish, bearish, profit inside a trading range or profit outside a trading range. A Glossary with approximately 200 definitions is included as a reference tool.

While you can read this book from cover to cover, you can also use it as a reference for specific strategies and solutions. And if you are already familiar with some of the basic concepts covered, you can simply skip chapters and go directly to the information you need. For every level of trader, The Complete Guide to Option Strategies will serve as an invaluable educational tool and an enduring reference to the options markets.