Den of The Lion Investor

If you trade options but do not know what the “Greeks” are, you are playing a game without knowing the complete rules.

And if you trade warrants listed on SGX but do not know that they are a form of options, then it is far worse. You do not even know what game you are playing.

In options trading, there are four greek terms that you need to understand:

• Delta - Tells you how much a change in the underlying will affect the price of the option
• Gamma - The rate of change of delta
• Theta - Measures the amount of money that the option will lose with each passing day
• Vega - Measures the sensitivity of the price of the option to changes in volatility

The terms confused me initially too, and it took me some time of researching before I could find a good explanation for them.

Be warned - they are pretty heavy stuff and it will probably take you some time before you can reach a stage of unconcious competence with regards to understanding and using the greek terms.

Rather than reinventing the wheel and trying to explain them here, I’ll direct you to a couple of good articles on this topic.

This first article helps you to understand the meaning of the greek terms:

Getting to know the Greeks

This second article helps you to understand the relationship between them. The table in the article paints a very good picture:

Using the Greeks to Understand Options

If you go through the exercise of understanding the greeks, you will realise how important these terms can affect your options trading strategy.

On most advanced platforms, you can actually have access to these values when you are trading options.

Unfortunately, for warrants listed on SGX, you do not really know what they are. This is a severe handicap but if you can at least understand how they work, it will give you a slight edge over the rest of the playing field.

A few days ago, I attended a preview of an options trading seminar conducted by Ron Ianieri. Ron was supposedly one of the best option traders in the United States. He is also the co-founder of The Options University, and has trained many new trader trainees.

Before Ron Ianieri gave his presentation, Adam Khoo came on to cover some fundamentals of options. He used an example of a property purchase to illustrate what an option is.

A simple definition of an option is that it gives you the right (but not the obligation) to buy or sell the underlying asset at a particular price. This price is called the strike price.

Most of you will probably be quite familiar with the many call and put warrants that are traded on the Singapore Stock Exchange. Both these instruments are examples of options with stocks as the underlying asset.

At the preview, we were given a nice little notebook which contained the 7 deadly sins of options trading. They are:

1. Not fully understanding the independent effects of time and volatility on your option.
2. Forcing a pre-selected strategy on every opportunity.
3. Not fully understanding the proper meaning of leverage as applied to trading.
4. Not fully understanding the foundations or building blocks of option theory.
5. Thinking that cheapness or expensiveness of options is determined by dollar cost.
6. Overcomplicating otherwise simple strategies.
7. Not knowing how to pick the correct option for the selected strategy.

Trading options without first understanding the mathematics behind it is a sure recipe for disaster.

I won’t be going into too much details about the technical aspects of options in this post. Instead, I will focus more on some of the strategies that I pick up from Ron Ianieri.

A) Stock Replacement Strategy (Bullish Play)

This strategy involves buying call options instead of buying the stock directly. The advantage is that a lower capital is required to get the same amount of exposure. You get leverage and if done correctly, your loss can also be controlled.

A rollup play involves selling your long call with a lower strike price while simultaneously buying a new call with a higher strike price in a 1 is to 1 ratio. This trade helps to lock in your profit with a credit which is money received.

B) Stock Replacement Strategy (Bearish Play)

This strategy is an opposite to the above strategy. Put options are used to get a short exposure instead of shorting the stocks directly.

C) Earning Monthly Income (Covered Call)

For this strategy, basically you just sell call options on stocks you own. This is a premium collection strategy and not a directional play.

D) Stock Replacement Covered Call

This is a combination of strategy A and D. This strategy is far superior to a basic covered call but the price of superiority comes at a potential cost.

Morphing

This refers to the switching of your position from one direction to another in just one trade. Example:

1. Buy a call.
2. When stock retraces, short the share.
3. Cover the short and then collect more profit on the upside.

And finally ….

The Big Secret

Most amateurs trade backwards. They learn a few tactics and then go out to find stocks that fit this strategy. Sometimes, they force a situation to meet their strategies.

Ron says that we should recognise the opportunity, and then apply the correct strategy from our trading arsenal to meet that scenario instead.