UNDERSTANDING

OPTIONS

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 TABLE OF CONTENTS

Introduction...................................................................................................................................................3

Option Contracts........................................................................................................................................................3

Call Options..................................................................................................................................................................3

Put Options..................................................................................................................................................................5

Using Leverage...........................................................................................................................................................6

Pricing An Option......................................................................................................................................................6

Learning the Basics..................................................................................................................................................8

Understanding the Bid/Ask Spread................................................................................................................10

Changing Sides.........................................................................................................................................................11

Buying vs. Selling.....................................................................................................................................................12

Managing Positions at Expiration....................................................................................................................13

American vs. European.........................................................................................................................................13

Cash vs. Share Settlement...................................................................................................................................13

Avoiding Major Pitfalls..........................................................................................................................................14

Choosing Your Position.........................................................................................................................................15

Understanding Implied Volatility.....................................................................................................................16

Giving Up Your Edge on Entries.........................................................................................................................18

Fibonacci Ratios......................................................................................................................................................20

Closing Statements................................................................................................................................................21
INTRODUCTION
For many newcomers to the stock market, the possibility of making money by trading from the
convenience of a laptop is intriguing, dangerous, and exciting. When the markets are closed, take
the time to learn the facts presented in this collaboration. It helps newcomers learn how to use and
understand option contracts.

For those just entering the field and moving into the world of options, it can be somewhat daunting.
For those coming from a stock background, the most simplistic form of understanding these methods
would be to buy low and sell high. In theory, this idea breaks it down so even the newest members can
understand, but that doesn’t mean it is always so simple.

With options, there are many working parts which make the machine, as a whole, more difficult to
understand, and even harder to master.

That said, trading still invites newcomers to come compete along-side lifelong professionals. Unlike
sports, for example, one could not sign up for the Masters after learning a basic golf swing, nor
could an individual compete as a professional race car driver after simply learning how to operate a
manual transmission.

If you feel like you’ve just set foot inside the Endeavour spaceship, where hundreds of lights, buttons, and
screens blink and beep in your direction, a sense of overwhelming tension can creep up, causing a clear
disadvantage in the market.

For those who already feel overwhelmed, remember to take each working part one step at a time, breaking
down pieces one-by-one, much like learning a dance, step-by-step, slowly mastering the entire process.

We overcome this disadvantage with a clear understanding of the market we’re participating in, with
a foundational knowledge of how each part works. This foundation begins by understanding what an
option contract is, how it works, and how you can implement it into your specific trading techniques.

OPTION CONTRACTS
An option contract, also known as “an option,” is defined as “a promise that meets the requirements
for the formation of a contract.” Essentially, this is a binding contract between two parties.

An option simply means that the buyer has certain rights. The buyer is the optionee, or beneficiary,
of the contract. This individual has rights, but not necessarily an obligation, to long (or short) a stock from
a predetermined price. There is a date in which this contract is good for, called an expiration date. There
are two types of options contracts: 1) calls and, 2) puts.

CALL OPTIONS
Call options give the buyer a guarantee that the person who sold the option, will sell those shares at a
predetermined price. That predetermined price is also known as the “strike price.” As a bullish bet, it is
likely to go up in value. “Bullish” means that an investor believes a stock price will increase over time;

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similarly, investors who purchase
calls are bullish on the underlying
stock. Conversely, “bearish”
indicates that an investor has faith
that the stock will decrease in value.

A call option is a bet that the

stock is going to increase
in value. For instance, if one
predicted that Apple’s stock was on the verge of rising, that person would buy a call option. The higher
Apple’s stock climbs, the more the call option appreciates. The risk with this is that the option could
expire worthless. If Apple’s stock were hovering at $500 and one bought a $510 call, it would expire
worthless and that money would be lost to the person who sold the call to that unfortunate investor.
What that seller managed to do is called “writing an option.” If a stock were going to go lower, one could
instead sell those options to a third party who believes it will go higher. That is called “writing premium,”
or “collecting premium.”

Writing call options is among the riskiest of trade strategies. A particularly unfortunate scenario was
illustrated when one individual sold hundreds of a $50 call option for approximately one dollar. The call
ended up expiring worthless, but that person had initially thought he would make $25,000 on the trade.
The next day he received the news that the stock was up to $50 a share, as it was being bought out. The
money he had invested was unable to be recovered. That is the risk associated with writing call options.
Writing a naked call is the riskiest because credit spreads (an options strategy in which a high premium
option is sold and a low premium option is bought on that same underlying security) become a factor.
When one purchases a call option, it offers the right to buy a given asset at a fixed price, also known as
the strike price. If a call option is purchased at $5 and the underlying asset increases in value, the call will
increase in value as well. At any time before the specified expiration date, the option writer (namely, the
individual who created the option purchased) has a legal obligation to sell the asset at the strike price.
Call options that have a strike price below the current market price of the underlying asset are said to be
“in the money.” If Apple were at $500, a $450 call option would be considered to be in the money, while a
$550 call option would be out of the money. Those acronyms are common: ITM, OTM, and ATM, or “at the
money.” Put options (discussed below) are the inverse of this.

It is also critical to remember that an option price consists of both the intrinsic value and the time value.
Extrinsic value has several variables that create that dollar value. The former is the amount that the
option is in the money. For example, if Apple’s price was at $500 and there was a $490 call, $10 of that
option is intrinsic.

Buying a call option is the least amount of risk that one could take. Selling a naked call option, on the
other hand, is the riskiest endeavor. The downside is essentially unlimited. However, this should not
indicate that buying will offer a constant stream of income; if one purchases the wrong stock, no money
shall be made. For instance, if one purchases a stock at $520 and there are options for $570, this would

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indicate a tidy profit. However, the stock could trade sideways, which would leave the trader with nothing
as the option expires worthless.

As an example, Apple’s March $515 call option was priced $23.10. The option buyer had the right to
purchase 100 shares of Apple stock at a strike price of $515 per share any time prior to the expiration
date. Hardly anyone among approximately 10,000 traders was interested in exercising the option. If
Apple was at $520 and one bought the $515 call option, the price might rise to $550. However, there is
still the option of keeping the stocks at the price of $515. Then an instant profit could be made because
the stock is actually trading at $550. Some experts discuss the possibility of assigning stocks, which is
uncommon but not unheard of. Generally the option is either bought or sold.

PUT OPTIONS
Put Options are the opposite of call options, and again, one can buy or sell a put option in the
same manner as a call option. If Apple’s stock were going to go down, one would buy a put option
because as that stock descends, the put option will increase in value. These options give you the right to
have sold shares from a given strike price, or they may be short from these levels.

Selling naked put options is a popular income strategy. For instance, if stocks keep rising, like days when
Apple continues to rally, one would sell naked put options. If the stock keeps rallying and the put options
expire worthless, that could be kept as income. This is a more conservative option than selling naked call
options because a stock can only fall to zero, which would be the maximum loss. One can also mitigate
the risk by utilizing credit spreads.

As mentioned earlier with an option being in or out of the money, with put options, the inverse holds
true: if put options have a strike price above the current market value of the underlying asset, those
would be considered to be in the money. If the strike price were below the current market value, those
would be out of the money.

The purchase of these contracts gives the buyer a bearish outlook on the market; meaning that they
hope the value will actually go down. Therefore, we buy puts when we expect a market to drop and buy
calls when we expect it to rise.

While it seems that we could still merely be talking about buying stocks rather than options, there is one
reason why options are also important: leverage.

Leverage means that a small amount of work can move a large force. Imagine using a pulley system
to lift a heavy object, or using a crow bar to open a jammed door. Leverage can help small individuals
move large objects. It can also be used in options to help build a powerful portfolio.

USING LEVERAGE
Leverage can actually allow traders with small accounts to grow exponentially while also allowing traders
with large accounts to free up excess capital. It is imperative to maintain several different accounts with
which to work. Some traders keep multiple accounts, each engineered for different work: short-term,

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long-term, day trading futures, swing trading options (swing means holding for more than 1 day),
among others.

Consider the example of RAX. Currently, RAX is trading for $31.76 in the market. A typical order of RAX
may be 100 shares, for a total of $3,176.00.

$31.76 x 100 = $3,176.00

A delta 1.00 call option (delta meaning the rate of change for an options price, relative to a one-unit
change in the price of an underlying asset) will give you the exact same movement as the 100 shares
of stock, but it will only cost the buyer $800, rather than a price over three grand. Generally, one should
aim for a delta value of 70 or higher. Gamma, additionally, is the rate of change of the delta.

In both of these examples, the buyer will receive $100 for every $1 that RAX increases. If both of these
scenarios give the same movement, why not trade option to save on capital?

Usually when something is too good to be true, it is. In this particular scenario, it’s important to discuss
the other moving parts that make the machine operate.

Cheap leverage does not come without a cost. Traders who over-leverage themselves may not truly
understand the risk involved. Imagine giving a fulcrum to children, or even adults who haven’t been
trained in operate the device, and then asking them to move a large object; risk is involved.

PRICING AN OPTION
In terms of our machine’s “moving parts,” this really only refers to how an option is priced. The most common
method is the Black-Scholes Option Pricing Formula, which has been the premier method of valuating
options since Fischer Black and Myron Scholes published their theorem regarding the subject in 1973:

c = S N ( d 1) X e -yTN ( d 2)
S = Stock price
p = X e -yTN ( - d 2) - S N ( - d 1) . X = Strike price of option
r = Risk-free interest rate
d1 = 1n(S/X) + (r+a /2)T 2
T = Time to expiration in years
a T 0 = Volatility of the relative
price change of the underlying
stock price
d 2 = 1 n ( S / X ) + ( r + a 2/ 2 ) T N(x) = The cumulative normal
= d1 - a T distribution function
a T

To be fair, the formula above is a little overbearing and most traders will never actually have to use it. It’s
included, however, for those who would like to understand the fundamentals of trading, presented as
several moving parts.

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Specifically, this formula emphasizes the point that your options price is a moving target. Exercise comes
back to being the buyer vs the seller. If you’re long the option you can exercise at any time. For beginners,
the following variables should be noted from the formula above:

1. Stock Price
2. Strike Price
3. Time Until Expiration
4. Volatility

Of the four variables listed above, volatility is perhaps the most critical.

Implied volatility (IV) is one of the most important concepts for options traders to understand for two
reasons. First, it shows how volatile the market might be in the future. Second, implied volatility can
help you calculate probability. There are various indexes to watch on a daily basis: NASDAQ 100 options
(the continental benchmark for securities and technology stocks), ETFs (exchange-traded funds), SPDRs
(as said before, an abbreviated version of Standard & Poors depositary receipt), and others. There are
actually reverse-ETFs, in which an exchange-traded fund, which is made by utilizing various derivatives,
leads to a profit from a decline in the value of an underlying benchmark. These are ideal for traders who
feel comfortable doing shorter-term work.

Some individuals believe that market internals, or hourly updates from within the market itself, provide
valuable information. While they do offer information and help situate a trader before buying or selling,
the data is not the benchmark from which someone should measure. If the trading is to be done on
SPDRs, then market internals will be valuable. Other times, market internals will indicate an overall
downward trend while individual stocks are rising.

With that in mind, it can be measured as a deviation or variance between several returns within a security
or market index. Essentially, the higher the volatility, the more risk involved.

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LEARNING THE BASICS
The image below can come off as a little daunting to newcomers, but remember to take each piece one at
a time, in order to soon learn the entire puzzle.

From left to right, each of the four working parts is presented above. Time Until Expiration is on the left,
in red. On the upper right, Stock Price is listed with Strike Price and Implied Volatility sit underneath.

This specific example comes from ThinkOrSwim.com, so not all programs will be designed, or presented
in this exact way.

1. Stock Price 3. Time Until Expiration

2. Strike Price 4. Volatility

In this example, the Time Until Expiration is presented in red, with exception to the third option. When
red (in this example), these are generally weaker options.

The strike price points to different numbers. These strike prices relate directly to the underline stock
price. With stocks, it’s important to understand what the stocks may be worth upon expiration, to know if
these stocks or bearish or bullish.

It’s important to think of where the stock is trading. In many cases, 90 percent of lower priced stocks will not
lead to success and will expire worthless. Instead, take time to study those stocks that sit within the money.

In addition, think about options from their intrinsic standpoint.

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Implied volatility is the next step to study. Take a look at the numbers presented here, listed in black font
on blue background near the Implied Volatility bubble.

In this example, the numbers are relativity the same until April 14. When you see something like this (a
jump from 15 to 25), this usually signals an earnings period for the company.

Market makers (traders on the other side of your position) price the option to cover their risks. Essentially,
rather than take the chance of losing any money, the price simply rises during earnings periods to make
sure the stock doesn’t take any large jumps or falls. Now, take a look at the four black bars.

Apple is bullish, but it’s important to know when the stock will move. For example, if you
expect the stock to move within 48 hours, you can examine how the stock has moved in
the past. If the numbers will not add up in 48 hours, consider giving yourself seven days
for the stock to move, knowing you will only pay an additional two dollars overall.

In April, however, many of these numbers nearly double (presented in lower portion of
graph). This is a direct impact of the Implied Volatility. This is crucial and relates back to the intrinsic value.

For example, take a look at the 540 call. Take a look at the beige colors on the left side of the chart above
(page 7). For this particular example, the beige strikes are in the money and the white strikes are out of
the money.

While the 540 call is in the money, it’s only worth $2.55, with the remainder of the value being the juiced
up volatility along with the premium, making profit difficult to attain.

When an option expires in the money, it will be worth however far it got in the money. Meaning, if these
options stopped on Friday, then they would only be worth $2.55. When purchasing directional calls,
timing is everything.

Also, despite these numbers being presented in the form of decimal dollars, when buying, they actually
represent hundreds of dollars. For example, if you were to purchase a 2.55 stock, this is actually $255.00
and not $2.55, in real dollars.

This all comes down to intrinsic value, versus extrinsic value—knowing what that option will be worth
upon expiration.

Imagine buying the 540 call, and doing so for only $15. Now, where will that set your break-even price?
Paying 15 up front means that Apple will have to be sitting at 555 on the expiration date just for the
buyer to break even.

If the call was only $10, but sat at 550, then the stock would have to increase all the way to 560 just for
the buyer to break even. For those not paying close attention, in this scenario, it’s possible to take a large
hit, losing money upon expiration.

Once again, if this seems overwhelming, take some time to digest the chart above, allowing for the
information to sink in. These four variables will come back again and again.

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UNDERSTANDING THE BID/ASK SPREAD
Presented in red next to the stock price, the Bid/Ask spread is presented as two numbers. Unlike all
other purchases, there is not a listed price. At your local grocery store, all items are priced and there is
nothing more to discuss. The Bid/Ask Spread itself is the amount of money by which the ask price actually
exceeds the bid.

With trading, there is always a negotiation that takes place, much like how buying used to take place in
the market place. The negotiation exists between the buyer and seller, along with hedge funds, floor
traders, and those trading online.

Using a Bid/Ask, there is no set price, but a variable that needs to be agreed upon. Let’s take a look back
at the Black-Scholes model to understand more.

With theoretical pricing, take a look at the Mark, Volume, Open, Bid, and Ask. In the example above, using
Theoretical Pricing, there is no Stock Price Adjustment or Volume Adjustment, which means that stock
should (theoretically) trade at 8.27.

The Bid/Ask spread, indicated by the fifth and sixth columns, is 35 wide, sitting between 8.15 and 8.40. In
this sample, there were over 3,000 sold (Volume).

The Bid is 8.15 and the Ask is 8.40, so (theoretically), the bid rests somewhere in the middle, in the case at
8.27, with sellers asking for more and buyers asking for less. When searching for equilibrium between the
two, a sell can be made.

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Let’s look at another example:

This option is not nearly as liquid as the previous option.

Auto Zone traded 232,723 options that day, which is relatively thin. In this scenario, that will affect
the numbers. Specifically, AZO doesn’t trade weekly’s (or weekly options, for which premiums can be
extremely high; when dealing in weekly options, it is best to be a seller as opposed to a buyer), but they
do trade monthly’s, meaning there is not an option to sell a spread the following week.

Lower volume stocks do not have weekly’s. In this example, the Bid/Ask rests between 10.60 and 11.40.
For newcomers, it’s best to focus on liquid markets, such as the one illustrated in the first example.

In the example above, looking under volume on the chart, only 1 single option was traded that day, on an
interest of 88. That means that only 88 people have come into to purchase a fresh interest in the stock.

The Bid/Ask spread specifically relates to what the market maker will ask for and what the buyer will pay.
Much like an asking price at a car dealership, there is a sticker price (MSRP is theo price), but there is some
leniency until the two parties reach an agreement. The agreed-upon price is the last price traded, or “last.”

Keep it simple: an option is only worth what a buyer is willing to pay.

CHANGING SIDES
Once these ideas have become more understandable, buyers are more comfortable thinking of
themselves as the market makers, or sellers. Imagine buying a car from a dealership, and then becoming
an independent dealer. As a seller, you want to find the highest bidder in order to make the most money.

Buying an option versus selling one is also a key factor in how the Greeks will affect your position. The
main three to focus on are delta, theta, and vega (theta meaning the measure of premium decay, and
vega indicating the measure of how much an options premium will increase or decrease given a
change in volatility).

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BUYING VS. SELLING
Selling options can give you an edge in the market. Take a look at the 535 calls in Apple (APPL):

In this scenario, we see a delta of .56, theta of -.22 and a Vega of .43.

Disregard the positive and negative values until you actually take a position. This can be especially
confusing when one number is negative and the other two positive. If we come in as the buyer of the
option, then we will be focusing on the bid and the “theo price.”

Once we enter our position, the Greeks will take a positive or negative stance.

In this example, we have one loan option that has fourteen days before expiration. The market price is
538 and the market change is -4. There are long deltas, which rest at 57.37, meaning that as APPL rises,
the market will rise at that value.

However, each day theta will fall -21.88, as theta moves exponentially rather than linearly, which is
different from delta and vega. This means that if APPL opens up at 538 and doesn’t move a penny, the
buyer will still lose 21 dollars due to leverage.

Therefore, our contract will react each day as we move forward in time, to each dollar the underlying
rallies and how much the contract will gain or lose for each 1 percent change in the volatility of the
underlying asset.

If the seller of the option focuses on ask and theo price, then the Greeks will take their corrective positive
or negative stances upon the position.

In the above example, the stock was sold, reversing the values of the Greeks. So, if the individual sells, the
seller will lose 57 dollars. Whatever hurts the buyer will help the seller.

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This occurs because theta is the only Greek that will absolutely move forward.

Short options carry more risk (leverage), but it puts the constant variable of time in your favor—the only
real truth within the formula. It is always important (and always worth the investment) to pay more for
time. Without time, the market will work the trader instead the trader working the market.

MANAGING POSITIONS AT EXPIRATION

The third Friday of each month is the monthly expiration.

This is where all standard monthly equity options will stop trading and the buyer/seller will have to
determine whether or not they are in or out of the money and what that value means to their overall
portfolio. Some index options will vary on their expiration, but there are ways to better understand those
issues. Remember; take options and their expirations one step at a time.

AMERICAN VS. EUROPEAN

American style options (MSFT, APPL) can be exercised anytime on or before the date of expiration. With
European options (RUT, NDX), these can only be exercised at expiration.

CASH VS. SHARE

SETTLEMENT
Cash settled options means that
there is no way for the buyer/
seller to be assigned shares of
an underlying at expiration. The
strike of the contract will be
compared to its “money-ness”
and the different will arrive in the
account.

If an individual expires in the

money with APPL, for example, it’s possible to be forced to take the shares, depending on the size of the
account in question.

If the stock opens flat, meaning it can be flipped on the same day to meet margin requirements, there is no
harm. However, if there is a heavy margin, it’s possible to take a loss, putting the individual back to square one.

One way to remind your-self, or verify that a market would be cash settled, is to look the volume for
that ticker. In the case of SPX, this is cash settled because there are no actual shares of SPX or trade. It is
simply a measure of the S&P 500 that gives us another instrument or trade.

As the buyer, there is more flexibility than the seller, which is why most people begin as a buyer rather
than a seller. As a buyer, there is no risk when action is not taken, which is untrue in the case of sellers.

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Note: in this example, the “No Volume” option has
been presented using the Think or Swim website,
which presents a flat-line for study.

In these two images, there is a different

between SPX, with SPX expiring early. Make
note of the days left showing in your trading
platform. These two images specifically show the
difference of SPX against NDX, with NDX expiring
a day earlier.

These were taken together to show that NDX

has already expired. These platforms can
actually take a great deal of the difficult work out
of the equation.

AVOIDING MAJOR
PITFALLS
First, choose your position size and manage risk
accordingly. Understanding and managing risk
based on the initial investment is perhaps the
most important aspect in trading.

Understanding implied volatility is another

aspect of avoiding pitfalls. With earnings, the
market will make an example of you if your
actions aren’t performed correctly, using all
known information.

Much like covering a spread, many buyers will

assume that APPL will make money during
earnings, which they usually do. However,
even if they make money, they may not make
enough for the buyer to make a profit, or even
break even.

This will lead to these buyers feeling as if market

makers took advantage of them, when the truth
is that they didn’t understand the inner workings
of the system.

Finally, giving up your edge on entries is the last

mistake to avoid.

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CHOOSING YOUR POSITION
With options, there are countless variables to consider. Make sure to understand those variables, giving
each their fair share of understanding.

This will differ for everyone and is something each person must learn in order to make progress in the
market. This will also vary depending on what type of goals each person has within their own specific
portfolios.

Many people do not understand the risk because they assume they are choosing a
winner. Like gambling, do not risk more than you can afford to lose.

As an example, let’s say you’re trading on a $100,000 account and you’re

focused on steady income and would like to limit drastic swings in the account.
Meaning, you will sit around the 2 percent range, which is $2,000 to risk.

While $100,000 may seem steep at first, it’s a solid number for providing
examples. Feel free to scale this number to better fit your needs after
understanding the basics of the formulas.

Sizing up a 2 percent risk ($2,000), will differ depending on the strategy being
used. Directional calls are easiest to measure in this case since it is a debit
transaction, meaning you can add up contracts until you reach your limit of
$2,000.

For example, if an option is $5.00, you can buy 4, because that $5.00 actually equals $500, and four would
equal $2,000.

Situations where you sell a spread are different, but your risk has been defined.

If you’re selling a spread that is $5.00 wide and you take a $2.50 as a credit that means you have $2.50 of
risk ($5.00 - $2.50 = $2.50).

Then, using the max value, divide it by the dollar amount, meaning you could sell 8 of these options at
$250 x 8 = $20.00.

For smaller accounts, focus on doing longer-term, directional plays. Buy options around 100 days out.
When selling spreads, you must take into account the larger risk, or loss, possible.

Look at risk with the attitude: “What is the absolute worst case scenario for my position, and how much
would I lose if that came to pass?”

Using this kind of risk control for your account does several things to help newcomers to the world of trading.

First of all, you’re never going to blow an entire account on a single trade, though there might be some
considerable damage. There are certain traders who feel that the market (or the world) is against them.
With this mindset, poor performance becomes acceptable, which is wrong. Know your risks.

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Next, you will have a more objective outlook on your position rather than being stuck focusing on the P/L
(profit and loss). Put on the spread and know how much you are risking by keeping a strict limit on what
you can afford to lose.

Do not find yourself in a “deer in the headlights” situation, or, in a trade you can’t handle. Meaning, do
not tense up due to exceeding your risk.

UNDERSTANDING IMPLIED VOLATILITY

Implied Volatility is one of the Greeks previously discussed and is an enormous factor to give an edge in
options trading. This is a computed value that has to do with the option itself rather than the underlying
asset. Simply put, this states that the intrinsic portion of an option will always remain the same. The
premium portion of that option, however, has the ability to change drastically depending on surrounding
circumstances. If the stock is right before earnings, there might be an extra $20 of premium since the
implied volatility jumps up 100%.

The above is why some traders have trouble with “straddles” prior to earnings, which is an options
strategy that has the investing holding a position in both a call and put, with the same expiration date
and strike price.

The first way to understand this is to look at a direct comparison with basic implied volatility. This
indicator can be found on most trading platforms.

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Here, we have the clean price option and the basic implied volatility. In this example, we can see earnings
as they arrive over the span of a year. These same earnings, which seem positive, can crush newcomers
who do not understand earnings. If the implied volatility is approximately 20% or anything up to 40%,
that is a deal that is safe and worth considering. If a deal is anywhere in the upper range—anywhere near
80% or higher—one should be extremely careful. There will be a large premium attached to that deal.

Take a look at the small icon on the upper graph. As APPL earnings arise, the lower graph falls
tremendously. Buying high volatility in this example caused a big loss.

While the numbers do arise towards the day of earnings, it will then fall and the pattern will continue to
repeat itself.

Now, let’s split the implied volatility into thirds. While these values aren’t exact, they can be used for
traders as a general measure on whether they should be buying or selling options.

The volatility analysis can help decide whether the numbers will rise or fall. By splitting these numbers
into thirds, traders can compare the results of APPL to other numbers along the same line.

Many traders will examine the results of Apple and then compare those numbers to Google, which is
like comparing apples and oranges. Instead, use the graph above to compare Apple’s numbers to Apple,
extended over a period of time.

This visual graph shows the highs and lows to better help traders understand the range. Draw a line at
the highest point and the lowest point. Then, begin to think about your individual contract, helping decide
when and how to trade.

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For Think or Swim users, there
is also another way to analyze
this value.

Check the Trade tab in Today’s

Options Statistics. This is
essentially the same numbers
as presented on the graph, but
rather than an image, there is
a numerical value assigned to
each point.

Therefore, when examining the two graphs, notice that the 17 percent represents the end of the green
line of the graph above Today’s Options Statistics. Meaning, Implied Volatility is at a low point, when
compared to the possibility of 100 percent, which would be the highest point that the green line reached.

The percentage comes from the

highest and lowest point of the
graph.

On this bar graph, it’s time to

once again consider the rule
of thirds. The Buy Options
represents 0-33 percent. The
Buy or Sell represents the
middle of the range, providing
options to traders. With Sell
Options, the IV range (or implied
volatility range) is the highest.

When the IV range is in the

upper portion of Sell Options, it’s not possible to buy options.

Play volatility as its own independent trading instrument.

With the spread, buy a long contract with the hope of not having to use it. Much like putting insurance on
a home, it is something for safety that you hope not to use.

GIVING UP YOUR EDGE ON ENTRIES

This is a lesson on discipline.

With options, if you give up your edge, you can lose. When you first start trading options, or trading in
general, there’s a tendency to wait to get in until things “look good.”

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The problem with this is once you
think things look good, so does
everyone else. This is typically where
professionals are waiting to unload
their positions (selling them at the
ask in the most lucrative examples)
giving buyers a bad buy.

To avoid these situations, just

remember if it feels like you are
chasing, then you are.

Step back and wait for retracement. Know what you are willing to buy and if prices don’t meet that point,
wait for the next opportunity.

Also, do not buy extensions. In regards to extension, prices above 100 percent of a given swing,
typically 127.2 percent and 161.8 percent, these swing ratios are beyond this text, but simple enough to
understand to get an edge in options.

For those unsure of whether or not they are chasing, focus on extensions.

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Looking at SYK, the closing bar notes a new 52-week high, giving a bullish appearance to the chart above.
This also depends on the amount of data pulled (meaning for ten days, it would be the “high of ten days”).

This feature is especially useful to find a 1-year high or 5-year high. This data can help traders known
when and how to make a purchase.

However, on this chart, when these new highs are compared to the 127.2 percent extension, traders can
see that the risk to reward ratio is incomprehensible.

These results from Fibonacci ratios and their existence in the market.

FIBONACCI RATIOS
Fibonacci ratios are a tool that technical traders use to
identify key numbers. Developed from mathematician
Leonardo Fibonacci, the sequence of numbers results
in extreme points on a given graph. After levels have
been identified, a horizontal line identifies support and
resistance levels, as presented above.

In the example above (page 23), the extreme high to the

extreme low (swing high to swing low), the horizontal line represents 100 percent. The point at the end of
the graph, the point represents 127.2 percent, as it sits above the swing high.

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While fundamentals are important, the buy and hold era is coming to an end, so these ratios are crucial
when it comes to risk and profit.

Meaning, in this example, if you choose to buy at 84.12, this essentially means that you can make a
dollar, but you are willing to risk six dollars, which is foolish. We are trying to predict what will occur in the
future, taking as little risk as possible.

When everyone is trying to buy, the higher-ups are most likely about to dump, which can cause a loss to
many newcomers within the market.

CLOSING STATEMENTS
Most individuals who trade options lose money. This is because the only approach utilized is that of
purchasing options. There need to be other option strategies in place, and players need to remember
that 80% to 90% of options expire worthless. The general public will buy options without paying attention
to the fair value of the option and the implied volatility. This can lead to buying overpriced options and
losing even more money. There are many beginners’ mistakes that can ensnare the unsuspecting trader,
such as not diversifying strategies and not chasing out of the money options. However, a trader simply
needs to purchase delta 70 options with an implied volatility that has not skyrocketed. Furthermore, do
not chase a big move with an out of the money option.

With a bit of time, practice and patience, sticking to this fundamental outline will increase returns, lower
stress, and hopefully give you a relatively gentle introduction into the world of options.

At Simpler Trading we have a nightly options trading video newsletter service that will prepare you for the
next trading day. To learn more about Simpler Trading go to www.SimplerTrading.com.

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