Wednesday, June 28, 2006

Trading P.I.T. Session 1

Tonight was Session 1 of Wealth Intelligence Academy's Trading P.I.T. Advanced Training Course. My presenter is Bill Keevan and I'm very excited to be in his class. Why? Firstly, I dig his personality -- he's funny. Probably more importantly, he has a nationally syndicated radio show; check out his profile on He's also the co-ordinator for all the online training classes, and I've seen him pop in during some Master Trader sessions. He's instilled a new mantra in me in only one night. I'll be chanting this in my sleep (that keeps getting interrupted by my cat): win often and never lose big.

Bill did give us homework. We need to write a review for 2 out of 4 possible brokerage firms; possible firms:,,, and I've already set up an account with Options Xpress and am about 85% complete with an Interactive Brokers account. I'll write up my Interactive Brokers adventure soon, it should be quit entertaining, you won't want to miss it! Since I've already taken the tours of each of these and have set up the account, they'll probably be the ones I write about, however I will look at the other two as well. I'll also post my review here for your reading pleasure.

Tonight was an overview of Options as well as an introduction to the Bull Call Spread. What's that classic definition? Oh yes: An option is a contract between a Buyer and Seller, that give the buyer the right, but not the obligation to buy or to sell a specific stock at a specific price on or before a specific date in exchange for a market premium. By the way, that was from memory because I have not yet received the materials for this course (and I'm not a very good note-taker). The "specific price" in that definition is referred to as the strike price and the "specific date" is known as the expiration date. Options expire on the 3rd Saturday of each month, but for all practical purposes we only have up to the last trading day before the expiration to exercise the option. However, as Bill Keevan explained, we should never exercise, and especially we should never exercise an option. Instead of exercising the option, we should close our position by buying or selling the option.

There are two types of options that we can Buy and Sell: a Call Option and a Put Option.

When you buy a Call Option, you have the right, but not the obligation to Call the stock away (to buy the stock) at the Option's Strike Price. This is a debit trade, because you pay a market premium for the right to purchase the stock. Typically, you would buy a Call Option if you expect the stock to go up. For example, if the stock is currently trading at $35 today, you could buy the October 40 Call (a Call option with the strike price of $40 that expires the 3rd Saturday of October), anticipating that the stock would increase in value between now and October. Let's say it cost you $2 per share for the Option (the market premium). You'd end up spending $200 for the right to buy (to Call away) the stock for $40. If the stock does not increase in value, you lose that market premium. If the stock increases to anything above $40, say $45, you have the right to purchase the stock for $40, ensuring that you will make $5, minus the cost of the option ($2) meaning you stand to profit $3 for simply exercising the option.

When you sell a Call Option, you are obligated to sell the stock (have the stock Called away from you) at the strike price. This is known as a credit trade because you receive the money up-front. It also means you place yourself in an unlimited risk position as you are obligated to deliver the stock at the strike price. Bill made it very clear that he will NEVER recommend selling more options than you buy for this exact reason.

Buying a Put Option gives you the right, but not the obligation to sell the underlying security (to Put the stock to someone else) for the Strike price. You typically purchase a Put Option when you anticipate the value of the stock will decrease in value. You pay a market premium to have the right to sell the stock (to Put the stock) to someone else. If the value of the underlying stock is less than the Strike price, you stand to make a profit.

Selling a Put Option means you sell the right for someone to sell the stock to you (to put the stock to you) for the striking price. This one seems to be the oddest one of the bunch doesn't it? After all, you're selling the right to have the stock sold to you. This, like selling a Call Option, is a credit trade and puts you in an unlimited risk position. You are obligated to purchase the stock for the strike price because you were paid the market premium. You could profit from this trade if the stock's value increased while the option was still good. However, your profit is limited to the credit (the market premium) you receive when you sell the option.

The At-The-Money (ATM) Option is the option with a strike price that is nearest the current stock value. An In-The-Money (ITM) Call Option means the value of the stock is greater than the option Strike price. An Out-of-The-Money (OTM) Call Options means the value of the underlying security is less than the Strike Price. The opposite is true of a Put Option, it is ITM when the value of the stock is less than the Strike Price and OTM when the stock is greater than the Strike Price.

A bit more on terminology: If you Buy an Option you are described as Long the Option or the Option Holder. If you are Selling an Option you are Short the Option or the Option Writer. Why is all this terminology important? It's the language traders speak. If you don't know what it means to be an Option Writer, you don't know what the person is attempting to convey to you. And, of course, you need to know the difference between Calls and Puts and what it means to buy or sell either of those options. It is also important to know the Intrinsic Value versus the Extrinsic Value of an option. The Intrinsic value is simple enough. If the Option is In-The-Money (ITM) the option has intrinsic value, specifically the difference between the strike price and the current value of the stock. For more information about Options take a look at Wikipedia's entry on Options.

The introduction of the Bull Call Spread necessitated an explanation of Delta and Net Delta. Delta describes the value change per $1 move, so the Delta of a stock is 1-to-1. For every dollar the stock moves the value of holding the stock moves one dollar. Options are far more interesting because the Delta changes relative to the underlying stock. An Option's delta is at 0.5 when the stock value equals strike price, and approaches 1 when the option is deep enough In-The-Money (ITM). Likewise the further Out-of-The-Money (OTM) the option becomes the lower the Delta.

The Bull Call Spread involves taking advantage of simultaneously buying the At-The-Money (ATM) Call Option and selling an OTM Call Option. I'd share with you TMTT's specific rules for entry into this kind of a trade, but I'll let you pay for classes if you'd like to know. However, I will let you know that understanding Delta is important, and that you calculate the Net Delta by subtracting the OTM Option Delta from the ITM Option Delta.

If all this has your eyes glazed and your head spinning, not to worry. Bill will be reviewing all of the above information on the first half of Session 2 of the Trading P.I.T. If you've been reading this blog, you'd know that I gave myself a head-start by going through the OnDemand classes nearly a month ago. It's been my plan all along to go through the materials more than once to really solidify what I'm learning. I have a feeling most of these Trading P.I.T. Sessions are going to be on the technical side, and honestly I don't think I'll be able to share the specifics so as to no violate TMTT's copyrights and such. I'll do my best to give you a decent, general idea of what the class is about. Thanks for reading all this, I know it isn't easy!

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