LOL, I had to reply.I rarely add more than 8 replies a day anyway, cuz I tend to be long winded, as you are soon to find out. Dont consider yourself a slow wit. It took me about 2 years just to learn all the mechanics of most of the type of option strategies out there and i studied 6-7 hours a day until I could memorize them. I still dont understand them all-lol. I would encourage you to play options in a way that sells premium instead of buying it.
See if this makes sense to you. When you buy front month premium, Time is your enemy. The minute you buy a call or a put, time starts to decay your premium if it isnt deep in the money. Most option OTM plays are losing trades because of this decay and because the stock doesnt move strongly enough before the TIME eats away all the premium. Thats why, if you buy premium and the trade goes against you, then you have choices to make: I normally chose 1 and 3. Number 3, gives you the option of turning a losing trade into a winning tade.
1. Get out early, so the loss is minimal or at least not too hurtful.
2. Double down, increasing your risk dramatically and possibly wiping out your acct. This happens to many option traders at some point. I have porbably come in contact with a few thousand option traders over the years and many have said they wiped out thier accounts by buying premium and not getting out soon enough when the trade goes south after doubling down.
3. Sell premium, if possible, against the premium you originally bought to try to manage a profitable position. If a trade goes against you and you own calls, It may be possible to sell the same month (this is called a Vertical Credit Spread), lower strike call against it so you collect the premium on that sell and let that premium decay if the stock continues south or trades sideways. As long as the stock closes below the lower strike call on expiry, you can keep the entire premium on expiration friday and both options expire worthless. You keep premium and you dont even have to pay commissions.
THIS is important to note however. Even if both of the calls are not ITM on expiration Friday and are worthless and you have collected all the premium, you are still at risk of obtaining a defined maximum loss on that trade because the option doesnt officially expire until the third saturday and you still have a short call open (this would be the call you sold when the trade turned against you). If fantastic news comes out on Friday after the stock market closes and the stock shoots up above the original calls you bought, then you will recieve max loss if it closes after hours above that original call strike. Thats why I always close out my short positions if I am green on a vertical spread trade. You take all the risk off the table by buying back those short calls. My broker will buy back any short option before the close of the market on expiration friday for no commission. Now that's a broker that I like- One who doesnt want thier customers to risk money and are willing to let them close their short out of the money options that are worth .05 or less for free.
The trick with turning a losing trade into a winning trade is to sell the premium as soon as the trade goes against you and before your loss is too much. You may be able to sell enough premium to cover the cost of original calls that you bought before the trade went south, so you break even from a losing position. Note also that you must now monitor and manage both sides of the trade, the short call and the long call. If the stock turns back up then you need to set stops for what you are willing to risk on the premium you sold. So be aware to monitor both positions at all times.
I play about 5% of my portfolio on vertical spreads. I try to sell no more than 40 days of premium. Typically I will use them when a front month or 2nd month long option turns against me.
You can do the same with puts. If you own puts, you can sell front month puts against them if a stock starts to go up. Simply sell the next strike above the puts you bought and keep the premium if the stock stays above your sold premium price.
Sometimes, if you are good you can hold a long side and daytrade the short side to try to pay off your long positions and if the stock eventually turns back in your favor then you make money on both positions as a stock fluctutes. I did this with AIG this month. I originally bought the 23 puts a while ago and AIG continued up. So each day I was selling 25 and 24 puts against them, then buying them back as soon as they were 10-50%profitable. After several days I traded enough to pay off the 23 puts I own and actually brought in a few thousand extra in premium. If AIG takes it in to the crapper next week, those 23 puts could bring a nice chunk o change as well. If not, then the I can still sell those 23 puts for something. This has happend several times for me where I made money selling premium while the trade went against me, held the long position ( and in a couple of cases adding to that position while the premium was really low) and the stock reverses and the long position pays off hansomely too. I now hold 40 AIG 23 puts that were virtually paid for by selling/covering the 24 and 25 puts over and over last week as AIG climbed and retraced.
Read about credit spreads in my education thread for details on the mechanics of vertical spreads. Take your time reading about them until you totally understand the dynamics.
Once you have digested this, I'll introduce you to diagonal spreads, one of my favorite mid term option strategies.
If you've enjoyed this lil bit of information even half as much as I did, well, then I enjoyed it twice as much as you-LOLOLOLOLOLOL :)
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