As with trading any financial product, there are many strategies to choose from. One strategy isn't necessarily better than another and many times the strategy that works best for you simply depends on your trading style.
Today's guest blog post is from Elizabeth Harrow of Schaeffer's Research and she is sharing 2 different options strategies that revolve around playing dividends. Enjoy the post below and leave a comment on the blog. If you like this article and wish to receive 6 months free Option recommendations, please click HERE.
As you may or may not be aware, dividends are one of the many factors that influence an option's price. Because dividends don't have as big an impact as other variables, such as time decay and implied volatility, they're generally not a topic that I dedicate a lot of time and analysis to. However, every option trader worth his or her respective salt should know that dividends create trading opportunities (even if only so that he or she can break out this tidbit at particularly boring cocktail parties). So, in today's column, we're going to take a look at two common ways to trade around dividends.
Many people like options because they believe them to be less risky than futures. Options sometimes offer reduced risk, but usually at the cost of reduced profit potential.
One drawback of options is that a trader must consider market speed (volatility) as well as direction. Traders who buy or sell options outright to profit from up or down moves in the underlying market can find themselves fighting an uphill battle against volatility and time decay. With futures, if you're right about market direction, you'll win. With options, you can be right about the market and still lose.
If a market is trading at 200 and you buy a 210 call expecting a rally, you'll still lose on the trade if the market only rallies to 205 by expiration; your 210 call will be worthless. The same thing would happen even if the market rises as high as 220, but does so one week after expiration. In each case you would be right about market direction but would not profit.
The advantage of options is their flexibility. Because of the variety of strike prices and expiration dates a trader can choose, options naturally lend themselves to spreading strategies (simultaneously buying an selling different options), accommodating varying views of market direction and risk levels. Traders can design option strategies that will profit if the underlying market goes up or down, moves in either direction by a certain degree or remains unchanged.
Options also allow you to profit without predicting market direction because of time decay and fluctuation in volatility that increase and decrease premium. For example, a trader might sell as out-of-the-money call on a relatively volatile futures contract he thinks will fall. Over then next two months, however, the market does not fall, but gradually moves higher, trading in a narrow range (but still below his strike price). The trader was wrong about market direction, but finds the combination of decreased volatility and time decay has eroded the value of his option to the point that he can buy it back at a profit (or perhaps hold it until expiration).
Part 3 will be posted on Thursday (5/12/11). Do you like this short lesson series? Let us know in our comments section.
Over the years, the trades you take will change, but the fundamentals you need to trade will always stay the same. With this in mind, we've dug into our vault and pulled out some of the best, most worthwhile Classic Trading Videos we could find.
These trading classics are only available for a limited time, so we suggest that you sign-up today before we take them offline for good.
Larry McMillan explains just how easy it is to trade options. In this fascinating trading seminar, Larry shares his a short-term trading system and philosophy on options. Larry is a best-selling finance author and an expert on options trading.
Simply visit the link above and tell us where to send the link and password to watch this educational trading seminar.