Financial Life-Learning Paper, Research Paper Example

Introduction

Nowadays trading options are most appropriate and convenient ways to make money. They are most integrated, complex, many-sided, and changeable investment instrument. In fact options are among today’s real, comfortable and easy to use investment tools. Providing protection contrary to loss and an opportunity for forthcoming profits, they are indeed perfect for investors and traders.

The main goal of this Life-Learning Paper is to become a practical guide in helping to understand various options strategies, risk management, using credit for any financial transaction and how to save the gain in permanently modifying and changing market.

This paper discusses and analyses that the investors and traders should understand and learn the ways of using stock options rationally, carefully and reasonably. In that method they will make themselves suitable and appropriate to modern horizons in investing and trading.

The paper expounds how to explore some of effective and easy to use strategies for combining the power and straight of options into trading program. This Financial Life-Learning Paper is made in David Kolb’s model of Prior Learning. It shows how easy and profitable options investing and trading are and provides with the information, attainments and instruments which are important for options trading.

The case study uses a multi-method approach including book analysis and research.

Concrete Experiences

The United States of America “stock market has been growing since 1790” (O’Neil, 2002, p. 242). Since that time many has been changed. Today, options trading became a powerful and one of the most important instruments in finance sphere. Lots of newspapers, books, and other media providers demonstrate 15 active market stocks, O’Neil (2002) underlines. This list contains stocks which trade enormous quantity of shares a day. In its turn, Investor’s Business Daily created particular daily list to distinguish the stocks “with the biggest percentage changes in their trading volume for the day versus their average daily volume over the prior 50 days” (O’Neil, 2002, p. 175). The stocks final shut-off for the day is single out from those closing. This enables to see how the stocks money flows each day (O’Neil, 2002).

The financiers distinguish two kinds of people who use options. They are traders and investors. As a matter of fact, the majority of options users are neither unsophisticated traders, nor unsophisticated investors. All of them invest part of their stock and trade with their money. Such difference is the basic for trading and investment strategies, which deal with particular features of option, performing trading and investing strategies (Allaire, 2003). Williams and Hoffman (2001) believe that everyone can be an investor, but at the same time no one is a successful and felicitous trader.

The marketplace has the basic and principal players. Each of these players plays an important and essential role in creating an effective and resulting market. There is a market maker whose main purpose is to consult, and provide “continuous market with bid and ask spread” (Najarian, 2001, p. 22). Also, there is a broker who is obligated to carry out customer orders. The last are the local traders whose main goal is to speculate on the stock exchange. As Najarian (2001) emphasizes, to comprehend the role of each market player is essential for understanding options.

In modern world there are lots of steps and ways of investing and trading: “day trading, position trading, option trading, stock trading, futures trading, and so on” (McMillan, 2002, p. 154). Nevertheless not each is appropriate for all traders. All investors and traders who trade options no matter what their purposes, strategies and goals are rapidly understand that utilizing credit for any financial transaction which is provided by options is a step to the world of foremost and progressive trading opportunity (Cramer, 2005).

The traders desire to earn money in the marketplace that they “commit a majority of their capital to a position without taking the time to analyze the risk / reward profile” (Williams, & Hoffman, 2001, p. 2). Williams and Hoffman (2001) underline that such behavior is the reason why lots of the traders lost their money. Especially it concerns the situation while hedging the risks for setting up a profitable and favorable position. Defining which hedge is better grounded on knowing “not only the original risks of the trade but also the corresponding risk” (Williams, & Hoffman, 2001, p. 242). That is why, all traders and investors need special education. The newsletters and / or several days training courses on how to trade are not suitable way to receive good knowledge. The traders and investors need fundamental information about the market and the risks they could come across with.

The trader wants to receive high profit not only today, but tomorrow and the day after tomorrow. A good and professional trader doesn’t search the way to gain all the money in one day. Of course, if a trader does so, it is really great. In return for the trader should concentrate on continuously winning not very big amounts. Williams and Hoffman (2001) pay great attention that trading is not something like playing raffle. It concerns the understanding everyday risks and the way to control and manage trader’s position.

For the trader the single way to “close the option position before expiration” (Yates, 2003, p. 10) is to make in the marketplace a contrary transaction. This use calls and puts. It means that in case the trader purchased a call, selling the same call is the only way to save him / her. But, the trader must comprehend that purchasing a put is not able to do this. At the same time, in case of selling another call on the similar basis doesn’t to this. Resembling trades may lower the trader’s risk, Yates (2003) believes. The possible variant for closing the position in the marketplace with contrary transaction is to exercise it. After exercising a stock option, the trader has to make necessary payment for getting shares of stocks.

“The business is fast and a trader needs to be hedged at all time” (Najarian, 2001, p. 7). Even in several minutes the market could change and move very well. That means that the customer may not receive the expected profit (Najarian, 2001).

Observations and Reflections

When a trader purchases an option, he / she doesn’t control a company or its piece. This trader owns the right to own, control or sell anything. Options are a “speculative opportunity in case a stock price does, indeed, move your way” (Najarian, 2001, p. 22). On the other side, if options are purchased and not sold, they are acting like a kind of policy of insurance for cutting down the risk (Najarian, 2001).

The traders frequently buy options because of a considerable opportunity to use a credit for any financial transaction when a fast motion appears (McMillan, 2002). As O’Neil (2002) believes, difficult is the state that options can be “artificially and temporarily overpriced” (p. 223) because of a passing and temporary growth in value in the underlying share or general market. In case an option’s present value has fall up to a zero, the trader should sell the options for internal value or at least a little bit less. Yates (2003) identified the internal value as a low level “for the price of an option” (p. 10). That means that in case the trader sells an option “with zero or nearly zero time value” (Yates, 2003, p. 10) the trader is able to be assigned.

The traders are losing money because of several reasons, Williams and Hoffman (2001) underline. The first is that most traders do not comprehend the risk management. Their main tactic and strategy is based on their instinct, chance and hope. The second reason of why the traders are losing their money is that they treat trading as a raffle, not as a business. Those traders who have been less fast and quick to perform stayed on the “sidelines” (Williams, & Hoffman, 2001, p. 2).

Trading activity and work will normally execute and generate volume well till there is an acceptable sum of liquidity in the stock options. When such situation appears it is important to purchase calls and puts. It is significant to purchase calls when there is a high preference of call volume by anyone who is trading these options. To purchase puts is necessary when there is high put trading by these insiders (McMillan). When a trader purchase calls, he hopes that the price to go upward. Thus for example when a stock trading at $ 95, the trader may purchase a call at $ 100. In case the stock increases to $ 125 after two months and the trader didn’t sell his call option, he can earn $ 25 gain less the premium he paid. (O’Neil, 2002).

McMillan (2002) underlines that if insiders are purchasing a lot of calls the stock has a tendency to increase in its cost. This appears because of two main causes. The first reason is that the institutions accept these talks and use them by trading stocks. The second reason is that the market makers, whose main goal is to sell options to the insiders, want to insure themselves after selling the options. The trader must understand that when the short call is assigned, he / she is not able to deliver his “mutual fund shares” (Allaire, 2003, p. 182) merely he / she must make a payment in cash which is identical to the in-the-money option sum. In reality, whatever loses the trader incurs on his / her “short call position” (Allaire, 2003, p. 187) will be quiet offset by profit on the mutual fund. At the same time, from an option trading the trader’s short call will be managed as precarious.

Allaire (2003) believes that there are two sides to this. The first is that the trader shall receive approval from his broker to “write uncovered index options” (Allaire, 2003, p. 182) what is lot more complicated than receiving approval for covered option and demands the trader meets different tests in terms of bill volume and his trading experience. The other side is margin and possible income. In case the trader has the permission and write uncovered call option, the trader should margin this short account. In all probability the trader’s shares of the mutual fund will perform as concomitant for this short call stand. At the same time, if the trader is assigned on his written call, he is obligated to make a payment in cash for solving this assignment Allaire (2003) underlines.

O’Neil (2002) believes that when the trader considers options, he must cut down the percentage of his whole portfolio. A cautious and careful “limit is 10 % to 15 %” (O’Neil, 2002, p. 223). The trader, should accept a rule about where the trader is about to limit and stop all his loses. On the gain side, the trader may examine accepting a rule that he / she will take lots of his / her profits when they “hit 50 % to 75 %” (O’Neil, 2002, p. 223).

If any trader on Wall Street receive progressive and forward knowledge of merger or acquisition of any company or other significant information that can remarkably and notably influence the price of a stock the avidity is bringing to the forefront. That causes that the person will impetuous to buy the options or the stock to be confident and assure that he / she will receive a profit (McMillan, 2001). Generally, the activity of the traders indicates how effective trading volume increased and the growth in price level – historic volatility and option contract also. Traders have to use a model to define whether options are cheap or extremely expensive. A significant strategy and tactic for traders is to “set a stop before entering a position – and adhere to it” (McMillan, 2002, p. 154).

Williams and Hoffman (2001) supposes that there are several steps to successful and safe trading. The first and most important is to be aware the risks involved in options trading at the time of hedging. The second step is to establish a gainful position.

Najarian (2001) strongly believes that the most important for traders is their discipline and training. In case the trader is independent, the discipline must be his / her main feature. Without discipline the trader almost has no any chance to be successful and forehanded trader. The first and most significant principle of option trading or any kind of investing is to feel convenience with the strategies and tactics that the trader uses. The trader has to understand that notwithstanding what other says about the best and more comfortable strategy, he / she should use the one he / she has already chosen and feels it to be the best for him / her McMillan (2002) underlines.

Nowadays many newcomers do not comprehend the stock options for using it effective and resulting as one of the most important components of a general investment strategy (Williams, & Hoffman, 2001). For newcomers Cramer (2005) recommends to give up a part of their holdings to a stock market game. Cramer (2005) underlines that a strategy and tactic of purchasing and holding is not an appropriate one not only for newcomers, but for professionals. In case the trader is not able to spend several hours per week looking for each oh his / her stocks, such trader should pass his portfolio to mutual funds.

Abstract Conceptualizations and Generalizations

The distinction among the “theoretical value of an option and its current market price” (Williams, & Hoffman, 2001, p. 52) is the trader’s starting point for defining which options are having too high value and which are having low value (Williams, & Hoffman, 2001). Beginning with the foundations of options trading and options it continues to disclose the particular strategies to use: increase the trading income; guard and defend business against an unexpected market collapse; protect stocks against unexpected and unforeseen incidents; use modern and progressive options methods and principles for achieving success (Allaire, 2003).

Allaire (2003) supposes that for comprehending any option strategy, certain theoretical knowledge is important. Among all strategies, Williams and Hoffman (2001) underline the importance of so-called bearish strategy. This strategy gives a chance to the traders and investors to produce gain in a declining marketplace. Unluckily, many investors have a hard time “being bearish because they have been taught that a downward turning market is a bad thing” (Williams, & Hoffman, 2001, p. 151). That means that for them using their trading intuition is very difficult. At the same time the traders starting to be interested in the options market, the main strategy they have to use is “purchasing call options” (Allaire, 2003, p. 55). More frequently these reduce to the trader’s first breakdown and derangement with the options market.

According to various personality types, Williams and Hoffman (2001) singles out some types of traders. The first type is “the day trader” (Williams, & Hoffman, 2001, p. xx). This type of trader is organized, optimistic, concentrated, able to make quick decisions and all the time pay his attention to the marketplace. Such type of trader trades energetically “in and out marketplace” (Williams, & Hoffman, 2001, p. xx). The next type of traders, according to Williams and Hoffman (2001) is the “swing trader or technical trader” (p. xxi). Such trader analyzes market thoroughly for making selling and purchasing decisions, he is considered to be well educated in managing trading strategies. This type of trader is able to hold the same position for several days, weeks, or even months. The last type of traders is the “potential trader” (Williams, & Hoffman, 2001, p. xxi). Such trader has a mathematical cast of mind. He / she is patient, risk opposed, and a perfect person who solves various problems. The potential trader accepts strategies of advanced options for decreasing risk (Williams, & Hoffman, 2001).

According to Yates (2003), options can be systematized in “terms of style, which relates to the two ways in which they can be exercised” (p. 11). In case the option is able to be always exercised till its termination, it is known as “American style” (Yates, 2003, p.11). Nevertheless, a lot of options are able to be exercised solely on termination day, what is known as “European style” (Yates, 2003, p. 11). Yates (2003) pays great attention that neither American style, nor English style are having any connection to the options trade on the continents. These two styles options are effective in Europe, America, and other continents. For example, in the United States of America, whole stock options and over the half of share index is American style. A share index is European style. The same considers the futures options which are European and American style (Yates, 2003).

Williams and Hoffman (2001) believe that the investors have to understand that “market is its own animal” (p. 151) and that it will go on to grow and fall. The authors pay great attention that the investors and traders should decide whether they wand to take preference of these tendency.

Majority of stock brokerage firms use various levels of confirmation for options trading. A characteristic examples of this levels Allaire (2003) described. They are: covered option purchasing puts and calls, expansion; “writing equity puts” (p. 245), and naked call writing. Today, almost all option traders understand that “naked options have big risks and are not conservative strategies” (McMillan, 2002, p. 19). n case the trader is a newcomer in options trading market, he / she must not look forward more than the second level of confirmation unless he gets more experience. Moreover, when the trader is refused confirmation at a particular level, he / she must not assume it personally (Allaire, 2003).

As Yates (2003) found out, there are three significant things “an options analysis program cannot predict which the user must provide” (p. 144). The first means that there is no any options analysis endeavours to forecast the direction of future value of an underlying asset. The second significant thing Yates (2003) researched is modification in volatility, which has a great influence on trader’s options positions. This denotes that options are expensive when there is a great inconstancy, and vice versa. The last significant thing, which Yates (2003) found out is that while reproducing values for future options, the analysis of options should be done to forecast in what way every “future’s price will behave relative to the one futures contract selected to be the independent variable” (p. 145).

Nowadays there are many options models which accept various pricing models. Yates (2003) believes that each models “while valuable, have their limitations” (p. 144). The author supposes that option pricing model is the basic “of an options trader’s work” (p. 127). Option pricing model is using not only for determining what option is better to purchase or sell, but also for reproducing the future fulfilment of intended position.

Applications and Testing

Nowadays, option trading is one of the most financially useful and helpful instrument among numerous of investment strategies.

After studying this Financial Life-Learning Paper it is evident that trading options are one of the best and suitable ways of making money. Today many financiers and analytics consider that the possibility of losing invested value has a straight connection to the coercion which is involved in a bargain.

The knowledge received after studying this Financial Life-Learning Paper is applicable and pertinent in other spheres of life. Realizing and achieving goals, making decisions, assuming risks, and being devoted to the business the person is mostly interested in all have important and significant usage in mental and personal relations. From a mental perspective, realizing and achieving goals is the first step to develop and ameliorate the relationship with God by way of dedication to an everyday plan of Bible learning. To assume risks with physical facility for the advantage and preference via fasting and / or celebration are significant applications of these peculiarities. Personal relations application is obvious in the sphere of marriage. Realizing and achieving goals for a development of marriage relationship is important to stave off the relations from becoming useless and stagnant. Making decisions is other significant feature the traders and investors perform in to the marriage and family life.

The economic position in the world has a huge influence the options trading and investing. This knowledge on the part of market is advantageous for the traders and investors. The traders must be informed that “heavy speculative activity” (McMillan, 2002, p. 111) can mean some kind of insider trading, or even talks in the marketplace.

The traders and investors must understand, that for them sometimes the better investments are the options that “appear to be overpriced but really not” (McMillan, 2002, p. 73) because the losing of gain can appears in the future. Investors and traders have to be well educated for answering the appeared questions and knowing exactly what they are doing. Notwithstanding the investor or trader is planning to make options trading its profession, or he / she is planning it to be a part-time work, he / she is obligated to be well educated the sphere he / she works. The trader must know and understand the whole system of how to purchase and how to sell along with call option and put option (Eisenberg, 1998).

For each trader it is important to know and follow the number one principle of trading in the marketplace – “use only trade systems and strategies” (McMillan, 2002, p. 245) with which the trader sure and devoid of tenseness. The strategy, the trader use must accept his philosophy. Each of the traders must remember that it does not matter who says the trader the way to make profit, only the trader is obligated to determine which applicable and corresponding point of view is for him / her.

To conclude everything expounded it is important to say that the most beneficial and useful skill the person can ever become proficient is the skill and ability of trading.

Conclusion

Trading options is the most convenient and suitable way to make and save money. After learning and comprehending the trading options it is possible to see how the research fares the world of trading and investing.

Understanding the importance and value of options and studying how modification and changes affect options’ value the trader has to take advantage of price disparity in the marketplace. This basic knowledge is fundamental for understanding the risk and rate perspective of options trading. For making gain, the traders and investors, have to comprehend various options strategies, the way of using stock options rationally. Risk management, and how to save the profit in permanently modifying and changing market are very important for each trader who is going to make gain and become a professional in this sphere.

The reality is that market development and conditions are changing and modifying all the time. The changes in unsteadiness may offset the real and true evaluation value for an option. So as to defend and guard the positions against these modifications, it is significant to be ready to act any way to answer and affect any changes.

References

Allaire, M. (2003). The options strategist. New York, NY: McGraw – Hill.

Cramer, J. J. (2005). Jim Cramer’s real money: sane investing in an insane world. New York, NY: Simon & Schuster.

Eisenberg, R. (1998). The money book of personal finance. Clayton, USA: Warner Books.

McMilan, L. G. (2002). Profit with options: essential methds for investing success. Hoboken, New Jersey: John Wiley & Sons.

Najarian, J. (2001). How I trade options. Hoboken, New Jersey: John Wiley & Sons.

O’Neil, W. J. (2002). How to make money in stocks: a winning system in good times or bad. New York, NY: McGraw – Hill.

Williams, M. S., & Hoffman A. S. (2001). Fundamentals of the options market. New York, NY: McGraw – Hill.

Yates, L. (2003). High performance options trading: option volatility & pricing strategies. Hoboken, New Jersey: John Wiley & Sons.