Essential Option Strategies. J. J. Kinahan
a publicly traded instrument like a stock, index, or fund. For example, the ticker for General Electric is straightforward. It's GE. However, sometimes the ticker is less intuitive and requires a symbol lookup. This is easy to do using most brokerage platforms.
After the ticker symbol is identified, enter it into the Quick Quote box (Figure 1.2) to see the latest stock prices and the change for the day. In this case, the stock is Microsoft, and the ticker is MSFT. The stock is up $0.55 for the day and last traded at $54.48 per share.
Figure 1.2 Quick Quotes
The default setting for Quick Quotes on the thinkorswim platform also includes two other important pieces of information – the bid price and the ask price. The bid price is currently the best bid price by a buyer. If an investor wants to sell in the current market, he can expect to receive $54.47 per share. On the other hand, a buyer pays the asking price or $54.48 per share.
Bid and ask reflects the current quotes to buy or sell a stock, option, or futures contract. The bid reflects a willingness to buy, and therefore a seller can expect to receive the bid price at the time of sale. The ask, or offering price, is a level that a seller or sellers are willing to receive for the security. A buyer typically pays the asking price.
Bids and asks are constantly changing, and there is no guarantee that you can buy or sell at the quoted prices. In addition, less actively traded names can see fairly large differences between bids and asks, which is also called the bid-ask spread. In later chapters we explore the mechanics of order entry and explore bids, asks, and bid-ask spreads in more detail. For now, the point to take away is that the last price is not necessarily an indication of the current market price to buy or sell. Bids and asks provide the latest market prices available to sellers and buyers.
Charts
A stock chart is simply a graph that shows price changes over time. In this book, I use two types. The first is a chart that shows the price of the underlying instrument, like stock, future, or index, over a period of time. The second is a payoff chart, or risk graph, and shows the potential risks and rewards of an options strategy. It is covered in more detail in later chapters. For now, let's discuss the basics of stock charting.
The simplest chart type is a line chart. For instance, it's easy to plot a line chart in a spreadsheet using data like date and price. Figure 1.3 shows a daily chart of hypothetical oil prices over twelve months. The line connects the twelve points where price and date intersect on the graph. It starts at $50 per barrel in January and ends at $53 in December.
Figure 1.3 Line Chart of Monthly Oil Prices
Traders plot charts for instruments like stocks, interest rates, or commodities to see trends over time. Obviously, few create the charts by hand or in spreadsheets. Charts are readily available on financial websites like StockCharts.com or Google Finance and also through online brokerage firms.
A second, more widely used chart is the open-high-low-close, or OHLC, chart. While the line chart is plotted using just the closing price, an OHLC chart includes bars that contain four pieces of price information.
Figure 1.4 shows an individual bar of an open-high-low-close chart. The small horizontal lines are the opening and closing prices. In this example, the stock opened at one price and closed at a lower price. The length of the vertical line represents the trading range of the day, because the top of the bar is the highest price and the bottom is the lowest.
Figure 1.4 OHLC Bar
Like the price chart, the horizontal axis (or bottom) of the OHLC chart represents time, such as days, weeks, or months. The vertical axis (or side) indicates price per unit, such as shares or contracts. Figure 1.5 shows an OHLC chart for a three-month period ended 11/30/2015. The time frame is plotted across the horizontal axis, and the change in price is depicted along the vertical axis.
Figure 1.5 Daily Chart of S&P 500 Index (8/31/2015–11/30/2015)
Notice that the OHLC bars are not all the same length. Longer ones suggest greater distances between highs and lows, and therefore increasing volatility in the security. Shorter ones suggest narrow trading, smaller daily moves, and periods of lower volatility or narrow trading ranges.
The time frame of an OHLC chart can be changed to weekly or monthly. If so, each bar represents the change over one week or one month. Short-term traders sometimes watch intraday bar charts at five-, ten-, or fifteen-minute intervals. Most of the examples throughout this book use daily OHLC charts.
More advanced charting tools are covered in Appendix B. If you have no previous experience with charting, take some time to learn how to identify areas of support and resistance with indicators like trend lines and moving averages. In addition, because the focus of later chapters is on options strategies, volatility studies are also useful. Those are covered in Appendix B as well.
Commissions and Fees
Brokerage firms vary in what they charge their customers. The costs associated with traditional brokerage activities like executing buy and sell orders have been somewhat commoditized, and costs are significantly lower today than they were twenty years ago. The growth of discount and online brokerages is a big reason.
But costs are relative to service. That is, brokerage services can range from very personal to simply taking orders online. Costs typically relate to service level and tools being offered. In short, you can expect to pay higher costs at some firms relative to others, and in an ideal world, the higher costs reflect the value being added.
At the end of the day, the investor's trading plan is a determining factor in broker selection. Are you trading once per month or five times per day? Some firms offer lower rates to active traders, and some charge more for broker-assisted trades.
Also, what types of investments are you buying and selling? Some firms offer certain products that others do not. In fact, futures are regulated under a different umbrella and require different account approvals compared to equities and equity options accounts.
Certain rules apply to investors who trade frequently. A pattern day trader is defined as someone who buys and sells a security in the same trading day (intraday) and does it four or more times during a rolling five-business-day period. In order to pattern day trade, the investor must maintain a minimum of $25,000 in a margin account.
Lastly, what kind of technology does the firm offer? Not long ago, charting software, quotes, and live news were expensive. Some firms still charge for these services, and some don't. Other firms also offer premium subscriptions to newsletters, research, and other analytics. Lastly, the costs of trading vary by firm as well. Some of the fees active traders are likely to encounter include:
• Stock trading costs. Brokerage firms typically charge a commission to execute stock trades. Some charge a flat commission per trade, some a commission per share, and some a combination of flat plus per share. The rates vary quite a bit across the industry, and many firms will charge more for broker-assisted trades or phone trades compared to online orders.
• Options trading costs. The commission and/or fees on options trades vary from one firm to the next. Some firms charge a flat fee or commission plus a per-contract fee. Others might charge only a flat commission or only a per-contract charge. Some offer a combination