Welcome to the second lesson from our
HOW TO PROFIT FROM COMMODITY OPTION TRADING course.Today we are going to discuss the simple option purchasing strategy.
BUYING A CALL OR PUT OPTION:
The simple strategy of buying a call or put option is the most profitable option strategy to trade. However, it is a known fact that it’s the most abused strategy among uneducated option traders. It’s also a known fact that most traders who abuse the strategy fail and never become successful traders!
So let’s take a moment to examine why most option traders fail, and with a little common sense, determine how we can avoid their same mistakes to increase our chances of success.
Mistake 1) THEY PURCHASE FAR OUT-OF-THE-MONEY OPTIONS There are three levels of association between a particular option strike price and the underlying futures contract. They are: in-the-money, at-the-money and out-of-the-money.
An option’s strike price that is currently equal to the current futures contract price is considered “at-the-money”. An example would be if December corn futures is currently trading at 3.00, the December corn 3.00 call option is considered as “at-the-money”. If Dec. futures is trading at 3.50, the Dec. 3.00 call is considered as “in-the-money” because Dec. futures is trading beyond the 3.00 strike price. If Dec. futures is trading at 2.50, the Dec. 3.00 call option is considered to be “out-of-the-money” because Dec. futures has not yet reached the 3.00 strike price level.
Obviously, the in-the-money option is going to be the most expensive option to purchase because it not only has time value, it has real intrinsic value because the futures price has already exceeded the option’s strike price. The at-the-money option will be the next most expensive, and the out-of-the-money option strike price will be the least expensive. In fact, the farther out-of-the-money the option’s strike price is, the cheaper it becomes because there is a smaller chance that the underlying futures price will reach that particular strike price.
By the time a new futures price trend is well underway, option strike price premiums have substantially increased. Sadly, this is about the time that most uneducated traders decide to enter the market out of fear of getting left behind on a major price move, or by taking someone else’s advise!
However, they can only afford to purchase the FAR out-of-the-money options at this point. This means that the futures price must move a very long ways before their option makes money. Those far out-of-the-money options have little chance of becoming profitable, and in my opinion, are nothing more than a cheap lottery ticket. But uneducated traders insist on purchasing them letting their greed and fear get the best of them.
So, it’s no secret that we need to concentrate on purchasing the at-the-money options and no further out-of-the-money than two strike prices. This gives us the best opportunity of profiting because the underlying futures price has to move very little to put our options in-the-money. But, remember those are the most expensive options! We want to purchase them when they are less expensive before the underlying futures price moves higher. We can do this by simply using our futures charts and the option trader’s most powerful weapon; IMPLIED VOLATILITY.
So let’s take a look at mistake number two and how we can turn their mistake into more profits for us.
Mistake 2) CAUGHT BY THE IMPLIED VOLATILITY CRUSH! Implied volatility sounds like a complicated term, but it’s quite the opposite.
The most overlooked and underutilized factor by most option traders is the significance of volatility. This includes both the effect of volatility on the premium cost of the option when purchased and of future changes in volatility on the position.
Volatility is simply a mathematical computation of the magnitude of movement in an option. This is based on the activity in the underlying market. If the market is making a rapid move up or down, volatility will rise; in a quiet market, volatility will be low.
The daily implied volatility rankings are available to use free on the Internet with 43 commodity markets ranked from the most overvalued option markets to the most undervalued in an easy to follow table. So there is no need to purchase option evaluation software to get the information!
But what does it mean to get caught in a volatility crush? If you have ever purchased an option, and even though the futures price moved in your favor, your option gained no or very little value, and in many cases LOST value, you were caught in an implied volatility crush!
To explain, there are two types of volatility. Implied and statistical. The statistical volatility measures the average volatility range for any given period of time (six months, one-year or two years” and in any given market. Implied volatility measures the current activity in that market on a daily bases. If the market changes trend or an exciting news story comes out, Implied volatility will spike higher and the statistical will stay about the same.
At some point in time, statistical volatility will act like a rubber band and snap back the implied volatility to its statistical range. This generally occurs when the excitement has calmed down.
So, the often fatal mistake of purchasing an option at the worst time (when Implied Volatility is ranked high) will result in being caught in the volatility crush when statistical volatility snaps back implied volatility.
So you can eliminate this problem by simply seeing which markets are considered as undervalued and using your futures charts to spot possible trading opportunities.
It’s really that easy, and my LOW-RISK OPTION TRADING COURSE will show you exactly how to do it! I show you how to purchase those $100 to $300 options at just the right time and see them explode in profits like purchasing $100 to $300 dollar options in July corn and reaping profits of $3000 to $7000 in less than one-month! Take a look at my option course page for a chart of the corn trade and three others at: http://www.vtuniversity.com/options.html
There are other mistakes traders make which are explained in my course, but these two are the most common and are responsible for the most losses that uneducated option traders make. Turning the tables on these two mistakes alone will increase your probability of profit and reaching successful trader status by at least 80%!
In tomorrow’s lesson I’m going to show you my favorite option position that takes advantage of both the mistakes described here today to produce a STRESS-FREE TRADE that has absolutely NO RISK OF LOSS! You don’t want to miss this one!
The email course is not designed to be an introduction to option trading. It is designed to explain the option trades that I teach and to give you some real-world examples of how you can immediately put the positions to work in your own account. If you are a complete beginner option trader who needs to learn the basics, I have put the basics on a web page for you. Just go to this page address:
Disclaimer - I am not a commodity trading advisor. The information on this site is for trading education only. There are no trading recommendations for any one individual made on this site and this information is paper trades for trading education. All trades are extemely risky and only risk capital should be used when trading.
U.S. Government Required Disclaimer - Commodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.
CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.