Options Trading Strategies - Book Review - Guy Cohen, The Bible of Options Strategies

Options Trading Strategies - Book Review - Guy Cohen, The Bible of Options Strategies Most trading literature on option strategies tend to lean towards mathematical formulas to define the construction of a spread. Guy Cohen has chosen to use pictorial logic, even with the Greeks unique to a particular strategy, to piece together the legs of a spread with diagrams. Diagrams that connect with each other are a much more intuitive way to learn for those less inclined to numerical formulas. Still, the logic of the math remains robust and intact. The layout of the book makes it easy to navigate around the text. In addition to strategies being listed by the chapter and page there is a reference to the strategy’s main category with sub-categories, which are:  Proficiency: Novice, Intermediate, Advanced and Expert trader.  Direction: Bullish, Bearish and Direction Neutral.  Volatility: High Volatility and Low Volatility.  Risk/Reward: Capped Risk, Uncapped Risk, Capped Reward and Uncapped Reward.  Type: Income and Capital Gain. Guy Cohen has extensive experience of both the US and UK derivatives and stock markets. He specializes in trading and analytics applications ranging from real estate to derivatives and has developed comprehensive business, trading and training models, all expressly designed for maximum user-friendliness. There are adequate reader reviews on Amazon and Google Book Search, to help you decide if you will get the book. For those who have just started or are about to read the book, I’ve summarized the core concepts in the larger and essential chapters to help you get through them quicker. The number on the right of the title of the chapter is the number of pages contained within that chapter. It is not the page number. The percentages represent how much each chapter makes up of the 302 pages in total, excluding appendices. 1 2 3 4 5 6 7 8

The Four Basic Options Strategies Income strategies Vertical Spreads Volatility Strategies Sideways Strategies Leveraged Strategies Synthetic Strategies Taxation for Stock and Options Traders

20 68 30 56 44 20 54 10

6.62% 22.52% 9.93% 18.54% 14.57% 6.62% 17.88% 3.31%

Focus on chapters 2, 4, 5 and 7, which makes up about 74% of the book. These chapters are relevant for practical trading purposes. Here are the key points for these focus chapters, which I’m summarizing from a retail option trader’s perspective. Chapter 2: Income Strategies. These strategies construct spreads where part of the spread sells Theta as premium within a shorter term (typically 30-45 days), to collect income. In its entirety the strategy may result in a Net Debit or Net Credit spread. There are 13 types of spreads in this category: Covered Call, Short (Naked) Put, Bull Put Spread, Bear Call Spread, Long Iron Butterfly, Long Iron Condor, Covered Short Straddle, Covered Short Strangle, Calendar Call, Diagonal Call, Calendar Put, Diagonal Put and a Covered Put (a.k.a. Married Put). Chapter 4: Volatility Strategies. These strategies use spreads that are indifferent to price direction, so long as price explodes out of range. For a given explosion in price, the volatility of the spread needs to rise for a Net Debit spread and fall for a Net Credit spread,. There are 11 spread types are defined in this category: Straddle, Strangle, Strip, Strap, Guts, Short Call Butterfly, Short Put Butterfly, Short Call Condor, Short Put Condor, Short Iron Butterfly and Short Iron Condor. Chapter 5: Sideways Strategies. These strategies involve non-directional spreads, requiring price to drift within a confined range. As price remains range bound, the volatility of the spread needs to rise for a Net Debit spread and fall for a Net Credit spread. There are 11 types of spreads in this category: Short Straddle, Short Strangle, Short Guts, Long Call Butterfly, Long Put Butterfly, Long Call Condor, Long Put Condor, Modified Call Butterfly, Modified Put Butterfly, Long Iron Butterfly and Long Iron Condor. Chapter 7: Synthetic Strategies. Synthetic strategies mimic the risk profile of a stock, futures or other option position by combining calls, puts with or without stock. Though typically, most synthetic positions are either long or short stock. If you have a 401K plan or employee stock purchase plan that is long stock, then it may make sense to consider synthetic strategies, as you are already long Delta. There is unlimited risk for

some synthetic spreads, regardless if the strategy involves stock or not. There are disadvantages to using synthetics. 12 spread types are defined in this category: Collar, Synthetic Call, Synthetic Put, Long Call Synthetic Straddle, Long Put Synthetic Straddle, Short Call Synthetic Straddle, Short Put Synthetic Straddle, Long Synthetic Future, Short Synthetic Future, Long Combo, Short Combo and Long Box. From a retail option trader’s viewpoint, I prefer to establish positions without the use of stock. Using stock synthetically in a position makes each trade more capital intensive than it needs to be. Especially, if your trading account is below USD $50,000. The use of stock in configuring these positions does not add material merit in controlling risk and there is no added monetary benefit in tying up available trading capital in a stock-dependent synthetic position that could otherwise be achieved without the use of stock. As an options trader in the first place, you want as little to do with the stock itself as possible, other than to configure the required option position around the underlying product, which can be substituted with a cashsettled Index instead of a stock-settled Index. Out of a total of 56 strategies covered in the book, I have reduced the list down to 35 Limited Risk Spread types that do not need to include stock as part of its original construction. Limited Risk means there is a cap to the maximum loss – “Capped Risk” is the term used in the book. This should always be the starting point of any strategy you choose to construct. Do not just look at the unlimited profit (Uncapped Reward) side of the strategy without realizing that there is an unlimited loss (Uncapped Risk) side to same strategy. Limited Risk Spreads with “Unlimited” Reward and their Directional outlook. 1. Long Call Bullish 2. Long Put Bearish 3. Put Ratio Backspread Bearish; reverse Bullish 4. Call Ratio Backspread Bullish; reverse Bearish 5. Straddle Indifferent/~Neutral 6. Strangle Indifferent/~Neutral 7. Strip Bearish 8. Strap Bullish 9. Guts Indifferent/~Neutral 1-9 are Debit spreads: IV needs to rise. 10. Bull Put Ladder Bearish 10-11 are Credit spreads: IV needs to fall. 11. Bear Call Ladder Bullish Limited Risk Spreads with Limited Reward and their Directional outlook. 12. Bear Put Spread Bearish 13. Bull Call Spread Bullish 14. Long Call Calendar Bullish; Indifferent/~Neutral 15. Long Put Calendar Bullish; Indifferent/~Neutral 16. Long Call Butterfly Indifferent/~Neutral 17. Long Put Butterfly Indifferent/~Neutral 18. Long Box Indifferent/~Neutral 19. Long Call Condor Indifferent/~Neutral 20. Long Put Condor Indifferent/~Neutral 21. Long Iron Butterfly Indifferent/~Neutral 22. Long Iron Condor Indifferent/~Neutral 12-22 are Debit spreads: IV needs to rise. 23. Bear Call Spread Bearish 23-35 are Credit spreads: IV needs to fall. 24. Bull Put Spread Bullish 25. Short Iron Butterfly Indifferent/~Neutral 26. Short Iron Condor Indifferent/~Neutral 27. Diagonal Call Bearish 28. Diagonal Put Bullish 29. Modified Call Butterfly Bearish to ~Neutral 30. Modified Put Butterfly Bullish to ~Neutral 31. Short (Naked) Put Bullish 32. Short Call Butterfly Indifferent/~Neutral 33. Short Call Condor Indifferent/~Neutral 34. Short Put Butterfly Indifferent/~Neutral 35. Short Put Condor Indifferent/~Neutral Other than the 35 Defined Risk Spreads that do not require stock as part of their original construction for entry, there are 6 Defined Risk spreads that need stock to configure their positions. The 6 positions that I

have deliberately excluded from the list above are the Long Call Synthetic Straddle, Long Put Synthetic Straddle, Synthetic Call, Synthetic Put, Collar and Covered Call. In conclusion, for new to intermediate traders do not be overwhelmed by the 56 strategies in the book. It’s entitled the “Bible of Options Strategies” for a reason. What is critical is to get a deep understanding of the Long Call, Long Put, Short Call, Short Put, Long Vertical Call/Put, Short Vertical Call/Put and the Long Calendar Call/Put. That is the 4 Basic Options Strategies, plus the Vertical and the Calendar – the only 2 strategies that floor traders define as true spreads. The other combinations are a mixture of the basics with or without stock. ---------------------Thanks for reading my article, Clinton Lee. Founder, Home Options Trading: a uniquely retail-focused option-centric trading firm. Please see Consistent Results at http://www.homeoptionstrading.com/consistent_results/, displaying the Model Portfolio's Performance YTD, updated each month-end. The portfolio models a typical retail option trader's account up to USD $50,000. Here's the stats in summary:  Return: Profit/Start of Year Cash Balance = $91,593/$58,380 = UP 157%.  Win/Loss Probability = 60/68 = 88.24%.  Performance Ratio = (Win/Loss Probability) x (Average Win/Average Loss) = 88.24% x $2.99 = 2.64.  Positive Expectancy = (Win Probability x Average Win) - (Loss Probability x Average Loss) = $1,347 per trade. Preview an original 55 hour video-based course for online options trading from home, at http://www.homeoptionstrading.com/original_curriculum.html Purchase the curriculum and receive an $800 options basic course as a Bonus! Clinton's career spans 16 years of treasury, finance and banking across Hewlett Packard, JP Morgan Chase, Citibank, Royal Bank of Scotland (previously ABN Amro); and, is currently a Senior Liquidity Advisor at Bank of America in its Global Treasury Services division. Despite the years in the finance/banking industry, it did not help him directly grasp online options trading from home.