Good-bye Mr. burglar

Democracy Warrior Farewell
"It has been the home belongs to a god in heaven on December 30, 2009 on Wednesday at 18:45 wib, former President of the Republic of Indonesia to the four, Mr. Abdurrahman Wahid (Gus Dur)"
Nation-Indonesia lost a son of the nation's best "The siege", he was Abdurrahman Wahid, who nicknamed the "Gus Dur".
He was a great statesman this nation, He was a teacher Nations, he was a true warrior of democracy, he was a simple in his life, he was a warm and faithfully defend the minorities and weaker indiscriminately, tribe, race, whatever the language, and he a host of fresh air for the nation Indonesia, Gus dur lot of merit in the nation and the people of Indonesia is only he who can make a big change in a democracy for Indonesia,
we are lost, a lot of memories that never will be forgotten by the nation such as Indonesia jokes, thinking that sometimes controversy, and just in the act, speak out frankly in saying that's typical of him. Indonesia is very fortunate nations had led him oelh though only for a moment but it has made phenomenal changes to this country.
"Good-bye Mr. Abdurrahman Wahid, who we love, may receive side GOD ALMIGHTY, and got his side a decent place, we will always remember his services, and will continue the struggle, only prayers that we prayed his soul may rest in calm, Once again we say Good-bye the siege, the true heroes of democracy ".

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white snow has come
day by day, year change in
and alternated seasons come and go
failure will change success
have changed their sorrow joy and happiness
and snowy white hope always faithful await us
hopefully in the new time, new year
This is the moment of resurrection for us all
and the moment of our journey to lasting financial freedom

"Merry Christmas 25 December 2009

  and
 "Happy new year 01 January 2010"

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Technical Analysis : Introduction basic V-VIII

Technical Analysis V: Trending and Ranging Markets

 

In Trending Markets

The existence of a trend in any market depends on a series of relative highs and lows. Two consecutive relative highs, each above the previous relative high, and two relative lows above the previous low would be constitute a tentative up-trend. A third relative high would confirm the trend.

The chart below illustrates a up-trend of EUR/USD:

The continuation of a trend depends on the successive rallies reaching a greater price than the previous ones. Traders can buy at relative lows and profit from the rest of the trend. Or traders can speculate the reverse of the trend and sell at relative highs. If an up-trend establishes a relative high and the subsequent rally fails to break through to a higher price, then the up-trend is in doubt. A series of decreasing relative lows would be necessary to determine that the market trend had reversed to a downtrend. More likely, the market will be range bound for a period.

In Range Bound Markets

Markets do not always move in trends. They spend a lot of time in ranges, fluctuating between established highs and lows. Often a range bound market is considered to have a sideways trend, since it is neither moving upwards to new highs or down to new lows. If the short-term trend is that of a sideways market, it is sometimes called a consolidation range. The price during a consolidation period is simply building up support for a continued move in the original direction. See the following chart:

Technical Analysis VI: Trend Lines

What are Trend lines?
Trend lines are lines drawn on the historical price levels that depict general direction of where the marking is heading, and provide indications of support or resistance.
Drawing trend lines is a highly subjective matter. The best test of whether a trend line is a valid one is usually whether it looks like a good line. In an up trend, a trend line should connect the relative low points on the chart. A line connecting the lows in a longer-term rally will be a support line that can provide a floor for partial retracements. The down trend line that connects the relative highs on the chart will similarly act as resistance to shorter moves back higher.

Any two relative highs or lows will be on the same line, so it is possible to draw a tentative trend line between any two points. Traders can use tentative trend lines as an indication of where support or resistance might be, but until a tentative line holds as support or resistance, it is not yet confirmed as valid.
Of course, the more times a trend line holds, the stronger it will be in the future. If a single line can connect 4 or 5 relative lows, then the chances of the next pullback bouncing off the line are high.
The best trend line?
It is an unusual situation where three points on a chart will exactly coincide with a straight line connecting them. More often, prices will be close to a line, and a best-fit line will have to suffice. This is where trend lines become more art than science. Different traders may draw different trend lines given the same chart or even connecting the same series of relative low points.
Sometimes a trend line will have to be revised as new relative highs or lows appear. Even if the trend line is a very close fit between three or more points, it is important to be flexible and redraw trend lines when necessary.

Using High/Low or Close/Open
Often the differences in drawing trend lines depend on whether the high and low prices are used or whether the closing and opening prices are used to determine the line. On a candlestick chart, the question becomes using the wicks of the candlesticks instead of the solid bodies of the candles only.

Generally closing prices are more significant points than the intra-day prices on a chart, and if a trend line can be drawn using the body rather than the wick of a candle, the body should be used. Similarly, when drawing a trend line, an intra-day spike through a line should not automatically invalidate it. If there is a candle that closed below the trend line, though, it would be a much more serious breach of the line.

Technical Analysis VII: Trading the Trend Lines

Only one of two things can happen when a price approaches support or resistance: the price can break through it, or it can bounce off and reverse direction. The same is of course true for trend lines.
1. Trading on a Pullback
If a chart is trending in a clear direction, and a trend line can be drawn connecting a series of relative highs or relative lows, trading opportunities exist when the price approaches the trend line. If the price bounces off the trend line and resumes the trend in the original direction, this can be an excellent opportunity to enter the market in the direction of the dominant trend. This is often referred to as buying on a pullback in an up trend or selling into strength in a downtrend.

Buying on a bounce off such a support line can be done through a limit order just above the support.
2. Trading a Break of the Trend
The second possible trade is the break of the trend line, which can be traded just as any other broken support or resistance line. If a candle closes through a trend line to the downside, as in the example below, the proper entry point would be to sell once the price moves below the low of the breakthrough candle.

This ensures that the short term force is in the direction of the break lower. The opposite would be true for a break above a resistance line.

Technical Analysis VIII: Price Channels

A trending market can move between parallel support and resistance levels. A price channel between two parallel lines can often be drawn in a trending market. The key to a price channel is that the lines be parallel to each other. The value of the price channel in predicting the ongoing speed of a trend depends on the lines being parallel.

Unlike trend lines, which can be drawn on any chart with two relative lows or highs, price channels should not be forced on a chart where they are not quickly apparent. Once a trend line is established, create a duplicate parallel line on the chart. Then move it up to the relative highs above or down to the relative lows below the trend line. If two or more fit with the line, there may be a valid price channel. Otherwise, the market may simply be too volatile - even in the midst of a strong trend - to plot a channel.

In the above example the (support) trend line itself is valid, but creating a parallel line on the opposite side of the prices does not add any value to the chart and is not warranted by the data. Placing a support or resistance line where it does not belong will simply provide you with false signals to buy or sell.

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Technical Analysis : Introduction Basic I-IV

Technical Analysis I: Introduction

There are two major approaches to analyzing the currency market, fundamental analysis and technical analysis. The fundamental analysis focuses on the underlying causes of price movements, such as the economic, social, and political forces that drive supply and demand. The technical analysis focuses on the studies of the price movements themselves. Technical analysts use historical data to forecast the direction of future prices.
The premise of technical analysis is that all current market information is already reflected in the price movement. By studying historical price movements, investors can make informed trading decisions. The following articles aim to give a thorough presentation of technical analysis tools and theories.
The primary tools of technical analysis are the charts. The articles first introduced common kinds of charts available on charting software. Charts are also used to identify trending and ranging markets. The articles continued on how to identify support and resistance price, trend lines and price channels. Next, it presented simple trading strategies in trending and ranging markets.
Through careful observation, technical analysts have found recurring patterns on the charts that can give us indication about future price movements. The articles introduced the important patterns, such as the trend reversal and trend continuation patterns. In addition, the Japanese Candle Stick has its own implications in terms of patterns, the articles then introduced how to read the Japanese Candle stick and the inference of its patterns.
Technical indicators are mathematical calculations based on historical prices, they are used extensively in technical analysis to predict changes in trends or price patterns. The final part of the technical analysis is a serious of articles introducing two major types of indicators: trend following indicators and oscillators.

Technical Analysis II: What are Charts?

A chart is the most important tool for understanding the total sum of what is going on in the market. Almost all traders today, particularly those who trade actively, use their favourite types of charts to analyse the market. In the end, a chart is a visualised representation of the price movements, a reflection of the psychology of the market and a visualization of the interaction between buyers and sellers in the market. Because it is a reflection of all the activity that has taken place for a particular traded instrument, a chart also shows how the market values a particular asset based on all the information available. And because a chart has the potential to offer such insight and to accurately reflect the entire perspective of the market, it is an indispensable tool in the arsenal of any trader.
There are three major kinds of charts: bar charts, candlestick charts, and line charts. These charts are described below. Within the articles, we will use primarily candlestick charts, because they are the most commonly used charts amongst active traders.
Three major types of charts:

1. Bar Charts

Bar charts provide traders with four key pieces of information for a given time frame: the opening price during that time frame; the closing price; the high price; and the low price. Bar charts can be applied to all time frames, and hence a single bar can summarize price activity over the past minute or over the past month. Different traders use time frames in various manners, although a good rule of thumb is that the longer the time frame, the more significant it is as it will account for more data -- and hence will be a better reflection of the market's psychology.
Below is an analysis of how a bar chart conveys information.

2. Candlestick Charts

The candlestick charts were invented by the Japanese in the 1700s. Just like a bar chart, a candlestick contains the market's open, closing, low and high price of a specific time frame. The main difference is the candlestick's body part, which represents the range between the opening price and the closing price of that particular time frame. When the body part is filled with red (or black), it means the closing is lower than the opening. When the body part is filled with blue (or white), it means the closing is higher than the opening. While the bar charts put more emphasis on the progression of closing price from the last bar to the next, while the candlestick charts put more emphasis on the relationship between the opening and the closing price within the same time frame. Above and below the candlestick's body are the ‘wicks', while the wick on the top is the highest price and the wick at the bottom is the lowest price of that period. Candlestick charts are more popular than the bar charts and the line charts, because they tend to be more visually appealing.
Below is an analysis of a candlestick chart and its components.

3. Line Charts

Unlike bar and candlestick charts, line charts present much less information; they only show the closing price for a series of periods. As a result, line charts serve best to measure the overall direction of long-term trends, and hence are of limited used for most traders.
Below is an example of a line chart. Note how it clearly and simply shows the direction of the trend.

Technical Analysis III: Support and Resistance

What are support and resistance?
Support levels are prices where buyers have shown or are likely to show strength. Resistance levels are prices where sellers are likely to be strong.

Support

Support levels essentially give the market a 'floor', since they are areas where buyers tend to be strong. If the price falls to a strong support level, traders should expect buyers to step in and drive the price up, or at least keep it from moving any lower.
Because support levels are prices where buyers are supposed to be strong, if the price falls below a support level, this is a signal for the market. It shows that there is more selling pressure (or less buying) pressure than previously thought, and it often leads more traders to exit long positions and take short positions.

Resistance

Resistance levels perform the opposite function of support, which provide a 'ceiling' to the market. If the price rises to a strong resistance level, short sellers should be expected to enter the market and traders in long positions may cover their positions to take profits. This combination of selling pressure will often drive the price lower.
Resistance functions in the same manner as a safety net for short positions and an entry point for traders looking to buy on a breakout.

When a price breaks through a resistant level, it often triggers a large number of stop orders and makes for even greater buying power. Often the stronger the resistant level, greater the number of stops that are triggered and the larger the move above resistance.
Unfortunately, not every breakout is valid. Because they know that many traders place stops to sell just above resistant levels, some large institutional traders attempt to drive the price higher in the short term just to trigger these stops. Without any real force behind the move higher, the price can fall back to resistance. The same dangers of false breakouts apply to support levels as well.

Technical Analysis IV: Identify the Market Trend

Three Phases of Major Trends

A trend represents a general direction of the market. Dow Theory asserts that major trends have three distinct phases: accumulation, public participation and distribution. The accumulation phase represents the first part of the trend in which those who are well-informed buy or sell. In other words, if the well-informed recognize that the recent downtrend is soon coming to an end, they would buy, and vice versa.
The public participation phase involves the masses following the major trend. This occurs as prices begin to accelerate rapidly and there is news supporting the trend.
The final distribution phase occurs as the news highly favors the current trend and speculative volume and public participation increase even further. At this point, the well-informed investors who accumulated when the market was at its peak (trough) begin to sell (buy) before other investors begin to follow suit.

A Trend Is Assumed to Be in Effect Until It Gives Definite Signals That It Has Reversed

This is a major theory that essentially mirrors the physical law stating that an object in motion tends to continue in motion until some external force causes it to change direction. Relating that principle to price trends, a strong trend will tend to continue in its current direction unless there is a price reversal indication, as per technical or even fundamental analysis. The later articles will focus on learning to spot reversals in the market and how traders can place orders to take advantage of such reversals.

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Options Trading

Conversions

Like Reversals, conversions are often used by savvy traders in an attempt to capitalize on minor price discrepancies between Calls and Puts. Like other arbitrage strategies, a conversion involves buying something in one market and simultaneously selling it in another to capitalize on whatever small discrepancy exists between the two.

When options are relatively overpriced, a trader would buy stock on the open market and sell the equivalent position in the option market. Theoretically, this is a strategy with very little risk because the profit is locked in immediately. The idea here is to create a synthetic short position and offset it with a long position in the same underlying stock. The synthetic short position is created by selling a Call and buying a Put with the same strike price and expiration.

Combining the synthetic short position with a long stock position creates a conversion:

• Short call + long put + long stock 
• Profit potential: limited
• Loss potential: limited
• Break-even point: Call price - put price = stock price - strike price

Index Options

By definition, an index is a group of stocks traded or listed as one entity, such as the Dow Jones Industrial Average (DIA) or the S&P 500 (SPX). There are literally hundreds of different indexes traded throughout the world, with many tied to securities on the U.S. exchanges.

There are several advantages associated with trading the indexes themselves, as well as a number of different investment vehicles available with which to trade them. Some of these investment vehicles include: managed index funds - where your contributions are managed within a mutual fund that specifically targets the various funds themselves; or index tracking stocks (also known as exchange traded funds or ETFs), or the most exciting vehicle of all, index options.

Most index options are heavily traded and carry large premiums. This makes them ideal for selling time, as with a Covered-Call, or to show dramatic increases in the option value for a given movement in the underlying index by virtue of the leverage associated with options.

Unfortunately, not all indexes are optionable. For the purposes of our discussion, we'll only focus on optionable indexes.

Most Common Optionable Indices:

It's probably safe to assume you are somewhat familiar with most, if not all, of the indexes. However, let's quickly review the names and common ticker symbols for the optionable indexes we'll be discussing (notice that many of the indexes listed have more than one ticker symbol).

Complete definitions for these indexes can be found at the CBOE Web site at http://www.cboe.com.

You may be wondering why there are so many different ticker symbols for the various indexes listed. The reason is that each of the different ticker symbols represents a completely different security, tracking the same base set of stocks, but often following a completely different pricing structure.

Here's an example: the SPX tracks the performance of the top 500 companies in the Standard & Poor's index. The XSP also tracks the S&P 500, but at 1/10th of the value of the SPX.

Another possible variation between option types is their exercise style: American-style options vs. European style options. There are advantages and disadvantages to each discussed below.

American vs. European Style Options

Many European investors also trade on the U.S. exchanges, enjoying the protection of the U.S. regulated markets and the wide variety of financial instruments available. Many European traders are also attracted to the trading flexibility possible with American-style options.

The main difference between an American style option and a European style option is when they can be exercised. European-style options can only be exercised on the day they expire, which tends to reduce the risk to the option seller. With either American or European-style options, you have the ability to buy or sell the options at any time prior to expiration - it's the freedom to exercise the options that is the real difference.

Most options based upon an underlying stock are American-style options. American-style options can be bought and sold or exercised to take possession of the underlying stock at any time prior to expiration. Since most index options are tied to the value of a basket of stocks, there is no physical stock to possess – these options are cash-settled. Most cash-settled options are of the European variety.

If you imagine yourself as the seller of an index option, (think Covered Call) you can see how advantageous it could be to know with certainty that you won't awaken early one morning to find that your index option contracts have been exercised, leaving you on the hook for a hefty cash settlement. You only need to worry about settlement on the day of expiration and at no other time. This gives you the comfort of knowing that you're free to "buy-to-close" your contracts to cover an upside-down trade and limit your losses rather than being forced to turn over a large cash sum – as long as you do it before expiration day. This protection from potential down-side risk clearly works to the advantage of the option seller. Sellers of American-style options run the risk of being "called out" and having their options exercised at any time. For this reason, American-style options have a greater premium than European-style options for a given option position.

SPX:

One of the most actively traded indexes and some of the most actively traded options contracts come from the S&P 500. This benchmark index is generally traded by large institutional traders with plenty of cash at their disposal. The options contracts are expensive and volatile. It is not unusual to see the SPX index move anywhere from 2 to 30 points in a single day.

The SPX trades as a European-style option and can only be exercised on expiration day. The last day you can actually trade the SPX is the Thursday of the week the contracts expire. The options are cash settled at the price of the open on expiration Friday. SPX options are pricey, but each point in movement of the S&P 500 index is equal to a $100 movement in the SPX.

Other than the European-style exercise date for the SPX, the options are just like any regular option, officially expiring on the Saturday following the third Friday of the option's expiration month. Options in the SPX are traded through the Chicago Board Options Exchange (CBOE) and are traded in the Central time zone from 8:30 a.m. to 3:15 p.m., Monday through Friday.

XSP (aka Mini-SPX):

The XSP follows the same core basket of stocks as the SPX, but at only 1/10th of the cost. This brings the option much closer to the price range of individual investors, resulting in fairly significant daily trading volumes. For example, if the SPX were currently valued at $1500, the XSP would have a value of $150.

DIA:

Mention the U.S. stock market anywhere in the world and people will likely think of the Dow Jones Industrial Average (DIA). This index is one of the more popular with investors worldwide due to its versatility and diversity. The stock symbol DIA can be traded as an Exchange Traded Fund (ETF), just like an individual stock. The DIA, along with all other ETFs, is traded on the American Stock Exchange. Information regarding the DIA, as well as other ETFs, can be found on the American Stock Exchange Web site at http://www.amex.com.

One strong benefit of ETFs like the DIA is the diversity they offer. With one position, you have a portfolio diversified among 30 stocks. Plus, it can be shorted on a downtick.

You can play options on the index as well. Since the DIA acts like any other optionable stock, Covered Calls are an effective way to leverage your investments.

Options on the DIA are American-style, meaning they can be exercised any time prior to options expiration. Since the underlying stock can be bought and sold, DIA options result in physical settlement of the option trades. Thus, in the event you sell a Covered Call and you are called out, you need to sell the underlying stock to the option buyer to settle the transaction.

DIA options are also traded on the CBOE, which is open Monday through Friday from 8:30 a.m. to 3:15 p.m., Central Time. DIA options can be traded up to the closing bell on expiration Friday for their individual expiration month (though the true expiration date is the third Saturday of the month the options expire).

DJX:

Investors who prefer to trade indexes as a straight index and not as an ETF can trade the Dow Jones Industrial Average as an index option with the DJX. This option trades at roughly 1/100 of the Dow and follows the rules of a European-style option. Thus, the last day to trade the DJX is the Thursday before expiration, with the settlement price locked in at the open on expiration Friday. The DJX is traded on the CBOE, so trades are processed from 8:30 a.m. to 3:15 p.m., Central Time, Monday through Friday.

QQQQ:

Investors wanting to trade the NASDAQ 100 (NDX) can trade the index as a stock using the ticker symbol QQQQ. This index is often referred to as the Q's, or the triple Q. This ETF carries the same characteristics as a normal stock, yet provides you with a diversified portfolio of 100 of the NASDAQ's largest companies.

The QQQQ offers options with a physical settlement. So if you exercise options on the QQQQ, you can take physical possession of the stock by purchasing the shares at the option strike price. The QQQQ is traded on the CBOE.

The QQQQ tracks the average price of the top 100 companies of the NASDAQ. At the time of this printing, the QQQQ was averaging about $35 per share. This means that not only is the stock relatively affordable but the options aren't all that expensive either.

NDX:

If you're approved for Level 5 trading authority, you may want to consider the advantages of trading naked index options on the NDX, one of which is a much higher premium. Also, because there is no stock to own, options on the NDX are cash settled. Another characteristic of the NDX is that is a European-style option.

If you have Level 5 trading authority, the premium associated with NDX options can be quite attractive. If you were to look at the premium for the at-the-money Call for next expiration month on the QQQQ and the at-the-money Call for next month on the NDX, you would see that the difference in premium is significantly higher for the NDX.

RUT:

The Russell 2000 (RUT) is an index that continues to gain popularity. The RUT actually tracks the smallest 2,000 of the 3,000 largest stocks in the U.S. markets. It's a European-style option that is cash settled on expiration Friday. As with the previous examples, the RUT is traded on the CBOE, open for trading from 8:30 a.m. to 3:15 p.m., Monday through Friday, Central Time.

Caution: Only experienced investors who understand how to make volatility work for them should trade index options. Index options can be quite volatile and expensive, so if you're a novice to options investing, this shouldn't be the first strategy you try.

Practice before entering your first index option trade. There isn't anything wrong with paper-trading index options until you're more confident in how an index moves.

Advantages of Index Options:

You may ask yourself, "Why would I want to invest in index options?" There are some very distinct and profitable opportunities associated with index options. Here are a few:

Index options can be traded both on the long side and the short side for profits in either an up or a down market.

Since you are trading an index, you no longer need to scour the markets for a stock. This helps make more efficient use of your research time.

Each index is a combination of many different stocks, so fundamental analysis is not necessary. Also, index options are short-term plays, so you're only concerned with the stock's technical merit.

Because index options are generally traded by large institutional investors who move hundreds of contracts at a time, they are extremely liquid. Individual investors have the ability to move in and out of index options without attracting any attention.

An index represents a wide-ranging group of stocks, so your portfolio is immediately diversified.

Risks of Index Options:

Although index options have many benefits, they also carry some risks:

l Index options can be very expensive, which can lead to big losses. It only takes one or two of big losses to empty an options account.

l Index options are heavily traded and are subject to high volatility. Wide price swings in the SPX and XSP in particular are not unusual and can result in extraordinary price ranges throughout the day. Unless you're able to track options price quotes throughout the day, you may be in for a surprise at the end of the day when you discover an unexpectedly large loss in your trading account.

l The volatility of some exchanges can leave an index that started in a positive position at a large loss by the end of the day. The Dow has been known to swing from a gain to a 100-point loss in just a few trading hours.

l If you are a buyer of time (Calls), an option could fall in value even if the index is steadily moving higher. This is due to the fact that index options are extremely overvalued and that time value erodes quickly as the index nears expiration day.

How Does an Index Option Compare to a Stock?

Until you compare the two, the differences between stock options and index options can be difficult to visualize. But let's see how the two react to price movements. For this example, let's consider options on the OEX and Ford Motor Company.

With the OEX trading at $498, the closest Call option is the $500 Call with an option premium of $10. The $500 Put premium is trading at $12.

On the other hand, Ford is trading at $10.77. The $10 Call option is trading at $1, even though it has $0.77 of intrinsic value. The $10 Put for Ford is trading at $0.20.

The OEX options are more expensive because the value of the OEX is tied to the S&P 100 index (which is made up of 100 stocks). By contrast, options on Ford are tied to the value of a single stock. This is an important factor to consider. Although the OEX options look expensive, the premiums are large because traders think there is a chance to profit from the transaction.

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Options Trading

Butterfly

Think you can peg a stock's price at expiration and want to catch a profit? Try a butterfly - its bite can be gentler than with other strategies. Butterfly spreads are traditionally done with either all calls or all puts, and involve four options (2 long and 2 short) for each spread. The expiration months and increments between strike prices for all options should be the same. Because the total cost for the 2 long options will generally be more than the total premium received for the 2 short ones, these spreads will usually be established for a net debit. Butterflies can commonly be established as a unit - i.e., 2 options purchased and 2 options sold in one single transaction.

• Maximum profit potential: limited
  You should see your maximum profit if the underlying stock closes exactly at the written options' strike price at expiration. If this happens, your short contracts will expire at-the-money and should have no value, and the long option that is in-the-money will have intrinsic value.
• Loss potential: limited on both the upside and the downside
  Your maximum loss potential is limited to the premium paid for the spread in the first place. At expiration this will occur at underlying stock prices on the upside equal to or greater than higher strike price, and on the downside equal to or less than lower strike price.
• Break-even point (B.E.P.) at expiration: Upside B.E.P. = underlying stock price = higher strike price - net debit paid for spread Downside B.E.P. = underlying stock price = lower strike price + net debit paid for spread.

Short Butterflies

A short butterfly is simply the opposite of the long butterfly discussed here. Here's an example:

• write 1 option with lower strike price
• buy 2 options with middle strike price
• write 1 option with higher strike price

We view the long side on these pages primarily because more investors take a long rather than a short position, and wait until expiration to sell it, hopefully at a profit. The potential limited profit compared to the risk of a short butterfly is not attractive, as you can see from the P&L graph.

Condor

Want to butterfly a stock, but with more chance of profit? Condors offer a bigger range of profitable underlying stock prices. Condor spreads can be done with either all calls or all puts, and involve calls & puts options (2 long and 2 short) for each spread. The expiration months and increments between strike prices for all options should be the same. Condors can be established as a unit – i.e., 2 options purchased and 2 options sold in one single transaction.

• Maximum profit potential: limited profit, if the underlying stock closes at or between the sold options' strike prices at expiration.
• Loss potential: limited to the premium paid for the spread on both the upside and the downside
• Break-even point (B.E.P.) at expiration:
  Upside B.E.P. = underlying stock price = highest strike price – net debit paid for spread
  Downside B.E.P. = underlying stock price = lowest strike price + net debit paid for spread
  
  
  

  Reversals

  Reversals are often used by savvy traders in an attempt to capitalize on minor price discrepancies between Calls and Puts. Like other arbitrage strategies, a reversal involves buying something in one market and simultaneously selling it in another to capitalize on whatever small discrepancy exists between the two.
  When options are relatively underpriced, a trader would sell stock on the open market and buy the options equivalent in the option market to establish a reversal. Theoretically, this is a strategy with very little risk because the profit is locked in immediately. The idea here is to create a synthetic long position and offset it with a short position in the same underlying stock. The synthetic long position is created by buying a Call and selling a Put with the same strike price and expiration.
  Combining a synthetic long position with a short stock position creates a reversal:
  
  
  
  • long call + short put + short stock
  • Profit potential: Limited
  • Loss potential: Limited
  • Break-even point: call price - put price = stock price - strike price
   
  
  

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Beginners' Tutorials Forex Trading Basic Concepts I-VII

Basic Concepts I: Introduction

 

The Foreign Exchange (often abbreviated as Forex or FX) market is the largest market in the world with daily trading volume of over 1.9 $trillion in September 2004*. With its high liquidity, low transaction cost and low entry barrier, the 24-hour market has attracted investors around the world.

The following articles aim to introduce the key concepts in forex trading, the terminologies and the characteristics of the FX market.

The articles first introduced the concept 'spread', which is the most important transaction cost in forex trading, how the spread is presented in the price quotes, what is the significance of it and what is the trick behind it. As most of the retail customers choose to trade forex with margin account, the articles then introduced what is margin trading, what is the significance of margin, how to trade a margin account and how to choose the correct leverage ratio.

In trading online forex, there are many types of orders that you can make to facilitate your trades. The articles then explained the rationale behind each type of orders, when and how to use each of them.

Being one of the most actively trading markets, the forex market is yet, may not be the most well known market. The articles then gave a little historical background and explained the nature of the forex market, and made an overall comparison of various trading markets. It also discussed the pros and cons of trading forex market and what are the recent trends.

Like any other trading instruments, traders should understand the terminologies and the basis of the market before he/she starts real trading. The above articles serve as an essential beginners' guide to the world of forex trading.

Basic Concepts II: Nature of the Foreign Exchange Market

The Foreign Exchange Market is an over-the-counter (OTC) market, which means that there is no central exchange and clearing house where orders are matched. With different levels of access, currencies are traded in different market makers:

The Inter-bank Market - Large commercial banks trade with each other through the Electronic Brokerage System (EBS). Banks will make their quotes available in this market only to those banks with which they trade. This market is not directly accessible to retail traders.

The Online Market Maker - Retail traders can access the FX market through online market makers that trade primarily out of the US and the UK. These market makers typically have a relationship with several banks on EBS; the larger the trading volume of the market maker, the more relationships it likely has.

Market Hours

Forex is a market that trades actively as long as there are banks open in one of the major financial centers of the world. This is effectively from the beginning of Monday morning in Tokyo until the afternoon of Friday in New York. In terms of GMT, the trading week occurs from Sunday night until Friday night, or roughly 5 days, 24 hours per day.

Price Reporting Trading Volume

Unlike many other markets, there is no consolidated tape in Forex, and trading prices and volume are not reported. It is, indeed, possible for trades to occur simultaneously at different prices between different parties in the market. Good pricing through a market maker depends on that market maker being closely tied to the larger market. Pricing is usually relatively close between market makers, however, and the main difference between Forex and other markets is that there is no data on the volume that has been traded in any given time frame or at any given price. Open interest and even volume on currency futures can be used as a proxy, but they are by no means perfect.

Basic Concepts III: History and Recent Trend of Online FX Market

The recently technology advancement has broken down the barriers that used to stand between retail clients of FX market and the inter-bank market. The online forex trading revolution was originated in the late 90's, which opened its doors to retail clients by connecting the market makers to the end users. With the high-speed Internet access and powerful central processing unit, the online trading platform at home user's personal computer now serves as a gateway to the liquid FX market. Retail clients can now trade together with the biggest banks in the world, with similar pricing and execution. What used to be a game dominated and controlled by major inter-banks is becoming a common field where individuals can take the same opportunities as big banks do.

Technology breakthroughs not only changed the accessibility of the FX market, they also changed the way of how trading decisions were made. Research showed that, as opposed to unable to find profitable trading methodologies, the primary reason for failure as a speculator is a lack of discipline devoted to successful trading and risk management. The development of iron discipline is among the most challenging endeavors to which a trader can aspire. With the help of modern trading or charting softwares, traders can now develop trading systems that are comprehensive, with detailed trading plans including rules of entry, exit, and risk management model. Furthermore, traders can do backtesting and forward testing of a particular strategy on a demo account before commitment of capital.

When the system trading softwares were first introduced into the store of trading tools, traders would need programming skills and a strong background in mathematical technical analysis. With the effort of system trading software companies making their products more adaptable to mass market, the system trading softwares are now more user-friendly and simpler to use. At this point, non-programmers with basic understanding of mathematical technical analysis can enjoy the amusement of system trading.

While system trading might not provide the 'holy grails' of trading, it offers as prototypes or guidelines for beginners to starting trading with sound mathematical model and risk management. Over time, traders can develop trading systems that match their individual personality.

Basic Concepts IV: Comparison of Various Financial Markets

The table presents the comparison of various financial markets and some of their basic features.

	Equities	Futures	Forex
Market Structure	Over the Counter (OTC) or Exchanged Traded, with Electronic Communication Network (ECN) routing available for both.	Exchanged Traded through open outcry in trading pits; some contracts are traded by ECN after hours.	Over the Counter (OTC) market with access to price determined by the market maker.
Spreads	Spreads fluctuate according to demand and supply.	Spreads fluctuate according to demand and supply.	Spreads fluctuates on Inter-bank market, many online market makers have fix spread.
Execution	Orders on listed stocks are placed with a specialist, who matches buyers and sellers, providing liquidity from his own account as well. OTC orders can be sent to market makers who take the opposite side of the trade at their quoted side.	Orders are executed via open outcry at the exchange pit for each future contract. Orders entered electronically are routed to the pits to be executed.	Orders on the Inter-bank market are sent directly to the counter party via Reuters or EBS. Orders executed with online market makers are executed at the market maker with the market maker as the counter party.
Order Types	Market, Limit, Stop, Fill or Kill, All or None, Opening Price Guaranteed, Market on Close, Stop-limit, Market if Touched, Good Until Cancelled, Day Order	Market, Limit, Stop, Fill or Kill, All or None, Market on Open, Market on Close, Stop-limit, Market if Touched, Good Until Cancelled, Day Order	Market, Stop, Stop-limit, Limit
Trading Hours	Typically 9:30am to 4:00pm local time. Off-hours trading can occur through ECN's but it is illiquid.	Vary by product, usually starts from 9:00am to 3:00pm local time. Off-hours trading is possible but illiquid.	24 hours during weekdays.
Volume	Available	Available	Not Available
Market Size	100-200 billion USD daily volume in the US.	300-500 billion USD daily volume in the US.	1.5 trillition daily volume worldwide.
Transaction Cost	Spread and commission/service charge.	Spread and commission/service charge.	Spread only.

Basic Concepts V: Spreads

What is a spread?

In margin forex trading, there are two prices for each currency pair, a "bid" (or sell) price and an "ask" (or buy) price. The bid price is the rate at which traders can sell to the executing firm, while the ask price is the rate at which traders can buy from the executing firm.

Bid/Ask

For example, when you see the price quote of EUR/USD is 1.2881/1.2884 as in the above picture, the bid is 1.2881 whereas the ask is 1.2884. That means traders looking to sell must do so at 1.2881, those looking to buy must do so at 1.2884.

The difference between the bid and ask price is the spread, which constitutes the cost of the trade. In fact, all traded instruments - stocks, futures, currencies, bonds, etc. - have spread. If a trader buys at 1.2884 and then sells immediately, there is a 3-point loss incurred. The trader will need to wait for the market to move 3 points in favour of his/her position in order to break even. If the market moves 4 points in your favour, he/she starts to profit.

Many online trading firms like to promote margin forex trading as an almost cost-free instrument - commission free, no service charge, no hidden cost, etc. Traders should know that spread is the cost of trading, and in fact, it also represents the main source of revenue for the market maker, i.e. the forex trading company. The spread may appear to be a minuscule expense, but once you add up the cost of all of the trades, you will find it can eat away quite a portion of your account or your profit. If you check the price tag of a T-shirt before you buy it, do the same thing when you trade forex, look into the spread before you decide to trade. Your trade needs to surmount the spread (the cost) before it profits.

Know your expense: the spread

Spread is the cost to a trader. On the other hand, it is a revenue source of the firm who executes the trade. In the foreign exchange market, the spread can vary a lot depending on the executing firm and the parties involve. Inter-bank foreign exchange can have spread as tight as 1-2 pips, while the bank can widen the spread to 30-40 pips when dealing with individual customers. If you check out the spread of those small exchange shops nearby the tourists' sights, you may find the spread can go up to 400 to 600 pips.

Thanks to keen market competition, the spread of online forex trading is getting tighter in the past few years. For major online forex companies, their spreads are essentially the same. The table shows the typical spread of four major currencies of online forex trading at the time being:

Currency pairs	Spread
EUR/USD	2-3 pips
USD/JPY	3-4 pips
USD/CHF	5 pips
GBP/USD	5 pips

It is important for a trader to find the tightest spread as possible, but anything that is far lower than the typical spread is skeptical. The spread is the main source of revenue of a forex trading firm, if the firm cannot earn enough from the spread, there maybe some other hidden cost in the transaction.

Another point to note is that many market makers often widen the spread when market conditions become more volatile, thus increasing the cost of trading. For instance, if an economic number comes out that is off expectations, thereby creating a flood of buyers or sellers, the market maker may often widen the spread to restore the balance between buyers and sellers. As a result, traders should inquire about the execution practices of their clearing firm; firms with poor execution of orders and a tendency to widen spreads will ultimately result in higher trading costs for the end user.

Basic Concepts VI: Types of Orders

The forex market provides different kinds of orders for trading. The following are some major types of orders that can be found on forex trading stations.

Market orders - A buy or sell order in which the forex firm is to execute the order at the best available current price. It is also called at the market.

Entry orders - A request from a client to a forex firm to buy or sell a specified amount of a particular currency pair at a specific price. The order will be filled once the requested price is hit.

Stop Loss orders - An order placed to close a position when it reaches a specified price. It is designed to limit a trader's loss on a position. If the position is opened with buying a currency pair, the stop loss order would be a request to sell the position when the price fall to the specified level. And vice versa. Traders are strongly recommended to use stop loss orders to limit their losses. It is also important to use stop loss orders when investors may enter a situation where they are unable to monitor their portfolio for an extended period.

Take Profit Orders - An order placed to close a position when it reaches a predetermined profit exit price. It is designed to lock in a position's profit. Once the price surpasses the predefined profit-taking price, the take profit order becomes market order and closes the position.

Good Until Cancelled (GTC) - In online forex trading, most of the orders are GTC, meaning an order will be valid until it is cancelled, regardless of the trading session. The trader must specify that they wish a GTC order to be cancelled before it expires. Generally, the entry orders, stop loss orders and take profit orders in online forex trading are all GTC orders.

The above are the basic orders types available in most of them trading systems. Some trading systems may offer more sophisticated orders. Traders should be familiar with the different orders and make the most of them during trading.

Basic Concepts VII: Margin

What is Margin?

Margin is the amount of equity that must be maintained in a trading account to keep a position open. It acts as a good faith deposit by the trader to ensure against trading losses. A margin account allows customers to open positions with higher value than the amount of funds they have deposited in their account.

Trading a margin account is also described as trading on a leveraged basis. Most online forex firms offer up to 200 times leverage on a mini contract account. The mini contract size is usually 10,000 currency unit, 1/200th of 10,000 equals to 50 currency unit, meaning only 0.5% margin is required for open positions. Compare to future contracts, which require 10% margin for most contracts, and equities require 50% margin to the average investor and 10% margin to the professional equity traders, foreign exchange market offers the highest leverage among the other trading instruments.

The equity in excess of the margin requirement in a trading account acts as a cushion for the trader. If the trader loses on a position to the point that equity is below the minimum margin requirement, meaning the cushion has completely worn out, then a margin call will result. Generally, in online forex trading, the trader must deposit more funds before the margin call or the position will be closed. Since no calls are issued before the liquidation, the margin call is better known as ‘margin out' in this case. The account will be margined out, meaning all the positions will be closed, once the equity falls below the margin requirement.

Example:

Account	A
Account Equity	500USD
Contract Size	10,000
Currency	EUR/USD
Spread	3 pips
Margin Requirement	50USD
Leverage	1,000:50 = 200:1
Pips to margin out (1 lot)	447

Consider Account A, the margin requirement for 1 lot of position is 50USD. The free usable margin is Account Equity - (Margin Requirement + Spread) = 500 - (50 + 3) = 447. The account will be margined out if EUR/USD moves 447 pips against the position.

Why Margin Requirement Matters?

Leverage is a double-edged sword. With proper usage, it can enhance customers' funds to generate quick returns and increase the potential return of an investment. However, without proper risk management, it can lead to quick and large losses. Consider the following example:

Account	A	B
Account Equity	500USD	500USD
Contract Size	10,000	10,000
Currency	EUR/USD	EUR/USD
Spread	3 pips	3 pips
Margin Requirement	50USD	200USD
Leverage	1,000:50 = 200:1	1,000:200 = 50:1
Pips to margin out (1 lot)	447	297
Max no. of lots at one time	9	2
Pips to margin out (max lots)	3	47

The initial conditions of the accounts are the same, except for account A, the margin requirement per lot is 50USD and account B is 200USD.

Free usable margin = Account Equity - (Margin Requirement + Spread)*no. of lots

Maximum number of lots open at one time = Account Equity / (margin requirement + spread)

In account A, for 1 lot of position, the free usable margin is 500 - (50+3) = 447, which means the account will be margined out if EUR/USD moves 447 pips against the position. The max number of lots open at one time = (500/(50+3)) = 9 lots, with 500 - (50+3)*9 = 23USD free usable margin left for 9 lots. Once EUR/USD moves 23/9 = 3 pips against the positions, there would be not enough usable margin and account A will be margined out.

In account B, the free usable margin for 1 lot is 500 - (200+3) = 297, which means the account will be margined out if EUR/USD moves 297 pips against the position. The max number of lots open at one time = (500/(200+3)) =2 lots, with 500 - (200+3)*2 = 94USD free usable margin for 2 lots. If EUR/USD moves 94/2 = 47 pips against the positions, account B would be margined out.

With 1 lot of open position, account A has 447USD usable margin as cushion before being margined out, while account B only as 297USD. However, with more usable margin, account A has higher probability of being over traded. As shown in the above example, the more open positions, the easier is the account to get margin out.

Most forex trading firms offer customizable leverage; traders can choose the leverage ratio they feel most comfortable with. Customers should be aware of how to guard against over trading an account and managing overall risk.

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5 Tips for Trading During Volatile Markets

Increased volatility leads many traders to seeing an increase in trading opportunities. The huge market swings trigger thoughts of monumental upside, but also for potential loss especially if traders do not take the necessary precautions. During times of volatility, traders need to adjust their strategy to compensate for erratic market. When trading during these market conditions, traders should follow the rules below.

1. Be More Selective Before Placing Trades

Wanting to take advantage of all the trading opportunities that present themselves in volatile markets, traders are tempted to place an increase number of trades. This temptation should be avoided. It is important to remember that in volatile times, losses are likely to be big. Before placing a trading, assess risk tolerance levels. Determine the level of risk that is acceptable for the trader both psychologically and financially before placing any trades.

2. Use Less Leverage

During high market volatility, losses can be traumatic. With the average trading range increased in volatile times traders should be considering how leverage will affect trades. At a one percent or even a half percent margin, investors should be mindful of how much leverage or even the size position being traded can affect their portfolio. In normal market conditions, placing a 2 lot position is fine when you are looking to make about 50-100 pips. During a more volatile time, when the potential loss is 100-200 pips, it stops being an effective risk to reward ratio. To compensate traders should look to taking on smaller trading positions, in this case only one lot as opposed to the average 2 lot position.

3. Trade with More Discipline

Traders should always follow their predetermined trading strategy regardless of market condition. During volatile markets, this is even more important to use that same level of restraint. Traders must adhere to any set stops, contingency plans or risk management benchmarks without hesitation. This will help to define how much risk is taken should price action be uncontrollable. Without this level of discipline and self control losses can be great.

4. Tighten Stops

Many traders are hesitant to use tighter stops in volatile markets because they see the large swings increasing the likelihood that the position will be taken out. Having tighter stops can also provide great risk managers in times of extreme volatility. For example, on a EURUSD trade, rather than setting an 80 pip stop to protect your position, consider placing a 50-60 pip stop. This will insure the protection of your currency position and if the stop is broken, there is a high likelihood that the trend will continue lower and the stop took you out before you could potentially lose more money.

The width of the stop being set does depend on the currency pair being trading as some pairs have wider ranges. In a Yen cross like the GBPJPY or AUDJPY, traders may be more likely to have wider stops as their average daily range is 50% more than that of the EUR/USD. With that said, stops during volatile market conditions should not as wide as before. Instead of a stop 100 pips below entry, traders may consider a 25 pip reduction and have a 75 pip stop. Below is a chart showing the EURUSD and the GBPJPY on the same very volatile day in the forex market. The EURUSD had an impressive range of nearly 600 pips! The GBPJPY far dominated though with nearly a 2000 pip trading range.

5. Be Prepared

It also helps a trader to know what is causing the current spate of volatility in the markets in order to be prepared for the unexpected. As such, an investor can accommodate their strategy to the market environment and not just the currency pair being traded. The first of these considerations is accounting for emotions in a market: is fear currently driving the market lower? Or is it buyer's mania that is keeping the bullish tone alive? Traders' overreaction and emotion tend to push markets to overextended targets. This fact alone creates volatility through simple supply and demand.

Volatility can also, and more than likely will, be sparked by economic events. In this instance, market participants may interpret fundamental data differently and not as cut and dry as the more novice trader. A perfect example of this is usually monthly manufacturing reports that are released in pretty much all industrial economies. The classic scenario has the market honed in on a particular number for the month. However, traders young and old will sometimes wonder why the market sold off if manufacturing showed positive growth. The answer is simple. The market had a different interpretation and positions were violently reshaped and shifted. These tend to create great opportunities for some and horrible memories for others. Below is an hourly chart of the EUR/USD during ISM Manufacturing for October 1, 2008. Here we can see the huge price gap that occurred due to market volatility as well as the resulting trend.

Panic and erratic momentum can additionally be found in certain market environments. Not to be confused with fear or greed, panic selling and buying can create very choppy and relatively untradeable markets. These conditions will lead some to flip flop their positions while leaving others gaping at the fact that the position was right, only to be stopped out prematurely. These two common examples will create further panic and volatility as traders abandon their own individual strategy for the possibility of instant profits or stoppage revenge. As a result, a vicious cycle of volatility ensues until a definitive market direction can be established.

The simple rules above, and a task of getting to know the current trading environment, can empower every trader through the ranks. Although some relate volatility with difficult and untouchable markets, opportunities continue to remain abound in these less than attractive conditions to those focused and fortunate.

By following these five simple steps, trading in volatile market conditions should be a little simpler. Don't forget to adjust leverage based on volatility, follow your trading plan, tighten your stops and know why you are getting into a trade before you place it.

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Options Trading

Long Strangle

Much like a Straddle, a Strangle trade is used when you're forecasting a large move in the stock price in one direction or the other before expiration. The difference between a Straddle trade and a Strangle trade are the strike prices of the options purchased.

When you're expecting a major news announcement for a particular stock, but you're not quite certain how investors will react to that news, this is the time to consider using the Long Strangle. A good example of this is the price movement of a stock in reaction to an earnings announcement.

Background

Suppose you've identified a stock with an expected news announcement due any day. That stock is currently trading for $30 per share, but you aren't certain which direction the stock will move in reaction to the news. Thus, in order to protect yourself regardless of the direction the stock takes, you decide to hedge your position with both a Put and a Call. Using a Long Strangle like this, a large swing in the stock price is essential in order to potentially profit, so be sure to find a stock with a high degree of volatility before entering the trade.

Case Study

With the stock trading for $30 per share, place two trades: one to give you an advantage if the stock price goes up, and the other to benefit you if the stock price goes down. Since you are expecting the news announcement to have a short-term effect on the price of the stock, you choose to purchase the options for the current expiration month (August, in this example). In this case, you don't plan to hold the options long enough to justify the expense of a later expiration month.

1. The first step to a Long Strangle play is to place a buy-to-open trade to purchase the out-of-the-money call contract for the $35 strike price for the current expiration month.  Since the call is out-of-the-money, it can be purchased for a relatively low price. Suppose the ask price for the $35 strike price call is $0.50 per share, or $50 per contract.

2. Next, you would likely purchase the out-of-the-money put contract for the $25 strike price in order to help protect your investment in the event the stock drops in price. Let's assume the ask price for the $25 strike price is currently $0.25 per share or $25 per contract.

Your overall investment in the stock is now the $0.50 per-share price you paid for the call ($50) plus the $0.25 per-share price you paid for the put ($25), or $0.75 per share total ($75).

Using this figure, you can calculate an upper and lower boundary for the stock's price movement. These boundaries are the price points at which your trade becomes profitable.

Upper Boundary

To calculate the upper boundary, take the strike price for the Call option you purchased, $35 in this example, and add to it the cost per share you paid to enter the trade, which is $0.75 in this example. This means the stock price needs to go up to $35.75 or higher per share before you begin to profit with the Call option side of the Strangle.

Lower Boundary

The lower boundary is calculated in a similar fashion. Take the strike price for the Put contract you purchased, $25 in this example, and subtract the cost per share you paid to enter the trade, which is $0.75. This tells you the stock needs to fall below $24.25 for the Put option side of the equation to begin to profit.

Since the stock is now trading for $30 per share and the upper and lower boundaries are significantly higher and lower than the current stock price, it becomes essential that you identify an extremely volatile stock in order to ensure the greatest potential for a profitable trade.

Exiting the Trade:

Be careful when deciding to exit the trade. Even a significant price move doesn't necessarily guarantee a profit. Let's consider the example above:

The stock is trading for $30 per share

You purchase the $35 strike price Call for $0.50 per share

($50 per contract)

You purchase the $25 strike price Put for $0.25 per share

($25 per contract)

Your total investment is $0.75 per share ($75)

Now, if the stock rises in price and closes at $35.50 per share on expiration Friday, this represents an 18% increase in the stock price. However, this means nothing to you. Although the stock has experienced a relatively significant increase in price, your $35 Call has only earned $0.50 per share of intrinsic value ($50 per contract) and the Put expires worthless. The $50 in revenue you make on the sale of the Call won't cover the $75 you originally invested to enter the play.

When the news you've been expecting is finally released, you would close out the losing position that results from the price movement. Be careful not to exit this side of the trade too soon. If the stock price is slowly creeping upward, don't close out the Put side of the Strangle. You might want to wait until the news is released, since it may actually have a negative effect on the price of the stock.

Maximum Profit

One advantage to a Long Strangle is that there is no limit to your potential gain. For example, using the numbers from above, suppose the stock reacts poorly to bad news and falls quickly to close at $23 per share on options expiration Friday.  This leaves the Put option you purchased at the $25 strike price with $2 of intrinsic value, for $200 profit ($2 x 100 shares = $200). Once you subtract your initial investment of $75, this leaves a $125 profit or a 166% return on your investment.

Once the news is announced and the trend of the stock becomes apparent, leave the appropriate option in place for as long as you can. And remember, you must place a sell-to-close order to get out of the trade once the move is over or before expiration - whichever comes first.

Maximum Loss

The maximum loss you can sustain using a Long Strangle is the cost of the initial investment. This occurs when the stock fails to move either above or below your upper or lower boundaries by expiration Friday. In this case, your options expire worthless, or retain so little value it would cost you more in commissions to exit the trade than you would be able to make on the sale of the options.

Summary

The Long Strangle is often used when you are expecting an extreme movement in a stock in one direction or the other. It doesn't matter which direction the stock moves, as long as the movement is large. The strategy typically works best when you plan your trade in conjunction with expected news announcements that could have a significant bearing on the price movement of the stock, such as an earnings announcement.

To place a Long Strangle trade, first purchase a Call option one strike price out-of-the-money above the current price of the stock. Then, purchase a Put contract one strike price out-of-the-money below the current price of the stock.

Calculate the lower and upper boundaries for the trade by taking the price paid for both the call and put contracts and adding it, per share, to the stock price for the upper boundary or subtracting the price paid, per share, from the stock price to find the lower boundary. The stock price must move either above or below these boundaries before expiration Friday for the trades to become profitable.

A Long Strangle play limits the maximum loss you will experience, even if the trade goes completely against you, while there is an unlimited potential gain for the trade. However, the stock itself must be extremely volatile in nature in order to ensure the greatest potential profit.

Short Strangle

As with a Short Straddle discussed previously, a Short Strangle is a strategy that lends itself to sideways-trending stocks.  Similar to a Long Strangle, a Short Strangle employs option strike prices out-of-the-money above and below the current price of the stock.

An advantage of the Short Strangle is that by using out-of-the-money strike prices for the trade, the stock has some moving room before action needs to be taken to close the trade to avoid being called out or assigned the stock.

Another advantage with a Short Strangle is that you don't have to identify a stock with very low volatility. In fact, a stock with some degree of volatility will most likely result in a higher premium for the options you sell, resulting in a higher potential profit.

Background

With a Short Strangle, you're forecasting the stock trend to remain neutral for the next few weeks. Since you're selling naked options on the stock, you will need to have at least Level 4 trading authority to place the trades.

Once again, you need to calculate an upper and lower boundary for the price movement of the stock in order to measure the points at which you will need to take action to minimize your risks.

Case Study

1. In order to place a Short Strangle trade, begin with a stock that is expected to remain neutral or not move very much. Sell the out-of-the-money Call and the out-of-the money Put on either side of the current stock price to help generate a profit.

2. Monitor the trade daily to ensure that you aren't in danger of being assigned the stock or being called out.

Let's say you have a stock currently trading for $30 per share. You want to limit your liability in the trade, so you sell the options for the current expiration month (for this example, the current expiration month is August).

Placing the Order

There are two steps to placing a Short Strangle trade:

1. First, sell the Call option for the first strike price out-of-the money for the current August expiration. Using the example above, the current stock price is $30 per share. Thus, you need to sell the $35 strike price call option. If the bid price is $0.50 per share, you can expect to earn $50 per contract for the sale of the Call option.

2. Next, sell the $25 Put option for the August expiration. Let's say the bid price is $0.35 per share, which results in a credit to your account of $35 per contract for the sale of the Put contract.

The total credit to your account now totals $85 ($50 + $35 = $85).

Upper and Lower Price Boundaries

Since you've sold both the Call and Put options, you're expecting the stock won't move outside of the strike prices you've sold, meaning it shouldn't go above $35 or $25. The strike prices of the Call and the Put you sold become the upper and lower price bounds for the trade. Now, as long as the stock remains between $35 and $25 per share by options expiration, your contracts expire worthless, allowing you to retain the entire premium you received from the initial sale of the options.

Maximum Profit

Your maximum profit on the trade is the $85 received from the sale of the options themselves. As long as the stock price stays between the strike price for the Call ($35) and the strike price for the Put ($25) you retain your full profit from the trade.

Maximum Loss

Since you're expecting the stock to make only small moves between the two option strike prices, you'll experience a loss if the stock moves dramatically beyond those strike prices.

Stock Price Rises Above the Strike Price of the Call

In the event the stock price rises above the $35 strike price Call option you sold, you may want to act immediately and consider placing a buy-to-close order to back out of the position. This removes your obligation on the trade and prevent you from being forced to buy the stock to cover the trade. The Put contract you sold would expire worthless. The profit from the short strangle, if any, is whatever funds remain from the initial credit you received, minus the cost to buy back the Call option contract to remove your obligation.

Stock Price Falls Below the Strike Price of the Put

If the stock price falls below your $25 strike price Put option, act immediately and place a buy-to-close order with your broker to back out of the Put trade, removing your obligation to buy the stock for $25 per share. The Call you sold will expire worthless. The profit from the short strangle, if any, is whatever remains from the initial credit you received, minus the cost to buy back the Put option to remove your obligation.

Summary

The Short Strangle has an advantage over the Short Straddle, in that you sell the Call and Put options at strike prices that are further away from the stock price. This provides flexibility for a small movement in the stock price before you are forced to take action to remove your obligation.

As long as the stock reaches expiration Friday at a price somewhere between the strike price of the Call and the strike price of the Put you sold, you retain your maximum profit.

If the stock price moves above or below these price boundaries, you must act quickly to place a buy-to-close order to remove your obligation on the options.

This is an aggressive strategy, and requires at least Level 4 trading authority, as you are selling both a naked call and a naked put.

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