Call options give the taker the right but not the obligation to buy the shares at a specific price on or before a specific date.

The put options give the taker the right but not the obligation to sell the shares at a specific price on or before a specific date. The taker of a put is only required to deliver the underlying shares if they exercise option.

There are a few advantages in option trading:

Put options allow you to hedge against a possible fall in the price of the shares you hold. You can consider taking it out as insurance against a loss in the share price.

By taking a call option, the purchase price for the shares is locked in. This gives the call option holder until the expiry date to decide whether he or she will or will not buy the shares. This is also applicable to the taker; he or she has to decide whether or not to sell the shares before the deadline.

The ease of trading in and out of an option position makes it possible to trade options with no intention of ever exercising them. If you expect the market to rise, you may want to buy call options, and if you are expecting a fall in the market, you may decide to buy put options. This means that you can sell the option prior to the expiry date to take a profit or limit a loss.

Options also allow you to build a diversified portfolio for a lower initial outlay than purchasing shares directly.

The income generation for options can get you profits over dividends by writing call options against your shares. By writing an option, you receive the option premium up front. While you get to keep the option premium, it is possible that you could be exercised against and have to deliver your shares to the taker at the exercise price. This strategy uses stock bought on margin.

By combining different options, or stocks with options, you can create a wide range of strategies.

You can earn extra income by writing options against shares you already own or are purchasing. This is one of the simplest and most rewarding strategies.

Using options gives you time to decide. Taking a call option can give you time to decide if you want to buy shares. You pay the premium, which is only a fraction of the price of the underlying shares.

The option then locks in a buying price for the shares if you decide to exercise. You then have until the expiry date of the option to decide if you want to buy the shares. This is the same as to the put option.

Keep in mind that, same as any other trades do not trade what you cannot afford to lose.

There must be a more compelling reason for you to trade stock other than just for the movement, if only 20% is unique to the underlying equity in question.  Consider this, in context of the Fundamental Analysis or stock picking software that you bought on a per $1 basis.  For each $1 dollar you spend, you “outsourced” the analysis at a cost of 80 cents, only to receive back 20 cents worth of work. Shouldn’t the 80:20 rule of “outsourcing” be the other way round? The problem is that you are still stuck with 80% of the work, to analyze price movement!  Plus, the more you use FA techniques/stock picking software, the more trading capital is stuck in equities alone.Now, you can say “special” research papers help you pick stocks.  Let’s have a look at some of the more common fundamental metrics in these research subscriptions:1. Dividend Yield: the problem is in the variability of yields as firms are in different stages of their business development.  A Mature company that dominates in a well established sub-segment/sector is able to afford a different dividend yield; versus, a Young company in a growth-oriented field; versus, a Small firm in a growing area that may not be able to afford a dividend payout.  Bear in mind there is nothing special about firms that pay a dividend.A company that gives away a portion of it’s retained earnings – which is what a dividend is – effectively gives away part of its valuation, which means it is not worth as much as a company that does need to give investors candy to commit capital to it.  So, a dividend paying stock has to be far superior to a non-dividend paying stock for reasons other than the dividend.  If it is not, there’s no point looking for dividend paying products to trade, there are plenty of non-dividend paying Indexes to trade.2. Price/Book Ratio: the problem is this metric varies across industries and from company to company, as the asset base and capital structures of companies change over time. It lacks cross sector applicability and accounting complexity arises from a firm’s capital structure as it changes due to acquisitions/divestments/CAPEX for new product lines; or, product line cut-backs, as recently seen in the restructuring of major US car companies.3.  Price/Cash Flow Ratio (the cousin of the P/E): accounting laws on depreciation vary across Asia, Europe and US.  As accounting rules are driven by tax codes, which change considerably across regions despite adoption of global accounting standards, there is a lack of uniformity in homogenizing a fundamental ratio that will fit as a common benchmark across geographies. These metrics fail to help you compare say a Dell parented in the US to an Acer parented in Taiwan; but, is listed as an ADR in the US, even though both are competitors in the same sector as computer manufacturers. Furthermore, the current dislocated cost of capital in credit markets, impairs the ability of corporations to optimize the operating cost of their balance sheets.  In essence, corporations are left with the working capital cash flows remaining on their balance sheets, as testament to their financial strength. Do not waste your money on Fundamental Analysis software or research paper subscriptions.As there is a fundamental flaw in fundamental analysis and stock picking, how do you select trades? Trade the options of a broad-based Equity Index to replace single stock exposure.  To replace Fundamental Analysis, use the Relative Strength measure based on Point & Figure methods.What is Relative Strength?  It is nothing more than taking one price as the Numerator, divided by another price as the Denominator, then multiplied by 100.  RS = (Price 1 / Price 2) x 100.  Typically, RS calculations use daily closing prices.  Though simple in its mathematical construction, RS is ingeniously powerful when it is applied not only within a sector; but, across sectors and between asset classes.Let’s start of within a sector.  For example, if you choose 2 semiconductor stocks trading at different prices, how do you know if one stock is outperforming the other in the same sector, when the 2 stocks have price changes at different rates; plus, the sector’s price itself is also changing?SOX = Semiconductor Sector Index, trades up from 452.24 to 467.81.Numerator1:      Price1 = BRCM 33.15    RS1 = 7.33    Price2 = 33.80    RS2 = 7.23Numerator2:      Price1  = TSM 9.91    RS1 = 2.19    Price2 = 13.43    RS2 = 2.87Common Denominator:      SOX  Price 1 = 452.24           Price 2 = 467.81BRCM’s RS1 = (33.15/452.24) x 100 = 7.33. BRCM’s RS2 = (33.80/467.81) x 100 = 7.23.  TSM’s RS1 = (9.91/452.24) x 100 = 2.19.  TSM’s RS2 = (13.43/467.81) x 100 = 2.87.BRCM’s price rises from 33.15 to 33.80 and TSM’s price also rises from 9.91 to 13.43.  Simply because BRCM is a larger stock, does that mean it benefits from the SOX trading up? No, the RS reading (RS1 compared to RS2) shows BRCM’s RS reading dropped (7.33 down to 7.23) against TSM’s RS reading, which increased (2.19 to 2.87).  RS confirms TSM as the outperformer rising in price strength versus BRCM’s weakened price.  RS is constructed on pure price rules.  Using an Index as the denominator, acts as a much more durable benchmark and is structurally more reliable, compared to any “magical” TA indicator; or, combination of income statements, balance sheets and cash flow statements touted in stock picking programmes.You can replace BRCM or TSM with Indexes or ETFs.  Using Indexes with Relative Strength enables a common denominator to compare Equities against Bonds, Commodities and Currencies, to crossover into asset classes other than stocks to trade.  It’s not that Relative Strength is infallible.  But compared to the fundamental metrics cited above, Relative Strength fails the least.  Break the mould on what you learnt about stock option trading.Is there an example of an optionable and consistently profitable portfolio that trades using Relative Strength across multiple asset classes? Yes.  Follow the link below, entitled “Consistent Results” to see a retail online option trading portfolio that excludes the use of single stocks and Fundamental Analysis, using broad based equity Indices, Commodity ETFs and Currency ETFs.  There is no need to trade FX directly. Just trade the options of Currency ETFs.

You can apply this calculation to the VIX, or any optionable product that you have identified a trade on.Why divide the front month’s volatility by 16?  As you know, volatility is expressed as an annualized number.  So, to get the daily volatility number, we divide it by the square root of the number of trading days in a year, which is 256 (rounded off).  There is no trading on weekends and exchange holidays, because prices cannot change on these days.  There are some years with more or less than 256 days, but using 256 is the norm.  The square root of 256 = 16. As part of your pre-market preparation, calculate on a spreadsheet the market ranges of the day (Dull, Normal or Big) for the DJX, MNX, SPY and the VIX at minimum. This is not to pick direction, as you will not know if the market will open to the upside/downside and STAY there, even if futures indicate an upside/downside bias. The calculation gives you a measured gauge, once the market opens to see if the trading range of the day is leaning towards a Dull, Normal or Big Day. Then, assess if it makes sense to theoretically price a spread, be it a Calendar, Iron Condor, Vertical, etc.  This guards you from chasing price near 1 Standard Deviation, to get your orders filled on a Big Day.  Doing this pre-market work, determines if you will be filling orders or scaling off for profit; alternatively, reducing exposure to losses, when the market opens.Want to see a consistently profitable portfolio that prices entries on Dull/Normal Days but takes profit/limits losses on Big Days, at work? Follow the link below, entitled “Consistent Results” to see a retail online option trading portfolio that practices this daily discipline.Statistically there are more Dull and Normal Days to price spreads for entry, especially during mid-July till August, as many floor traders go on leave.  On Dull and Normal Days aggressively pricing the order 0.10-0.15 below Theoretical Price for a debit spread; or, 0.10-0.15 above for a credit spread just means it takes 1-2 hours more to get filled.  If your order is filled within 5 minutes, you were lax in working the entry hard; versus, getting filled in 1-2 hours.  Diligence does make a material difference in the trade’s price-performance.  In avoiding entries on Big Days, you are not missing out on not getting in, when most retail traders are chasing price to get filled.  One key factor of the consistency in your account’s P/L is the price you got in and out of.  The discipline of staying consistent is to get filled within a sustainable range of the spread’s fair value for that particular trading day.  Remaining in the business of online options trading requires as much sense to stay out of trades, as it does to get in to trades.

Where can I see this step up function in a consistently profitable portfolio, with these portfolio measures and trade performance metrics? Follow the link below, entitled “Consistent Results” to see a model retail option trader’s portfolio that shows these traits.Moving onto the hard metrics.  There’s 2 ways to count the Return on your trading capital.

In both cases, you can minus the Total Cost of Commissions from Total Profit, to get a Total Net Profit number.  The, divide the Total Net Profit by the Start of Year Cash Balance; or, Net Liquidating Value.  Net Liquidating Value is how much your entire trading account is worth, which is equal to Total Cash + Options Value + Stocks Value + Commodities Value + Bonds Value. The Start of Year Cash Balance is straightforward – it is the money in the account at the beginning of that trading year. Cash increases when you are short securities; but, cash decreases, as you get long on securities.To review your performance, calculate these metrics using the Profit (wins) and Loss (losers) from your account:

The Average Win divided by the Average Loss measures how RESPONSIVE you are in taking profits and cutting losses.Combine the Accuracy ratio with the Responsiveness ratio to get your Performance Ratio.Performance Ratio = (Win/Loss Probability) x (Average Win / Average Loss).  Always aim to maintain the Performance Ratio above 1.00. Why?  The commonly known money management rule is to allocate 2%-5% of (60% x Net Liquidating Value of the account) per trade.  What is not commonly practiced is the discipline of moderating a +/- 1% in trade allocation between the 2%-5% allocation.

This is how to achieve a ladder effect in stepping up profits and stepping down losses. This mechanism of stepping up/down is an indispensable tool for rewarding profit and to discipline the risk of losses.  It forces you to improve both ACCURACY and RESPONSIVENESS before raising your position size.

Where can I learn more about portfolio measures and trade performance metrics as part of a total trading system? Follow the link below, for 55 hours of video-based learning of online options trading from home.