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.

Writing options means we are sellers of an options contract, which can be risky under some circumstances, but not with covered calls. In fact, covered call writing is probably the most conservative options-writing strategy because the contract you write is backed by your ownership of the underlying stock. Let’s say you own 500 shares of a highly liquid blue chip stock like Microsoft. Microsoft isn’t very volatile and that makes it an ideal candidate for covered call writing. It’s a good idea to write calls on stocks that aren’t very volatile because we’re going to write out-of-the-money calls and collect some income in the form of a premium for doing so. Say Microsoft is trading at $23. We might write calls on the $25 strike for the next month’s contract. The risk here is that if the underlying stock rises above the strike price before expiration, the buyer of the call can call our stock away at $25, which is a discount to the market price. Now you see why you have to own the stock you’re writing covered calls on and why you want to select stocks that are range-bound. As a rule of thumb, you would write one call contract for every 100 shares of the underlying you own.

Another fairly conservative options strategy is the married put trade. Married puts are a lot like covered calls in that you already own the underlying stock and you’ll buy an amount of puts equivalent to the number shares you own. Here, you’ll be long on the puts, but since you own the underlying stock, the puts act as a hedge. In other words, they give you a way to make money if the stock declines.

There are several different options strategies known as spreads. One of the more basic ones is the bull call spread. In this trade, you buy calls at one strike price and then sell the same amount of calls at a higher strike price. So if you bought five Microsoft 25 calls, you might sell five Microsoft 27.50 or 30 calls. The contracts have to have the same expiration month and underlying security for the trade to be considered a bull call spread. This is a bullish strategy.

The bearish cousin of the bull call is the bear put spread. Here you’ll buy puts at one strike price and then sell the same amount of puts at a LOWER strike price. Both strategies limit gains, but they also limit losses.

As you can see, a lot of options strategies offer protection to investors. Another one of these trades is the protective collar. With a protective collar, you’ll purchase an out-of-the-money put option and write (or sell) an out-of-the-money call option on the same security. This strategy is used by investors that have already gotten substantial appreciation from the underlying security as a way of locking in profits.

Got a feeling that a stock is about to make a big move, but you’re not sure what way the move is going to go? That’s OK because you buy both a put and call with the same strike price and expiration on the same security. This is known as the long straddle and positions you perfectly to profit from a big move in the underlying, regardless of the direction.

A related strategy is the long strangle, but there’s a twist with this trade. With a long strangle, you’ll buy a put and a call on the same security with same expiration date, but with different strike prices. A strangle is usually a little cheaper than a straddle because you’ll be buying out-of-the-money contracts. And with both long straddles and strangles, your loss is limited to the cost paid to enter the trade.

The butterfly spread is an advanced options strategy that may seem confusing to the novice options investor. In a butterfly spread, we combine bullish and bearish spreads using three different strike prices. An example of a butterfly spread would include buying one put or call at the lowest or highest available strike price, then purchasing two of whatever we didn’t purchase in the first leg at higher or lower strike prices and then one final put or call at a lower of higher strike. Let’s try to make this easy to understand. Buy one call, buy two puts, then add another call. Voila, there’s your butterfly spread.

Another unique options strategy that is geared more to experienced options traders is the iron condor. The iron condor is risky and complex because you simultaneously hold a long and short position in two different strangles. This is the type of trade you need to research before randomly committing money to it.

And our final options trade that we think you ought to know is another butterfly. The iron butterfly allows investors to combine a long or short straddle with the purchase or sale of a strangle. With the iron butterfly we use both puts AND calls, not one or the other. Using out-of-the-money options is advisable to keep costs and risks to a minimum.

In an effort to keep things simple, new options investors should focus on equity options. These are options where the underlying security is a common stock. There are options available for myriad products and these are worth including in your portfolio, but only after you’ve mastered the basics of equity options. Remember that when you see the price for an option that price is for each share in the contract and an equity options contract grants you control of 100 shares. So if you see an options quoted at $2, it will cost you $200 to buy one contract ($2 x 100 = $200). Next, let’s look at the basics of beginning options strategies. As rookie options traders, it’s probably best to stick with buying puts and calls. We buy puts when we’re feeling bearish about a stock. As put buyers, we’re “long” on the puts because the puts increase in value as the underlying stock decreases. Buying puts is a great alternative to directly shorting stocks because our risk is limited to the premium paid for the contract. When we directly short stock our risk is unlimited because, in theory, the stock could rise to infinity, destroying our account in the process. The next beginner options strategy is buying calls, which we do when we’re feeling bullish about the underlying stock. Again, our risk is limited to the premium paid for the contract and that keeps our risk profile low. Another advantage of calls is that if we pick the right ones, they pack great profit potential and can often return greater percentages than the underlying stock even as the stock rises itself.

While we would never enter into any investment vehicle without knowing the chances for success, this is especially true with options. See the rub with options is we can’t hold them forever. We can’t even hold them for three or four years like we can with stocks or bonds. Options are impacted by time decay. Options contracts expire on the third Friday of every month and as our contracts get closer to expiration, time decay becomes more of an issue. Look at it this way. Let’s say you buy some August 50 calls in Coke when the stock is trading at $49. You need Coke stock to be ABOVE $50 on expiration date to make money on this trade. The other problem with time decay is that as expiration date draws near and your option is sitting out-of-the-money more traders start to take positions in the opposing contracts that are in-the-money, making it harder for you to make money. To counter this problem and put the probabilities on your side, you have to study statistical and implied volatility. Both of these can help options investors calculate their risk and understand their desired options’ chances for success. Beginning options traders need to understand time decay in order to be successful.

It may seem like a good idea to take on more risk by purchasing puts or calls that are out-of-the-money, meaning a call’s strike price is below the current market price and a put’s strike price is above where the stock is trading at. The premiums for out-of-the-money options are cheaper for a reason: Because they are riskier. Yes, there is more profit potential, so consider buying out-of-the-money options as a step you graduate to after becoming proficient with in-the-money purchases. There’s no doubt that playing options is great to boost your portfolio’s returns and hedge risk in the process. Options are suitable for investors of all stripes, from aggressive to conservative and everyone in between. Just remember that an informed options trader is a successful options trader.

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.

Since an option is a depreciating asset, meaning it has a limited life, the extrinsic value in the option will wither away daily until expiration. This decay is not a linear function meaning it is not equally distributed between all of the days to expiration.

As the option gets closer to expiration, the daily rate of decay increases and continues to increase daily until expiration of the option. At expiration, all options in the expiration month, calls and puts, in-the-money and out-of-the-money must be completely devoid of extrinsic value as noted in the time value decay charts below.

As more time goes by, the options extrinsic value decreases. Again, it is important to note that the rate of this decrease is not linear, meaning not smooth and even throughout the life of the option contract. An option contract starts feeling the decay curve increasing when the option has about 45 days to expiration. It increases rapidly again at about 30 days out and really starts losing its value in the last two weeks before expiration.

This is like a boulder rolling down a hill. The further it goes down the hill, the more steam it picks up until the hill ends.

By selling the option and owning the stock, the covered call seller captures the extrinsic value in the option by holding the short call until expiration.

As mentioned earlier, an options loss of extrinsic value over its life is called time decay. In the covered call strategy the options time decay works to the sellers advantage in that the more that time goes by, the more the extrinsic value decreases.

Key Point The covered call strategy provides the investor with another opportunity to gain income from a long stock position. The strategy not only produces gains when the stock trades up, but also provides above average gains in a stagnant period, while offsetting losses when the stock declines in price.

We have now seen how a covered call strategy is constructed and how it is supposed to work. Keep in mind that the trade can be entered into in two ways. You can either sell calls against stock you already own (Covered Call) or you can buy stock and sell calls against them at the same time (Buy Write).

Example 1

You own 1000 shares of Oracle at $9.50.

The stock has been stuck around this level for a long time now and you have grown impatient. You finally give in and sell the front month (November for example) at-the-money calls. The at-the-money calls would have a strike price of $10 if the stock was trading at $9.50.

You sell the calls at a $.50 premium per contract which creates a $10.50 breakeven point. Remember, in a buy-write, the breakeven point is the strike price plus the option premium. Lets look at what our returns will be in each of the three scenarios.