Table of Contents From the Publisher Meet Oliver Velez Introduction: Welcome to Options Trading Chapter 1: The Four Styles of Trading A Look at Available Timeframes The Four Styles Chapter 2: The Tools for Options Trading Charting Tools Technical Tools Options Tools Chapter 3: The Pristine Method Who Won the Battle? Count Your Way to Profits When to be a Bull When to be a Bear Pristine Combinations 2 Time to Strike Summary Chapter 4: Pristine Options Options Defined The Advantages of Options Of Course, There are Disadvantages The Types of Options How the Numbers Work Chapter 5: Putting it All Together Appendix: Option Pricing Glossary Trading Resource Guide Recommended Reading 3 4 Copyright © 2007 by Oliver L. Velez Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions. 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Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com. Library of Congress Cataloging-in-Publication Data: 6 From the Publisher The editors at Marketplace Books have always kept a steady goal in mind, and that is to present actionable information on stock trading in the most straight-forward, practical medium available. Sometimes this involves a book, sometimes a newsletter, a DVD, or an online course program. What we’ve learned from the many products we’ve developed over the years is that a cross-medium approach is the most effective way to offer the greatest possible value to our readers. So an idea was born. This innovative book and DVD set is one of the first in a series that combines a full course book derived from the actual presentation itself. Our idea grew out of a simple question. Students of stock trading spend a great deal of their own money attending lectures and trade shows. After all the travel, effort, and expense, that student will still have to assimilate a host of often complex theories and strategies. Sometimes he or she may want to ask a question or dig deeper into an issue, but they hold back; maybe because they still don’t know enough about the bigger picture or maybe they don’t even know some of the basic terminology. They may buy the DVD, but still . . . a lecture in itself is not a comprehensive learning tool and a person may still need yet another lecture or host of trial and error book purchases to master the subject. So the question was: Does the average student of trading get enough out of an individual session to effectively carry their studies home and master a subject? The answer was a resounding no! Most attendees get bits and pieces of the message out of a long and expensive lineage of lectures, with 7 critical details hopefully captured in page after page of scribbled notes. For those who are gifted with a photographic memory and vast organizational skills, the visual lecture is just fine, but for the rest of us, the combination of the written word and a visual demonstration is the golden ticket to the mastery of any subject. A comprehensive approach to learning is the course you are about to embark upon. We’ve taken Oliver Velez’s original lecture and extracted his core content into an easy to read and understand course book. You’ll be able to pour over every word of Velez’s groundbreaking presentation, taking in each important point in a step by step, layer by layer process. All of this is possible because our editors have developed this title in classic textbook form. We’ve organized and highlighted the key points, added case studies, glossaries, and key terms. Let’s face it, stock trading in any medium takes years to master. It takes time to be able to follow charts and pick out the indicators that mark the wins you’ll need to succeed. And beyond the mathematical details and back-tested chart patterns, every presenter has three very basic premises for every student trader; they are to control your emotions, stay close to your trading plan, and do your homework. It’s so important to know the full picture of the profession because it could either make you rich or put you in line for that second night job. This DVD course book package is meant to give you all the visual and written reinforcement you need to study, memorize, document, and master your subject once and for all. We think this is a truly unique approach to realizing the full potential of our Traders’ Library DVDs. 8 As always, we wish you the greatest success. Accessing the Video To access the streaming video that comes with this book, please register at www.wiley.com/go/wileytradingvideo. 9 Meet Oliver Velez Oliver L. Velez, best selling author, trader, advisor, and entrepreneur, is one of the most sought after speakers and teachers on the subject of trading financial markets for a living. His seminars and speaking events have been attended by more than 60,000 traders all over the world, and his runaway best selling books, Strategies for Profiting on Every Trade and Tools and Tactics of the Master Day Trader, are considered must-read classics for anyone interested in trading markets for a living. Dow Jones dubbed him “the messiah of day trading” and financial programs on CNBC, Bloomberg and Fox News frequently seek out his expertise. Mr. Velez and his life-long dedication to bringing more awareness to trading as a way of life, have been favorably mentioned in the New York Times, the Wall Street Journal, Barron’s, Forbes, Stocks & Commodities and a whole host of other financial publications. He has also been the subject of numerous articles and books written about Wall Street’s most successful traders, including the popular book, Bulls, Bears and Brains. Oliver L. Velez is internationally known for founding and growing Pristine Capital Holdings, Inc. (a firm he started out of his New York City basement apartment) into one of the country’s premier educational institutions for investors and self-directed, retail traders. After serving as Pristine’s Chairman and CEO for 12 years, Mr. Velez decided to turn his full attention to the professional trading arena. His new training program called Trade for Life™, which includes a 2-day seminar and 5-day Live Trading Session with Mr. Velez himself, is designed to train traders to go beyond retail to trade the markets professionally. 10 Today, Mr. Velez runs Velez Capital Management, LLC (“VCM”), one of the country’s fastest growing private equity trading firms. VCM currently employs 260 professional traders who have been meticulously trained to trade his own personal account. Mr. Velez financially backs each one of his traders, absorbing all their losses, while sharing in the gains with the trader. Mr. Velez’ vision is to grow his professional team of traders to more than 1,000 globally over the next 3 years. For the past 19 years, he has espoused the revolutionary idea that “micro trading,” like “micro banking” has the potential to serve as a solution to many of the world’s social ills. Through VCM and the Velez Family Foundation, Mr. Velez will be opening up trading divisions and training centers in Beijing, Vietnam, Moscow and Mexico City. More major cities throughout the world will be added in the future. 11 Introduction Welcome to Options Trading the Pristine Way Welcome to Options Trading the Pristine way. Let me take a few minutes to explain exactly what that means. I’m sure that most of you reading this book have had some form of experience trading either stocks or options. Most of you have had experience doing both. Most of you, I am willing to bet, have had negative experiences more often than positive experiences, and that is certainly nothing to be ashamed of. It is a fact of life, simply because 85% of all those who participate in the markets from a short term perspective lose money. I am Oliver Velez, and you may know me as the CEO of Velez Capital Management or as the co-founder of Pristine Capital Holdings. For those of you that are not aware of Pristine.com, it is the number one rated website for active, self-directed traders, and Pristine.com has been rated America’s number one leading educational firm for active, self-directed traders. This is a game for those who have not only more knowledge than the majority of the market participants, but more discipline to carry out that knowledge. You need to be very aware, if you are not, of the fact that knowledge alone means absolutely nothing in the markets. As a matter of fact, having too much knowledge, even too much of the right knowledge, without the discipline can be a very dangerous combination. Knowing what to do is no guarantee that we will do it. The unique combination of knowledge and the discipline to carry 12 out that knowledge is certainly what creates the necessary ingredients for success in the market. I want to make it abundantly clear that in the course of one book it is virtually impossible to learn how to trade options. In the course of one book, it is impossible to learn how to trade stocks. But, what I can do in this book is give you a very firm foundation and an understanding of how I deploy various option tactics to maximize returns, minimize risk, hedge, and speculate. First of all, let’s get rid of some of the misconceptions out there. If you stay up late enough, and watch the right cable channels, you have probably learned many different ways to make millions in the market, especially if you use options. Some of these advertisements are really quite tricky because they imply that you do not need to know anything about the stock market. It is as if there were simply option strategies that existed independent of underlying price patterns. Nothing could be further from the truth. Options do not exist in a vacuum; their primary mover is the price of the underlying stock. Options have many important strategies and uses. They are not a source of risk-free trading, however. Any option strategy requires or benefits from the knowledge of where the underlying price pattern is going. When you hear of strategies that are thought to be “risk-free,” it is referring to the fact that once established, the position has a limited risk. You may “leg into” a position and establish it at no cost, but in that case you have already earned the money that you are leaving 13 invested in the trade, which allows you to call it a risk-free trade. There is also a concept called arbitrage. This, however, is really taking advantage of the imperfections in the marketplace. It is a specialty and fairly hard to find. It involves the simultaneous buying and selling of the same or similar security to capture the difference. Options have a variety of uses. They may be used to set up highly leveraged positions. They may be used as a hedge to current portfolios. They can be used to add income to a current portfolio. They can be used to enter stock positions at a specified price, and actually, it’s possible to be paid to enter the position you would have entered anyway. You may be the seller of options and earn premium for taking the other side of option transactions. Options have many uses including limiting risk, but they are never risk-free. The uses and various strategies of options are almost countless. There is an option tool to do almost anything you want to do in the marketplace. No matter how sophisticated you are in your options’ applications, no matter how knowledgeable you are about options, you will be a failure as an options trader if you do not know how to predict price movement with some degree of accuracy. I’m appalled at the number of people who actually come into the market having no knowledge of stocks, but feel that because options, from a numerical point of view, are cheaper to purchase, this is the ticket to wealth in the markets. This is 14 absolutely wrong. Options, as you know, are derivative of the item. If you do not know how to trade the item, you have no business trading the derivative. If you do not know how to successfully predict, with a high degree of accuracy, what a stock may do in the upcoming days or weeks, you have no business trading options. The key is to understand the movement of the underlying security and enter the proper option transaction at the proper time. Understanding the movement of the underlying security is what the Pristine Method™ is all about. When you couple the technical ability of the Pristine Method™ with some basic option strategies, the result can be very good. Please continue reading this introductory chapter. I want you to understand several things about the market in general and about trading options specifically. We need to talk about psychology and discipline. We need to discuss the fact that no option trade in the world can survive without understanding the movement of the underlying stock. We will be discussing the need for an approach to the market that is not the same old buy and hold philosophy. We also need to discuss briefly the difference between fundamental and technical trading. As a prerequisite to trading options, we must know how to trade stocks; as a prerequisite to both of these, we need to understand psychology and how the market works. As I mentioned above it is likely that your initial experiences with the stock market or with options was not all that favorable. How do I know that? I know that because the stock market is one of those arenas where 90 percent of the people 15