Trading Options to Win: Profitable Strategies and... (PDF) (2024)

Page 1

Page 2

TradingOptionsto WinProfitable Strategies andTactics for Any TraderS. A. JOHNSTONJohn Wiley & Sons, Inc.

Page 3

Page 4

TradingOptionsto Win

Page 5

Founded in 1807, John Wiley & Sons is the oldest independent publishingcompany in the United States. With offices in North America, Europe,Australia, and Asia, Wiley is globally committed to developing andmarketing print and electronic products and services for our customers’professional and personal knowledge and understanding.The Wiley Trading series features books by traders who have survivedthe market’s ever changing temperament and have prospered—someby reinventing systems, others by getting back to basics. Whether anovice trader, professional, or somewhere in-between, these bookswill provide the advice and strategies needed to prosper today andwell into the future.For a list of available titles, please visit our Web site atwww.WileyFinance.com.

Page 6

TradingOptionsto WinProfitable Strategies andTactics for Any TraderS. A. JOHNSTONJohn Wiley & Sons, Inc.

Page 7

Copyright © 2003 by S. A. Johnston. All rights reserved.Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.Designations used by companies to distinguish their products are often claimed astrademarks. In all instances where John Wiley & Sons, Inc. is aware of a claim, theproduct names appear in initial capital or all capital letters. Readers, however, shouldcontact the appropriate companies for more complete information regarding trademarksand registration.No part of this publication may be reproduced, stored in a retrieval system, ortransmitted in any form or by any means, electronic, mechanical, photocopying,recording, scanning, or otherwise, except as permitted under Section 107 or 108 ofthe 1976 United States Copyright Act, without either the prior written permission ofthe Publisher, or authorization through payment of the appropriate per-copy fee tothe Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923,978-750-8400, fax 978-750-4470, or on the web at www.copyright.com. Requests to thePublisher for permission should be addressed to the Permissions Department, JohnWiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008,e-mail: [emailprotected].Limit of Liability/Disclaimer of Warranty: While the publisher and author have used theirbest efforts in preparing this book, they make no representations or warranties withrespect to the accuracy or completeness of the contents of this book and specificallydisclaim any implied warranties of merchantability or fitness for a particular purpose. Nowarranty may be created or extended by sales representatives or written sales materials.The advice and strategies contained herein may not be suitable for your situation. Youshould consult with a professional where appropriate. Neither the publisher nor authorshall be liable for any loss of profit or any other commercial damages, including but notlimited to special, incidental, consequential, or other damages.For general information on our other products and services, or technical support, pleasecontact our Customer Care Department within the United States at 800-762-2974, outsidethe United States at 317-572-3993 or fax 317-572-4002.Wiley also publishes its books in a variety of electronic formats. Some content thatappears in print may not be available in electronic books.For more information about Wiley products, visit our web site at www.Wiley.com.Library of Congress Cataloging-in-Publication Data:Johnston, S. A.Trading options to win : profitable strategies and tactics for any trader /S. A. Johnston.p. cm.ISBN 0-471-22685-8 (alk. paper)1. Stock options. I. Title.HG6042 .J64 2003332.64′5—dc212002153117Printed in the United States of America10 9 8 7 6 5 4 3 2 1

Page 8

ContentsPreface viiCHAPTER 1 Making Money with Money 1CHAPTER 2 On the Trail of a Method: Risk, Leverage,and Markets 22CHAPTER 3 Profitability 101: Expectation and Options 45CHAPTER 4 Just the Facts, Ma’am: AvoidingMoonshine, Morons, and Myths 71CHAPTER 5 No Hammer, No House: The Tools ofthe Trader 89CHAPTER 6 Thomas More’s Revenge: A Strategy for AllSeasons 100CHAPTER 7 Apocalypse Never: The Uses of Defense 122CHAPTER 8 Don’t Just Stand There, Do Something:The Straddle 146v

Page 9

vi ContentsCHAPTER 9 Don’t Just Do Something, Stand There:The Strangle 168CHAPTER 10 Hi-Yo, Yogi! Riding the Bear 188CHAPTER 11 The King of Strategies: The MartianRatio-Spread 207CHAPTER 12 Every Once in a While: The Picador 226CHAPTER 13 Pay Me after Lunch: The Endplay 238CHAPTER 14 Filling in the Cracks: Ideas,Understanding, and Winning 252APPENDIX A Studies of Historical Gross Movement inSelected Markets, 1990–2002 263APPENDIX B Distribution of Contract Highs and Lows inSelected Markets, 1980–2002 280Index 297

Page 10

Prefacehere are thousands of books about trading. Some books approach trad-ing as an exercise in mathematics and focus on effective ways to turnTthe mathematics of the marketplace into a profit-generation machine.Some approach trading as an exercise in psychology and tactics, attemptingto generate profit from a correct understanding and appreciation of what theother traders in the market are doing. Some are catalogues of strategies.Some apply economic, statistical, or logical principles to trading in the mar-ketplace. Some are practical guides to the minutiae of markets.This book either fits into none of those categories or is a mixture of allof them with several other topics included. I’m not sure which. What it is, atbottom, is my understanding of the whats, hows, and whys of earning a trad-ing profit, acquired over 30 years of trading in all sorts of markets (all sorts—remind me to tell you sometime about the great caviar-for-condoms caper).I didn’t become a steadily profitable trader until I came to understand someof the assumptions and conditions that underlie markets and to figure outcertain practical and usually effective ways to combat the assorted risksthat markets present; in short, to learn to deal effectively with the nature ofthe beast.This book is informal, because I’m an informal guy. There’s almost noth-ing I like better than talking with other traders about trading, and so the textis written in a generally conversational style. We will crunch a few numberson occasion, to clarify various topics and as an aid in looking at practicalexamples of trading, but there are no formal mathematical demonstrations atall in this book for two very good reasons.First, a number of fine analysts and remarkable scholars have publishedextensive compilations of the mathematics involved in quantitative analy-sis, numerical methods, and risk and price modeling, and there’s no pointwhatever in even attempting to replicate their efforts. A motto of mine is,“Always go to the best source available,” which is usually the original author.Who wants to read a rewrite of someone else’s work, anyway, particularlya very good original work? Can you even imagine Hamlet as rewritten by,say, Danielle Steele? Ghastly thought.vii