SECRETS OF A MASTER TRADER:TIPS AND STRATEGIES FOR MAKING

A FORTUNE IN OPTIONS

SECRETS OF A MASTER TRADER:TIPS AND STRATEGIES FOR MAKING

A FORTUNE IN OPTIONS

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© 2005 by Agora Financial LLC. Printed in the United States of America10 9 8 7 6 5 4 3 2 1No part of this book may be reproduced, stored in a retrieval system, or transmitted in any form by any means, electronic, mechanical, photocopy, recording, or otherwise, without the written permission of the publisher, except for brief quotations in critical reviews or articles.

Editor: Steven Sarnoff • Publisher: Addison Wiggin

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SECRETS OF A MASTER TRADER:TIPS AND STRATEGIES FOR MAKING A

FORTUNE IN OPTIONS

There’s only one sure way to make money inoptions...you have to keep buying them.

It may sound like a joke, or even just commonsense. It’s a little like the lottery — you can’t win ifyou don’t play. But don’t get me wrong...unlike thelottery, winning with options isn’t simply a matter ofluck.

In the end, winning big with options comes downto your choices.The more correct choices you make, themore money you’ll rake in.And the only way to learnwhat the correct choices are is to keep buying options.

Still, you’d be surprised how many people simplythrow their hands up and stop buying options after asingle loss or two.

Sometimes, it’s a lack of money — the losses wipean investor out, leaving no cash for future plays.Sometimes it’s a lack of confidence — a few lossesconvince an investor he can’t win in the options game.

But whatever the cause, they pass up the opportu-nity to win back what they’ve lost (and more!).Andthey warn anyone who will listen to stay away fromoptions.

That’s a real shame. Because in most cases, a simple change in mind-set could have meant the difference between cashing out at a loss and rackingup a fortune in profits.

If you wish to become a serious options trader,you need to be prepared to stay in for the long haul.That’s why we’ve prepared this guide to help youdevelop a firm plan of action — a way to handle yourprofits and bounce back from the occasional loss.

In short, there are three keys to staying in thegame.You need to manage:

�Your emotions

�Your money

�Your strategy.

While it may sound difficult, you can easily trainyourself to handle all three. Even the toughestone...managing your emotions.

Managing Your EmotionsLet’s face it...humans are emotional beings. It’s

inescapable.

Unfortunately, emotions have little place in investing. Don’t get me wrong — you can feel sadwhen a trade goes against you. Or you get excitedwhen a trade hits triple digits.

But emotions can also cause you to make thewrong decision at a critical moment...you may findyourself relying on how you feel instead of howthings actually are. It’s a sure path to disaster.

Luckily, learning to control your emotions is easierthan you think.

But don’t worry...I won’t start quoting SigmundFreud or use pop psychology buzzwords like "self-actualization."

Instead, I’ll keep it simple, giving you some tips onhow to develop the two traits every successfulinvestor relies on...and how to avoid the two mostdangerous emotions a trader must conquer.

The Two Traits of EverySuccessful Trader

If you want to make triple-digit profits in options,you need courage and discipline — the will and thedrive to succeed.There is no other way around it.

To some people, courage and discipline come naturally. But if you’re not one of them, don’tworry...because you can learn courage and discipline.In fact, you must learn them!

But there are two emotions you must avoid —two primitive instincts found in all living things. I’mtalking about fear and greed. Luckily, as you develop

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courage and discipline, you’ll automatically conquerfear and greed.

First, we’ll talk about fear and courage.

Don’t Be Afraid to Make Money

Fear is one of the biggest obstacles to makingmoney. It’s that nagging voice that keeps remindingyou how much you can lose...the feeling you’ve madethe wrong decision...and the urge to protect yourselfat all costs...

There’s nothing wrong with a little fear. In fact,the entire point of fear is to keep us safe.A child whoisn’t afraid of fire could get seriously burned. But let-ting fear get the best of you can be just as bad.A childwho doesn’t learn to control his fear of fire will avoidcandles, fireplaces, etc.

And when you learn to overcome fear, the sky’sthe limit.

Again, I’m not saying you shouldn’t feel a little fearwhen you’re investing, because you can lose money.But that risk of loss shouldn’t control your actions.

The fact is every investment involves some levelof risk. Even "safe" investments like savings accounts,money market funds, even IRAs and 401(k)s, can gobust. It’s rare...but it does happen.

In other words, if you’re investing in anything, youhave already overcome some of your fear of risk. So allyou need to do is push that tolerance to the nextlevel.

Start by saying to yourself:

� I will have losses — but my wins will overpowerthem

� I will make mistakes — but I will learn fromthem and won’t repeat them

� I will make money — but only if I don’t give up.

Of course, reading these is one thing...believingthem is something completely different. Don’t expectit to happen overnight. But the more you tradeoptions, the more confident you’ll become.And soon,fear won’t be a factor in your investment decisions.

Now all you need is discipline to follow throughon your decisions.

It’s Easy to BecomeDisciplined

First, let me assure you that when I say you needto develop discipline, I’m not talking about anythingdrastic. I certainly don’t mean punishing yourself. ButI also don’t mean making drastic changes to the wayyou live.You don’t have to plan on going to bed aftermidnight and waking up before dawn.

The kind of discipline I’m talking about is twofold.First, you must set aside some time to monitor youroptions. Second, you must learn to stick to yourinvestment strategy.

We’ll start off as easy as possible.Your first goal isto schedule 15 minutes for yourself each workday, andstick to it.

It helps to make it a set time — say, 8:30 everymorning or 5:15 every evening.Try to keep it consis-tent every business day, if your schedule allows. Butbe realistic! Don’t schedule a time when you’re busymore often than not.

You’re going to use this time to check your optionprices or check in with the professional who is moni-toring your position.

They don’t ring a bell when it’s time to get out ofyour position. Check where the underlying shareprice is in relation to your complete game plan (strat-egy) for each trade. See the support and the resistancelevels from the "Open Positions Review" section ofSunday and Wednesday broadcasts.

At the most basic level, you’re checking to seehow much your options are up or down from yourbuy-in price.You should also keep track of how muchthe option is rising or falling day to day.After all, ifone of your options has doubled or more but is nowslipping back, you may want to sell it.

But don’t overcheck your options! You shouldn’tfret every up and down tick. Usually, once a dayshould be enough.

Before long, checking prices should become auto-matic.When that happens, you’ve taken a very bigstep toward developing solid discipline.And you needdiscipline to avoid another dangerousemotion...greed.

Greed Isn’t GoodIn the movie Wall Street, Michael Douglas’ Gordon

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Gekko famously says, "Greed is good." Don’t believe it.

In options trading, greed is that nagging voice thattells you to hold onto an option for just a few daysmore — hoping to squeeze a few more percentagepoints out of the play. Greed looks over your shoulderwhen you’re buying options, telling you the more youbuy, the more profits you could see.

It sounds tempting...but it’s also very dangerous.For one thing, options are wasting assets — the closerthey get to expiration, the more their value will drop.So you don’t want to hold them any longer than youhave to.

Develop a complete plan for what action to take ifthe underlying shares move for you or against you.That way, there are no surprises.

And of course, when you buy an option, youcould lose your entire investment.That’s why youneed to keep your option buying firmly in check.

The solution is to develop a sound money management system (which I’ll get to in a minute).But even more importantly, you need to develop thediscipline to stick with it.

This is the hardest thing you’ll probably have todo as investor — trust your system, making what areusually very emotional decisions using only cold, hardfacts.

That doesn’t mean you can’t feel happy when apick is doing well, just like you can feel upset if a playgoes against you. But every choice you make musthave a rational reason behind it.

If your option has hit your target and you stillwant to hang onto it, there has to be a real reasonbehind it — NEVER because you think you can ride ita little longer. Look for some news that changes thesituation...or if something new has appeared on thechart.And no matter what, set hard stop-loss limits foryourself and stick to them.

You’ll learn that the less emotion you put intoyour investment decisions, the better you’ll be atadapting your money management system to handlealmost any situation that comes up. It could meanthousands of dollars of extra profits for you.

That’s not being greedy...it’s being smart.And withthat kind of discipline, it becomes very easy to comeup with a money management system.

Developing a MoneyManagement Plan

A proper money management system helps makesure you always have enough money to buy theoptions — so you never risk missing a triple-digithome run because of a lack of funds.

If you’ve been trading without a money manage-ment system, consider yourself lucky that you’re stillin the game. But don’t expect your luck to continue.

Today, I’d like to give you a few pointers on howto develop a money management strategy that fitsyour style. Even if you’re happy with your trading success so far, I urge you to pay attention.You mightdiscover a way to improve it.

In fact, that’s lesson No. 1 — don’t fall in love withyour strategy.The markets are always changing. Moreimportantly, your life is always changing, too.Thatmeans you need a little flexibility in your plan.

But first, of course, you need a plan.

Expect the Best,but Plan for the Worst

The first thing to do is to set aside some moneyfor options trading. Remember, options are for "playmoney" — that is, money you can afford to lose. Sohow much should you set aside?

Obviously, I can’t tell you how much money youshould risk. Even if we were best friends and I kneweverything about your life, I still wouldn’t feel com-fortable telling you that. It’s just something you knowin your gut…how much money you could honestlysay goodbye to without getting upset.

In general, you should plan to spend as close to anequal amount in each options pick as possible.That is,if you feel comfortable risking $1,000 on your firstoptions play, you should plan to risk about $1,000 oneach options play.

The reason is simple — one of my option recom-mendations isn’t really better than another. Eventhough I carefully research each one, there’s still achance something unexpected could happen.

You don’t want to risk putting too much money onthe rare bird that ends up losing.And by keeping theamount you risk each time about the same, you almostensure that your wins will outweigh your losses.

Along those lines, you should also put asideenough money so you can play every trade. It’s criti-cal that you stay in the game. Every so often, a playcomes up short...but a lot more tend to double ormore.You don’t want to risk missing the plays thatdouble, triple, or more.Taking part in every recom-mendation is your best chance to see your wins out-weigh your losses.

Again, I can’t tell you how much is right for you torisk. But I can give you a few guidelines.

Since Jan. 1, 2003, the most expensive option Ihave recommended was $500 for a single position. Sofive options contracts would have cost you $2,500.Ten would have cost $5,000.

The average time it takes an Options Hotline pickto reach its high is 28 days. So you should expect yourmoney to be tied up in each play for at least a month— of course, sometimes it will be longer, sometimesshorter.

Finally, Options Hotline comes out with a newpick just about every week.

That should be enough information to estimatehow much money you should devote to OptionsHotline’s recommendations.You want to have enoughmoney so you can play each recommendation.Andyou want to try to put an equal amount in each one.

I highly recommend keeping this money in a sepa-rate account, away from your regular investmentfunds.That way you won’t be tempted to risk moneyyou can’t afford to lose.

Feel free to transfer your winnings from youroptions account to your regular account. But if you’veplanned correctly, you should never have to depositmore money into your options account.Your winnings should fund future trades.

These tips are just ways to help you start a soundmoney management plan.And with a plan in place,you’re ready to start working on your investmentstrategy.

Know Your StrategyThere are two ways to define your strategy —

how you choose your options and how you playthem.

Of course, you don’t have to worry about devel-oping a system for choosing your options. I already dothat for you in Options Hotline.

My system combines a unique charting systemwith proprietary computer screening programs...butthere’s really no point in going into specifics here.Allyou really need to know is that it has a long history ofbeing right.

But as you become more familiar with options,you might want to develop your own system — a wayto find option plays on your own. It isn’t easy...andsome people spend a lifetime developing a system,only to have it never quite pan out.

If you’re up to the challenge, though, here are afew books that could help get you started:

� Technical Analysis From A to Z, by Steven B.Achelis

� Technical Analysis Explained, by Martin J. Pring

� Option Volatility & Pricing, by SheldonNatenberg

Again, you don’t need to worry about a system,because I do all the work for you.All you need to dois play the options right.And since Options Hotlinetells you the best time and price to buy, all you haveto do is watch for when to sell.

Let me make this perfectly clear — I rarely offersell advice for my recommendations. Selling is a personal decision...one based on your risk tolerance.But I can give you some pointers on how much riskto tolerate.

The Art of Selling Believe it or not, knowing the best time to sell an

option can be even harder than buying.That’s becausewhen you were thinking about buying an option, youwere dealing with unknowable "what-ifs."

Now that you’ve bought the option, you’ve actuallyput your money on the line. So your decisions willresult in real profits or losses.As I said before, emotionhas no place in options trading. But it’s easy to forgetwhen cash is at stake.

Once again, the best way to counter your emotions is with a plan. First, we’ll handle the badnews...what to do when an option doesn’t go the wayyou expect.

If you’re holding a losing option, you have a fewchoices.The simplest choice is to hold on. If you’vefactored the total options price risk into the moneymanagement aspect of your complete game plan for

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trading success — and the movement of the underlyinginstrument still supports your position — you canafford to hold the option, even if that means risking aworthless expiration.

How low should you ride an option down? Again,that’s up to you.

One choice may be to sell if the option’s premiumfalls by half — if that is your money management strategy. In other words, if you paid $150 for an option,you sell at $75.

To make things even easier, you can set up anarrangement like this with most brokers: It’s called astop-loss order. In short, you instruct your broker tosell the option if its price falls by half.

Keep in mind this doesn’t absolve you of yourobligation to monitor your position carefully.There is asmall chance your order could get lost in the shuffle.But an even more likely event is that your brokerwon’t be able to execute your trade at exactly a 50%loss.

That’s because a stop-loss order is simply that —an order.And orders need to be processed oncethey’re executed. In other words, if your $150 optionfalls to $75, your broker has to make the call or other-wise let the trading floor know you’re ready to sell.And by the time the transaction is made, the optioncan be worth less than $75. Stop orders become market orders when triggered.

So if you see your option teetering near your stop-loss price, especially if it gets there fairly quickly, youmay want to sell sooner to get a better price.

A more advanced way to limit your losses is witha trailing stop order.A trailing stop order is simply astop-loss order that moves with your option.

For instance, if you pay $150 for an option, youtell your broker to set a stop-loss limit at $75. If theoption falls to $75, your broker will try to resell theoption. If, however, the premium closes at $151, youshould move your stop loss to $75.50.

Even if the price moves back to $150, keep yourstop price at $75.50.And if the price keeps going up,keep moving your stop up.

Each time the option closes at a new high, youraise your stop loss. (Of course, it may be easier to seta new stop loss for every new $1 high...$2high...maybe even $5.)

The point is, you are locking in profits. If your$150 option jumps to $400, your trailing stop shouldfollow to $200. Now, as long as your order is carriedout, you’ve virtually guaranteed yourself a profit.

In fact, the more profits you make, the smaller percentage you might want to use for a stop loss.Youmay wish to try a 30% trailing stop loss, or even 25%.Just remember that options are very volatile, so youdon’t want your trailing stop loss level to be narrow. Ifyou keep a 10%, or even a 20%, stop loss, you couldeasily get kicked out of an option sooner than you’dlike just due to day-to-day fluctuations.

Not every broker accepts trailing stop orders, soyou may need to update a stop order with your broker often.And as always, even if your broker doesfollow trailing stops for you, it’s a good idea to double-check yourself.

Limiting losses with stop losses and trailing stoplosses can be an important leg of your overall moneymanagement strategy.

And now that we have the bad news out of theway, let’s discuss what to do with a winning option!

Selling at the TopHopefully, a losing option isn’t something you’ll

have to deal with often. But don’t think handling awinning option is any easier.

For one thing, this is where your enemy, greed,tends to show up. Greed will make you want to pushthings just a little bit further...hold on just a little bitlonger.And that could be disastrous if you’re not paying attention.

On the other hand, you don’t want to give in tofear and sell too soon. So here are some tips for getting the most money out of your option trades.

Eye on the TargetYour very first line of defense is to have a profit

target in mind.The key is to focus on the stock, notthe option.

Remember, a lot of factors go into options pricing,including intrinsic and extrinsic calculations. (Seeyour Option Buyer’s Handbook for a review.) So theoption price can fluctuate for a variety of reasons.

But the biggest factor influencing the option priceis the movement of the underlying shares.That’s whyevery Options Hotline recommendation has a target

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price based on the stock price, not the option.And togive you a clearer picture of where the stock isheading, I also tell you the stock’s support and resistance.

Support, Resistance,and Options

Support and resistance are part of technical analysis — using charts and formulas to determinewhich way a stock is moving.Technical analysts eachhave their own way of calculating support and resis-tance. So it’s not really important to tell you how I calculate them. It’s just important to know what theterms mean.

Support is an area of expected institutional buying.Resistance represents expected professional selling.

Or more simply, support represents the expected"floor" of a stock.That is, the lowest price you canexpect it to go.That’s because when the price falls tothis, institutions and investors tend to step in, buyingup the stock.That buying "supports" the stock price.

Think of it this way: Suppose a fictional company,Widget Co., is trading for $53.And let’s say that brokerage houses have a lot of standing orders fromtheir clients to buy Widget Co. at $50.

In other words, these orders will not trigger aslong as Widget Co. is selling for more than $50. But ifthe stock falls to $50, the brokers start executing thelimit orders.All of a sudden, there is a flood of buyersfor the stock.The demand keeps the price up.

Of course, support is not foolproof. In fact, stockscan and often do break through their support lines. Itmeans that more people are selling the stock thanbuying...so the bears are in control.

When a stock breaks through resistance, on theother hand, it’s a bullish sign. Resistance can be considered a stock’s ceiling. It is the price a stock isexpected to have trouble breaking through.

Just like with support, resistance is controlled byinstitutional investors. Except this time, it is the priceat which they can be expected to sell the stock.

For example, again assume Widget Co. stock is at$53. But instead of falling, the stock rises.And keepsrising.

In this example, a lot of people will want to takeprofits if the stock rises $10. So they put in limit

orders...and if the stock hits $63, the selling begins.The shares flood the market, driving the stock pricedown.

Of course, resistance isn’t absolute, either.And ifthere are more buyers than sellers, the stock willbreak through resistance. It’s a good sign the stock isin a bull run.

Knowing a stock’s support and resistance canhelp you decide what to do with your options.

What to Do When We’re RightWhat do you do if the option reaches your target

or comes close to hitting the support or resistancelevels? That depends on your risk tolerance. Each indi-vidual has a different exit strategy.The safest thing todo is take your money off the table.As the old adagesays, "No one ever lost money taking a profit."

Of course, greed will suggest otherwise — whis-pering to set a new profit target, hold on just a littlelonger.And remember, there’s nothing wrong withfeeling greedy...as long as your decisions are based oncommon sense.

You want to sell as close to the top as you can.Unfortunately, a bell doesn’t ring when an option topsout.

Again, my support and resistance targets can help.

Remember, if a stock breaks through support, it isfalling — and the bears are in charge of a stock price.If you have a call option, it can be very bad news foryou.You may want to consider selling the option incase the stock goes even lower.

Of course, a lower stock price is what you wantto see if you have a put on it. So if the stock breaksthrough resistance, it should mean profits for you.Youreally have two possible actions now.You can sell theoption, locking in your profits. Or you can ride thestock down, squeezing more profits out of youroption on the way.

Just be careful, because the stock can turn aroundwithout warning.As always, you are in charge of youroption. If you hold on, monitor your position carefullyand use proper trading discipline to sell at the bestprice.

(As you can probably guess, the opposite thinkingapplies to resistance. If you own a put and a stockbreaks through resistance — meaning it’s headinghigher — consider selling the put. If you own a call,

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use your money management system to decidewhether to take profits or hang on for more.)

You, or the person monitoring your position,should compare the movement of the underlyingshares to the support and resistance targets providedin Options Hotline.

Of course, you shouldn’t expect to buy at theabsolute bottom and sell at the absolute top.You wantto capture a healthy move in the middle.A common-sense exit strategy — as part of your sound moneymanagement plan — will help you do that.

And before long, your profits should begin to addup.

Putting It All TogetherSo here we are.You have the courage to make the

kind of plays that could double or triple in shortorder.You’ve developed the discipline you need toclosely monitor your positions and sell when the timeis right.

You also have a money management strategy inplace — a way to limit your losses while compoundingyour gains.

Put it all together, and you have a method for making money in options...a process you can use toconsider every recommendation.

And whether you’re using Options Hotline’srecommendations or are analyzing options on yourown, the steps are the same:

Step 1: Decide If You Can Afford the Trade

With a sound money management plan, this stepis a no-brainer.You should have enough "play money"to put an equal amount of money in every option recommendation.

Step 2: Figure out What You Stand to Loseand What You Could Gain

Successful option trades start by figuring out howmuch you could lose, not how much you could gain.Remember, you could lose 100% of your investment inoptions. But the profit potential is nearly unlimited.Realizing that will keep your fear in check.And evenif things don’t go your way, your money managementplan is ready to absorb the loss.

Step 3: Buy the Option

Once you’ve overcome your fear, there shouldn’tbe anything holding you back. Remember, your money

management plan dictates how many contracts youbuy.There shouldn’t be any guesswork on your part.It’s simply a matter of contacting your broker and executing the play.

Step 4: Monitor Your Position

This is where your discipline comes in. Checkingon your recommendations must be second nature,whether you’re calling your broker each day or moni-toring them on your own.

Step 5: Sell Your Position When It’s Time

This is probably the hardest step to master,because it taxes every skill you’ve learned in optionstrading.You need to conquer your fear and greed...youmust follow your money management plan...and some-times you need to simply make an educated guess.

Just remember that no one rings a bell when it’stime to get out of a position.You have to decide foryourself.

Above all, the decision to sell should not be anemotional one.

These five steps incorporate everything you’velearned so far: controlling you emotions, developing amoney management system, and following a strategy.Follow these rules for every options trade you make,and your winners should far outnumber your losers.

Before long, your skills will be honed and thesesteps should become automatic.When that happens,you can start to consider yourself a true options trader.

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Notes

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400R

0023

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