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Profitable Option Investing

Profitable stock option investing requires:

  • A system to select profitable investments
  • A critical mass of funds to invest
  • Risk management strategies

Selecting Profitable Option Investments

The vast majority of stock options are priced "fairly". By definition a "fairly" priced option is one whose premium price is set so that neither the buyer nor the seller has a profit advantage. If hedging or insuring a portfolio is your overriding objective, then there is nothing wrong with paying or collecting a fair price for an option, but if your objective is to consistently profit from option investments, you must find investments where the pricing is not "fair". Only market makers (via their bid/ask spread) and brokers (via their commissions) make money on fairly priced options. can help you find options that are not fairly priced, but rather are priced in your favor, "advantaged option investments".

We believe that identification of "advantaged option investments" requires analysis of how news events should affect a company's fundamentals. Data related to "technical indicators" and earnings expectations can be processed by automated computer analysis algorithms and therefore are instantaneously built into the current option price. The key to finding "advantaged option investments" is to identify information that is important but not easily processed by these automated systems. This type of information can usually be found in company news stories, but you must read beyond the headlines to find it. A human must spend time digging into a news story, build an understanding of how the company's stock will act when the meaning of the news becomes clear, and determine that the news is not properly priced into the company's stock. The universe of companies and news stories is very large, so an enormous amount of time can be spent in unproductive analysis. makes this process more efficient. analyzes hundreds of stocks and tens of thousands of option positions daily looking for situations where pricing has become significantly different from the pricing that should occur based upon the investments recent price history. This difference in pricing indicates a potential profit opportunity. The investments with the most significant potential profit opportunities are published in the site's Hot List reports. By using the Hot List as a guide, news analysis becomes much more efficient and productive.

A common scenario is that a significant news event occurs for a company and drops its stock price by 5%. The news event results in a bipolar reaction in the company's stock options. Both Call and Put premiums significantly increase. Call option prices have significantly increased because a large portion of the investing population believes that the stock was overly punished and the probabilities of future stock price increases are high. Put option prices have also increased because a large percentage of the investing population is worried that the probabilities of further stock price decreases are high. This lack of consensus results option pricing that will give a profit advantage to the investor who correctly determines the significance of the event. identifies the difference between the current pricing and trended pricing, and identifies this situation as a potential opportunity. You research the news event and determine that although the headline was negative, the effects of the bad news are limited and not as serious as the recent price drop indicates. You expect that the stock will rebound when some of the fear around the news story dissipates, so you open a Bull Put Vertical Spread at a strike price a few percent below the current stock price. By placing the spread (short option) strike price below the current price you create a safety margin for your judgement. You don't need to be right. You profit as long as you are not very wrong.'s analysis rates these opportunities by "annualized net expected return on risk". First a probability analysis is performed to compute "expected profit" based upon the underlying stock continuing to move based upon its historical characteristics. This profit is adjusted for typical brokerage commissions and is then divided by the risk of the investment and annualized. This rating makes it easy to compare potential investments and direct your attention to the investments that provide the highest returns and the least risk.

Investments reported in the Hot List feature have historically trended return on risks that are both significant and in your favor. If your news analysis determines that the historical trend should continue, then you should expect to realize this significant profit. If you are totally wrong in your analysis and the news is properly priced into the options (the options are fairly priced), then your expected loss amounts to the brokerage commission paid. If your analysis is partially right, then your expected return will be somewhere in-between.

Since investments identified in the Hot List have expected "annualized net return on risks" that are no worse than "fair" and could be significantly in your favor, succeeds in presenting you with a system to select profitable option investments.

Next Section: Critical Mass - (It takes money to make money)

Previous Section: Do Options Fit In Your Portfolio?

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