Mr. Kutumba Rao's- FUNDAMENTALS OF OPTIONS TRADING -- STRATEGIES PRIMER.pptx

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1. FUNDAMENTALS OF OPTIONS TRADING STRATEGIES PRIMER PROFIT YOUR TRADE EDUCATION SERIES PRESENTED BY CHERUKURI KUTUMBA RAO 06-03-2021

2. “In INVESTING, always remember that Rome was not built in a DAY………”   “In TRADING, always remember that Hiroshima and Nagasaki were destroyed in a DAY……..”

3. Brief Recap on Basics of Futures & Options Options and futures are similar trading products that provide investors with the chance to make money and hedge current investments. An option gives the buyer the right, but not the obligation, to buy (or sell) an asset at a specific price at any time during the life of the contract. A futures contract gives the buyer the obligation to purchase a specific asset, and the seller to sell and deliver that asset at a specific future date unless the holder's position is closed prior to expiration. Types of Options: Call and Put Options There are only two kinds of options:  Call options  and  Put options . A call option is an offer to buy a stock at the strike price before the agreement expires. A put option is an offer to sell a stock at a specific price. Let's look at an example of each—first of a call option. An investor opens a call option to buy stock XYZ at a Rs50 strike price sometime within the next three months. The stock is currently trading at Rs49. If the stock jumps to Rs60, the call buyer can exercise the right to buy the stock at Rs50. That buyer can then immediately sell the stock for Rs60 for a Rs10 profit per share. Alternatively, the option buyer can simply sell the call and pocket the profit, since the call option is worth Rs10 per share. If the option is trading below Rs50 at the time the contract expires, the option is worthless. The call buyer loses the upfront payment for the option, called the premium. Meanwhile, if an investor owns a put option to sell XYZ at Rs100, and XYZ’s price falls to Rs80 before the option expires, the investor will gain Rs20 per share, minus the cost of the premium. If the price of XYZ is above Rs100 at expiration, the option is worthless and the investor loses the premium paid upfront. Either the put buyer or the writer can close out their option position to lock in a profit or loss at any time before its expiration. This is done by buying the option, in the case of the writer, or selling the option, in the case of the buyer. The put buyer may also choose to exercise the right to sell at the strike price.

4. Key Differences that set both Options and Futures apart. Here are some other major differences between these two financial instruments. Despite the opportunities to profit with options, investors should be wary of the risks  associated with them. Options Both call and put options generally come with the same degree of risk. When an investor buys a stock option, the only financial liability is the cost of the premium at the time the contract is purchased. However, when a seller opens a put option, that seller is exposed to the maximum liability of the stock’s underlying price. If a put option gives the buyer the right to sell the  stock  at Rs50 per share but the stock falls to Rs10, the person who initiated the contract must agree to purchase the stock for the value of the contract, or Rs50 per share. The risk to the buyer of a call option is limited to the premium paid upfront. This premium rises and falls throughout the life of the contract. It is based on a number of factors, including how far the strike price is from the current underlying security's price as well as how much time remains on the contract. This premium is paid to the investor who opened the put option, also called the  option writer. The Option Writer The option writer is on the other side of the trade. This investor has unlimited risk. Assume in the example above that the stock goes up to Rs100. The option writer would be forced to buy the  shares a t Rs100 per share in order to sell them to the call buyer for Rs50 a share. In return for a small premium, the option writer is losing Rs50 per share. Either the option buyer or the option writer can close their positions at any time by buying a call option, which brings them back to flat. The profit or loss is the difference between the premium received and the cost to buy back the option or get out of the trade. Futures Futures contracts involve maximum liability to both the buyer and the seller. As the underlying stock price moves, either party to the agreement may have to deposit more money into their trading  accounts  to fulfil a daily obligation. This is because gains on futures positions are automatically  marked to market  daily, meaning the change in the value of the positions, up or down, is transferred to the futures accounts of the parties at the end of every trading day. The obligation to sell or buy at a given price makes futures riskier by their nature.

5. How to Read Options Chain? Explained with Example For a beginner in Options trading, an Options Chain Chart may look like a complex maze of data. And it may be overwhelming to understand. Browse across forums and trading websites and you'll find Options Chain to be a subject of many discussions, with many traders asking questions like: "How to read a Stocks Options Chain?" "How to find Options chain?" "How to analyze Options chain charts?" And so on. Option chain is an important chart, full of vital information that helps a trader make profitable decisions. If you want to make profitable trades in Options then mastering the Options Chain Chart is a must. I hope this explanation will help you gain a good understanding of the Options Chain, make sense from the various data available and take the right trading decision. What is an Option Chain? An Option Chain Chart is a listing of Call and Put Options available for an underlying for a specific expiration period. The listing includes information on premium, volume, Open Interest etc., for different strike prices. Let's first see how an Option Chain looks like and understand the various data available in it. NSE provides you with Option chain charts for all trading Options. Here's what you need to do find the desired Option Chain:

6. Understanding an Option Chain These are various components of an Options Chart. Let's understand each component in detail now: Options Type : Options are of two types; Call and Put. A Call Option is a contract that gives you the right but not the obligation to buy the underlying at a specified price and within the expiration date of the Option. A Put Option, on the other hand, is a contract that gives you the right but not the obligation to sell the underlying at a specified price and within the expiration date of the Option. Strike price is the price at which you as a buyer and seller of the Option agreed to exercise the contract. Your Options trade will become profitable only when the price of an Option crosses this strike price. We can see on both sides of the strike prices, data like OI, Chng in OI, Volume, IV, LTP, Net Chng , Bid Qty , Bid Price, Ask Price and Ask Qty. let's understand what each of them means: OI : OI is an abbreviation for Open Interest. It is a data that signifies the interest of traders in a particular strike price of an Option. OI tells you about the number of contracts that are traded but not exercised or squared off. The higher the number, the more is the interest among traders for the particular strike price of an Option. And hence there is high liquidity for you to able to trade your Option when desired. Chng in OI : It tells you about the change in the Open Interest within the expiration period. The number of contracts that are closed, exercised or squared off. A significant change in OI should be carefully monitored. Volume : It is another indicator of traders interest in a particular strike price of an Option. It tells us about the total number of contracts of an Option for a particular strike price are traded in the market. It is calculated on a daily basis. Volume can help you understand the current interest among traders. LTP : It is the abbreviation for Last Traded Price of an Option. Net Chng : It is the net change in the LTP. The positive changes, means rise in price, are indicated in green while negative changes, decrease in price, are indicated in red.

7. IV : IV is an abbreviation for Implied Volatility. It tells us about what the market thinks on the price movement of the underlying. A higher IV means the potential for high swings in prices and low IV means no or fewer swings. IV doesn't tell you about the direction, whether upward or downward, movement of the prices. Bid Qty : It is the number of buy orders for a particular strike price. This tells you about the current demand for the strike price of an Option. Bid Price : It is the price quoted in the last buy order. So a price higher than the LTP may suggest that the demand for the Option is rising and vice versa. Ask Price : It is the price quoted in the last sell order. Ask Qty : It is the number of open sell orders for a particular strike price. It tells you about the supply for the Option. Now let's understand why a part of the date is highlighted in a shade while the rest is in white. To understand it, we need to first learn ITM, ATM, and OTM. In-The-Money (ITM) : A call option is in ITM if its strike price is less than the current market price of the underlying asset. A put option is ITM if its strike price is greater than the current market price' of the underlying asset. At-The-Money (ATM) : When the strike price of a Call or Put option is equal to the current market price of the underlying asset then it is in ATM. Over-The-Money (OTM) : A call option is OTM if the strike price is greater than the current market price of the underlying asset. A put option is OTM if the strike price is less than the current market price of the underlying asset. The highlighted part is in ITM while those in the white are OTM. So for Call Options, strike prices lower than the current price of the underlying are highlighted while for Put Options strike prices greater than the current price of the underlying are highlighted. Conclusion A deep study of Options Chain can provide with a lot of insights on an Option and help you make an informed decision on your trade. So master reading an Options chain to make better trading decisions.

8. Using Open Interest to Find Bull/Bear Signals Traders often use open interest is an indicator to confirm trends and trend reversals for both the futures and options markets. Open interest represents the total number of open contracts on a security. Here, we'll take a look at the importance of the relationship between volume and open interest in confirming trends and their impending changes. Volume and Open Interest Volume, which is often used in conjunction with open interest, represents the total number of shares or contracts that have changed hands in a one-day trading session. The greater the amount of trading during a market session, the higher the trading volume. A new student to technical analysis can easily see that the volume represents a measure of intensity or pressure behind a price trend. According to some observers, greater volume implies that we can expect the existing trend to continue rather than reverse. Many technicians believe that volume precedes price. They think the end of an uptrend or a downtrend will show up in the volume before the price trend reverses on the bar chart. Their rules for both volume and open interest are combined because of similarity. However, even supporters of this theory admit that there are exceptions to these rules. There are many conflicting technical signals and indicators, so it is essential to use the right ones for a given application.

9. General Rules for Volume and Open Interest The basic rules for volume and open interest: Price Volume Open Interest Market Rising Up Up Strong Rising Down Down Weak Declining Up Up Weak Declining Down Down Strong Price action increasing during an uptrend and open interest on the rise are interpreted as new money coming into the market. That reflects new buying, which is considered bullish. Now, if the price action is rising and the open interest is on the decline, short sellers covering their positions are causing the rally. Money is, therefore, leaving the marketplace—this is taken as a bearish sign. If prices are in a downtrend and open interest is on the rise, some chartists believe that new money is coming into the market. They think this pattern shows aggressive new short selling. They believe this scenario will lead to a continuation of a downtrend and a bearish condition. Suppose the total open interest is falling off and prices are declining. This theory holds that the price decline is likely being caused by disgruntled long position holders being forced to liquidate their positions. Some technicians view this scenario as a strong position because they think the downtrend will end once all the sellers have sold their positions. Bullish: an increasing open interest in a rising market Bearish: a declining open interest in a rising market Bearish: an increasing open interest in a falling market Bullish: a declining open interest in a falling market

10. According to the theory, high open interest at a market top and a dramatic price fall off should be considered bearish. That means all bulls who bought near the top of the market are now in a loss position. Their panic to sell keeps the price action under pressure. Contrarian Criticism Other analysts interpret some of these signals quite differently, mostly because they place less value on momentum. In particular, excessive short interest is seen by many as a bullish sign. Short selling is generally unprofitable, particularly after a significant downward movement. However, naive price chasing often leads less informed speculators to short an asset after a decline. When the market rises, they have to cover. The typical result is a short squeeze followed by a fierce rally. In general, momentum investors are not nearly as good at predicting trend reversals as their contrarian counterparts. While it is true that there is generally more buying and bullish price action all the way up, that does nothing to help investors decide when to sell. In fact, volume often increases before, during, and after major market tops. Some of the most respected indicators are based on contrarian views. The most relevant signal here may be the put/call ratio, which has a good record of predicting reversals. RSI is another useful contrarian technical indicator. KEY TAKEAWAYS Many technicians believe that volume precedes price. According to this theory, increasing volume and open interest indicate continued movement up or down. If volume and open interest fall, the theory holds that the momentum behind the movement is slowing and the direction of prices will soon reverse. Contrarian analysts interpret some of these signals quite differently, mostly because they place much less value on momentum.

11. Forecasting Market Direction With Put/Call Ratios One of the most reliable indicators of future market direction is a contrarian-sentiment measure known as the put/call options volume ratio . On balance, option buyers lose about 90% of the time. Put/Call ratio is an important tool used by traders to gauge the overall sentiment of the market. Put/call ratio help traders decide the price movement of an underlying security and guides them to place directional bets on the stocks. Being a contrarian indicator, it helps traders not to get trapped with Herd Mentality . As the ratio is calculated both in terms of open interest and volume, the entire trading behavior of market participants can be analyzed using the Put/call ratio. As often happens when the market gets too bullish or too bearish, conditions become ripe for a reversal. Put/Call ratio (PCR) is a popular derivative indicator, specifically designed to help traders gauge the overall sentiment (mood) of the market. The ratio is calculated either on the basis of options trading volumes or on the basis of the open interest for a particular period. If the ratio is more than 1, it means that more puts have been traded during the day and if it is less than 1, it means more calls have been traded. The PCR can be calculated for the options segment as a whole, which includes individual stocks as well as indices. Put / Call Ratio Interpretation If put-call ratio increases as minor dips getting bought in during an up trending market Bullish Indication. It means the put writers are aggressively writing at dips expecting the uptrend to continue If put-call ratio decreases while markets testing the resistance levels Bearish Indication. It means call writers are building fresh positions, expecting a limited upside or a correction in the market. If put-call ratio decreases during down trending market Bearish indication. It means option writers are aggressively selling the call option strikes.

12. STRATEGY 1: LONG CALL For aggressive investors who are very bullish about the prospects for a stock / index, buying calls can be an excellent way to capture the upside potential with limited downside risk. Buying a call is the most basic of all options strategies. It constitutes the first options trade for someone already familiar with buying / selling stocks and would now want to trade options. Buying a call is an easy strategy to understand. When you buy it means you are bullish. Buying a Call means you are very bullish and expect the underlying stock / index to rise in future. When to Use : Investor is very bullish on the stock / index. Risk : Limited to the Premium. (Maximum loss if market expires at or below the option strike price). Reward : Unlimited Breakeven : Strike Price + Premium

13. STRATEGY 2: SHORT CALL When you buy a Call you are hoping that the underlying stock / index would rise. When you expect the underlying stock / index to fall you do the opposite. When an investor is very bearish about a stock / index and expects the prices to fall, he can sell Call options. This position offers limited profit potential and the possibility of large losses on big advances in underlying prices. Although easy to execute it is a risky strategy since the seller of the Call is exposed to unlimited risk. A Call option means an Option to buy. Buying a Call option means an investor expects the underlying price of a stock / index to rise in future. Selling a Call option is just the opposite of buying a Call option. Here the seller of the option feels the underlying price of a stock / index is set to fall in the future. When to use : Investor is very aggressive and he is very bearish about the stock / index. Risk : Unlimited Reward : Limited to the amount of premium Break-even Point : Strike Price + Premium

14. STRATEGY 3: SYNTHETIC LONG CALL: BUY STOCK, BUY PUT W e purchase a stock since we feel bullish about it. But what if the price of the stock went down. You wish you had some insurance against the price fall. So buy a Put on the stock. This gives you the right to sell the stock at a certain price which is the strike price. The strike price can be the price at which you bought the stock (ATM strike price) or slightly below (OTM strike price). In case the price of the stock rises you get the full benefit of the price rise. In case the price of the stock falls, exercise the Put Option (remember Put is a right to sell). It is a strategy with a limited loss and (after subtracting the Put premium) unlimited profit (from the stock price rise). Here you have taken an exposure to an underlying stock with the aim of holding it and reaping the benefits of price rise, dividends, bonus rights etc. and at the same time insuring against an adverse price movement. When to use : When ownership is desired of stock yet investor is concerned about near-term downside risk. The outlook is conservatively bullish. Risk : Losses limited to Stock price + Put Premium – Put Strike price Reward : Profit potential is unlimited. Break-even Point : Put Strike Price + Put Premium + Stock Price – Put Strike Price

15. STRATEGY 4: LONG PUT Buying a Put is the opposite of buying a Call. When you buy a Call you are bullish about the stock / index. When an investor is bearish, he can buy a Put option. A Put Option gives the buyer of the Put a right to sell the stock (to the Put seller) at a pre-specified price and thereby limit his risk. A long Put is a Bearish strategy. To take advantage of a falling market an investor can buy Put options. When to use : Investor is bearish about the stock / index. Risk : Limited to the amount of Premium paid. (Maximum loss if stock / index expires at or above the option strike price). Reward : Unlimited Break-even Point : Stock Price - Premium

16. STRATEGY 5: SHORT PUT Selling a Put is opposite of buying a Put. An investor buys Put when he is bearish on a stock. An investor Sells Put when he is Bullish about the stock – expects the stock price to rise or stay sideways at the minimum. When you sell a Put, you earn a Premium (from the buyer of the Put). You have sold someone the right to sell you the stock at the strike price. If the stock price increases beyond the strike price, the short put position will make a profit for the seller by the amount of the premium, since the buyer will not exercise the Put option and the Put seller can retain the Premium (which is his maximum profit). But, if the stock price decreases below the strike price, by more than the amount of the premium, the Put seller will lose money. The potential loss being unlimited (until the stock price fall to zero). When to Use : Investor is very Bullish on the stock / index. The main idea is to make a short term income. Risk : Put Strike Price – Put Premium. Reward : Limited to the amount of Premium received. Breakeven : Put Strike Price - Premium

17. STRATEGY 6: COVERED CALL You own shares in a company and would still like to earn an income from the shares. The covered call is a strategy in which an investor Sells a Call option on a stock he owns (netting him a premium). The Call Option which is sold in usually an OTM Call. The Call would not get exercised unless the stock price increases above the strike price. Till then the investor in the stock (Call seller) can retain the Premium with him. This becomes his income from the stock. This strategy is usually adopted by a stock owner who is Neutral to moderately Bullish about the stock. An investor buys a stock or owns a stock which he feel is good for medium to long term but is neutral or bearish for the near term. At the same time, the investor does not mind exiting the stock at a certain price (target price). The investor can sell a Call Option at the strike price at which he would be fine exiting the stock (OTM strike). By selling the Call Option the investor earns a Premium. Now the position of the investor is that of a Call Seller who owns the underlying stock. If the stock price stays at or below the strike price, the Call Buyer (refer to Strategy 1) will not exercise the Call. The Premium is retained by the investor. In case the stock price goes above the strike price, the Call buyer who has the right to buy the stock at the strike price will exercise the Call option. The Call seller (the investor) who has to sell the stock to the Call buyer, will sell the stock at the strike price.

18. This was the price which the Call seller (the investor) was anyway interested in exiting the stock and now exits at that price. So besides the strike price which was the target price for selling the stock, the Call seller (investor) also earns the Premium which becomes an additional gain for him. This strategy is called as a Covered Call strategy because the Call sold is backed by a stock owned by the Call Seller (investor). The income increases as the stock rises, but gets capped after the stock reaches the strike price. Let us see an example to understand the Covered Call strategy. When to Use : This is often employed when an investor has a short-term neutral to moderately bullish view on the stock he holds. He takes a short position on the Call option to generate income from the option premium. Since the stock is purchased simultaneously with writing (selling) the Call, the strategy is commonly referred to as “buy-write”. Risk : If the Stock Price falls to zero, the investor loses the entire value of the Stock but retains the premium, since the Call will not be exercised against him. So maximum risk = Stock Price Paid – Call Premium Upside capped at the Strike price plus the Premium received. So if the Stock rises beyond the Strike price the investor (Call seller) gives up all the gains on the stock. Reward : Limited to (Call Strike Price – Stock Price paid) + Premium received Breakeven : Stock Price paid - Premium Received

19. STRATEGY 7: LONG COMBO: SELL A PUT, BUY A CALL A Long Combo is a Bullish strategy. If an investor is expecting the price of a stock to move up he can do a Long Combo strategy. It involves selling an OTM (lower strike) Put and buying an OTM (higher strike) Call. This strategy simulates the action of buying a stock (or a futures) but at a fraction of the stock price. It is an inexpensive trade, similar in pay-off to Long Stock, except there is a gap between the strikes (please see the payoff diagram). As the stock price rises the strategy starts making profits. Let us try and understand Long Combo with an example. When to Use : Investor is Bullish on the stock. Risk : Unlimited (Lower Strike + net debit) Reward : Unlimited Breakeven : Higher strike + net debit

20. STRATEGY 8: PROTECTIVE CALL / SYNTHETIC LONG PUT This is a strategy wherein an investor has gone short on a stock and buys a call to hedge. This is an opposite of Synthetic Call (Strategy 3). An investor shorts a stock and buys an ATM or slightly OTM Call. The net effect of this is that the investor creates a pay-off like a Long Put, but instead of having a net debit (paying premium) for a Long Put, he creates a net credit (receives money on shorting the stock). In case the stock price falls the investor gains in the downward fall in the price. However, in case there is an unexpected rise in the price of the stock the loss is limited. The pay-off from the Long Call will increase thereby compensating for the loss in value of the short stock position. This strategy hedges the upside in the stock position while retaining downside profit potential. When to Use : If the investor is of the view that the markets will go down (bearish) but wants to protect against any unexpected rise in the price of the stock. Risk : Limited. Maximum Risk is Call Strike Price – Stock Price + Premium Reward : Maximum is Stock Price – Call Premium Breakeven : Stock Price – Call Premium

21. STRATEGY 9: COVERED PUT This strategy is opposite to a Covered Call. A Covered Call is a neutral to bullish strategy, whereas a Covered Put is a neutral to Bearish strategy. You do this strategy when you feel the price of a stock / index is going to remain range bound or move down. Covered Put writing involves a short in a stock / index along with a short Put on the options on the stock / index. The Put that is sold is generally an OTM Put. The investor shorts a stock because he is bearish about it, but does not mind buying it back once the price reaches (falls to) a target price. This target price is the price at which the investor shorts the Put (Put strike price). Selling a Put means, buying the stock at the strike price if exercised (Strategy no. 2). If the stock falls below the Put strike, the investor will be exercised and will have to buy the stock at the strike price (which is anyway his target price to repurchase the stock). The investor makes a profit because he has shorted the stock and purchasing it at the strike price simply closes the short stock position at a profit. And the investor keeps the Premium on the Put sold. The investor is covered here because he shorted the stock in the first place. If the stock price does not change, the investor gets to keep the Premium. He can use this strategy as an income in a neutral market. When to Use : If the investor is of the view that the markets are moderately bearish. Risk : Unlimited if the price of the stock rises substantially Reward : Maximum is (Sale Price of the Stock – Strike Price) + Put Premium Breakeven : Sale Price of Stock + Put Premium Let us understand this with an example.

22. STRATEGY 10: LONG STRADDLE A Straddle is a volatility strategy and is used when the stock price / index is expected to show large movements. This strategy involves buying a call as well as put on the same stock / index for the same maturity and strike price, to take advantage of a movement in either direction, a soaring or plummeting value of the stock / index. If the price of the stock / index increases, the call is exercised while the put expires worthless and if the price of the stock / index decreases, the put is exercised, the call expires worthless. Either way if the stock / index shows volatility to cover the cost of the trade, profits are to be made. With Straddles, the investor is direction neutral. All that he is looking out for is the stock / index to break out exponentially in either direction. When to Use : The investor thinks that the underlying stock / index will experience significant volatility in the near term. Risk : Limited to the initial premium paid. Reward: Unlimited Breakeven: · Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid · Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

23. STRATEGY 11: SHORT STRADDLE A Short Straddle is the opposite of Long Straddle. It is a strategy to be adopted when the investor feels the market will not show much movement. He sells a Call and a Put on the same stock / index for the same maturity and strike price. It creates a net income for the investor. If the stock / index does not move much in either direction, the investor retains the Premium as neither the Call nor the Put will be exercised. However, in case the stock / index moves in either direction, up or down significantly, the investor’s losses can be significant. So this is a risky strategy and should be carefully adopted and only when the expected volatility in the market is limited. If the stock / index value stays close to the strike price on expiry of the contracts, maximum gain, which is the Premium received is made. When to Use : The investor thinks that the underlying stock / index will experience very little volatility in the near term. Risk : Unlimited Reward: Limited to the premium received Breakeven: · Upper Breakeven Point = Strike Price of Short Call + Net Premium Received · Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

24. STRATEGY 12: LONG STRANGLE A Strangle is a slight modification to the Straddle to make it cheaper to execute. This strategy involves the simultaneous buying of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock / index and expiration date. Here again the investor is directional neutral but is looking for an increased volatility in the stock / index and the prices moving significantly in either direction. Since OTM options are purchased for both Calls and Puts it makes the cost of executing a Strangle cheaper as compared to a Straddle, where generally ATM strikes are purchased. Since the initial cost of a Strangle is cheaper than a Straddle, the returns could potentially be higher. However, for a Strangle to make money, it would require greater movement on the upside or downside for the stock / index than it would for a Straddle. As with a Straddle, the strategy has a limited downside (i.e. the Call and the Put premium) and unlimited upside potential. When to Use : The investor thinks that the underlying stock / index will experience very high levels of volatility in the near term. Risk: Limited to the initial premium paid Reward : Unlimited Breakeven: · Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid · Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid

25. STRATEGY 13: SHORT STRANGLE A Short Strangle is a slight modification to the Short Straddle. It tries to improve the profitability of the trade for the Seller of the options by widening the breakeven points so that there is a much greater movement required in the underlying stock / index, for the Call and Put option to be worth exercising. This strategy involves the simultaneous selling of a slightly out-of-the-money (OTM) put and a slightly out-of-the-money (OTM) call of the same underlying stock and expiration date. This typically means that since OTM call and put are sold, the net credit received by the seller is less as compared to a Short Straddle, but the break even points are also widened. The underlying stock has to move significantly for the Call and the Put to be worth exercising. If the underlying stock does not show much of a movement, the seller of the Strangle gets to keep the Premium. When to Use : This options trading strategy is taken when the options investor thinks that the underlying stock will experience little volatility in the near term. Risk : Unlimited Reward: Limited to the premium received Breakeven : · Upper Breakeven Point = Strike Price of Short Call + Net Premium Received · Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

26. STRATEGY 14: COLLAR A Collar is similar to Covered Call (Strategy 6) but involves another leg – buying a Put to insure against the fall in the price of the stock. It is a Covered Call with a limited risk. So a Collar is buying a stock, insuring against the downside by buying a Put and then financing (partly) the Put by selling a Call. The put generally is ATM and the call is OTM having the same expiration month and must be equal in number of shares. This is a low risk strategy since the Put prevents downside risk. However, do not expect unlimited rewards since the Call prevents that. It is a strategy to be adopted when the investor is conservatively bullish. The following example should make Collar easier to understand. When to Use : The collar is a good strategy to use if the investor is writing covered calls to earn premiums but wishes to protect himself from an unexpected sharp drop in the price of the underlying security. Risk : Limited Reward: Limited Breakeven : Purchase Price of Underlying – Call Premium + Put Premium

27. STRATEGY 15: BULL CALL SPREAD STRATEGY : BUY CALL OPTION, SELL CALL OPTION A bull call spread is constructed by buying an in-the-money (ITM) call option, and selling another out-of-the-money (OTM) call option. Often the call with the lower strike price will be in-the-money while the Call with the higher strike price is out-of-the-money. Both calls must have the same underlying security and expiration month. The net effect of the strategy is to bring down the cost and breakeven on a Buy Call (Long Call) Strategy. This strategy is exercised when investor is moderately bullish to bullish, because the investor will make a profit only when the stock price / index rises. If the stock price falls to the lower (bought) strike, the investor makes the maximum loss (cost of the trade) and if the stock price rises to the higher (sold) strike, the investor makes the maximum profit. Let us try and understand this with an example. When to Use : Investor is moderately bullish. Risk : Limited to any initial premium paid in establishing the position. Maximum loss occurs where the underlying falls to the level of the lower strike or below. Reward : Limited to the difference between the two strikes minus net premium cost. Maximum profit occurs where the underlying rises to the level of the higher strike or above Break-Even-Point (BEP) : Strike Price of Purchased call + Net Debit Paid

28. STRATEGY 16: BULL PUT SPREAD STRATEGY : SELL PUT OPTION, BUY PUT OPTION A bull put spread can be profitable when the stock / index is either range bound or rising. The concept is to protect the downside of a Put sold by buying a lower strike Put, which acts as an insurance for the Put sold. The lower strike Put purchased is further OTM than the higher strike Put sold ensuring that the investor receives a net credit, because the Put purchased (further OTM) is cheaper than the Put sold. This strategy is equivalent to the Bull Call Spread but is done to earn a net credit (premium) and collect an income. If the stock / index rises, both Puts expire worthless and the investor can retain the Premium. If the stock / index falls, then the investor’s breakeven is the higher strike less the net credit received. Provided the stock remains above that level, the investor makes a profit. Otherwise he could make a loss. The maximum loss is the difference in strikes less the net credit received. This strategy should be adopted when the stock / index trend is upward or range bound. Let us understand this with an example. When to Use : When the investor is moderately bullish. Risk : Limited. Maximum loss occurs where the underlying falls to the level of the lower strike or below Reward : Limited to the net premium credit. Maximum profit occurs where underlying rises to the level of the higher strike or above. Breakeven : Strike Price of Short Put - Net Premium Received

29. STRATEGY 17: BEAR CALL SPREAD STRATEGY : SELL ITM CALL, BUY OTM CALL The Bear Call Spread strategy can be adopted when the investor feels that the stock / index is either range bound or falling. The concept is to protect the downside of a Call Sold by buying a Call of a higher strike price to insure the Call sold. In this strategy the investor receives a net credit because the Call he buys is of a higher strike price than the Call sold. The strategy requires the investor to buy out-of-the-money (OTM) call options while simultaneously selling in-the-money (ITM) call options on the same underlying stock index. This strategy can also be done with both OTM calls with the Call purchased being higher OTM strike than the Call sold. If the stock / index falls both Calls will expire worthless and the investor can retain the net credit. If the stock / index rises then the breakeven is the lower strike plus the net credit. Provided the stock remains below that level, the investor makes a profit. Otherwise he could make a loss. The maximum loss is the difference in strikes less the net credit received. When to use : When the investor is mildly bearish on market. Risk : Limited to the difference between the two strikes minus the net premium. Reward : Limited to the net premium received for the position i.e., premium received for the short call minus the premium paid for the long call. Break Even Point : Lower Strike + Net credit

30. STRATEGY 18: BEAR PUT SPREAD STRATEGY: BUY PUT, SELL PUT This strategy requires the investor to buy an in-the-money (higher) put option and sell an out-of-the-money (lower) put option on the same stock with the same expiration date. This strategy creates a net debit for the investor. The net effect of the strategy is to bring down the cost and raise the breakeven on buying a Put (Long Put). The strategy needs a Bearish outlook since the investor will make money only when the stock price / index falls. The bought Puts will have the effect of capping the investor’s downside. While the Puts sold will reduce the investors costs, risk and raise breakeven point (from Put exercise point of view). If the stock price closes below the out-of-the-money (lower) put option strike price on the expiration date, then the investor reaches maximum profits. If the stock price increases above the in-the-money (higher) put option strike price at the expiration date, then the investor has a maximum loss potential of the net debit. When to use : When you are moderately bearish on market direction Risk : Limited to the net amount paid for the spread. i.e. the premium paid for long position less premium received for short position. Reward : Limited to the difference between the two strike prices minus the net premium paid for the position. Break Even Point : Strike Price of Long Put - Net Premium Paid

31. STRATEGY 19: LONG CALL BUTTERFLY: SELL 2 ATM CALL OPTIONS, BUY 1 ITM CALL OPTION AND BUY 1 OTM CALL OPTION. A Long Call Butterfly is to be adopted when the investor is expecting very little movement in the stock price / index. The investor is looking to gain from low volatility at a low cost. The strategy offers a good risk / reward ratio, together with low cost. A long butterfly is similar to a Short Straddle except your losses are limited. The strategy can be done by selling 2 ATM Calls, buying 1 ITM Call, and buying 1 OTM Call options (there should be equidistance between the strike prices). The result is positive in case the stock / index remains range bound. The maximum reward in this strategy is however restricted and takes place when the stock / index is at the middle strike at expiration. The maximum losses are also limited . When to use : When the investor is neutral on market direction and bearish on volatility. Risk: Net debit paid. Reward Difference between adjacent strikes minus net debit Break Even Point : Upper Breakeven Point = Strike Price of Higher Strike Long Call - Net Premium Paid Lower Breakeven Point = Strike Price of Lower Strike Long Call + Net Premium Paid

32. STRATEGY 20: SHORT CALL BUTTERFLY: BUY 2 ATM CALL OPTIONS, SELL 1 ITM CALL OPTION AND SELL 1 OTM CALL OPTION. S trategy for volatile markets. It is the opposite of Long Call Butterfly, which is a range bound strategy. The Short Call Butterfly can be constructed by Selling one lower striking in-the-money Call, buying two at-the-money Calls and selling another higher strike out-of-the-money Call, giving the investor a net credit (therefore it is an income strategy). There should be equal distance between each strike. The resulting position will be profitable in case there is a big move in the stock / index. The maximum risk occurs if the stock / index is at the middle strike at expiration. The maximum profit occurs if the stock finishes on either side of the upper and lower strike prices at expiration. When to use : You are neutral on market direction and bullish on volatility. Neutral means that you expect the market to move in either direction - i.e. bullish and bearish. Risk: Limited to the net difference between the adjacent strikes (Rs. 100 in this example) less the premium received for the position. Reward : Limited to the net premium received for the option spread. Break Even Point: Upper Breakeven Point = Strike Price of Highest Strike Short Call - Net Premium Received Lower Breakeven Point = Strike Price of Lowest Strike Short Call + Net Premium Received

33. STRATEGY 21: LONG CALL CONDOR: BUY 1 ITM CALL OPTION (LOWER STRIKE), SELL 1 ITM CALL OPTION (LOWER MIDDLE), SELL 1 OTM CALL OPTION (HIGHER MIDDLE), BUY 1 OTM CALL OPTION (HIGHER STRIKE) A Long Call Condor is very similar to a long butterfly strategy. The difference is that the two middle sold options have different strikes. The profitable area of the pay off profile is wider than that of the Long Butterfly (see pay-off diagram). The strategy is suitable in a range bound market. The Long Call Condor involves buying 1 ITM Call (lower strike), selling 1 ITM Call (lower middle), selling 1 OTM call (higher middle) and buying 1 OTM Call (higher strike). The long options at the outside strikes ensure that the risk is capped on both the sides. The resulting position is profitable if the stock / index remains range bound and shows very little volatility. The maximum profits occur if the stock finishes between the middle strike prices at expiration . When to Use : When an investor believes that the underlying market will trade in a range with low volatility until the options expire. Risk: Limited to the minimum of the difference between the lower strike call spread less the higher call spread less the total premium paid for the condor. Reward: Limited. The maximum profit of a long condor will be realized when the stock is trading between the two middle strike prices. Break Even Point : Upper Breakeven Point = Highest Strike – Net Debit Lower Breakeven Point = Lowest Strike + Net Debit

34. STRATEGY 22: SHORT CALL CONDOR: SHORT 1 ITM CALL OPTION (LOWER STRIKE), LONG 1 ITM CALL OPTION (LOWER MIDDLE), LONG 1 OTM CALL OPTION (HIGHER MIDDLE), SHORT 1 OTM CALL OPTION (HIGHER STRIKE). A Short Call Condor is very similar to a short butterfly strategy. The difference is that the two middle bought options have different strikes. The strategy is suitable in a volatile market. The Short Call Condor involves selling 1 ITM Call (lower strike), buying 1 ITM Call (lower middle), buying 1 OTM call (higher middle) and selling 1 OTM Call (higher strike). The resulting position is profitable if the stock / index shows very high volatility and there is a big move in the stock / index. The maximum profits occur if the stock / index finishes on either side of the upper or lower strike prices at expiration . When to Use : When an investor believes that the underlying market will break out of a trading range but is not sure in which direction. Risk: Limited. The maximum loss of a short condor occurs at the center of the option spread. Reward: Limited. The maximum profit of a short condor occurs when the underlying stock / index is trading past the upper or lower strike prices. Break Even Point : Upper Break even Point = Highest Strike – Net Credit Lower Break Even Point = Lowest Strike + Net Credit

35. Option Greeks: 4 Factors for Measuring Risk An option's price can be influenced by a number of factors that can either help or hurt traders depending on the type of positions they have taken. Successful traders understand the factors that influence options pricing, which include the so-called "Greeks"—a set of risk measures so named after the Greek letters that denote them, which indicate how sensitive an option is to time-value decay, changes in implied volatility, and movements in the price its underlying security. The four primary risk measures—the Greeks—that a trader should consider before opening an option position. Vega: Measures Impact of a Change in Volatility Theta: Measures Impact of a Change in Time Remaining Delta: Measures Impact of a Change in the Price of Underlying Gamma: Measures the Rate of Change of Delta Options contracts are used for  hedging  a portfolio. That is, the goal is to offset potential unfavorable moves in other investments. Options contracts are also used for speculating on whether an asset's price might rise or fall. The Greeks help to provide important measurements of an option position's risks and potential rewards. Once you have a clear understanding of the basics, you can begin to apply this to your current strategies. It is not enough to just know the total capital at risk in an options position. To understand the probability of a trade making money, it is essential to be able to determine a variety of risk-exposure measurements. Since conditions are constantly changing, the Greeks provide traders with a means of determining how sensitive a specific trade is to price fluctuations, volatility fluctuations, and the passage of time.

36. Delta Delta is a measure of the change in an option's price (that is, the premium of an option) resulting from a change in the underlying security. The value of delta ranges from -100 to 0 for puts and 0 to 100 for calls (-1.00 and 1.00 without the decimal shift, respectively). Puts generate negative delta because they have a negative relationship with the underlying security—that is, put premiums fall when the underlying security rises, and vice versa. Conversely, call options have a positive relationship with the price of the underlying asset. If the underlying asset's price rises, so does the call premium, provided there are no changes in other variables such as implied volatility or time remaining until expiration. If the price of the underlying asset falls, the call premium will also decline, provided all other things remain constant. A good way to visualize delta is to think of a race track. The tires represent the delta, and the gas pedal represents the underlying price. Low delta options are like race cars with economy tires. They won't get a lot of traction when you rapidly accelerate. On the other hand, high delta options are like drag racing tires. They provide a lot of traction when you step on the gas. Delta values closer to 1.00 or -1.00 provide the highest levels of traction. Three things to keep in mind with delta: Delta tends to increase closer to expiration for near or at-the-money options. Delta is further evaluated by gamma, which is a measure of delta's rate of change. Delta can also change in reaction to implied volatility changes.

37. Gamma Gamma measures the rate of changes in delta over time. Since delta values are constantly changing with the underlying asset's price, gamma is used to measure the rate of change and provide traders with an idea of what to expect in the future. Gamma values are highest for at-the-money options and lowest for those deep in- or out-of-the-money. While delta changes based on the underlying asset price, gamma is a constant that represents the rate of change of delta. This makes gamma useful for determining the stability of delta, which can be used to determine the likelihood of an option reaching the strike price at expiration. For example, suppose that two options have the same delta value, but one option has a high gamma, and one has a low gamma. The option with the higher gamma will have a higher risk since an unfavourable move in the underlying asset will have an oversized impact. High gamma values mean that the option tends to experience volatile swings, which is a bad thing for most traders looking for predictable opportunities. There are some additional points to keep in mind about gamma: Gamma is the smallest for deep out-of-the-money and deep-in-the-money options. Gamma is highest when the option gets near the money. Gamma is positive for long options and negative for short options.

38. Theta Theta measures the rate of time decay in the value of an option or its premium. Time decay represents the erosion of an option's value or price due to the passage of time. As time passes, the chance of an option being profitable or in-the-money lessens. Time decay tends to accelerate as the expiration date of an option draws closer because there's less time left to earn a profit from the trade. Theta is always negative for a single option since time moves in the same direction. As soon as an option is purchased by a trader, the clock starts ticking, and the value of the option immediately begins to diminish until it expires, worthless, at the predefined expiration date.  Theta is good for sellers and bad for buyers. A good way to visualize it is to imagine an hourglass in which one side is the buyer, and the other is the seller. The buyer must decide whether to exercise the option before time runs out. But in the meantime, the value is flowing from the buyer's side to the seller's side of the hourglass. The movement may not be extremely rapid, but it's a continuous loss of value for the buyer. Some additional points about theta to consider when trading: Theta can be high for out-of-the-money options if they carry a lot of implied volatility. Theta is typically highest for at-the-money options since less time is needed to earn a profit with a price move in the underlying. Theta will increase sharply as time decay accelerates in the last few weeks before expiration and can severely undermine a long option holder's position, especially if implied volatility declines at the same time.

39. Vega Vega measures the risk of changes in implied volatility or the forward-looking expected volatility of the underlying asset price. While delta measures actual price changes, vega is focused on changes in expectations for future volatility. Higher volatility makes options more expensive since there’s a greater likelihood of hitting the strike price at some point. Vega tells us approximately how much an option price will increase or decrease given an increase or decrease in the level of implied volatility.  Option sellers benefit from a fall in implied volatility, but it is just the reverse for option buyers. It’s important to remember that implied volatility reflects price action in the options market. When option prices are bid up because there are more buyers, implied volatility will increase. Long option traders benefit from pricing being bid up, and short option traders benefit from prices being bid down. This is why long options have a positive vega , and short options have a negative vega . Additional points to keep in mind regarding vega : Vega can increase or decrease without price changes of the underlying asset, due to changes in implied volatility. Vega can increase in reaction to quick moves in the underlying asset. Vega falls as the option gets closer to expiration.

40. The Importance of Trading Psychology Containing fear and greed are key to making money Many skills are required for trading successfully in the financial markets. They include the abilities to evaluate a company's fundamentals and to determine the direction of a stock's trend. But neither of these technical skills is as important as the trader's mindset. Containing emotion, thinking quickly, and exercising discipline are components of what we might call trading psychology. There are two main emotions to understand and keep under control: fear and greed . Snap Decisions Traders often have to think fast and make quick decisions, darting in and out of stocks on short notice. To accomplish this, they need a certain presence of mind. They also need the discipline to stick with their own trading plans and know when to book profits and losses. Emotions simply can't get in the way. Overall investor sentiment frequently drives market performance in directions that are at odds with the fundamentals. The successful investor controls fear and greed, the two human emotions that drive that sentiment. Understanding this can give you the discipline and objectivity needed to take advantage of others' emotions.

41. Understanding Fear When traders get bad news about a certain stock or about the economy in general, they naturally get scared. They may overreact and feel compelled to liquidate their holdings and sit on the cash, refraining from taking any more risks. If they do, they may avoid certain losses but may also miss out on some gains. Traders need to understand what fear is: a natural reaction to a perceived threat. In this case, it's a threat to their profit potential. Quantifying the fear might help. Traders should consider just what they are afraid of, and why they are afraid of it. But that thinking should occur before the bad news, not in the middle of it. Fear and greed are the two visceral emotions to keep in control. By thinking it through ahead of time, traders will know how they perceive events instinctively and react to them, and can move past the emotional response. Of course, this is not easy, but it's necessary to the health of an investor's portfolio, not to mention the investor. Overcoming Greed There's an old saying on Wall Street that "pigs get slaughtered." This refers to the habit greedy investors have of hanging on to a winning position too long to get every last tick upward in price. Sooner or later, the trend reverses and the greedy get caught. Greed is not easy to overcome. It's often based on the instinct to do better, to get just a little more. A trader should learn to recognize this instinct and develop a trading plan based on rational thinking, not whims or instincts.

42. Setting Rules A trader needs to create rules and follow them when the psychological crunch comes. Set out guidelines based on your risk-reward tolerance for when to enter a trade and when to exit it. Set a profit target and put a stop loss in place to take emotion out of the process. In addition, you might decide which specific events, such as a positive or negative earnings release, should trigger a decision to buy or sell a stock. It's wise to set limits on the maximum amount you are willing to win or lose in a day. If you hit the profit target, take the money and run. If your losses hit a predetermined number, fold up your tent and go home. Either way, you'll live to trade another day. Conducting Research and Review Traders need to become experts in the stocks and industries that interest them. Keep on top of the news, educate yourself and, if possible, go to trading seminars and attend conferences. Devote as much time as possible to the research process. That means studying charts, speaking with management, reading trade journals, and doing other background work such as macroeconomic analysis or industry analysis. Knowledge can also help overcome fear. Stay Flexible It's important for traders to remain flexible and consider experimenting from time to time. For example, you might consider using options to mitigate risk. One of the best ways a trader can learn is by experimenting (within reason). The experience may also help reduce emotional influences. Finally, traders should periodically assess their own performances. In addition to reviewing their returns and individual positions, traders should reflect on how they prepared for a trading session, how up to date they are on the markets, and how they're progressing in terms of ongoing education. This periodic assessment can help a trader correct mistakes, change bad habits, and enhance overall returns.

43. Three Dimensions (3D) Trader Personality Quiz Please choose the statement that best describes you:   1 a ) I often arrive early for appointments and events to make sure I’m not late. b ) I’m not very time-oriented and often show up late to appointments and events.   2 a ) When a problem occurs in my trading, I first feel frustrated and vent my feelings either outwardly or at myself. b ) When a problem occurs in my trading, I first try to focus on what went wrong and what I can do to fix it.   3 a ) When I go out to eat, I generally go to my favorite restaurants and order my favorite foods. b ) When I go out to eat, I like to try new and unfamiliar restaurants and foods.   4 a ) I tend to be detail-oriented and try to get each aspect of a job done as well as I can. b ) I focus on the big picture instead of details and don’t sweat the small aspects of a job.   5 a ) If you could hear the thoughts in my head as I’m trading, you’d hear worried or negative thoughts. b ) If you could hear the thoughts in my head as I’m trading, you’d hear me analyzing the market action . 6 a ) If I had a choice of car to drive, I would choose one that is comfortable and quiet. b ) If I had a choice of car to drive, I would choose one that is fast and that handles well.   7 a ) I would be good at following a diet or exercise program. b ) I would often cheat on a diet or exercise program.  

44. 8 a ) It is hard for me to shake off setbacks in the market. b ) I take market setbacks as a cost of doing business.   9 a ) I like vacations that are peaceful and relaxing. b ) I like vacations where you see and do a lot of different things.   10 a ) I get routine maintenance done on my car when it is scheduled. b ) I don’t follow deadlines for routine maintenance on my car.   11 a ) Sometimes I feel on top of the world in the market; other times, I’m down or down on myself. b ) I don’t have many emotional ups or downs in the market . 12 a ) I would like a job with a stable company that pays a guaranteed salary and benefits, even if I might not get rich. b ) I would like a job with a startup company that offers me a chance to get rich, even if I might get laid off if things don’t work out.   13 a ) I try to eat healthy foods and get a good amount of exercise and rest. b ) I’m very busy and don’t always eat, exercise, and sleep as I should.   14 a ) I trade by my gut. b ) I trade with my head.   15 a ) I avoid arguments and conflict. b ) I like to argue and hash things out.  

45. Scoring   Items 1, 4, 7, 10, and 13 measure a personality trait called “conscientiousness”. A conscientious person is someone who has a high degree of self-control and perseverance. If you scored mostly a) responses for these items, you are high in conscientiousness. Conscientious traders are good rule-followers, and they often do well trading mechanical systems. Traders who are low in conscientiousness will have difficulty following explicit rules and often trade more discretionarily. Ideally, you want a style of trading that is more structured and detail-oriented if you are more conscientious. Trying to trade in a highly structured manner will only frustrate a trader who is low in conscientiousness. Such a trader would do better with big picture trades that do not require detailed rules and analysis. Similarly, very active trading with rigid loss control will come easier to the conscientious trader; less frequent trades with wider risk parameters will come easier to the trader lower in conscientiousness.   Items 2, 5, 8, 11, and 14 measure a personality trait called “neuroticism”. Neuroticism is the tendency to experience negative emotions. If you scored mostly a) responses for these items, you are relative high in neuroticism. The trader prone to neuroticism tends to experience more emotional interference in his or her trading. Wins can create overconfidence; losses can create fear and hesitation. The trader who is low in neuroticism is more likely to react to trading problems with efforts at problem solving and analysis. He or she will not take wins or losses particularly personally. Neuroticism is a mixed bag when it comes to trading. Often the person who is high in neuroticism is emotionally sensitive and can use this sensitivity to obtain a gut feel for market action. The trader who is low in neuroticism may experience little emotional disruption with trading, but may also be closed off to subtle, intuitive cues when a trade starts to go sour. In my recent experience, I have been surprised at how successful gut traders are often relatively neurotic traders. Very active trading methods are particularly challenging for such traders, as they don’t allow much time for regaining emotional equilibrium after losses. This can lead to cascades of losses and significant drawdowns of equity. It is much easier for the non-neurotic trader to turn losses around, since these are less likely to be tied to self-esteem.   Items 3, 6, 9, 12, and 15 measure a trader’s risk aversion. A risk-averse trader is one who cannot tolerate the possibility of large losses and who would prefer smaller, more frequent wins with controlled losses to larger wins with greater drawdowns. If you scored mostly a) responses for these items, you are a relatively risk-averse trader. Trading with careful stops and money management, and trading smaller time-frames where risk can be controlled with the holding period will come most naturally for the risk-averse trader. The risk-seeking trader is one who enjoys stimulation and challenge. Larger positions and longer holding periods are easier to tolerate for the risk-seeking trader. Very often, the risk-seeking trader will be impulsive in entering trades and will have difficulty trading during periods of boredom (low volatility). The risk-averse trader often experiences difficulty hanging onto winning trades and will cut profits short to avoid reversals . This trader will be challenged during periods of high market volatility. Position sizing is key and often overlooked as a trading variable. Trading too small will bore the risk-seeking trader, who will then lose focus. Trading too large will overwhelm the risk-averse trader, who will also then lose focus.

46. Ultimately it is the blending of these three dimensions of trader personality and not any one in isolation that is most important in shaping trading outcomes. In my experience, the traders who are most poorly suited to trading are those that are risk seeking and who are low in conscientiousness and high in neuroticism. Such traders often take large gambles on impulse, and very often those impulses are driven by emotional frustrations. An example would be a trader who gets frustrated after a loss and doubles his position size on the next trade just to make the money back quickly.   Conversely, I have seen very few successful traders who were highly risk-averse. The risk-averse trader, particularly who is high in neuroticism, is motivated more by a fear of loss than a desire for gain. This makes it difficult to sustain meaningful position sizes during promising trades. Often such traders berate themselves for being self-defeating or sabotaging, but the reality is that they might be better suited for investing than trading.   If I had to identify an ideal personality pattern for traders, I would say that such a person would be risk-tolerant, low in neuroticism, and high in conscientiousness. Such traders are generally good at following trading rules (entries, exits, money management) and disciplined in their preparation. They don’t take losses personally, which gives them the perseverance to weather losing periods. When they see a good trade, they are comfortable trading in size, so that the average size of their wins exceeds that of their losses.   Finally, let me mention one other important dimension that is related to neuroticism and emotionality. I strongly suspect that cognitive style is just as important as personality style in trading. Some people process information intuitively, relying on gut cues and subtle, non-verbal information. Others process information explicitly, through reasoning and analysis. Both cognitive styles can make traders money in the markets, but it is essential that one’s cognitive style match one’s trading methodology. As one trades shorter and shorter time frames, moving from swinging to scalping, it is less practical to expect explicit analytical routines to guide trading. Very short-term trading is more about pattern recognition than historical research. Conversely , longer-term trades often benefit from modeling and statistical analysis that inform traders where the edge might lie. How traders process information most effectively is a neglected variable in selecting proper time frames to trade. ****** Yesterday’s resolved worries becoming today’s embedded wishes. When investing, it’s important to remember both—and say out loud the things you are assuming to be true—to avoid falling off the cliff of wishes that lies at the top of the worry wall.

47. THANK YOU