Schaeffers Weekly Options Trader Handbook

7/24/2019 Schaeffers Weekly Options Trader Handbook

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SCHAEFFERS

WEEKLY OPTIONS TRADER

Subscriber Guide

A Publication ofSchaeffers Investment Research, Inc.

Copyright 2013, Schaeffers Investment Research, Inc.

5151 Pfeiffer Road, Suite 250, Cincinnati, OH 45242http://www.SchaeffersResearch.com

Toll-Free (800) 448-2080

Revised 07/19/2013


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Note: The copyrighted Schaeffers Weekly Options Trader Subscriber Guideand recommendations are specifically

intended for your personal and confidential use as a subscriber. For your protection, any other usage or dissemination

of the above mentioned materials or information is prohibited. The information contained in SIR trading services is

intended for use solely by individual subscribers and is not offered to institutional investment organizations.

Any enclosed third-party promotional materials should be considered a paid advertisement and do not constitute an

endorsement of these products or services by Schaeffer's Investment Research.

Dear Subscriber:

Welcome to the select group of investors trading with my Schaeffers Weekly Options TraderCalendar-basedService. You now have direct access to a minimum of six option trades permonth that benefit from the use of weekly options.

Your advantage with Schaeffers Weekly Options Trader comes from my unique ExpectationalAnalysismethodology. I use this multi-dimensional analysis to seek out option trades that return100% or more.

While my recommendations are thoroughly researched, you will experience some losses usingmy trading approach (or any options trading approach, for that matter). We strive to build yourlong-term success by limiting losses and achieving winners such that profitable positions more

than offset losing ones. Also note that when my indicators no longer point to the same outlookfor an open position, you will receive a real-time follow-up to close out that trade.

Now is your chance to get ready to receive my very next recommendation. I encourage you tocarefully review your Schaeffers Weekly Options Trader Subscriber Guide, as it contains mycomplete trading strategy, examples, money management principles, and much more.

We want to ensure prompt, effective delivery of your service. Please review your accountinformation. If any corrections are necessary, please go online towww.SchaeffersResearch.com,log in toMy Account with your username and password, go to the Account Profilesection andclick onAddress Change.

If you have any questions regarding your subscription, please call one of my helpful Product

Specialists toll-free at (800) 448-2080. I again welcome you as a valued subscriber and lookforward to profitably serving you in the months and years ahead.

Sincerely yours,

Bernie SchaefferChairman and CEO
http://www.schaeffersresearch.com/http://www.schaeffersresearch.com/http://www.schaeffersresearch.com/http://www.schaeffersresearch.com/


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Schaeffers Investment Research, Inc.

Welcome to your new Schaeffers Calendar-based Service!How to get the most from your service

Here is a quick review of some points to consider when you start trading with a

Calendar-based Service. Please read this subscriber guide carefully and thoroughly.

This summary is not a replacement for the valuable information in this service guide.

Read this subscr iber guide! Its important.

Go through the sample trades inside. Make certain you feel comfortable with the difference

between a market order and a day-limit order.

Ensure that your trading account is in order.

Be prepared to execute trades as they become available. It is important that you execute the

recommended trades within the indicated time parameters.

Follow the trades exactly.

Options recommendation services work by trading actively over a given period.

Follow the money management guidelines str ictly.

Regularly review the money management section in this service guide and check your

account balance after each trade.

Expect losing trades.

As with any options- or stock-trading program, you will experience losses. Our programs profits

derive from a combination of strict money management, minimizing losses, letting profits run, andfollowing the trade instructions, especially the maximum (or minimum) entry price.

We appreciate your business!


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Schaeffers Investment Research, Inc.

Table of Contents

A.

Introduction ___________________________________________________________ 1

B.

Parameters of Schaeffers Weekly Options Trader___________________ 2

C.

How to Read Schaeffers Weekly Options Trader Recommendations4

D.

Schaeffers Weekly Options TraderTrading Rules ___________________ 5

E.

Money Management ___________________________________________________ 6

F.

Using a Maximum Entry Price______________________________________ 15

G.

How to Read Specific Option Symbols ______________________________ 16

H.

Delivering Your Service ______________________________________________ 17

I.

Contact Information___________________________________________________ 18

J. Disclaimer ____________________________________________________________ 19


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Schaeffers Weekly Options Trader Introduction

1 Schaeffers Investment Research, Inc.

A.

Introduction

Options that expire weekly were first introduced by the Chicago Board Options Exchange

(CBOE) in October 2005 on just four cash-settled index options. Today, there are weekly

options on 30 different equities, indices, and exchange-traded funds (ETF) and even more

classes could be introduced should the current regulatory cap on weekly listings be lifted. InJune 2013, weekly options accounted for roughly 15% of all option activity across the S&P

500 Index (SPX). This is remarkable given the limited number of weekly listings.

Some of the more popular names on which weekly options are available include Apple Inc.

(AAPL), Google, Inc. (GOOG), iShares SPDR Gold Trust (GLD), Nasdaq-100 Index

tracking stock (QQQ) and Goldman Sachs Group, Inc. (GS) (the list of available weekly

options can change from week to week and is available atwww.cboe.com/weeklys).

Weekly options begin trading on Thursdays and expire the following Fridays, provided that

such expirations were not previously listed. (In other words, weekly options will not be listed

with the same expiration dates as traditional monthly options.) Note that select securitieshave more than one weekly options series, with expirations scheduled over several weeks (up

to five consecutive weekly expirations).

From the perspective of the option buyer, weekly options are attractive for the same reasons

that attract traders during the traditional monthly expiration week. You achieve increased

leverage due to the low-dollar time premiums of near-expiration options, and short-term

directional traders can better match the life of their option plays with the length of their

forecast period. For most underlying securities, options during expiration week are at their

most liquid, and slippage costs tend to be minimized.

The Schaeffers Weekly Options TraderCalendar-based Service is aggressive due to the shorttime period in which we are looking for a move in the stock through the use of weekly

options. In addition, this service will focus on only straight purchases of calls and puts on

equities, indexes, and ETFs.
http://www.cboe.com/weeklyshttp://www.cboe.com/weeklyshttp://www.cboe.com/weeklyshttp://www.cboe.com/weeklys


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Schaeffers Weekly Options Trader Parameters of Schaeffers Weekly Options Trader

Schaeffers Investment Research, Inc. 2

B.

Parameters of Schaeffers Weekly Options Trader

We are always looking for opportunities that can make you money while reducing risk. As a

result, exceptions can occur in the following rules of thumb, if we assess that there is benefit

to you as a subscriber.

1. You Will Receive A Minimum of Six Schaeffers Weekly Options TraderRecommendations Each Month

The Schaeffers Weekly Options Traderservice will provide subscribers with a

minimum of six options trades each month.

2. Maximum Entry Prices Are Provided With Each Trade

For all trades, we provide you with a maximum entry price so you do not enter a

trade at a price that is too high relative to our evaluation of a trades profit potential

and risk. We strongly advise against paying more than the maximum entry price. If

a recommendation cannot be purchased for the maximum entry price (or less)

within the recommended entry window, skip it and wait for the next trade. Keep in

mind that the entry price should dictate the number of contracts that you buy, based

on the percentage of your trading capital that you allocate to each trade.

3. You Will Receive Real-Time Instruct ions On Every Trade

We closely monitor every position, and we will immediately contact you with

updated instructions should conditions change. You will receive real-time

instructions to exit any position, whenever we see the right time to take profits or cut

losses. As stated above, each option within a pair trade is treated as a separate

position.

4. We Will Provide You With Commentaries Explaining the Trade

Along with your recommendation, you will receive a link to our website explaining

the trade, and providing a detailed analysis of each recommendation.

5. The Recommended Trades Have A Set Hold ing Period And Target

Profits

The Schaeffers Weekly Options Traderrecommendations will have a holding

period of as short as one day or as long as three weeks (given the nature of weekly

options). Note that we may also elect to trade traditional options (that expire on the

third Friday of the month), as well as weekly options with expiration dates up tothree weeks in the future. In addition, we will recommend trades with a target profit

of 100% or more.

6. You Have Exclusive Access To Schaeffers Command Center

All Calendar-based Service subscribers have access to Schaeffers Command

Center, a one-stop location for everything you need to know about your Schaeffers


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Schaeffers Weekly Options Trader Parameters of Schaeffers Weekly Options Trader


Weekly Options Trader service where you can view your open positions, current

recommendations, and trade status.


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Schaeffers Weekly Options Trader How to Read Schaeffers Weekly Options TraderRecommendations


C.

How to Read Schaeffers Weekly Options Trader Recommendations

The following is a sample Schaeffers Weekly Options Trader recommendation:

Tuesday, September 17, 2013

New Recommendation

Place a day-limit order to buy (to open) the XYZ (XYZ) Company September 28, 2013 50-

strike put at a maximum entry price of 1.80 or less.

*** If you are unable to enter this position before the close today, we recommend that you

wait until the next trade. Do not attempt to get into this trade after the trading days close.

***

This option is currently bid at 1.50, offered at 1.70.

XYZ is currently at 45.59.

Day-limit order= A type of order entered through a broker that expires at the close ofbusiness on that day. See the Schaeffers Weekly Option Trader Trading Rulessection

for details on day-limit orders.

XYZ, etc.= Underlying Stock

September 28, 2013 50-strike put = The date when the option will expire, strikeprice (the price per share at which an option holder may purchase or sell the underlyingstock for calls and puts, respectively), and type of option (call or put)

Bid= Best price at which someone will buy

Offered (or asked)= Best price at which someone will sell

***= This section establishes the time window to enter the trade. For Schaeffers WeeklyOption Trader recommendations, there is a standard entry window of one day.


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Schaeffers Weekly Options Trader Schaeffers Weekly Options Trader Trading Rules


D.

Schaeffers Weekly Options TraderTrading Rules

1. You Will Generally Have One Day To Get Into Each Trade

Each recommendation will be delivered during market hours, between 9:30 a.m. and

4 p.m. Eastern time. The key is to enter the trade at or below the maximum entryprice. While it is possible to miss a quick mover by exercising the discipline to

refuse to pay more than the maximum entry price, your long-run bottom line will be

far better off by not chasing positions.

You will normally have one trading day to enter the trade at or below the maximum

entry price, unless otherwise instructed

2. Place Day-Limit Orders To Enter New Posi tions

Day-limit orders (a limit order entered through a broker that is automatically canceled

at the close of business on that day if not executed on that day) are by far your best bet

for assuring that you enter a recommendation at or below the maximum entry price.Unlike market orders, day-limit orders often get filled at prices between the bid/asked

spread, and sometimes are executed at the bid price. Market orders, on the other

hand, are almost always executed at the asked price, and the asked price is often a

moving target that gets ratcheted up as orders flow into the trading floor.

Therefore, always enter a day-limit order to purchase at the maximum entry price.

This will assure that you will purchase the recommendation at a price no more than

the maximum entry price. Never enter a market order to buy or sell a Schaeffers

Weekly Options Traderrecommendation.

3. Follow The Close-Out Instructions

An important benefit of our Schaeffers Weekly Options Trader recommendations is

that you will receive real-time instructions to close positions that either are not

performing as expected, or if a change in the short-term outlook forces us to take

profits quicker than initially planned. Rest assured that you will receive real-time

instructions on when and how to exit a position. Follow-ups will be initiated when

targets are achieved, or when we feel that profits should be taken or losses cut short.


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Schaeffers Weekly Options Trader Money Management


E.

Money Management

With all the talk about how the market is doing or where its headed, its easy to get caught

up in identifying the hot stock or sector. Adding options to the mix creates another layer of

analysis what option to pick, what strategy to use, what time frame to look at, etc. But

amid all this analysis is a factor that many believe is the most important and most ignored consideration to investment successproper money management.

Have an Intelligent Money Management System That Preserves Capital

The first step toward intelligent money management is to trade only with that portion of

your capital that can comfortably be devoted to speculation. This will permit you to act

rationally and to sleep soundly, neither of which is possible when your nest egg is at risk.

Once you have determined your trading capital, there is one final important rule. Never

risk your entire trading capital on a single trade. This rule holds regardless of how

successful you have previously been and regardless of how attractive the next trade

appears. There will always be losing trades. By compounding your capital after a few

profitable trades, you are exposing yourself to some potentially very painful dollar losses

once that loser comes along.

Always keep a large portion of your trading capital in reserve. By doing this, you will

then have the staying power to ride out the losers so you can ultimately profit from the

winners (including those winners that show paper losses early, but are eventually closed

out for gains). This intelligent money management approach also allows you to invest in

additional recommendations as they come along, as there will always be a number of

open trades that take away from the capital available to purchase new positions.

Logic versus Emotion

Why do many option traders embrace a losing strategy? Usually, for reasons related to

human emotion rather than to logic. After all, people trade options in the hope of

achieving substantial profits. But human nature often interferes, usually in the form of

two major culprits:

Fear- Purchasing an option involves the risk of a total loss of ones investment.

However, in exchange for the assumption of this risk, the investor has the

opportunity to realize profits of many times the initial investment. Many

investors bail out of a position when they have a small loss for fear of

sustaining a total loss. Unfortunately, they are robbing themselves of thepotential for huge gains and negating their reason for buying options in the

first place!


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Greed- The other side of the emotional coin is greed. The options investor will

accept the possibility of a total loss as the price for achieving large gains.

So far, so good. So where does the greedy investor go wrong? The

answer is both simple and financially tragic. Noprofit level is enough for

this individual. If he doubles his money, he wants a triple. If he achieves

a triple, why not aim even higher? This process never ends. The result?Some very healthy paper profits become tiny realized gains when the

direction of the underlying stock reverses. In fact, many paper gains

actually become realized losses!

It is clear that the fearful investor sharply limits his profit opportunities, and the greedy

investor lets his profits slip away. What are the cures for these very human, very

common, yet very financially costly afflictions? Lets deal with them individually.

Fear - How to Eliminate its Negative Impact

Many investors are attracted to options trading by the unique opportunity to achieve

profits of many times their original investment. Unfortunately, a basic tenet of optionstrading is often ignored or forgotten: To be in a position to realize the profit rewards of

the options market, you must be financially and emotionally capable of withstanding the

ups and downs of the options marketplace. Even the most profitable trades often show

paper losses at some point. Very few options go straight up, simply because very few

stocks go straight up or straight down. If a trader panics out of a position with every

downward blip in price, he will ultimately be a loser in options trading. So how does an

investor cope with fear?

Use Only Your Trading Capital For Options Trading -Never buy puts or calls

with money needed to pay bills or meet potential emergencies. Intelligent trading

decisions are rarely made when scared money is involved. You should restrict your

option commitments to funds that can be lost without undue financial hardship.

While we dont specify an actual amount, your minimum account size should be large enough

to allocate sufficient capital to each trade, maintain a cash reserve that can be devoted to

new opportunities as they develop, and provide a cushion of protection.

As a rule, your entire trading capital should never be at risk at any one time in the options

market, regardless of how attractive the current situation appears. Remember, there will

always be losing trades in the options game. Therefore, with rare exceptions, its best to

keep a portion of your trading capital in reserve.


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Diversifying Options Positions- A major advantage of trading in options is

truncated risk, whereby your loss is limited to your initial investment, yet your profit is

theoretically unlimited. Diversification will allow you to use truncated risk to its

maximum advantage. While some of your positions will inevitably be unprofitable, each

profitable position can offset several unprofitable trades. You are then insulated from the

impact due to overall market movements.

We strongly believe that an options investors diversification should be in two

dimensions. First, invest in options in several underlying stocks in unrelated industries.

Second, invest in both calls and puts so that (1) the investor is in a position to profit

regardless of overall market conditions, and (2) guessing wrong on the overall market

does not severely deplete trading capital. Many people believe that the only way to make

money in the market is to take a bullish position on an advancing stock. You can just as

easily take a bearish position by buying a put, while still enjoying the advantage of the

limited risk offered by options.

Stay the Course-It is important for the savvy options investor to realize that it isunwise to exit a trade as soon as a position moves against them. Many options traders

will purchase an option at 3 and then, out of fear, sell it the same day should it decline to

2.50. Assuming that (1) you have not changed your market outlook, (2) you are using

only your trading capital, (3) you are purchasing options within your risk threshold, and

(4) you are sufficiently diversified in calls and puts, there is never a need to panic and

sell. An option is purchased for its huge profit potential, which can only be fully realized

by allowing positions to remain open for a reasonable period of time.

Overcome Greed with Target Entry and Exit Points

The trading rules outlined here will maximize your chances of having several very

profitable option positions at any given point in time. The important question that any

investor must ask, because it will ultimately determine their bottom-line profitability, is

When do I sell?

Set A Target Exit Point For Each Trade A target exit pointis the logically basedunderlying stock price that would result in a substantial, yet attainable, profit. Using your

purchase price and the target profit, you can determine your target exit point.

Set your profit objectives in advance and determine your target exit pointbefore you

tradeor at the time you make your option purchase. By doing so, you avoid the

consequences of one of the major stumbling blocks to achieving trading profits - greed. Itis virtually impossible for most investors to set reasonable profit goals once a stock has

advanced substantially in price. That extra point or extra half-point becomes a

moving target with each advance in the stocks price. It is not surprising that often the

target is not achieved, and the investor is forced to panic out because of tumbling prices.

(Of course, this is not the case with credit spreads, where the target profit and the

maximum profit are the same.)


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Once you have entered the heat of the battle, the tendency will be to base your decisions

upon emotion and, therefore, your decisions will be incorrect. Resistthe temptation to

sell at a loss prior to the stock achieving its target price. You will be yielding to fear,

robbing yourself of some potential gains. Also, resistthe temptation to raise your profit

objective as the price of the stock nears your target exit point. You will be yielding to

greed, and your profits will slip away.

You Should Not Take Profits Haphazardly- Taking profits haphazardlyencompasses a multitude of sins. It includes having nospecific profit objective (the greed

syndrome) as well as setting illogical and insufficientprofit objectives (a 10% gain) oremotionalprofit objectives (This will be my lucky week).

Use A Maximum Entry Price When we send you a trade recommendation, one of

the most important pieces of information is the maximum (or minimum) entry price. This

indicates the maximum premium you should pay to get into a trade, regardless of how the

underlying stock is moving at the time. Sometimes trades run away from us above the

maximum entry price. Its very important to exercise discipline and not chase trades, asyoull overpay in too many situations relative to the few trades you might miss.

Because the entry price is based on our assessment of the probability that the trade will be

successful, paying too much for an option, even when we are targeting for a 100% return,

will decrease your potential reward while the risk remains unchanged. For instance, a

trade with a profit potential of 100 % and a maximum entry price of 1.30 would have a

target exit price of 2.60. If we instead entered at 1.50, the potential profit drops to 73%

because our target exit price does not change. This upsets the risk/reward balance for the

trade and will likely result in a decreased overall profit over the long run. We reiterate

the importance of following the maximum entry price guidelines in the next section,

using actual trading results from one of our recommendation services.

You Can Be Successful w ith A Winning Percentage of Under 50%

The principles of money management in options trading cannot be mastered without a

firm grasp of the statistical probabilities involved. In his esteemed book, Trading for a

Living, Dr. Alexander Elder sums up the importance of this concept in a word -innumeracy. According to Dr. Elder, Innumeracy - not knowing the basic notions of

probability, chance, and randomness - is a fatal intellectual weakness in traders.

Renowned investing and trading coach Dr. Van K. Tharp addressed the issue of winning

percentages in the November 1997 issue of Technically Speaking, the newsletter of theMarket Technicians Association. In his article, Why Its So Difficult for Most People to

Make Money in the Market, Dr. Tharp states, Most of us grew up exposed to an

educational system that brainwashes us with the idea that you have to get 94-95% correct

to be excellent. And if you cant get at least 70% correct youre a failure. Mistakes are

severely punished in the school system by ridicule and poor grades, yet it is only through

mistakes that human beings learn.


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Contrast that with the real world in which a .300 hitter in baseball gets paid millions. In

fact, in the everyday world few people are close to perfect and most of us who do well are

probably right less than half the time. Indeed, people have made millions on trading

systems with reliabilities around 40%.

It should be noted that Dr. Tharp is not specifically referring to options trading in hisdiscussion of winning percentages. In fact, you should expect winning percentages for

option premium buying to be lower than that for trading stocks or futures. Our research

shows that successful short-term options traders are correct on roughly 35% to 45% of

their trades (this refers to premium buying). Although this win rate may seem rather low,

there are factors such as fighting time decay and preserving capital by shutting down

losing trades beyond a certain point (some of which may ultimately have been winners)

that are particularly relevant to options trading. The important point is that positive

overall returns over the longer haul result from allowing your profitable trades to run and

cutting your losses in other trades relatively quickly.

The concept of limiting losses and letting the winners run cannot be overstated. In hisclassic work, The Battle for Investment Survival, Gerald Loeb states, Accepting losses is

the most important single investment device to insure safety of capital. It is also the

action that most people know the least about and that they are least liable to execute ...

The most important single thing I learned is that accepting losses promptly is the first key

to success. In addition, Loeb says, The difference between the investor who year in and

year out procures for himself a final net profit and the one who is usually in the red is not

entirely a question of superior selection of stocks or superior timing. Rather, it is also a

case of knowing how to capitalize successes and curtail failures.

Losing is Part of the Game

An offshoot of this lower winning percentage, and something that often comes as a

surprise to many traders, is the experience of coping with an extended losing streak. The

ultimate goal of achieving profitability will remain out of reach unless great care is taken

to control the amount of capital allocated to each position, as even wildly successful

traders are not immune to a string of losing positions. In short, the objective in options

trading is to stay in the game through proper money management techniques that allow

you to weather the inevitable storms of losing trades.

To shed some mathematical light on the importance of proper money management, our

Quantitative Analysis group created the following table that displays the likelihood of

experiencing losing streaks of various lengths based on a range of win rates.


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Win

Percentage

Probability Of Seeing At Least X Consecutive Losing Trades

Within A 50-Trade Period

2 3 4 5 6 7 8 9 10 11

5% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

10% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

15% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 99.9%

20% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 99.8% 99.1% 97.2%

25% 100.0% 100.0% 100.0% 100.0% 100.0% 99.8% 98.9% 96.2% 90.7% 82.2%

30% 100.0% 100.0% 100.0% 100.0% 99.6% 97.7% 92.2% 82.3% 69.1% 55.0%

35% 100.0% 100.0% 100.0% 99.7% 97.1% 89.0% 75.2% 58.5% 42.6% 29.6%

40% 100.0% 100.0% 99.9% 97.6% 88.4% 71.3% 51.7% 34.6% 22.0% 13.5%

45% 100.0% 100.0% 98.9% 90.7% 71.7% 49.1% 30.3% 17.6% 9.9% 5.4%

50% 100.0% 99.8% 95.2% 76.8% 50.8% 29.2% 15.5% 7.9% 3.9% 1.9%

55% 100.0% 99.0% 86.0% 57.5% 31.3% 15.2% 7.0% 3.1% 1.4% 0.6%

60% 100.0% 95.8% 70.4% 37.7% 16.9% 7.0% 2.8% 1.1% 0.4% 0.2%

65% 99.8% 87.8% 50.9% 21.5% 7.9% 2.8% 1.0% 0.3% 0.1% 0.0%

70% 99.0% 73.1% 31.8% 10.6% 3.2% 1.0% 0.3% 0.1% 0.0% 0.0%

75% 95.8% 53.0% 16.8% 4.4% 1.1% 0.3% 0.1% 0.0% 0.0% 0.0%

80% 86.5% 32.0% 7.2% 1.5% 0.3% 0.1% 0.0% 0.0% 0.0% 0.0%

85% 67.2% 15.0% 2.4% 0.3% 0.1% 0.0% 0.0% 0.0% 0.0% 0.0%

90% 38.9% 4.7% 0.5% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

95% 11.5% 0.6% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

The figures in this table are based on a 50-trade period, or roughly what subscribers

receive over a two-year subscription to most of our individual premium services. The

Win Percentage column encompasses a wide range of potential win rates, from 5% to

95%. The table shows the probabilities of seeing anywhere from two to 11 consecutive

losing trades during the 50-trade cycle, based on the corresponding percentage win rate.

For example, for a 30% win rate, the probability of experiencing five straight losing

trades at some point during a 50-trade cycle is essentially 100%. An extremely successful

options service is one that has a 40% win rate. Such a service still runs a 97.6% chance

of having a string of five consecutive losing positions. Also note that a strong winningpercentage of 40% will stand a better-than-50/50 chance of seeing eight consecutive

losses over a 50-trade period.


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Thus, given the high probability (and in some cases, certainty) of losing streaks within a

given period, it is critical to realize that investors who place too much capital into

successive recommendations run the risk of decimating their trading account during a

perfectly normal trading cycle. In other words, they will be unable to stay in the game.

Those that are able to stay in the game and reap the rewards of the hot streaks and higher

returns of winning trades stand a better chance of ultimate profitability over the longerhaul.

The moral of the story is that even though low winning percentages and long losing

streaks are part of the options buying game, profitability is achievable if you let winners

run and cut losses short (thats our job), while staying in the game by using proper money

management principles (thats your job).

Allocat ion is Crit ical

In the same spirit of staying in the game, we now turn our attention to allocations per

trade. We will not attempt to tell you a minimum dollar amount or percentage to trade.

This is a decision best left to each individual investor that takes into account their overallprofit goals and costs of trading (e.g., commissions). Rather, our goal is to discuss thepercentageallocation to each trade.

In an excellent chapter on money management inNew Thinking in Technical Analysis:

Trading Models from the Masters(Bloomberg Press, available on

www.SchaeffersResearch.com), Courtney Smith discusses how to play the game long

enough to master the skills and information needed to become a profitable trader using a

system he calls thefixed fractional bet. Simply stated, every trade should represent a set

percentage of your totalaccount.

For example, lets say you have $25,000 available for options trading and you wish to

allocate 10% of your total account to each trade. You would therefore trade $2,500 for

your first trade. Assume the trade gains 80%, or a $2,000 profit. Because your account

size is now $27,000, your next trade would be for $2,700 (0.1*27,000). Now lets say

your first trade lost 40% (remember you need to let your winners run and cut your more

numerous losses short), or $1,000. Your account would now stand at $24,000, meaning

that you would allocate only $2,400 to your next trade. Notice how this differs from a

fixed-dollar strategy in which you would invest $2,500 in each trade.

We should note that with options trading, it is difficult, if not impossible to trade exactly

10% (or whatever percentage you choose) on each trade. It is rarely the case that anoptions premium will divide evenly into your dollar allocation for any trade (e.g., five $5

contracts, or $2,500). The best solution is to trade as close to your allocated percentage

without going over. That is, if your allocated amount for a particular trade is $2,500 and

youre interested in a $7 option ($700 per contract), you should trade only three contracts

($2,100).
http://www.schaefferresearch.com/http://www.schaefferresearch.com/


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Also, do not let your allocation dictate what option you will play. For example, say you

have $2,500 for a trade and your trading system calls for higher-premium in-the-money

options. If you have your eye on one priced at 7 (three contracts, or $2,100), dont opt for

a cheaper out-of-the-money option priced at 3 (eight contracts, or $2400) just so the total

trade is closer to your allocated amount. In other words, dont compromise your trading

system for the sake of getting nearer to your allocation.

The Power of Convexity

One of the primary advantages of the fixed fractional bet system is the principle of

convexity playing more dollars on the way up, while fewer dollars are at risk after each

losing trade. On the downside, this system keeps you in the game longer by allowing you

to weather the losing streaks that will inevitably occur.

For example, if you start with $25,000 and play the same $2,500 per trade, you will lose

half your bankroll ($12,500) if you start off with 10 consecutive losses of 50% per trade.

While it is unlikely that you will have such a streak right off the bat, it is not beyond the

realm of possibility. However, the fixed fractional system has quite a different outcome.In fact, this methodology comes out $2,468, or nearly 20%, ahead of the fixed investment

approach, as shown below:

Trade

No.

Portfolio

Amount

Allocation

(10% of portfolio)

Amount Lost

(-50%)

New Portfolio

Balance

1 25,000 2,500 (1,250) 23,750

2 23,750 2,375 (1,188) 22,563

3 22,563 2,256 (1,128) 21,434

4 21,434 2,143 (1,072) 20,363

5 20,363 2,036 (1,018) 19,345

6 19,345 1,934 (967) 18,377

7 18,377 1,838 (919) 17,458

8 17,458 1,746 (873) 16,586

9 16,586 1,659 (829) 15,756

10 15,756 1,576 (788) 14,968

On the plus side, lets assume you enjoy five straight winning trades of 100% apiece.

Investing $2,500 per trade will result in a portfolio of $37,500 (25,000 + 12,500). On theother hand, the fixed fractional bet system results in a portfolio value of $40,263, or 7.3%

better, as shown below:


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Trade

No.

Portfolio

Amount

Allocation

(10% of portfolio)

Amount Gained

(100%)

New Portfolio

Balance

1 25,000 2,500 2,500 27,500

2 27,500 2,750 2,750 30,250

3 30,250 3,025 3,025 33,2754 33,275 3,328 3,328 36,603

5 36,603 3,660 3,660 40,263

In the real world, of course, you will encounter interspersed winners and losers, although

the losers will most likely be more frequent. As we have stated repeatedly, the goal of

options trading is to keep afloat long enough to take advantage of the bigger winning

trades and the winning streaks that will also occur. And proper money management is the

best way to play longer. As Smith states, risk management rules are really ways of

dealing with the psychology of trading[which] is the most important aspect of

tradingdiscipline is the key psychological trait that the trader needs to make money.Risk management rules are an effort at trying to enforce the necessary discipline.

Consistency is the Key

One other thing we should mention. Dont vary the percentage you allocate trade by

trade. Dont double up on a trade after a loss hoping to win your money back right away.

Theres a technique some blackjack players use in which they double their bet after each

loss, the idea being that eventually the cards will turn in their favor and they will be

ahead. Thats fine (we suppose) if youre betting $10 chips since you likelywill have a

sufficient bankroll to stay in the game long enough for that to happen.

But options trading is not so forgiving. The wins are not as frequent, the market may be

turbulent and volatile, your system may be flawed, and you might run into a series of

trades that will wipe you out. Sure, you may get out of the hole with that one winner, but

what if doesnt come in time? If youre sitting on the sidelines with no cash, theres

positively no way to benefit from those big winning options trades. And as the saying

goes, you miss 100% of the shots you never take.

Make Money Management an Integral Part of Your Option Trading

By applying all of the techniques enumerated here, you will have effectively managed

(reduced) your risk and managed (increased) your reward (profit potential) so that yourtarget risk/reward ratio is in your favor! A steadfast application of the principles of

risk/reward management will substantially improve your chances for success in options

trading and allow you to follow our strategy of letting profits run and cutting losses

short. We strongly suggest that you review this section from time to time, to refresh

yourself with our money management guidelines.


19/25

Schaeffers Weekly Options Trader Using a Maximum Entry Price


F.

Using a Maximum Entry Price

One of the most common reasons that options traders suffer losses is because they purchase

options at too high of a price. When analyzing an option opportunity, an investor should

calculate the maximum price that he or she is willing to pay for the option. Frequently,

options traders get caught in rising options prices and end up paying too much for the option

because they didnt want to lose out on the opportunity. To illustrate this concept, lets take a

look at the pre-commission past track record of one of our recommendation services. The

maximum entry price recommended and its correlated profit (loss) is listed in Table 1. In

Table 2, we illustrate the effect that the investor would have had if he or she chased the

recommendation and paid 1/8 of a point more than the maximum entry price. Please note

that the recommendations that are marked with an asterisk had half of the position closed out

at a double (+100%) in order to lock in a profitable position.

TABLE 1 TABLE 2

Maximum Percentage MEP Percentage

Entry Price Sale Profit plus Sale ProfitDate (MEP) Price (loss) 1/8 point Price (loss)

01/31 2.938 5.875 100% 3.063 5.875 92%01/31 2.625 0.000 100% 2.750 0.000 100%03/07 2.875 2.875 0%* 3.000 2.875 (4%)*

04/25 1.938 3.250 84%* 2.063 3.250 73%*05/15 1.719 1.813 5% 1.844 1.813 2%

06/01 3.063 2.000 (35%) 3.188 2.000 (37%)07/12 1.906 0.000 (100%) 2.031 0.000 (100%)

08/09 1.688 3.500 107% 1.813 3.500 93%09/14 2.906 4.500 55% 3.031 4.500 48%

09/20 1.719 3.063 78% 1.844 3.063 66%09/20 2.625 10.500 200%* 2.750 10.500 191%*09/21 2.438 1.875 23% 2.563 1.875 27%

10/18 2.063 4.188 103% 2.188 4.188 91%10/23 2.375 3.188 67%* 2.500 3.188 64%*

11/29 1.813 1.125 38% 1.938 1.125 42%12/01 1.875 2.375 63%* 2.000 2.375 59%*

12/18 1.563 0.813 (48%) 1.688 0.813 (52%)12/27 1.438 2.500 74% 1.563 2.500 60%

Total Profit of 592% Total Profit of 473%

* Indicates that 1/2 the position was closed out for a 100% profit.

As this illustration shows, the investor who paid 1/8 of a point more received a profit of

almost 120 percentage points less than the investor who followed our maximum entry price

guidelines. Clearly, chasing the market and paying an extra 1/8 of a point drastically reduces

your profit potential and increases your risk/reward ratio. In addition, by paying more than

the maximum entry price, you are encouraging market makers to ratchet up the price of the

option. Therefore, it is important to always follow your maximum entry price guidelines.


20/25

Schaeffers Weekly Options Trader How to Read Specific Option Symbols


G.

How to Read Specific Option Symbols

Option symbols are simpler than ever, thanks to some major changes that were instituted in

February of 2010. Prior to that time, option codes were an arcane and often confusing collection

of four or five letters that may or may not have included portions of the stock's ticker symbol.

Today it is far more intuitive and easier to understand.

For example, under the old current Options Price Reporting Authority (OPRA) codes, the symbol

for Apple Inc.'s (AAPL) December 250 put was AJL XEcompletely obscure to the average

option trader. However, in the aftermath of the conversion, the symbol for the same option would

look like this: AAPL 09 12 18 P 00250 000much more detailed and less cryptic.

Here is how to read the new symbol for the April 2010 250 strike put:

It's important to note that brokers are treating the new option codes as advisory rather than

mandatory. While all are including the four required elements -- the root symbol, the specific

strike, the expiration date, and the type of option (put or call) -- they are sequencing these

elements according to their own preference. For example, Charles Schwab will render the Apple

April 2010 250 put as AAPL 04 17 2010 250 P (ticker, expiration month, expiration day,

expiration year in four digits, strike price, call/put indicator). Meanwhile, Fidelity will call that

same option AAPL 10 04 17 P 250, while OptionsXpress will use AAPL April 10 250 Put. Check

with your own broker before making a trade.


21/25

Schaeffers Weekly Options Trader Delivering Your Service


H.

Delivering Your Service

One delivery problem that may arise for some subscribers is crucial e-mails being routed to a

junk mailbox by their Internet service provider (ISP). Due to the number of valuable

communications you will receive that are pertinent to your trading (market updates,

recommendations, closeouts, commentaries), some ISPs may label these e-mails as junk.Therefore, we strongly recommend that you do not turn on any e-mail junk file capabilities

offered by your ISP, as this could delay receipt of valuable trading information.

Some subscribers may want recommendations, commentaries, and follow-ups sent to

multiple e-mail addresses in order to receive timely information. We have the capability to

send to multiple addresses. Just inform your Schaeffers Product Specialist (contact

information is provided in the next section).


22/25

Schaeffers Weekly Options Trader Contact Information


I.

Contact Information

Web Address

http://www.SchaeffersResearch.com

This is the website for Schaeffers Investment Research, Inc. (SIR), which recentlywas ranked by Forbesas a Best of the Best and a Forbes Favorite in the options

category. It includes educational information on options, stock quotes, mutual fund

quotes, daily market commentaries, up-to-the-minute market observations

throughout the day, information on all of our real-time services, an introduction to

the company, and much more valuable information for options investors. See whyForbesrated SchaeffersResearch.com the best of the best for options traders.

Electronic Mail Address

[email protected] Customer Service

Fax Numbers

1-800-967-7461 United States

1-513-589-3810 International

Telephone Numbers

1-800-448-2080 Speak with a Product Specialist

Monday - Friday 8:30 a.m. 6 p.m. Eastern time

1-800-327-8833 Speak with Customer Service

Monday Friday 8:30 a.m. 5:30 p.m. Eastern time

1-513-589-3800 International

Monday Friday 8:30 a.m. 5:30 p.m. Eastern time
mailto:[email protected]:[email protected]:[email protected]


23/25

Schaeffers Weekly Options Trader Disclaimer


J.

Disclaimer

Schaeffer's Investment Research (SIR) does not give individualized market advice. Due to

the exclusive nature of our subscription services, many subscription fees are nonrefundable.

We publish information regarding companies in which we believe our readers may be

interested and our reports reflect our sincere opinions. However, they are not intended to bepersonalized recommendations to buy, hold, or sell securities. Investments in the securities

markets, and especially in options and futures, are speculative and involve substantial risk.

Only you can determine what level of risk is appropriate for you. Prior to buying or selling,

an investor must have a copy of Characteristics and Risks of Standardized Options. You can

access and download the booklet on the Options Clearing Corporation's (OCC) website at

www.optionsclearing.com. This link reference is provided as a courtesy and does not imply

that the OCC is endorsing SIR or its products. This booklet is also available for free from

your broker or from any of the U.S. options exchanges.

We encourage our subscribers to invest carefully and to utilize the information available at

the websites of the Securities and Exchange Commission at www.sec.gov and the FinancialIndustry Regulatory Authority at www.finra.org. You can review public companies filings at

the SECs EDGAR page. We encourage you to get personal advice from your professional

investment advisor and to make independent investigations before acting on information that

we publish. Most of our information is derived directly from information published by the

companies on which we report and/or from other sources we believe are reliable, without

our independent verification. Therefore, we cannot assure you that the information is

accurate or complete. We do not in any way warrant or guarantee the success of any action

which you take in reliance on our statements.

Our personnel may own positions in the equities mentioned in our reports. However, all

employees are prohibited from any transaction that directly or indirectly competes with the

interests of our subscribers. We are not compensated in any way for publishing information

about companies mentioned in our reports.

Residents of non-U.S. countries are responsible for paying any customs fees or similar

charges assessed on materials entering their country.

The information contained in SIR trading services is intended for use solely by individual

subscribers and is not offered to institutional investment organizations.

Testimonials may or may not be representative of actual results.


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Performance Figures

Performance figures are based on actual recommendations made by Schaeffers Investment

Research, Inc. Due to the time critical nature of stock, options and futures trading,

brokerage fees, and the activity of other subscribers, SIR cannot guarantee that subscribers

will mirror the exact performance stated on our track records or promotions. Performance

numbers shown are based on trades subscribers could enter based on our tracking guidelines.Past results are not necessarily indicative of future performance.

Limitation on SIRs Liability

SIR liability, whether in contract, tort, negligence, or otherwise, shall be limited in the

aggregate to direct and actual damages not to exceed the fees received by SIR from

Subscriber. SIR will not be liable for consequential, incidental, punitive, special, exemplary

or indirect damages resulting directly or indirectly from the use of or reliance upon any

material provided by SIR. Without limitation, SIR shall not be responsible or liable for any

loss or damages related to, either directly or indirectly, (1) any decline in market value or

loss of any investment; (2) a subscribers inability to use or any delay in accessing SIRwebsite or any other source of material provided by SIR; (3) any absence of material on SIR

website; (4) SIR failure to deliver or delay in delivering any material or (5) any kind of error

in transmission of material. SIR and Subscriber acknowledge that, without limitation, the

above-enumerated conditions cannot be the probable result of any breach of any agreement

between SIR and Subscriber.

Disclaimer of Warranty

ANY AND ALL MATERIAL PROVIDED BY SIR IS PROVIDED AS IS AND SIR

MAKES NO WARRANTY OF ANY KIND, EXPRESS OR IMPLIED, INCLUDING,

WITHOUT LIMITATION, ANY WARRANTIES OF MERCHANTABILITY OR

FITNESS FOR A PARTICULAR PURPOSE.

Brokers

SIR is not and will not be responsible for any trades made by the broker on the subscriber's

behalf under any circumstances.

Acknowledgement and Agreement

Notwithstanding any other agreement or other communications between SIR and Subscriber

to the contrary, receipt or use of any material provided by SIR, at any time and through any

means, whether directly or indirectly, represents acknowledgement by such person of this

disclaimer and agreement with its terms and conditions.


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Copyright Notice

Schaeffer's Investment Research is the copyright owner of all information contained in this

service, except as otherwise indicated. Other parties' trademarks and service marks that may be

referred to herein are the property of their respective owners. The copyrighted Subscriber Guide

(if applicable) and recommendations are specifically intended for your personal and confidentialuse as a subscriber. For your protection, any other usage or dissemination of the above mentioned

materials or information is prohibited. You may print a copy of the information contained herein

for your personal use only, but you may not reproduce or distribute the information to others or

substantially copy the information on your own server, without prior written permission of

Schaeffer's Investment Research. Use or reproduction of information from this service for any

other purpose is expressly prohibited by law, and may result in civil and criminal penalties.

Violators will be prosecuted to the maximum extent possible.

Schaeffers Weekly Options Trader Handbook

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