that  the  price  of  the  leg  you  already  traded  will  make  a  moveagainst you before the trade for the second leg of the position can be executed.
2. But the risk is reduced because you received cash for writing a put option.3. The same risk as any shareholder. I repeat this statement for emphasis, as manybelieve writing uncovered puts is very risky. In fact, it is not any riskier thanowning stocks.
4. Your broker requires an initial margin deposit to open an uncovered put posi-tion. Margin requirements vary over time, but currently the amount is approxi-mately 20 percent of the strike price (with some other factors involved), with aminimum of $250 per option.
5. This increases risk by an almost insignificant amount. Note: you must be 100
percent cash backed in a retirement account.
6. Carrying this position requires the payment of cash. A position with a net credit
occurs when cash is collected.
7. Anyone who buys this option must hold it and hope for a profit the followingweek. This is risky. Thus, the only potential buyers of this option are those whohave a short position and are willing to pay the minimum bid of $0.05 ($5 percontract) to buy-in their short option and eliminate all risk.
8. Some brokers provide this information to their online customers on Sunday.
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Notes
9. A straddle is one call and one put on the same underlying equity with the sameexpiration date and strike price. The investor is long the straddle when both theput and call are bought; and the investor is short the straddle when both aresold. This straddle is “covered” when the investor has a long stock position tocover the short calls.
10. Unless I choose to use a margin account and borrow money from my broker.For  simplicity,  I  assume  I’m  not borrowing  any  such  money.  Retirement  ac-counts are not allowed to borrow, and by adhering to that rule, every recom-mendation in this book is appropriate for investors to apply to their retirementaccounts. Warning: Some brokers do not allow uncovered put writing in retire-ment accounts, even though it is perfectly acceptable to the Securities and Ex-change Commission.
Chapter 171. The time premium in an option shrinks as the underlying moves away from thestrike price. If ETFQ rises to 43, it’s reasonable for the Jul 40 call to be tradingnear $4.40. That $4.40 is $3.00 in intrinsic value, but only $1.40 in time value, ormuch less than the $2.35 in time premium that’s available to you today. Rollingearly (in the example situation) allows you to take the $2.35 and not gamble onfuture option prices.
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Glossary
Assigned (an exercise notice) Notification that the option owner has exercisedrights, making the recipient obligated to fulfill the terms of the option contract.Assignment The process by which option writers fulfill their obligation. The callwriter sells, or the put writer buys, the underlying at the strike price.At the money (ATM) An option whose strike price is identical (or nearly iden-tical) to the price of the underlying asset.Break-even  point The  stock  price  at  which  the  profit  earned  from  a  positionusing options equals the profit earned from a stock position without options (upsidebreak-even) OR, the stock price at which a position using options is no longer prof-itable (downside break-even).Buy-write transaction The simultaneous purchase of 100 shares stock and theselling of one call option.Call A type of option that grants its owner the right to buy (before expiration) aspecified asset at the strike price.Cash  backed The  situation  in  which  your  brokerage  account  contains  enoughcash to completely pay the cost of stock, if you are assigned an exercise notice onput options you sold.Cash settled An expiration process in which cash, not shares of the underlying,is transferred from the option writer’s account to the account of the option owner.Covered A position in which a put or call option is backed by the shares under-lying the option contract.Credit Cash received when making a trade.Debit Cash paid when making a trade.Deep in the money A term applied to an option that is so far in the money (ITM)that it’s unlikely to move out of the money before it expires.Downside  break-even  point The  stock  price  below  which  the  covered  callwriter begins to lose money.Exercise The process by which the option owner chooses to do what the contractallows:  The  call  owner  buys,  or  the  put  owner  sells,  the  underlying  asset  at  thestrike price.Exercise notice Formal notification to the option seller that the option ownerhas chosen to buy (call) or sell (put) the underlying at the strike price. The optionseller is now obligated to honor the conditions of the contract.
227
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Glossary
Expiration The last day an option is a valid contract.Expiration day For listed stock options, the third Friday of the specified month.Expire worthless What happens to an option when expiration arrives and theoption is out of the money and the owner elects not to exercise.Far out of the money A term applied to an option that is so far out of the money(OTM) that it’s unlikely to move in the money before it expires.Front month The month with the nearest expiration date.Fungible An item that is completely interchangeable with another in satisfying anobligation. Any call or put option with the same underlying, expiration, and strikeprice is fungible.Hedge An investment that reduces the risk of another investment by partially off-setting the risk of owning the original investment.Implied volatility An estimate of the volatility of the underlying asset betweennow and the expiration of an option. It’s the volatility estimate used in option pric-ing models to make the actual market price of an option equal its theoretical value.In the money (ITM) An option with intrinsic value.Intrinsic value The amount by which the price of the underlying asset is abovethe strike price of a call option (or below the strike price of a put option).LEAPS Acronym for long term equity anticipation series. Call or put options withlonger expirations (nine months to three years), expiring in January.Leverage Using borrowed money (buying on margin), or using derivatives suchas options, to enhance returns without increasing the size of an investment. Lever-aged investing is risky because you can lose more than your entire investment.Naked See uncovered.Obligations The requirements imposed on the seller of an option contract if anoption owner exercises rights.Option A contract that gives its owner the right, but not the obligation, to buy(call) or sell (put) the specified asset at a specified price (strike price) for a speci-fied time.Out of the money (OTM) An option with no intrinsic value. For a call option,the strike price is higher than the price of the underlying; for a put option, the strikeprice is lower than the price of the underlying asset.Premium The price of an option.Put A type of option that grants its owner the right to sell (before expiration) aspecified asset at the strike price.Rights Privileges granted to the owner of an option contract.Rolling (a position) The process of buying an option sold earlier and selling anoption with a more distant expiration dateSell short The sale of an asset (stock or option) not owned. There is an obligationto  repurchase  in  the  future.  Note: If  the  option  eventually  expires  worthless,  theobligation to repurchase is nullified.Strike  price The  price  at  which  the  asset  underlying  an  option  can  be  bought(call) or sold (put).
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Glossary
229
Spread The simultaneous sale or purchase of two or more option contracts. Aspread usually establishes a hedged position.Strike price The price at which an option owner has the right to either buy (call)or sell (put) the underlying.Standardization of options Establishing consistent and predictable expirationdates and strike prices for options. Options became standardized when the ChicagoBoard Options Exchange (CBOE) first listed options for trading (April 1973).Straddle One call and one put with the same underlying, strike price, and expi-ration date.Theoretical value The worth of an option as calculated with an option-pricingmodel.Time value The portion of the option premium above the intrinsic value.Wasting  asset An  item  with  a  limited  lifetime  that  decreases  in  value  as  timepasses.Upside break-even point The price above which the covered call writer doesnot earn any additional profit.Uncovered A short option position that is not backed by shares of the underlying.Also called a naked position.Underlying The security that an option contract gives its owner—the right to buyor sell. It’s the asset from which an option derives its value.Volatility The  relative  rate  at  which  the  price  of  a  security  undergoes  dailychanges.Write Sell (an option).
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Index
Asset allocation, xiv, 7, 8, 12
Covered call writing:
Beating the market, success of
individual investors, 16professional money managers,
35–36BLDRs, 44–45Break-even point:downside, 85upside, 85when writing puts, 109
Buy and hold investing:
vs. covered call writing, 98
BuyWrite index:
investment methodology,111–112, 115
performance vs. S&P 500 index,
113–114
Call option, description of, 56Cash backing:
importance of when writing
puts, 108
Cash settlement, 112Choosing option to write, 66–67,84–92, 134–138comparing choices, trader’s
thoughts, 135–138
assignment verification
(importance), 146, 148broker, using a live, 148, 162,
172
buy and hold (comparison), 98choosing the option, 134–138consistent or flexible strategy,
139
exceeding the maximum profit,
188
getting started, 133–135not for everyone, 158residual cash and, 143risks, 96–97
dividend loss, 97psychological, 97vs. uncovered put writing, 
110
strategy summarized, 80–82uncovered put writing,
comparison, 100–101
Diversification, xiv
Efficient market theory, 9Exchange traded funds:advantages, 31 40–42
231
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Index
Exchange traded funds (cont.)
Index funds:
capital gains distributions and,
41closed-end, 51diversification and, 42–43history of, 31, 38hybrid security, 31international, 47–48miscellaneous funds, 50most actively traded, 38–39non-equity, 51open-ended mutual fund, 45tax efficiency, 41transparency, 41
Exercise-assignment process, 57Expiration date:
new listings, See also options,standardizationnew months, addition of, 67
Fund of funds, 23–24
fees and, 24
Fundamental analysis, xiv
Grantor trusts, 49Gurus (market advisors), 35
Hedge funds, 20–25criticism of, 23fees, 21
profit sharing and, 21
managers
arbitrage and, 20choosing investments, 20leverage and, 20
operate your own, xii, 24qualified investors and, 21
HOLDRs:
rebalancing portfolio and, 49voting rights and, 49
management fees and, 9sampling and, 13Indexing, 12, 18–19
diversification and, 15history of, 14passive management and, 15
Individual investors:
beating the market, 11–12, 16choosing stocks to own, 10underperforming the market,
11, 16
Investment clubs, 4, 16, 25,
214–215
beating the market and, 16Bivio and, 25NAIC and, 25iShares, 45–47
dividends and, 46
Margin considerations, 107Market timing, 15Markowitz, Harry M, 6Modern portfolio theory, 3, 5–8
basics, 6benefits, 5–6building a portfolio, and, 7diversification and, 8efficient market theory and, 9individual investors and, 3market timing and, 15passive investing and, 15summary description, 6
Montreal exchange:
covered call writer’s index,
116–117
investment methodology, 
117
performance vs. TSE60,
116–117
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Index
Mutual funds:
advertising, 11, 15, 34–35allegations (illegal) and, 32closed-end, 30exchange traded funds,
beginning of, 30
fees
performance and, 36–37consuming your account, 37
first mutual fundhistory ofinvestment results, 33–34load, 4management responsibilities,
32–33managers, 4
profitability and, 15
money market, 30Morningstar rating, 4no-load, 30open-end, 29popularity, 36purpose, 4scandals, xiiunderperforming the market
and, 35
Naked, See uncoveredNet asset value, 40
Option(s):
buying, rationale for, 70, 73buying, rationale for not, 74covered vs. uncovered, 76–77deep in the money, 63description (format), 62everyday usage, 58–59far out of the money, 63how does an option work,
56–58
233
intrinsic value, 63owner’s choices, 67, 75owner’s rights, 56–57owning vs. stock ownership,
72–73
seller’s obligations, 56–57selling, rationale for, 77–78standardization
strike prices, 61expiration dates, 61
time value, 65
opportunity value, 65types
at the money, 64expiring worthless, 203in the money, 63out of the money, 64
value:
dividend and, 68time remaining and, 67
what is an option, 56Optionable ETFs, 129–130Outperforming the market, xi
Passive investing, 17Portfolio, compiling, 124–128PowerShares, 44–45Profits, annualization of, 94Prudent man rule, 7, 8, 13passive investing and, 8Put option, description, 56
Risk, 7
controlling, 107–108
Rolling a position:
avoiding an assignment notice,
212
collecting an attractive
premium, 213
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Index
Rolling a position (cont.)
down and out for protection,
162–163, 212
using puts, 201using calls, 160
up and out to make money, 170,
172–173
Sampling, 13Sector spiders, 47, 49SPDR, introduction, 38Stock, buying at a discount, 103Strike prices. See also options,standardization
new listings, 66
Technical analysis, xiv, 15Time premium, 91
time remaining and, 67, 68, 91
Uncovered, 76–77Uncovered put writing:
advantages over covered call
writing, 195
assigned, follow-up strategy,
105–106cash backing and, 195strategy summarized, 100–102who should consider, 103–104Underperforming the market, xiUnit Investment Trust, 39, 43
dividends and, 44
VIPERs, 47–48Volatility:
implied, option prices and, 118portfolio, 6, 17
hedge funds and, 21value of an option and, 66Volatility index (VIX), 117–119
complacency, 118fear, 118
Whipsaw, 181
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