Southern Company ( SO ) - Dividend Reinvestment Chart

Southern Company ( SO ) Dividend Reinvestment Chart

Southern Company ( SO ) - 10 Year Chart

Starting with $10,000 investment 7/23/2001

Value on 7/19/2011 without dividend reinvestment - $17,634

Value on 7/19/2011 with dividend reinvestment - $28,512

Realty Income Corp - ( O ) Dividend Reinvestment Chart

Realty Income Corp ( O ) Dividend Reinvestment Chart

Realty Income Corp ( O ) - 10 Year Chart

Starting with $10,000 investment 7/30/2001

Value on 3/30/2011 without dividend reinvestment - $23,000

Value on 3/30/2011 with dividend reinvestment - $43,000

As you can see by using your dividends to buy more stock instead of spending them you would have an extra $20,000.

The Complete Guide to Option Selling

This is one of the most practical Options books out there. Pretty much a step by step blueprint for how to sell options. This book details how to sell options and profit from time decay. Anyone who has every bought options knows the power of time decay. This is one of the only constants you are going to find in the market. Why not put the odds in your favor and learn to sell options.

Selling options is equivalent to being a insurance company. You sell investors protection for their assets for a premium. Your only job is to manage your risk. Using the techniques in this book you can reduce your risk and make consistent returns in up, down and sideways markets.

Most market gurus will tell you that selling options is risky. I would say there is about as much risk as buying or selling futures. Maybe even less risk, because you have the premium you take in for a cushion. If you get your position sizing right the risk will not be a problem.

Three ways to win with options

There are three major factors that affect the profitably of an options trade. Options prices are influenced by the price of the underlying asset, the volatility of that asset, and the passage of time.

The first factor affecting options pricing is the price of the underlying asset. If you are long a call or short a put and the price of the underlying goes up you make money. If it goes down your long calls or short puts loose money. The inverse is true for a long put or short call.

The next factor that affects pricing of options is the volatility of the underlying. There are two types of volatility, Statistical and Implied. Statistical volatility (SV) or Historical volatility (HV) is the measure of how much the underlying asset moves. Implied volatility (IV) is how much the market expects the underlying to move. Volatility is mean reverting and tends to move back towards its average. When volatility is trading at extreme high or low levels there is a good chance that it will move back towards its historical average. When IV is greater than SV and IV is trading in the upper end of its range options are expensive. When IV is lower than SV and IV is trading in the lower end of its range options are cheap. When volatility moves higher options increase in value and when volatility drops options decrease in value. You should use options premium selling strategies when options are expensive and premium buying strategies when options are cheap.

Example of a Volatility Chart for SPY from IVolatility.com

The third factor affecting the value of options is time. This is the only constant factor you can count on when trading besides commissions and taxes. Options lose money everyday due to time decay. This can be good for the seller but bad for the buyer.

When trading you need all the edge you can get. Structuring you options trades to profit from price, volatility and time can help stack the odds in your favor.

High probability trading systems

It is easy to build a system with a high winning percentage. Set your stop loss at 10 times the size of your profit target and you will have a system that wins 90% of the time. The problem with a system like this is that the 10% losses will take away all of your profits. You simply can not gauge a trading system on probability alone.

To find out the rest of the story you have to calculate the expectancy of the system. Here is the formula for expectancy.

(Winning % * Average Profit) + (Losing % * Average loss) = Expectancy

Here is an example for a system I tested:

( 91.81% * $101.78 ) + ( 8.19% * -970.00 ) = $14.00

or

( .9181 * $101.78 ) + ( .0819 * -970.00 ) = $14.00

This system was always long and a new trade was opened as soon as a stop or target was hit. The profit target was set to $100 and the stop was set to $970. It won 91.81% of the time and lost the other 8.19%. The average winning trade was $101.78 and the average losing trade was -$970. If you put these figures into the expectancy formula, you can see that the expectancy is $14. That means that over a long period of trades you can expect to make an average of $14 per trade. If you factor in commissions and slippage it really isn’t that good.

What you are looking for is a system like this:

(91.81% * $101.78) + (8.19% * -200.00) = $77.06

This is the Holy Grail that everyone is looking for. Don’t get excited I haven’t found it yet.