Trading Room

Start from today, I will post any new trade I enter into this blog and all my opening position can be find on the lower left of the page. When I am not posting my trades, I will continue to post education article about the shares market and option. After I have cover the all the basic, I will share with you my trading system and my views on the market. Hope you will learn something and be more and more profitable trading the Hong Kong shares and option market.



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Trading Room
www.tradingforreal.blogspot.com

Hang Seng Bank Put Option

On the left hand side, I have post one of my trade opened last week.

Reason for entry:

1.Fundamentally speaking HSB (stock code 11) is a very good company which has make consistent profit with increasing EPS year from year. It also had a very stable dividend policy. With a current DPS of about $6 per share. If we get exercise on this one, we will be buying the share at $110 with a dividend yield of 5.4%p.a. (better than put it at the banks)

2. Technically HSB show a really good support at $110 and currently close to the 30 week Moving average. Which means it is good value at $110.



When talking to my option broker, I will say I am writing to open HSB put option with strike price of $110, expiry on Nov09, with premium of $2.68.



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Trading Room
www.tradingforreal.blogspot.com

Show me the Money

I know you might be thinking why do I bother talking about the option basic. This is because you need to understand option before you start making money with option trading. I think if you had read through my post, you should have some basic understanding of option. Ok we should get onto with the money stuff. But before we all jump into the share market, there is something you should know a bit. They are call Technical Analysis and Fundamental Analysis. Sounds boring isn't it. But I can tell you in order to make money in the market, it is essential you have some understanding of these two subjects. And the entry of my trading position will be base on both technical and fundamental analysis. Put it simply Technical analysis involve looking at the price chart and indicators. From the chart it will give us some idea where the market will be heading in the future. With Fundamental analysis, it involves looking at company financial statement and how good is the company. Is this a profitable company? We will focus on these two topic on my later post.

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Trading Room
www.tradingforreal.blogspot.com

Buy Call Option Example

Let say we think XYZ stock is going to go up to $100 in 1-2 months time and the current stock price is $88.00 at the beginning of OCT 2009. Instead of buying the stock, I can buy a Call option of XYZ to benefit from the raise in stock price. So we are buying a XYZ Call Option with a strike price of $90.00 and expiry at DEC 2009 for a premium of $4. The benefit of purchasing the option instead of the underlying security is leverage. If we buy the stock for $88 and sell it for $100, we are talking about 13% return on investment (ROI). But if we use $4 to purchase the option and the stock price reach $100 anytime from now to expiry. We can either exercise our right to buy the stock for $90 and sell it to the market for $100. So our ROI will be 100-90-4 = $6 which is 150% return on our initial investment. Or we can also choose to sell our Call option to the market. If the stock is trading at $100, our Call option with a strike price of $90 should have an intrinsic value of $10. Which mean we should be able to sell it for $10 at least excluding time value. And our ROI will be 10-4= $6 which is also 150%.So in this case, we are talking about a ROI of 150% VS 13%. This is the main reason why people would purchase a Call option instead of shares.

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Trading Room
www.tradingforreal.blogspot.com

Option Pricing Part 3

Time Value

The time value mainly represent the effective period of an option. The longer the time to expiry the higher the time value. But it is also influence by the following factors:
-- Volatility of the underlying share
-- Interest rate
-- Dividend payment
-- Market expectation

Out of these factors, I will say from personal experience the most important one is volatility. There is two type of volatility: Historical Volatility (HV) and Implied Volatility (IV). HV is a measure of how volatile the stock has been in the past. IV is how the market expects the volatility of a certain stock to be in the future. Therefore IV is much more important than HV since it will influence the current price of the option. So an option with high IV will be more expensive than option with low IV assuming other factors are equal. Most option trader will try to sell the option with high IV (the more expensive one) and buy the option with low IV (the cheaper one).


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Trading Room
www.tradingforreal.blogspot.com

TV Financial Advice

Today on one of the TV financial program, I noticed that the financial expert is recommending a buy for stock with a Buy price at $45, Target at $50 and stop-loss at $42.5 and the reason for entry is a technical breakout. I can’t remember the name of the stock. But I don’t think the name or the nature of the stock matter in this case. What I am thinking is that the financial advice given is not for the majority of the audience. So in that recommendation, we are talking about a target profit of 11% ROI with a stop loss place at 5.5% on our entry price. To me 11% ROI is not a good return to aim for and 2nd thing is the target to stop loss ratio is too close. In this case is 2:1. Which means we will break even if we had 2 losses and 1 win. This ratio should be increase in order to be more profitable on the long run. I heard trader that had 9 losses and 1 win but at the end they still get a profit. This is because their one Wining trade had already covered all the loss from their losing trades. The point I want to make here is in order to be profitable trading shares in the long run. The entry is not that important compare to the exit. Let say there is three ways a share price can go, UP, DOWN or Sideway. So theoretical the probability of the price going up will be about 33%. Let assume your probability of wining is about 30% and loss about 70%. With a high target to stop loss ratio of 5:1. Which means everytime you win, you profit 5 times more than your losing trade. So 1 win will cover 5 losses. In 10 trades, if you win 3 trades, you will be able to cover 15 losses. At the end of 10 trades, with 3 wins and 7 loses you should still be profitable even though you had more losing trade than wining trades.


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Trading Room
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Option Pricing Part 2

The intrinsic value for Put option is opposite to Call option. If the share is trading at a lower price than the strike price of a Put option, the option is said to be ITM and has intrinsic value. As the put option taker has the right to sell the share at the higher price than the current market price. The option is said to be OTM if the market price is higher than the strike price.

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Trading Room
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Option Pricing Part 1

The premium of an option can be divided into two parts
1. Intrinsic Value
2. Time Value

The Intrinsic Value is the different between the strike price of an option and the market price of the underlying securities. For example if HSBC OCT 09 $85 Call options are trading at a premium of $5.5 and HSBC shares are trading at $89 per share, the option has an intrinsic value of $4.0. This is because the option taker has the right to buy HSBC at $85 per share which is $4 lower than the market price. Option that has intrinsic value are said to be “In-The-Money” (ITM). When the share price equals the strike price, the call and put option are said to be “At-The-Money” (ATM). And if the HSBC was trading at $84, there will be no intrinsic value with the above option. So if the share price is less than the strike price of the call option, the option is said to be Out-Of-The-Money (OTM).

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Trading Room
www.tradingforreal.blogspot.com

Option Features

There are 5 main components of every option contract. They are
1. Underlying security
2. Contract Size
3. Expiry Date
4. Exercise (Strike) price
5. Premium

The underlying security in our trading is mainly shares. There is a list of optionable stocks on the HKEX website. The contract size for stock option depends on the underlying stock. So for example 1 lot of HSBC share equal to 400 shares, so the contract size for HSBC option will cover 400 shares. The expiry date is the date which all unexercised contract will expire worthless, because all options has a limited life span. The exercise price is the predetermined buying or selling price for the underlying share if the option is exercised. The premium is the price of the option that is trade. For example if the HSBC option premium is $1.00, then the price for buying one contract will be $400.

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Trading Room
www.tradingforreal.blogspot.com

Option Buyer, Seller and Writer

So before I go into example, I want to make a concept clear. We need to think of option as a contract and for a contract there is a buyer and a seller. There is only one type of buyer which is someone who buy the option. On the other hand, there are actually two types of seller. Type 1 is someone who buy the option in the first place and sell it later on. Type 2 is someone who don’t own any option but who is able to create an option contract and sell it to someone else. For Type 2 seller, which we will call writer from now on to save any future confusions. Therefore to “create an option contract” means to “write an option contract”. The risk for option buyer is limited as oppose to the unlimited risk of being an option writer. Sound scary isn’t it. I will show you how to control the risk later.

Option basic

So before we go on with trading, we need to first learn the basic. As I said before, my trading involve a combination of share trading and option trading. So what is Option. Option is a kind of deriviatives from the market. There is two main type of option. A Call option and Put option. So let say we use stock option as an example. The buyer of Call option has the right to buy a certain stock at a specific price within a certain timeframe. The buyer of Put option has the right to sell their certain stock at a specific price within a certain time period. The writer (which is the guy you create this option) of Call option has the obligation to sell a certain stock at a specific price when the buyer exercise his/her right within that timeframe. The writer of Put option has the obligation to buy a certain stock at a specific price when the buyer exercise his/her right within that timeframe. Sound complicated .. I will give more example at a later post...

Hong Kong Stock Options

Let me give you a quick review of my trading system. My trading is a combination of stock and stock options trading. Which means I only trade optionable stock in the Hong Kong stock exchange. First I will use an option to acquire the shares then I will either sell the share directly for capital gain or I will use option to sell my shares. It might sound complicated at first but after you have go through my posting in the future. It will become much more easy to understand.
Happy Trading.

Tradingforreal

"tradingforreal" mean I really do trade for myself and as my site develop further I will include real trades that I made currently on the Hong Kong stock exchange including the reason for entry and exit of the trade. Before I do so, I will also post education material regarding share trading and option trading in order to give beginners some basic understanding of trading in general. Hope you will learn something useful.

Goodday

Goodday everyone, Welcome to my blog. The intention of creating this blog is to share with you my thoughs on trading and my opinion on the market. Hope you will learn something useful from this blog.

Trading Room

First post!!