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[T70]Tax On Stock Options

by Roger Cox, Rog

As my first mentor, Dr. Stephen Cooper, says ?The trend is your friend?. Generally, when the overall market trend is upwards then trade calls, when the overall market trend is downwards trade puts. Why buck the trend? Keep it simple?

The general market direction is determined by what the institutional investors are doing. Institutional investors are large corporations such as investment banks, mutual funds and insurance companies. They have billions of dollars to invest and they move the market. Small private investors such as us have very little effect on the direction of the market or a particular stock. If these corporations are investing their millions into the overall market or particular stocks then you should follow them. They may not necessarily know what they are doing but they do make the market so if the Dow Jones Industrial Average is down 200 points as a rule don't buy calls, conversely if it is up 200 points, again as a rule, don't buy puts.

Of course these are general rules and there are always exceptions. A particular sector or stock may be performing exceptionally well and just because the overall market is going down you may still have good fundamental and technical reasons to be buying calls in that particular sector or stock. Always double check the news sources I mentioned in Key #2, check the fundamentals explained in Key #3 and check the technical reasons for entering a trade covered in Key #4, if all of these factors combined determine a good trade then by all means take into account the overall direction of the market but do not let it stop you making the trade.

When trading it is imperative that you don't just take any one factor into account when deciding to place a trade, always ensure there are at least two good reasons for entering the trade and make sure there are no reasons not to trade. Remember overtrading is a common mistake if there is not a good reason to trade then just wait until another day, the market is constantly providing good opportunities to make money, have patience and wait for the right one. And remember, the trend is your friend!

Until next week, happy trading.

US Government required disclaimer: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of the Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 (1-800-678-4667).

There are several strategies and ways to exit a trade and you must decide which way (or ways) suits you. It is infinitely more difficult to decide when to exit a trade than when to enter it because it is at this time that you will either be making a profit or taking a loss! You will be faced with a myriad of different emotions while you are in a trade, most notably fear and greed. Fear appears in several different forms, fear of losing a profit already made, fear of getting out too early, fear of taking a loss and facing a mistaken trade. Greed also rears its ugly head by encouraging you to stay too long in a winning trade and possibly giving back some or all of your gains. There is an old adage on Wall Street that says ?Bulls can make money, bears can make money but pigs always get slaughtered.?

As I mentioned you must determine what suits you when it comes to deciding how much of a loss you can handle and how much of a profit you want to take. This is a direct reflection of your risk to reward ratio. For example, I often say ?I never feel bad when taking a profit?. I like to take profits when I see them and I generally have a fixed dollar figure or percentage in mind. Unless there is no good reason to exit the trade I will take my profits and if the trade keeps going in my direction after I have exited it doesn't bother me. Conversely I always have a fixed % loss I will accept. Some people would not be able to handle leaving money ?on the table? so they may prefer to let their trades run, but then they may need larger stop losses as well. When trading options stop losses need to be much larger than when you trade stocks because options are so much more volatile. For example if you set a 10% stop loss it could easily get triggered during a normal intraday move. Bear in mind that there is not as much at risk when trading options as opposed to trading stocks. The capital investment is much smaller so a larger stop loss will not impact your account as much.

Some good rules of thumb are: First if there is profit on the table and the underlying stock breaks down or crosses below its 7 day moving average, take the profit. There is nothing worse than watching a winning trade steadily lose value while you sit there hoping it will rise again. However if market conditions have not changed and your technical analysis supports staying in the trade make sure you do not exit too early. Often the most outstanding profits are made by patient traders. Second, always exit the trade if you are at a 50% loss. Chances are if you are in a trade that is losing 50% it will keep going that way. It is imperative you preserve your capital in order to trade again. Third, always exit a trade if there is 30 days or less before expiration. During the month before expiration time decay can rob you blind of the value of your option.

I trust this has given you some things to consider when deciding to exit your trades, stay tuned for next week's installment where we will discuss how to put together a complete trading plan.

US Government required disclaimer: Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of the Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 (1-800-678-4667).

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Roger Cox has sinced written about articles on various topics from Finances, Investments and Finances. Roger Cox is a native of New Zealand and now resides in Los Angeles. Former President of an international freight company he decided corporate life wasn't for him and starting his own consulting business. Roger has been successful in trading stock options. Roger Cox's top article generates over 2900 views. to your Favourites.