Profits With Candlesticks Analysis

How Do They Produce Profits With Candlesticks?

Gaps (Ku) are called windows (Mado) in Japanese Candlestick analysis. A gap or

window is one of the most misunderstood technical messages. Most investment experts

advise not to buy after a gap. This is true only about ten percent of the time. The other

90% of the time, the gaps will reveal powerful high profit trades. Candlestick signals,

correlated with the appearance of gaps, provide valuable profit-making set-ups.

What is the best investment you can make? Simple! Learning investment techniques that

make you independent of having to rely on any other investment consultation. You can

easily learn and quickly master common sense analysis that will dramatically improve

your returns for the rest of your life. You will feel confident in every trade you put on. No

more “hoping” that a trade will move in your direction. The unique built-in forces

encompassed in the candlestick signals and the strength of a move revealed by the

existence of a gap produce powerful trade factors. You can rest easy! Obtaining the

knowledge that this combination of signals reveals will produce consistent and strong

profits.

 

These are not “hidden” secret signals or newly discovered formulas that are just now

being exposed to the investment world. These are a combination of widely known but

little used investment techniques. Candlestick signals obviously have a statistical basis to

them or they would not still be in existence after all these centuries. Gaps have very

powerful implications. Combining the information of the two produces investment

returns that very few investors take the time to exploit.

 

Dissecting the implications of a gap/window makes its appearance easy to understand.

Once you understand why a gap occurs at different points in a trend, taking advantage of

what the gaps reveal becomes highly profitable. Where a gap occurs is important. The

ramification of a gap in a chart pattern is an important aspect to Japanese Candlestick

analysis. Some traders make a living trading strictly off of gaps.

 

Consider what a window or gap represents. In a rising market, it illustrates a price

opening higher than any of the previous day’s trading range. (For illustration in this book,

the “day” will be the representative time frame.)  What does this mean in   reality? During

the non-market hours, something made owning this stock tremendously desirable. So

desirable that the order imbalance opens the price well above the prior day’s body as well

 

as the high of the previous day’s trading range. As seen in Figure 1, note the space

between the high of the previous day and the low of the following day.

 

Figure 1 – Illustration of a gap. 

Witnessing a gap or window at the beginning of a new trend produces profitable

opportunities. Seeing the gap formed at the beginning of the trend reveals that upon a

reversal of direction, the buyers have stepped in with a great amount of zeal. A common

scenario is witnessing a prolonged downtrend. A Candlestick signal appears, a Doji or

Harami, Hammer, or any other signal that would indicate that the selling has stopped.

What is required to verify that the downtrend has stopped is more buying the next day.

This can be more solidly verified if the next day has a gap up move.

 

Many investors are apprehensive about buying a stock that has popped up from the

previous days close. A risky situation! Yet a Candlestick investor has been forewarned

that the trend is going to change, using a signal as that alert. A gap up illustrates that the

force of buying in the new upward trend is going to be strong. The enthusiasm shown by

the buyers trying to get into the stock demonstrates that the new trend should have a

strong move to it. Use that gap as a strength indicator.

 

Gaps occur in many different places and forms. Some are easy to see, some are harder to

recognize. This book will take you through the different situations where a gap has

appeared. Each situation will be explained in detail, (1) to give you a full understanding

of what is occurring during the move and (2) to provide a visual illustration to become

familiar with the formation, making it easy to recognize. This allows the Candlestick

investor to spot an investment situation as it is developing.

Money Making Candlestick

Money Making Candlestick Formations Candlestick Line

 

Hammer

An important bottoming candle-stick line.  The hammer and the hanging man are both the same line, that is a small real body (white or black) at the top of the session’s range and a very long lower shadow with little or no upper shadow.  When this line appears during a downtrend it becomes a bullish hammer.  For a classic hammer, the lower shadow should be at least twice the height of the real body.

 

Hanging man

An important top reversal.  The hanging man and the hammer are both the same type of candlestick line (i.e., a small real body (white or black), with little or no upper shadow, at the top of the session’s range and a very long lower shadow).  But when this line appears during an uptrend, it becomes a bearish hanging man.  It signals the market has become vulnerable, but there should be bearish confirmation the next session (i.e., a black candlestick session with a lower close or a weaker opening) to signal a top.  In principle, the hanging man’s lower shadow should be two or three times the height of the real body.

 

Harami

Harami — a two candlestick pattern in which a small real body holds within the prior session’s unusually large real body.  The haramiimplies the immediately preceding trend is concluded and that the bulls and bears are now in a state of truce.  The color of the second real body can be white or black.  Most often the second real body is the opposite color of the first real body.

 

Harami cross

A harami with a doji on the second session instead of a small real body.  An important top (bot- tom) reversal signal especially after a tall white (black) candlestick line.  It is also called a petrifying pattern.

 

Inverted hammer

Following a down-trend, this is a candlestick line that has a long upper shadow and a small real body at the lower end of the session.  There should be no, or very little, lower shadow.  It has thesame shape as the bearish shooting star, but when this line occurs in a downtrend, it is a bullish bottom reversal signal with confirmation the next session (i.e., a white candlestick with a higher close or a higher opening).

 

Morning star

A major bottom reversal pattern formed by three candlesticks.  The first is a long black real body, the second is a small real body (white or black) which gaps lower to form a star, the third is a white candlestick that closes well into the first session’s black real body.

 

Morning Doji Star

Morning doji star — the same as a morning star except the middle candle- stick is a doji instead of a small real body.  Because there is a doji in this pattern it is considered more bullish than the regular morning star.

 

Piercing pattern

A bottom reversal signal.  In a downtrend, a long black candlestick is followed by a gap lower during the next session.  This session finishes as a strong white candlestick which closes more than halfway into the prior black candlestick’s real body.  Com- pare to the on-neck line, the in-neck line, and the thrusting line.

 

Tweezers top and bottom

When the same highs or lows are tested the next session or within a few sessions.  They are minor reversal signals that take on extra importance if the two candle- sticks that comprise the tweezers pattern also form another candlestick indicator.  For example, if both sessions of a harami cross have the same high it could be an important top reversal since there would be a tweezers top and a bearish harem cross made by the same two candlestick  lines.

Money Making Candlestick

Money Making Candlestick Formations Candlestick Line

 

Candlestick Line

Candlestick lines and charts — traditional Japanese charts whose individual lines look like candles, hence their name.  The candle- stick line is comprised of a real body and shadows.   See “Real body” and “shadow.”

 

Candlestick Formations

Belt-hold line — there are bullish and bear- ish belt holds.  A bullish belt hold is a tall white candlestick that opens on its low.  It is also called a white opening shaven bottom. At a low price area, this is a bullish signal.  A bearish belt hold is a long black candlestick which opens on its high.  Also referred to as a black opening shaven head .  At a high price level, it is considered bearish.

 

Counterattack Lines

Counterattack lines — following a black (white) candlestick in a downtrend (up- trend), the market gaps sharply lower  (higher) on the opening and then closes unchanged from the prior session’s close. A pattern which reflects a stalemate between the bulls and bears.

 

Dark-cloud cover

A bearish reversal signal.  In an uptrend a long white candlestick is followed by a black candlestick that opens above the prior white candlestick’s high.  It then closes well into the white candlestick’s real body.

 

Doji –a session in which the open and close are the same (or almost the same).  There are different varieties of doji lines (such as a gravestone or long-legged doji) depending on where the opening and closing are in relation to the entire range.  Doji lines are among the most important individual candle-stick lines.  They are also components of important candlestick patterns.

 

Engulfing Patterns

Engulfing patterns  — there is a bullish and bearish engulfing pattern.  A bullish engulfing pattern is comprised of a large while real body which engulfs a small black real body in a down-trend.  The bullish engulfing pattern is an important bottom reversal.  A bearish engulfing pattern (a major top reversal pattern), occurs when selling pressure overwhelms buying pressure as reflected by a long black real body engulfing a small white real body in an uptrend.

 

Doji Star

Doji star — a doji line which gaps from a long white or black candlestick.  An important reversal pattern with confirmation during the next session.

 

Evening star

A major top reversal pattern formed by three candlesticks. The first is a tall white real body, the second is a small real body (white or black) which gaps higher to form a star, the third is a black candlestick which closes well into the first session’s white real body.

 

Evening doji star

The same as an evening star except the middle candle- stick (i.e., the star portion) is a doji instead of a small real body.  Because there is a doji in this patter, it is considered more bearish than the regular evening star.

RSI – Relative Strength Indicator

 

RSI – Relative Strength Indicator

Developed by J. Welles Wilder and introduced in his book, New Concepts in Technical Trading

Systems, the Relative Strength Index (RSI) is an extremely popular momentum oscillator. The

RSI compares the magnitude of a stock’s recent gains to the magnitude of its recent losses and

turns that information into a number that ranges from 0 to 100. It takes a single parameter, the

number of time periods to use in the calculation. Wilder recommends using 14 periods.

 

The RSI’s full name is actually rather unfortunate as it is easily confused with other forms of

Relative Strength analysis. Most other kinds of “Relative Strength” stuff involve using more than

one stock in the calculation. Like most true indicators, the RSI only needs one stock to be

computed. In order to avoid confusion, avoid using the RSI’s full name and just call it “the

RSI.”To be used in conjunction with Bollinger Bands, the Relative Strength Indicator or index is

based on a ratio of the average upward changes to the average downward changes over a given

period of time. It has a range of 0 to 100 with values typically remaining between 30 and 70.

 

Higher values indicate overbought conditions while lower values indicate oversold conditions.

 

The Relative Strength Index at the beginning of a data series is not defined until there are enough

values to fill the given period. In addition, the value is defined as 100 when no downward

changes occur during the given period. The Relative Strength Index (RSI) is typically used with a

9, 14, or 25 calendar day (7, 10, or 20 trading day) period against the closing price of a security

or commodity. The more days that are included in the calculation, the less volatile the value.

 

The RSI usually leads the price by forming peaks and valleys before the price data, especially

around the values of 30 and 70. In addition, when the RSI diverges from the price, the price will

eventually correct to the direction of the index. The Relative Strength Index function determines

the internal strength of a field using the number of upward and downward price changes over a

given period of time. To simplify the formula, the RSI has been broken down into its basic

components which are the Average Gain, the Average Loss, the First RS, and the subsequent

Smoothed RS’s.

 

For a 14-period RSI, the Average Gain equals the sum total all gains divided by 14. Even if there

are only 5 gains (losses), the total of those 5 gains (losses) is divided by the total number of RSI

periods in the calculation (14 in this case). The Average Loss is computed in a similar manner.

 

Calculation of the First RS value is straightforward: divide the Average Gain by the Average

Loss. All subsequent RS calculations use the previous period’s Average Gain and Average Loss

for smoothing purposes.

 

When the Average Gain is greater than the Average Loss, the RSI rises because RS will be

greater than 1. Conversely, when the average loss is greater than the average gain, the RSI

declines because RS will be less than 1. The last part of the formula ensures that the indicator

oscillates between 0 and 100.

 

Wilder recommended using 70 and 30 and overbought and oversold levels respectively.

Generally, if the RSI rises above 30 it is considered bullish for the underlying stock. Conversely,

if the RSI falls below 70, it is a bearish signal. Some traders identify the long-term trend and then

use extreme readings for entry points. If the long-term trend is bullish, then oversold readings

could mark potential entry points.

 

Buy and sell signals can also be generated by looking for positive and negative divergences

between the RSI and the underlying stock. For example, consider a falling stock whose RSI rises

from a low point of (for example) 15 back up to say, 55. Because of how the RSI is constructed,

the underlying stock will often reverse its direction soon after such a divergence. As in that

example, divergences that occur after an overbought or oversold reading usually provide more

reliable signals.

 

The centerline for RSI is 50. Readings above and below can give the indicator a bullish or

bearish tilt. On the whole, a reading above 50 indicates that average gains are higher than

average losses and a reading below 50 indicates that losses are winning the battle. Some traders

look for a move above 50 to confirm bullish signals or a move below 50 to confirm bearish

signals.

 

 

Standard Deviations

In this example Microsoft is charted using 20 day Bollinger bands at 2 standard deviations.

Contracting bands warn that the market is about to trend: the bands first converge into a narrow

neck, followed by a sharp price movement. The first breakout is often a false move, preceding a

strong trend in the opposite direction. A contracting range [C] is evident in June 1998: the bands

converge to a width of $2, followed by a breakout in July to a new high.

 

A move that starts at one band normally carries through to the other, in a ranging market. A move

Outside the band indicates that the trend is strong and likely to continue – unless price quickly

Reverses. Note the quick reversal [QR] in early August. A trend that hugs one band signals that

the trend is strong and likely to continue. Wait for divergence on a Momentum Indicator to signal

the end of a trend.

In this example, 20 day Bollinger Bands at 2 standard deviations and 10 day Rate of Change.

1. Go short [S] – bearish divergence on ROC.

2. Contracting Bollinger Bands [C] warn of increased volatility. This begins with a false rally

(note the ROC triple divergence) followed by a sharp fall.

3. Go long [L] – price hugs the lower band, followed by a bullish divergence on ROC.

4. Go short [S] – price hugs the upper band, followed by a bearish divergence on ROC.

 

Primary Functions

Again, although Bollinger Bands can help generate buy and sell signals, they are not designed to

determine the future direction of a security. The bands were designed to augment other analysis

techniques and indicators. By themselves, Bollinger Bands serve two primary functions:

 

  • To identify periods of high and low volatility
  • To identify periods when prices are at extreme, and possibly unsustainable, levels.

 

As stated above, securities can fluctuate between periods of high volatility and low volatility.

Being able to identify a period of low volatility can serve as an alert to monitor the price action

of a security. Other aspects of technical analysis, such as momentum, moving averages and

retracements, can then be employed to help determine the direction of the potential breakout.

 

Remember, buy and sell signals are not given when prices reach the upper or lower bands. Such

levels merely indicate that prices are high or low on a relative basis. A security can become

overbought or oversold for an extended period of time. Knowing whether prices are high or low

on a relative basis enhances interpretation of other indicators and timing issues in trading.

 

Bollinger Bands are a pair of values placed as an “envelope” around a data field. The values are

calculated by taking the moving average of the data for the given period and adding or

subtracting the specified number of standard deviations for the same period from the moving

average. Since Bollinger Bands use a moving average, the value at the beginning of a data series

is not defined until there are enough values to fill the given period. Used to confirm trading

signals, normally from a Momentum Indicator, the bands indicate overbought and oversold levels

relative to a moving average.

 

The bands are calculated at specified standard deviations above and below the moving average,

causing them to widen when prices are volatile and contract when prices are stable.

 

Bollinger Bands are useful for determining whether current values of a data field are behaving

normally or breaking out in a new direction. For example, when the closing price of a security

increases above its upper Bollinger Band, it will typically increase in that direction.

 

Bollinger Bands can also be used for identifying when trend reversals may occur. New highs or

lows outside of the bands followed by another high/low inside of the bands typically indicates a

reversal in the current trend.

 

Since the standard deviation can be used as a volatility indicator, the current width of the

envelope can also be used for trend information. A wide envelope indicates a high amount of

volatility, while a narrow envelope indicates a lower amount. High volatility levels can

sometimes be used to time trend reversals, such as market tops and bottoms. Low volatility levels

can sometimes be used to time the beginning of new upward price trends following periods of

consolidation.

 

Another observable trait of Bollinger Bands is that moves that begin at one band tend to go all

the way to the other band. This can be useful for forecasting future values. Bollinger Bands are

similar to Trading Bands and share many of their characteristics. However, unlike Bollinger

Bands, Trading Bands do not vary in width based on volatility.

Three Bands Encompassing

Again, this indicator consists of three bands encompassing a security’s price action. Defaults are:

 

1. A simple moving average in the middle, usually 20 days for intermediate investing.

2. An upper band ( 20 day SMA plus 2 standard deviations)

3. A lower band (20 day SMA minus 2 standard deviations)

 

Standard deviation is a statistical term that provides a good indication of volatility. Using it

ensures the bands will react quickly to price movements and reflect periods of high and low

volatility. Sharp price changes and hence volatility, will lead to a widening of the bands.

Closing prices are usually used to compute Bollinger Bands. Other variations can also be used.

The length of the moving average and number of deviations can be adjusted to better suit

individual preferences and specific characteristics of a security.

 

One method to determine an appropriate moving average length is a visual assessment. Bollinger

Bands should encompass the majority of price action, but not all. After sharp moves, penetration

of the bands is normal. If prices appear to penetrate the outer bands too often, then a longer

moving average may be required. If prices rarely touch the outer bands, then a shorter moving

average may be required.

 

A more exact method to determine moving average length is by matching it with a reaction low

after a bottom. For a bottom to form and a downtrend to reverse, a security needs to form a low

that is higher than the previous low. Properly set Bollinger Bands should hold support

established by the second (higher) low. If the second low penetrates the lower band, then the

moving average is too short. If the second low remains above the lower band, then the moving

average is too long. The same logic can be applied to peaks and reaction rallies. The upper band

should mark resistance for the first reaction rally after a peak.

 

In addition to identifying relative price levels and volatility, Bollinger Bands can be combined

with price action and other indicators to generate signals and foreshadow significant moves:

 

Double bottom buy: A double bottom buy signal is given when prices penetrate the lower band

and remain above the lower band after a subsequent low forms. Either low can be higher or lower

than the other. The important thing is that the second low remains above the lower band. The

bullish setup is confirmed when the price moves above the middle simple moving average.

 

Double top sell: A sell signal is given when prices peak above the upper band and a subsequent

peak fails to break above the upper band. The bearish setup is confirmed when prices decline

below the middle band.

 

Sharp price changes can occur after the bands have tightened and volatility is low. In this

instance, Bollinger Bands do not give any hint as to the future direction of prices. Direction must

be determined using other indicators and aspects of technical analysis. Many securities go

through periods of high volatility followed by periods of low volatility. Using Bollinger Bands,

these periods can be easily identified with a visual assessment. Tight bands indicate low

volatility and wide bands indicate high volatility.

Bollinger Bands Rules

following are a few rules that serve as a good Beginning point.

 

1. Bollinger bands provide a relative definition of high and low.

2. That relative definition can be used to compare price action and indicator action to arrive at

Rigorous buy and sell decisions.

3. Appropriate indicators can be derived from momentum, volume, sentiment, open interest,

Inter-market data, etc.

4. Volatility and trend have already been deployed in the construction of bollinger bands, so

Their use for confirmation of price action is not recommended.

5. The indicators used should not be directly related to one another. For example, you might use

One momentum indicator and one volume indicator successfully.

6. Bollinger bands can also be used to clarify pure price patterns such as “m” tops and “w”

Bottoms, momentum shifts, etc.

7. Price can, and does, walk up the upper bollinger band and down the lower bollinger band.

8. Closes outside the bollinger bands are continuation signals, not reversal signals. (this has

Been the basis for many successful volatility breakout systems.)

9. The default parameters of 20 periods for the moving average and standard deviation

Calculations, and two standard deviations for the bandwidth may be varied for the market.

10. The average deployed should not be the best one for crossovers. Rather, it should be

Descriptive of the intermediate-term trend.

11. If the average is lengthened the number of standard deviations needs to be increased

Simultaneously; from 2 at 20 periods, to 2.5 at 50 periods. If the average is shortened the

Number of standard deviations should be reduced; from 2 at 20 periods, to 1.5 at 10 periods.

12. Bollinger bands are based upon a simple moving average. This is because a simple moving

Average is used in the standard deviation calculation and we wish to be logically consistent.

13. Make no statistical assumptions based on the use of the standard deviation calculation in the

Construction of the bands. The sample size in most deployments of bollinger bands is simply

Too small for statistical significance.

14. Finally, tags of the bands are just that, tags not signals. Touching the upper band is not in-

And-of-itself a sell signal and touching the lower band is not in-and-of-itself a buy signal.

 

Bollinger Bands

Developed by John Bollinger, Bollinger Bands allows users to compare volatility and relative

Price levels over a period time. Bollinger Bands are envelopes which surround the price bars on a

Chart. They are plotted two standard deviations away from a simple moving average. Because

Standard deviation is a measure of volatility, the bands adjust themselves to ongoing market

Conditions. They widen during volatile market periods and contract during less volatile periods.

Bollinger Bands are, essentially, moving standard deviation bands.

 

Bollinger Bands are sometimes displayed with a third center line. This is the simple moving

average line. Mr. Bollinger recommends using a 10 day moving average for short term trading,

20 days for intermediate term trading, and 50 days for longer term trading.

 

The standard deviation value may be varied. Increase the value of the standard deviation from 2

standard deviations to 2-1/2 standard deviations away from the moving average when using a 50

day moving average. Conversely, lower the value of the standard deviation from 2 to 1-1/2

standard deviations away from the moving average when using a 10 day moving average.

 

Bollinger Bands do not generate buy and sell signals alone. They should be used with another

indicator. I use them with RSI, described below. This is because when price touches one of the

bands, it could indicate one of two things. It could indicate a continuation of the trend; or it could

indicate a reaction the other way. By themselves they do not tell us when to buy and sell.

 

However, when combined with an indicator such as RSI, they become powerful. RSI is an

excellent indicator with respect to overbought and oversold conditions. When price touches the

upper band, and RSI is below 70, we have an indication that the trend will continue. When price

touches the lower band, and RSI is above 30, we have an indication that the trend will continue.

 

If we run into a situation where price touches the upper band and RSI is above 70 (possibly

approaching 80) we have an indication that the trend may reverse itself and move downward. On

the other hand, if price touches the lower band and RSI is below 30 (possibly approaching 20) we

have an indication that the trend may reverse itself and move upward.

 

Avoid using several different indicators all using same input data. If you’re using RSI with the

Bollinger Bands, don’t use MACD too. They both use the same inputs. Consider using On

Balance Volume, or Money Flow with RSI. Relying on different inputs they measure different

things. They can be used together as further confirmation of a trend.

Futures Stock Options Glossary

QUICK REFERENCE GLOSSARY ON FUTURES AND OPTIONS

FUTURES TERMINOLOGY

  1. SPOT PRICE: The price at which an asset trades in the spot market.
  2. FUTURES PRICE: The price at which the futures contract trades in the futures market.
  3. CONTRACT CYCLE: The period over which a contract trades. The index futures contracts on the NSE have one month, two months and three months expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three month expiry is introduced for trading.
  4. EXPIRY DATE: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.
  5. CONTRACT SIZE: The amount of asset that has to be delivered under one contract. For instance, the contract size on NSE’s futures market is 200’Nifties.
  6. BASIS: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each deliver}’ month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceeds spot prices.
  7. COST OF CARRY: The relation ship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.
  8.  INITIAL MARGIN: The amount that must be deposited.in the margin account at the time a futures contract is first entered into is known as initial margin.
  9. MARKING TO MARKET: In the futures market, t the end of each trading day, the margin account is adjusted to reflect the investor’s gain or loss depending upon the futures closing price. This is called marking to market.
  10. MAINTENANCE MARGIN: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day.
  11. OPTIONS TERMINOLOGY
  12. CALL OPTION: A call option gives the buyer, the right, but not the obligation to buy an asset before a certain date for a certain price.
  13. PUT OPTION: A Put option gives the buyer, the right, but not the obligation to sell an asset before a certain date for a certain price.
  14. BUYER OF AN OPTION: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.
  15. SELLER AVERT OF AN OPTION: The seller/writer of an option is the one who receives the option premium and is thereby obliged to sell/buy the underlying asset if the buyer exercises on him.
  16.  STOCK OPTIONS: Stock options are options on Individual Stocks.
  17.  INDEX OPTIONS: These options have the index as the underlying.
  18. AMERICAN OPTIONS: American options are options that can be
  19. exercised at any time up to the expiration date. Generally stock options are American.
  20. EUROPEAN OPTIONS: European options are options that can be exercised only on the expiration date itself. In India Index options are European,
  21. OPTION PRICE/PREMIUM: Option price/premium is the price
  22. which the option buyer pays to the option seller.
  23. EXPIRATION DATE: The date specified in the options contract is known as the expiration date, exercise date, strike date or maturity.
  24. STRIKE PRICE: The set price for which underlying shares can be purchased or sold in an option contract. It is also referred as exercise price.
  25. AT-THE-MONEY OPTION: If the Exercise price of an option is equal to the price of its underlying shares, then the option contract is Atthe Money.
  26. IN-THE-MONEY OPTION: A call option is In-the-Money when the underlying shares are selling above the exercise price. A put is In-the- Money when the underlying shares are selling below the strike price.
  27. OUT-OF-THE-MONEY OPTION: A call option is out of the money if strike price is above the market price of the underlying, A put option is out of the money if the strike price is below the market price of the underlying shares.
  28. NAKED OPTIONS: The selling of options for the premium income without owming the underlying securit ies.
  29. SPREAD: Two, options a put and a call, on the same stock and expiring on the same day. How ever, the strike price on the two options is different, and the speculator hopes to profit from the change in the difference. By buying the put, the speculator is guaranteed a sale if the market drops but is also guaranteed a buy if the market advances.
  30. INTRINSIC VALUE OF AN OPTION: That portion of an option’s value attributable to its selling In-the-Money. In a call option it is the excess of the market price of the underlying shares over the strike price, In a put option it is the excess of the strike price of the option over the market value of the underlying shares.
  31. TIME VALUE OF AN OPTION: The Value of an option premium that reflects only the period to expiration.
  32. OPTIONS – IMPORTANT POINTS:  The best time to buy options is when markets are dull and premiums are cheap. But cheap premiums do not provide enough of a reason to buy options. You must have a concrete reason to believe that some information within the exercise period will strongly move the underlying shares. Options are most costly in Bull markets, and calls are proportionately more expensive than puts.
  33. In-the-Money options are less speculative than out-of-the money options. Out-of-the money options have the most leverage. You can control the shares for the smallest premium. However, Out-of-the Money options have the least chance of being profitable.
  34. To profit on the sell side, you must sell overpriced options. The best time to sell calls is at the top of markets, and conversely, the time to sell puts is at the bottom.
  35. Sell Out-of-the Money options since the time value is certain to erode the option’s value. Profits can be made even before the expiration through an offsetting transaction.
  36. Since the options market is highly leveraged, You must monitor your positions daily.
  37. If you have a strong sense of market direction, you can capitalize on that talent by trading index options In volatile markets these options can be quite profitable.

 

 

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