The stock market often tends to close the week in the middle of a short-term trading range. SPX closed last week at about 1,259 1/2. Short-term support is at 1,246 (previous four-year high) and short-term resistance is at 1,273 (recent 4 1/2 year high). The trading range may continue next week, which is options expiration week.

Normally, options expiration weeks are volatile, and there are many events next week that will contribute to volatility. OPEC meets on Monday, the FOMC announcement is Tuesday, there are many important economic reports throughout the week (listed below), data on the holiday sales season will be reported, and oil prices will continue to influence the market.

The two charts below are SPX and OIH (oil ETF) daily charts. The central tendency of SPX next week may be 1,260. So, if SPX falls to the low 1,250s, that may be an opportunity to buy calls, and if it rises to the high 1,260s, that may be an opportunity to buy puts. OIH is relatively overvalued (compared to SPX and oil prices), because it has been rising into the OPEC meeting. However, OIH may pullback to around 125 sometime next week, and puts may be a buy.

Next week’s monthly or quarterly economic reports are: Monday-Treasury Budget, Tuesday-Retail Sales, and Business Inventories, Wednesday-Trade Balance, Export Prices, and Import Prices, Thursday-CPI, Empire State Index, Industrial Production, Capacity Utilization, and Philadelphia Fed, and Friday-the Current Account. The weekly retail sales report is Tuesday, the weekly oil inventory report is Wednesday, and the weekly unemployment claims report is Thursday.

The Nasdaq 100 was rebalanced after the close Friday (12 stocks were replaced), which may contribute to volatility Monday. The OEX Dec Max Pain point remains at 575 (with the value of calls far greater than puts) and QQQQ Dec Max Pain remains at 41 (with the value of puts far more than calls). OEX closed at about 574 3/4 and QQQQ closed at about 41 3/4 Friday. The second half of December is normally bullish. However, there are concerns about the "consumption bubble," created by strong housing demand over the past few years (consumption represents two-thirds of GDP).

Charts available at www.PeakTrader.com Forum Index Market Overview section.

Arthur Albert Eckart is the founder and owner of PeakTrader. Arthur has worked for commercial banks, e.g. Wells Fargo, Banc One, and First Commerce Technologies, during the 1980s and 1990s. He has also worked for Janus Funds from 1999-00. Arthur Eckart has a BA & MA in Economics from the University of Colorado. He has worked on options portfolio optimization since 1998.

Mr Eckart has developed a comprehensive trading methodology using economics, portfolio optimization, and technical analysis to maximize return and minimize risk at the same time and over time. This methodology has resulted in excellent returns with low risk over the past four years.

You may believe that professional traders have a huge advantage over the average “homegamer” as Jim Cramer likes to refer to the viewers of his very popular show on CNBC called “Mad Money”. You probably think the pros have a lot of advantages like top notch research and access to high level executives at many listed companies. Well, thanks to the internet, homegamers can now access that same research and thanks to Regulation FD, which mandates fair disclosure of all significant company information in a public forum like an SEC filing or a press release, those cozy one on one meetings are no longer legal although they probably still occur.

One of the professional trader’s advantages is something that you can easily adopt. It is called Money Management or Risk Management. There is nothing exciting or sexy about it, but without it you’re just gambling. I always recommend Vegas for gambling. The casinos there will at least give you a room, a meal and as many drinks as you can handle. Vegas makes it fun to gamble and lose. Wall St. will give you nothing but a quarterly statement reminding you that gambling does not work. Money management is the crucial step of calculating risk before entering every new investment or trade. In this article, I am going to explain how any homegamer can implement a money management system and start trading like a pro.

First, you need to assess your own risk tolerance. Are you willing to swallow large losses (greater than 2% of total account size) on any given trade or investment? Maybe you are only comfortable taking a ½ of 1% hit on any one idea. These are preferences unique to each investor. The next step is to set up the parameters for the trade. You need to be educated and realistic about expectations both good and bad. Stop price is the parameter you set usually based on analyzing a chart of the stock you’re considering for an investment or trade. The stop price could be a support level, a percent retracement from a recent high or a confirmation of a bearish chart formation. The idea of a stop price is to get you out of a stock before it really goes against you in an unrecoverable way. The target price is another parameter you set and is usually based either on a fundamental analysis of the stock to determine fair value or a technical analysis that uses charts to predict where the stock could ultimately move to before the momentum subsides. For example, let’s look at a potential investment in Microsoft (Symbol MSFT). The stock has traded in a $4 range for a year. If you decided to buy MSFT in October 2005 at $25 per share you can realistically frame your trade using the $4 range. You could set your stop price at $24 per share since that has shown to be a good support level during 2005. You could set your target to be $28 per share since that has been the top of the range for MSFT the whole year. Now if you plug in the rest of your parameters, let’s say 1% for risk tolerance, $100k for total account size into a Position Size Calculator such as the one available for free at http://broadbandbrew.com/positionsizing_calc.htm you will quickly see that you can safely purchase a maximum of 1000 shares of MSFT and still adhere to your risk management system. The Position Size Calculator is a calculator that uses parameters you set to determine the correct number of shares you should trade for each investment you are considering as well as the risk/reward ratio and total profit potential if your target is met. In the MSFT example the risk/reward is actually pretty good at 3.0 ($3 up and $1 down). The total profit for the trade is $3,000.00 (not including commissions) which is a 12% gain. That’s not bad for a homegamer.

The Microsoft example is one case. Now let’s look at another trade, one with very different dynamics. TLT Put Options that expire in 10 trading days. If you decided to buy this option at $0.25 on 11/28 and hold till maturity, it could very well be worth zero or several dollars. It actually was trading at $0.55 just 2 days after your hypothetical purchase. That’s over a 100% return in 2 days. You’re a genius or just real lucky. It doesn’t matter as long as you managed the risk.

How does one manage this high level of risk you might ask? Exactly the same way we did for the MSFT example. You could realistically use zero as your stop loss since it’s unlikely you will have a chance to stop out due to the extreme volatility. Using the same 1% risk tolerance and $100k account size, the Position Size Calculator comes up with 40 contracts, the maximum number of contracts (options trade in contracts where one contract leverages 100 shares) that you can safely buy and still adhere to your risk management system. If you sold the options at $0.55 you made $1200 (not including commissions) which is a 120% return in two days. Once again, that’s not bad for a homegamer.

I bring up these very different trading examples to make this point. By employing a risk management system, you can trade pretty much anything without fear of depleting your account beyond acceptable levels. Even if you lose, you will survive to trade another day.

I can’t stress enough the importance of risk management. The winning investments always take care of themselves. It’s the losing ones that cause homegamers problems. You just can’t let one losing trade impact your entire account to the point where getting back to even requires unrealistic returns.

It is interesting that most amateur investors and traders focus most of their efforts on investment selection and timing their trades. They spend little or no time on money management. Some always trade a fixed dollar amount while others use a fixed % stop loss regardless of the varying dynamics of each trade. If you don’t account for the different characteristics of each investment or trade, you are either taking too much risk or not enough. In the long run this will handicap your performance.

There are quite a few different position-sizing strategies that you can use. Some work best with stocks, while others are better suited for derivative trading (options, futures, etc…). All of them are anti-martingale strategies where the size of the position goes up as your account size grows. For a much more in depth discussion of money management systems and position sizing I recommend reading “Trade your way to financial freedom” by Van K. Tharp.

Yes you can trade stocks and options like a pro. You just need to focus on managing risk the way professionals do. You need to use position sizing models like the one employed by this position sizing calculator: http://broadbandbrew.com/positionsizing_calc.htm You need to be consistent in applying your own risk tolerance, and you need to have realistic parameters for each trade or investment you consider.

Anatole Raif is President and Founder of http://www.BroadbandBrew.com, an investor service of MicroE Technologies, LLC. Anatole is a professional stock trader. For over fourteen years Anatole has specialized in identifying and trading growth stocks in the short and intermediate-term time frames. http://www.BroadbandBrew.com is home to traders and active investors who are looking to benefit from working alongside professional traders. Anatole can be reached at anatole@broadbandbrew.com.

Next week is options expiration week, which is typically volatile. Also, important economic reports next week may generate even greater volatility. The Fed (i.e. Federal Reserve) has adopted a "data dependent" policy, which makes inflation related reports most important for the stock market.

Next week economic reports are: Mon–None, Tue–Retail Sales, and Business Inventories, Wed–Capacity Utilization, Industrial Production, Empire State Index, Net Foreign Purchases, Oil Inventories, Thu–Building Permits, Housing Starts, Import & Export Prices, Unemployment Claims, and Fri–PPI, Michigan Consumer Sentiment, Philadelphia Fed.

Inflation related reports are Capacity Utilization, Import Prices, Unemployment Claims, and the PPI. Moreover, the market may perceive strong production and consumption as inflationary, although weak growth with inflation, i.e. stagflation, is also of concern. One month of data don’t make a trend. Nonetheless, the market may react strongly to these reports.

Over the next few weeks, the market will estimate future monetary policy by tying together recent economic reports. Real economic growth is expected to pick-up this quarter to above 3% from the 1% growth rate in the fourth quarter. So, inflation data will be of particular concern.

The unwinding of options will also generate volatility. Some Feb Max Pain expirations are: SPX 1,275 with the value of calls roughly three times greater than the value of puts, OEX 575 with the value of calls over three times more than puts, and QQQQ 42 with the value of calls about 25% greater than puts.

The chart below is an SPX daily chart. Last week, SPX traded within the Dec consolidation area (also, see extended Price-by-Volume bar on left side of chart) roughly between 1,250 and 1,275. Feb Max Pain expirations indicate SPX will trade in the consolidation area again next week. However, the following week, SPX should break to the upside or downside.

In late Jan, the MACD indicator moved towards a potential bullish crossover and then gave a bearish kiss (see circle). Consequently, SPX fell shortly afterwards. Currently, MACD is moving towards another potential bullish crossover, which may determine a breakout above 1,275 or breakdown below 1,250.

The recent bearish megaphone pattern (of higher highs and lower lows) favors a breakdown. However, a MACD crossover may cause a powerful short-term bounce, while another bearish kiss may cause a breakdown below the lower line of the megaphone pattern. Nonetheless, uncertainty about monetary policy may persist for several more weeks, while the market and the Fed are "data dependent."

Charts available at http://www.peaktrader.com/ Forum Index Market Forecast section.

Arthur Albert Eckart is the founder and owner of PeakTrader. Arthur has worked for commercial banks, e.g. Wells Fargo, Banc One, and First Commerce Technologies, during the 1980s and 1990s. He has also worked for Janus Funds from 1999-00. Arthur Eckart has a BA & MA in Economics from the University of Colorado. He has worked on options portfolio optimization since 1998.

Mr Eckart has developed a comprehensive trading methodology using economics, portfolio optimization, and technical analysis to maximize return and minimize risk at the same time and over time. This methodology has resulted in excellent returns with low risk over the past four years.

As a performance incentive many companies are starting to offer employees the “option” to buy company stock as a part of their compensation packages. These “options” are referred to as stock options and they provide a unique opportunity for an employee to potentially increase his or her wealth along side company shareholders. The employee receiving company stock options should have a good understanding of the characteristics of the different types of stock options in order to maximize their potential benefits.

A stock option is a right granted by a company to an employee to purchase one or more shares of the company’s stock at a set time and predetermined purchase price. The employee benefits when the value of the company stock appreciates over and above the predetermined purchase price following the granting of the stock options, enabling the holder to purchase the company stock at a discount. There are two types of stock options: non-qualified stock options and incentive stock options.

Non-qualified stock options (NQSO) are more frequently offered to employees than Incentive Stock Options because of their flexibility and minimal requirements. NQSOs afford the employee the right to purchase a set number of employer shares at a specific, predetermined price. If the employee wishes to acquire the employer stock then he or she will exercise the option and purchase the employer stock at the predetermined (exercise) price. If the stock’s value has appreciated over and above the predetermined price the employee has received the benefit of acquiring the stock at a discount. The difference between the exercise price and the market value (commonly referred to as the bargain element) will be taxable income to the employee as ordinary income, potentially as high as 35%.

The other type of stock option is the Incentive Stock Option (ISO). In direct contrast to a nonqualified stock option, there is no income tax consequence when an employee exercisers the option to buy the employer stock. The difference between the exercise price and the market value (bargain element) is only taxable upon the ultimate sale of the employer stock. In other words, a gain is only recognized when the employer stock is sold and not when the option is exercised. If the stock is held the appropriate time period before being sold, all the gains recognized may qualify for long-term capital gains treatment, a maximum rate of 15%.

Being able to take part in an ISO program allows an employee to receive a number of tax saving benefits. But with these tax benefits comes added complexity to keep track of and to understand. For example, to qualify for the favorable long-term capital gain taxation, the employee must hold the stock for at least two years from the date the ISO was granted and for at least one year from the date the option was exercised. This is commonly referred to as the “2 year / 1 year rule”. If the employee sells the stock before these requirements are met, gain on the stock is taxed as ordinary income in the year of the sale, essentially converting the ISO to a non-qualified stock option.

An additional complexity of an ISO that should be kept in mind by the employee is the potential for an alternative minimum tax (AMT) consequence upon exercise of an ISO. For this and other reasons, it remains important to work with your financial advisor and tax professional when evaluating the strategies to take full advantage of the opportunities and benefits of stock options.

Fearing the American worker is being left in the dark, Mr. Morris, a fee based Investment Advisor Representative with Raymond James Financial Services, Inc., helps 401k participants get the most out of their retirement plan.

Statutory Stock Option Plans.

Generally, property transferred to an employee in connection with services performed by the employee, results in ordinary income to the employee and a deduction to the employer. The Code does provide for special tax treatment for statutory stock options. The transfer of a statutory stock option to an employee has no tax consequence until the employee sells the stock. At that time, the employee pays capital gains tax (generally 15%) on the difference between the option price and the amount received. However, if the option price was less than the fair market value at the time the option was granted, the employee must recognize ordinary income (taxed up to 35%) on the difference between the option price and the fair market value at the time the option was granted.

As this is extremely confusing, an example is appropriate:

In year one, Employer (GM) gives Employee a five year statutory stock option to purchase one share of GM for $100. At the time, shares of GM have a fair market value of $100. In year 3, when shares of GM have a fair market value of $150, Employee exercises the option by paying GM $100 for the share of stock. In year five, Employee sells stock to a 3rd party for $200.

There is no tax consequence to any party in year one. In year three, Employee does not recognize any income. GM may have capital gain income equal to the $100 received minus GM’s basis in the share. In year five, employee will have a $100 capital gain. GM does not receive a deduction.

Numerous requirements must be met to qualify as a statutory stock option. They provide a tax advantage for the employee in that tax on the appreciation is deferred until sale and the appreciation is taxed at a capital gains rate. There is no tax advantage for the employer, however, because no deduction is allowed.

If the employer’s marginal tax rate is as high as the employees’ marginal tax rate, there may be no overall advantage in utilizing a statutory stock option.

Non-statutory Stock Option Plans.

A non-statutory stock option plan is simply one that does not meet the requirements of a statutory plan. Generally, the employee will realize ordinary income at the time that the option is granted. Income recognition is deferred, however, if the employees’ rights to the stock are not vested or if the stock does not have a readily ascertainable fair market value. Although income recognition deferral is a general goal of tax planning, in this case, the advantage of deferral must be weighed against the disadvantage that the appreciation in the stock is taxed as ordinary income (up to 35% rate) rather than capital gain (usually a 15% rate).

In some circumstances, the employee may elect to recognize income at the time that the option is granted. By doing so, appreciation in the stock is taxed at capital gains rate when the stock is sold.

Employers are entitled to a deduction equal to the ordinary income recognized by the employee. The employer may not claim this deduction until the year the employee includes the income in his/her return. The employer may also have capital gain or loss when the option is exercised equal to the option price minus the employer’s basis in the stock.

It is more difficult to value a stock option than the underlying stock. The stock option value is based on the value of the underlying stock and the option privilege. Accordingly, it is more likely that a stock option will not have a “readily ascertainable value.” This means that the stock option is less likely to be immediately taxable to the employee (and deductible to the employer). This also means that an employee is less likely to be eligible to make an election to immediately recognize income (to avoid ordinary income taxation on stock appreciation).

For this reason, it is sometime preferable to issue stock bonuses rather than stock options.

Tax accountant John Huddleston has a law degree and masters in tax law from the University of Washington School of Law. He has been a guest tax expert on the radio. He advises small businesses in the Seattle Bellevue Kent Everett area on various tax issues. His firm, Huddleston tax accountants, also provides tax preparation service, quickbooks consulting and general accounting and bookkeeping service. Seattle Bellevue tax accountant John Huddleston is a frequent publisher of tax saving ideas.

INTRODUCTION

Having been trading stocks and options in the capital markets professionally over the years, I have seen many ups and downs.

I have seen paupers become millionaires overnight…

And

I have seen millionaires become paupers overnight…

One story told to me by my mentor is still etched in my mind:

“Once, there were two Wall Street stock market multi-millionaires. Both were extremely successful and decided to share their insights with others by selling their stock market forecasts in newsletters. Each charged US$10,000 for their opinions. One trader was so curious to know their views that he spent all of his $20,000 savings to buy both their opinions. His friends were naturally excited about what the two masters had to say about the stock market’s direction. When they asked their friend, he was fuming mad. Confused, they asked their friend about his anger. He said, ‘One said BULLISH and the other said BEARISH!’”

The point of this illustration is that it was the trader who was wrong. In today’s stock and option market, people can have different opinions of future market direction and still profit. The differences lay in the stock picking or options strategy and in the mental attitude and discipline one uses in implementing that strategy.

I share here the basic stock and option trading principles I follow. By holding these principles firmly in your mind, they will guide you consistently to profitability. These principles will help you decrease your risk and allow you to assess both what you are doing right and what you may be doing wrong.

You may have read ideas similar to these before. I and others use them because they work. And if you memorize and reflect on these principles, your mind can use them to guide you in your stock and options trading.

PRINCIPLE 1

SIMPLICITY IS MASTERY

When you feel that the stock and options trading method that you are following is too complex even for simple understanding, it is probably not the best.

In all aspects of successful stock and options trading, the simplest approaches often emerge victorious. In the heat of a trade, it is easy for our brains to become emotionally overloaded. If we have a complex strategy, we cannot keep up with the action. Simpler is better.

PRINCIPLE 2

NOBODY IS OBJECTIVE ENOUGH

If you feel that you have absolute control over your emotions and can be objective in the heat of a stock or options trade, you are either a dangerous species or you are an inexperienced trader.

No trader can be absolutely objective, especially when market action is unusual or wildly erratic. Just like the perfect storm can still shake the nerves of the most seasoned sailors, the perfect stock market storm can still unnerve and sink a trader very quickly. Therefore, one must endeavor to automate as many critical aspects of your strategy as possible, especially your profit-taking and stop-loss points.

PRINCIPLE 3

HOLD ON TO YOUR GAINS AND CUT YOUR LOSSES

This is the most important principle.

Most stock and options traders do the opposite…

They hold on to their losses way too long and watch their equity sink and sink and sink, or they get out of their gains too soon only to see the price go up and up and up. Over time, their gains never cover their losses.

This principle takes time to master properly. Reflect upon this principle and review your past stock and options trades. If you have been undisciplined, you will see its truth.

PRINCIPLE 4

BE AFRAID TO LOSE MONEY

Are you like most beginners who can’t wait to jump right into the stock and options market with your money hoping to trade as soon as possible?

On this point, I have found that most unprincipled traders are more afraid of missing out on “the next big trade” than they are afraid of losing money! The key here is STICK TO YOUR STRATEGY! Take stock and options trades when your strategy signals to do so and avoid taking trades when the conditions are not met. Exit trades when your strategy says to do so and leave them alone when the exit conditions are not in place.

The point here is to be afraid to throw away your money because you traded needlessly and without following your stock and options strategy.

PRINCIPLE 5

YOUR NEXT TRADE COULD BE A LOSING TRADE

Do you absolutely believe that your next stock or options trade is going to be such a big winner that you break your own money management rules and put in everything you have? Do you remember what usually happens after that? It isn’t pretty, is it?

No matter how confident you may be when entering a trade, the stock and options market has a way of doing the unexpected. Therefore, always stick to your portfolio management system. Do not compound your anticipated wins because you may end up compounding your very real losses.

PRINCIPLE 6

GAUGE YOUR EMOTIONAL CAPACITY BEFORE INCREASING CAPITAL OUTLAY

You know by now how different paper trading and real stock and options trading is, don’t you?

In the very same way, after you get used to trading real money consistently, you find it extremely different when you increase your capital by ten fold, don’t you?

What, then, is the difference? The difference is in the emotional burden that comes with the possibility of losing more and more real money. This happens when you cross from paper trading to real trading and also when you increase your capital after some successes.

After a while, most traders realize their maximum capacity in both dollars and emotion. Are you comfortable trading up to a few thousand or tens of thousands or hundreds of thousands? Know your capacity before committing the funds.

PRINCIPLE 7

YOU ARE A NOVICE AT EVERY TRADE

Ever felt like an expert after a few wins and then lose a lot on the next stock or options trade?

Overconfidence and the false sense of invincibility based on past wins is a recipe for disaster. All professionals respect their next trade and go through all the proper steps of their stock or options strategy before entry. Treat every trade as the first trade you have ever made in your life. Never deviate from your stock or options strategy. Never.

PRINCIPLE 8

YOU ARE YOUR FORMULA TO SUCCESS OR FAILURE

Ever followed a successful stock or options strategy only to fail badly?

You are the one who determines whether a strategy succeeds or fails. Your personality and your discipline make or break the strategy that you use not vice versa. Like Robert Kiyosaki says, “The investor is the asset or the liability, not the investment.”

Understanding yourself first will lead to eventual success.

PRINCIPLE 9

CONSISTENCY

Have you ever changed your mind about how to implement a strategy? When you make changes day after day, you end up catching nothing but the wind.

Stock market fluctuations have more variables than can be mathematically formulated. By following a proven strategy, we are assured that someone successful has stacked the odds in our favour. When you review both winning and losing trades, determine whether the entry, management, and exit met every criteria in the strategy and whether you have followed it precisely before changing anything.

In conclusion…

I hope these simple guidelines that have led my ship out of the harshest of seas and into the best harvests of my life will guide you too. Good Luck.

Jason Ng is the Founder of Masters ‘O’ Equity international. He is a fund manager specialising in options trading and his Star Trading System has helped thousands of traders worldwide achieve financial freedom. Please visit Masters ‘O’ Equity’s website at http://www.mastersoequity.com.

Options are most commonly used by investors for either leverage and / or insurance (hedging). As leverage, options allow the investor to control an equity position without paying 100% of the share price. For example, rather than going on the open market and purchasing 100 shares of IBM for $8,257 ($82.57 per share), an investor could control the same amount of shares at a given strike price for a fraction of the cost such as the Jan 07 $80 strike with a total cost of $1,050. As insurance / hedge, options can assist in protecting against price fluctuations. For example, the same IBM investor can sell a call against his shares which will reduce the basis in the equity position by the premium received. In other words, he has hedged his position against any short term fluctuations his equity position may experience.

Selling options provides many benefits with the major reason being collecting premium from the sale of such an option. The premium collected goes into your account and can then be used to invest in other positions. The writer keeps the premium regardless of whether or not the option is exercised. Another important aspect with selling options is that of time value which now works for you rather than against you.

Selling options is not new and it isn’t as complicated as many make it out to be. It is a viable means of generating consistent income from your portfolio. If you are not selling options against your positions you are losing out on money you could be putting in your pocket each and every month. Keep in mind writing covered calls are not get rich quick strategies. They are a means of generating income for the individual investor regardless of their trading expertise.

Stock Market Cash Machine helps traders learn the advantages of writing covered calls. Covered Calls are often misunderstood but when used correctly can assist investors in generating monthly income as well as providing downside protection.

Covered Calls

A highly successful financial product nowadays, stock options offer the investor flexibility, diversification and control to protect his/her stock portfolio or generate more investment income. Options are advantageous because they can be used under almost every market condition and for almost every investment objective. Options also help the investor to purchase stock at a lower price and to benefit from a stock price’s rise or fall without owing the stock or selling it outright.

As options have a unique risk/reward structure, they can be used in combination with other option contracts and/or other financial tools to seek profits or protection.

Using stock options, investors can fix the price for a specific period of time, at which an investor can buy or dispose of 100 shares of stock for a premium that is only a percentage of what one would pay to own the stock outright. This helps investors to leverage their investment power while increasing their potential reward from a stock’s price fluctuations.

As far as stock options are concerned, there are only limited risks for buyers. In no way can an option buyer lose more than the price of the option, the premium. With the right to purchase or sell the underlying security at a specific price expiring on a given date, the option will expire worthless if the conditions for profitable exercise or sale of the contract are not met by the expiry date.

Even as options offer many investment benefits, they are not meant for everyone. Just as one’s returns can be large, so too can the losses – leverage. Moreover, the means for realizing the potential for financial success in option trading may be difficult to create or identify. A large amount of information must be processed before an informed trading decision can be arrived at. Option trading is more complicated than stock trading because traders must choose from many variables besides the direction they believe the market will move. Careful consideration and sound money management techniques are a must for successful option trading.

Stock Trading provides detailed information on Stock Trading, Online Stock Trading, Option Stock Trading, Stock Trading Systems and more. Stock Trading is affiliated with Swing Stock Trading.

Know the Rules

Employee stock options can provide you with a substantial source of deferred income and permit you to control the recognition of taxable income. You generally pay no tax when an option is granted because you are not receiving any shares of stock, only the option to purchase shares at a later date.

In general, holding an option to acquire stock may be better than holding the stock itself. The option provides protection against loss should the value of the stock decline below the exercise price. In addition, the option gives the holder equivalent ownership rights in the corporation, without requiring any immediate investment. Employee stock options offer the potential to have post-exercise stock growth taxed as capital gains rather than ordinary income. This provides an advantage for those who are in the top tax brackets

Know the Difference

Nonqualified Stock Options (NSOs) give an employee the option to buy corporate stock at a specified, fixed price (usually at fair market value at the time the option is granted). In general, you must exercise your option to buy within a specified time period–typically 10 years or less.

Upon exercising your rights, any gain realized from the spread (the difference between the exercise price and the fair market value) is taxed as ordinary income. However, any gain realized from the date the option exercised until the date the stock is sold is taxed as capital gain.

Incentive Stock Options (ISOs) also offer the option to purchase corporate stock at a set price, but ISOs cannot be issued with an exercise price below the current fair market value of the stock.

Generally, the spread on ISOs is not subject to ordinary income tax at the time you exercise the option. However, spreads may be subject to the alternative minimum tax (consult your GROCO financial adviser for more information). Gain realized upon the sale of the ISO stock may be taxed as capital gain. Provided you have held the ISO stock for at least one year from the date of exercise and at least two years from the date the option was granted, the entire gain recognized upon sale of the stock is taxed as a long-term capital gain.

When to Exercise Your Options

The decision of when to exercise your options depends on several factors as well as your particular situation:

Your Company’s Plan

Generally, options become exercisable over a period of years. For example, options granted in the company plan vest 20 percent a year over five years. It’s important to know the details of your firm’s plan before you make a decision.

Your Company’s Growth

Understanding how your company is poised for growth is another important factor in your decision making process. Issues to review and understand are:

• How your company makes money – understand the industry that their earnings are tied to.

Your Current Financial Needs

The decision to exercise should consider the need for cash, the proximity to the option’s expiration and/or the current stock value as compared to its expected future value. With regard to ISOs, because of taxes, the required holding periods should be considered when determining when to exercise the options and/or sell the underlying stock.

Balancing Your Portfolio

You may also choose to exercise an option if your company’s stock represents a large portion of your investment portfolio and you wish to diversify your holdings. Some professionals say to reduce investment risk, company stock should not represent more than 40 percent of your portfolio.

Market Conditions

Obviously, market conditions will play a large role in your decision to exercise your option. If the stock underlying the option appreciates, you may wish to hold on to options as long as possible in order to take advantage of future gains.

Tax Ramifications

In the case of NSOs, you may want to consider exercising your option over a few years to avoid being forced into a higher tax bracket. Remember, the spread on NSOs is subject to regular income tax at the time of exercise. Because appreciation occurring before exercise is taxed as ordinary income, it may be advantageous to exercise over time.

Your company’s nonqualified stock options may be transferable to family members. If so, you may be able to trim your estate tax by giving options to your heirs. The transfer may be gift tax free if the value transferred is $11,000 or less ($22,000 if married). notwithstanding the transfer, upon exercise the executive will be responsible for any income taxes generated.

Alan L. Olsen is the Managing Partner at Greenstein, Rogoff, Olsen & Co., LLP, a top Bay Area CPA firm. A specialist in income tax planning, he frequently lectures and writes articles on tax issues for professional organizations and community groups. Alan has over 21 years experience in advanced tax planning including international tax, company reorganizations, multi-state taxation, financial statement preparation, stock options, estates and trusts, and representation before tax authorities. Alan received a BS in Accounting from Brigham Young University and an MBA in Taxation from California State University at Hayward. His website is ranked among the top accounting sites in the nation, featuring tax tools and wealth management articles: http://www.groco.com

An option pricing model is a magnificent "number crunching" trading tool. Without it, we are trading blind by the seat-of-our-pants. It is the difference between "knowing" and "guessing". It would be like a pilot flying without instruments.

It instantly computes implied volatilities, over/under evaluations, finds "best" trades based upon various scenarios, estimated outcomes, both "on-the-fly" and at expiration, and all that good stuff.

An option pricing model gives us an "edge" against those who trade without one and "levels the playing field" against those that do.

If we had to do the calculations ourselves (good luck with that), the market would close before we would get anything done.

But here’s the thing: It’s all THEORETICAL! It’s not real. It’s all guess work.

Forecasts are based on assumptions, which are nothing but educated guesses, and guesses are very "iffy" things.

There’s nothing wrong with using an option pricing model in forecasting, per se, as long as we realize that we’re never going to be right. We’re always going to be wrong.

We strive for perfection in an imperfect world. Sorry to have to be the one to tell you.

All our sophisticated "toys" allow us to do is find out what kind of guessers we are.

It’s all well and good to use an option pricing model, or any tool for that matter, to try to pierce through the "fog" of the future before we actually commit to a position.

However, once we commit it is no longer theoretical. It’s REAL!

From that point forward, the only thing that matters is price. Theory is out the window.

Have your targets, stop-loss points, and follow-up actions figured out in advance and stick to them. A good option pricing model program can help us with that also.

Once a trade is established, manage the trade to its conclusion. Then move on to the next trade. It’s as simple as that.

Because No One Cares More About Your Money Than You

http://dynamic-stock-market-strategies.com

Good trading,
Don Heggen