Our mission at Monument Traders Alliance is to change the way you approach speculation.

With The War Room, we’ll give you the tools, market intelligence and real-time, actionable advice to send your daily profit-making potential into the stratosphere.

The first step you need to take is simple – stop viewing options trading as reckless speculation.

Although I do consider options to be a speculative investment… there is nothing reckless about how I approach them.

I’ll provide you with calculated, precise strategy speculations that have proved successful and enormously profitable for decades.

A big part of smart speculation means completely understanding what risks you are taking and the potential rewards to be achieved.

In this guide, I’ll remove some of the stigmas, debunk some of the myths and give you a one-stop guide to the options world.

You’ll learn the ins and outs of various options trading strategies, and you’ll understand how my team provides trading methods that tilt the odds in your favor in The War Room.

Most importantly, I hope that by the time you finish reading, you’ll realize the incredible profit potential of options trading.

But it all begins with understanding. Knowledge is power in the options market. When you understand how options work, you’ll see why they can be so useful.

So let’s get started.

Playing Options, The War Room Way

Maybe you’re like most investors: confused by the terminology, unsure of the risks involved and skeptical of your own ability (we’ll soon fix that)… the result being that you shy away from options.

We think that is a huge mistake. Our team at Monument Traders Alliance has had tremendous success trading options. And we’re confident we can guide you to substantial profits of your own.

Soon you’ll be swatting your own investment home runs and scoring lottery-sized returns.

Cashing in on options is a lot more probable than you think when you have knowledge and strategy on your side.

What Are Options?

An option is an investment that gives you the right (but not the obligation) to buy or sell a specific security at an agreed price within a set period of time.

Every option is identified with a specific stock (or, in some cases, an entire index of stocks – you can buy options on the S&P 500, for instance).

So whenever you place an options trade, there will be an underlying stock or security whose movement will affect the success or failure of your investment. Options come in two standard varieties: calls and puts. And options trade in lots of 100 shares (called contracts).

Therefore, one call option gives you the right (but not the obligation) to buy 100 shares of a particular underlying stock at a specific price (the exercise price or strike price) before a specified date in the future (the expiration date).

One put option conveys the right (but not the obligation) to sell 100 shares of a stock at the strike price by the time the put option expires.

All options have expiration dates. It could be a matter of weeks, months or up to three years, in the case of certain options called Long-Term Equity Anticipation Securities (LEAPS) – more on this later. If you don’t exercise your right within that given time, the option expires worthless.

Options trade on the Chicago Board Options Exchange (CBOE), American Stock Exchange (AMEX), New York Stock Exchange (NYSE) and Chicago Board of Trade (CBOT).

Most of the activity takes place on the CBOE and the AMEX. But that is not something you have to concern yourself with. When you place a trade with your brokerage firm, it will search the exchanges for the best price.

The important thing for you to understand is that options are traded just like stocks in the sense that they have a symbol and you will be charged a commission on the transaction. Option prices can be tracked online at a number of websites, including Yahoo Finance and BigCharts.com.

How Do They Work?

Options are directly related to their underlying security – be it a stock, index, commodities future, etc.

For example, you could choose to simply buy 500 shares in Company XYZ, which is currently trading for around $10 a share.

Excluding commissions, that would cost you $5,000. However, you might not want to buy 500 shares at once, or you might think the price for that is a little too steep.

So rather than buying the stock outright, you can instead choose to buy options on it – which are significantly cheaper. This gives you the right to buy or sell those same 500 shares at a certain price at a certain time.

The key question you need to ask yourself is whether you think Company XYZ is going to go up or down.

If you think it’s going to rise, buy calls. If you think it’s headed for a decline, buy puts. You then need to decide on a strike price (your target price).

Next, you need to pick a time frame for your scenario to play out – the end of which is known as an expiration date. This can be anything from weeks to months to years.

Options prices vary depending on their expiration date, strike price and the volatility of the market or industry and company in question.

Once you’ve done that, you’re ready to buy.

Options trade in lots of 100 shares. One lot is known as a contract. When you buy an options contract, be it a call or a put, it gives you the right to buy or sell your 100 shares before a specified date in the future – hopefully when the underlying stock hits your strike price.

When you buy an option, it is as though someone is saying to you, “I will allow you to buy or sell 100 shares of this company’s stock at a specified price per share at any time between now and the expiration date.”

And it’s further understood that, “For that right, I expect you to pay me a fee.”

That fee is called the premium, which will vary considerably depending on the exercise price and time until expiration, as well as the stock’s volatility.

The Bid, the Ask and the Spread

Two of the most important parts of options trading are knowing what an option should sell for and getting it for what it’s worth. This requires knowledge of the bid, the ask and the spread.

The bid price is what people are willing to buy the option for.

The ask price is what owners of the option are willing to sell it for.

The spread is simply the difference between the bid and ask prices. Most transactions in the options market will take place between the bid and ask.

For example, shares in ABC Inc. are trading at $15.50. You want to buy July call options, and you see this:

Last trade: $0.55       Ask: $0.55        Bid: $0.40

Here’s why 90% of options lose money…

A rookie looks at those numbers and immediately dives in and pays $0.55 for the option. Since the option is really worth only the bid price, they’re already down 37% before they’ve even started.

When a market maker sees you buying options at market price, they know they can take your money. Here’s how to beat them: Use limit orders.

Just like stocks, you can place trades between the bid and ask. It’s the only way you can put some pressure on the market makers, tempting them to alter the price and bring the spread to a more reasonable level.

Never buy an option at the ask price or with a market order. Use a limit order that falls between the bid and offer. Take your time. If the underlying shares do not move, the option price will fall. If you can, place your order at the bid price. If the option is liquid, you’ll get filled at that price most of the time.

Intrinsic Value and Time Value

When executing an option trade, it is essential to know the following four things: underlying stock, option type (call or put), expiration date and strike price.

But it is critical to understand what factors affect the price of any given option. That’s where intrinsic value and time value come into play…

An option has two sources of value. The cost (or premium) of any given option is based on its intrinsic value and its time value.

Intrinsic value refers to the portion of the option premium that is in the money. Any additional value beyond that is considered time value.

For example: A call option has a current premium of $3 ($300) and a strike price of $45. At the time you buy the call, if the underlying stock’s market value is $46 per share, then we say the following about its intrinsic value, as well as its time value:

• This option has one point of intrinsic value. In other words, it’s $1 in the money or above the strike price.
• That leaves two points (the $3 premium minus the intrinsic value of $1) for the time value.

Even if the stock’s value stays the same, leaving the intrinsic value at $1, as the stock approaches expiration, its time value shrinks – leading to a decrease in the total amount of the premium. At expiration, the time value will equal zero, leaving the premium value equal to the intrinsic value (in this case: $1).

All options act the same when it comes to intrinsic value. All options that are in the money (i.e., the strike price of the option is less than the stock’s current value) will reflect that value. If an option is in the money by $5 (say the option is at a $35 strike and the current price is $40), then the option premium will be at least five points. If the option moves $10 into the money, then the option premium will reflect at least 10 points of value.

Conversely, if the stock declines and the option moves out of the money (for example, if the strike price is at $45 and the stock is at $44), then the intrinsic value goes to zero and the premium would reflect only time value.

When it comes to determining the time value, a number of factors come into play.

Obviously, the amount of time left until expiration is important, but so is the volatility of the underlying stock. A host of other factors affect time value, such as the perception of value by other investors, the stock’s price history, the company’s fundamental and technical indicators, the industry of the company, and whatever else investors hold important for this particular stock.

That means two companies – both priced at $55 per share, both with strike prices of $50 and both with identical times until expiration – can have different premium prices.

You need to look at each stock and each situation to determine whether the premium represents fair value. Remember that the clock is always ticking once you purchase an option, and that value is always at work when the option is being priced. The greater the perceived potential for price movement, the more investors are willing to pay for the time value of the premium.

So how can you determine whether an option is overpriced or underpriced? Fortunately, there’s help available.

Other Factors That Affect Value

The professionals and market makers on the options exchanges use the following six factors to determine whether options are overpriced or underpriced:

• Time to expiration
• Strike price
• Value of the underlying stock
• Implied volatility of the underlying stock
• Dividends
• Risk-free interest rate.

Their calculations are based on the Black-Scholes model – a formula created by Fischer Black and Myron Scholes, who won the Nobel Prize for their work. The model is quite complex; you certainly don’t need to memorize it! Your brokerage firm will provide online access to options prices, which usually includes a rating based on the Black-Scholes model. You can also sign up for a service provided by the Chicago Board Options Exchange that provides real-time quotes, Black-Scholes ratings, charts and much more. Go to: www.cboe.com.

All of the factors except for volatility are either set by the options exchanges or are readily available for everyone to use.

When you’re trying to gain an edge over the markets by finding the best possible prices, the volatility of the option is the key factor. Volatility has a direct effect on the price of an option. When a stock is fluctuating wildly, that means the stock is volatile, which in turn increases the volatility of the option.

When volatility increases, so do option prices. When stocks are stagnant, volatility decreases, which in turn brings down the options premiums.

Volatility, as it applies to options trading, is a number that quantifies how volatile the underlying stock has been in the past, as well as how volatile it is expected to be in the future.

There are two types of volatility that relate to options trading.

Historical volatility measures how erratic, or volatile, the stock has been in the past.

Implied volatility is a forward-looking calculation that makes an assessment of how erratic, or volatile, the stock might be in the future.

Since there are different time frames in which to measure and calculate volatility, you can guess that the volatility factor that goes into pricing an option can be confusing.

Some traders like to use 10-day, 30-day or 50-day “historical volatility” when pricing options, while others like to use the current “at-the-money implied volatility” of the front-month options.

Some like to calculate the volatility using the closing prices of the stock, while others like to incorporate the high, low and close of each session.

But you shouldn’t be overly concerned with how volatility is calculated or which measure is used. You should focus on how to tell whether options are expensive or cheap before you buy them. Volatility can tell you just that.

Volatility fluctuates in the same manner as a regular stock chart, oscillating between periods of high levels and periods of low levels. Your job is to know whether volatility is at a high or low level before purchasing your option contracts. Ideally, you want to buy when volatility is low – because option prices will be lower – but you are soon expecting an increase in volatility… which will increase prices.

Holding, Folding and Cashing In

So now that you know how to open an options trade, what can you do with it once it is open? Fortunately, it’s pretty straightforward and there are a couple of choices.

First of all, if you’ve bought a call option, you are not obligated to buy the 100 shares of stock (in each contract) if the strike price is hit.

Conversely, simply because you bought a put option, that doesn’t mean you have to sell those shares if your price is hit.

Remember that an option is a right, not an obligation. In fact, the vast majority of call buyers never end up buying the underlying stock. And the vast majority of put buyers never end up selling the underlying stock.

Rather, they make their profit in one of two ways.

If the call option goes the right way for you and the market value of the underlying stock rises above the strike price of the option, you can do one of two things:

1. You can exercise the call option and buy the stock at the agreed-upon strike price – which will be at a price below the current market value. At that point, you could immediately turn around and sell it for the going market price and pocket the gains or hold on to the stock for possible further gains.
2. If you don’t want to own the stock, you can sell the options into the open market. If the underlying stock has gone up to $10 above the strike price, then each option is worth at least $10 (the intrinsic value). This amount could even be more with the time value added in. Let’s say that with the time value, the option climbs to $12. The difference between what you paid for the call and the current $12 is your profit.

What to Do if Your Call Goes Down (Not Profitable)

Let’s assume you’ve bought an XYZ Inc. January $40 call option for $1 and it goes the wrong way for you. The market value of XYZ Inc. either does not change or declines in value, and your alternatives begin to narrow. Let’s say it gets to the end of November and XYZ is currently trading at only $36. Here are your alternatives:

1. Your first choice is to sell the call while it still has time value left. You would receive less than you paid for the option, due to the stock still being $4 out of the money and the option having less than two months until expiration (leaving less time for the stock to achieve the price objective). But at least you won’t be stuck with worthless paper after the expiration date. The option would, let’s say, be selling for about $0.50. You would sell the XYZ option for $0.50 and take a loss of $50 ($100 minus $50).
2. You can hold on and hope that XYZ shares go up and the option increases in value prior to its expiration, allowing you to recoup your costs or even make a profit. However, if XYZ does not increase in value and fails to reach your strike price before expiration, that option will expire worthless.

What to Do if Your Put Goes Down (Profitable)

Conversely, if you had purchased a put option, you’d be expecting the stock’s value to fall.

Let’s say XYZ shares are trading at $34. You buy the January $30 puts at a cost (premium) of $1.05.

If the price of XYZ goes the right way for you and the stock’s price falls to $20 ($10 under your $30 strike price), then you can do one of the following.

1. Sell the put before it expires. With the option $10 in the money, the put option that cost you $1.05 is now worth at least $10 (the intrinsic value of the option without any time-consideration value). At $10, you have made at least an $8.95 profit.
2. Exercise the put by buying 100 XYZ shares at the current price of $20. You would then immediately sell those shares at the agreed-upon strike price of $30 and make $10 on every share.
3. Do nothing. If the expiration date arrives with you in the money, your broker may be obligated to execute the trade. But that’s putting the responsibility for your profits into someone else’s hands – not a very sensible situation.

Remember that as a call buyer or put buyer, you are not obligated to buy or sell 100 shares just by virtue of owning the call or put option. That’s why they’re called options – not obligations.

Risks Associated With Options – and How They Can Work for You

Options are like burning matches: They will all extinguish themselves eventually. For most investors, the thought of putting money in an investment that literally evaporates after the passing of a deadline, or one that will decline just because time goes by, is enough to make them run in the opposite direction.

And because options expire, they are very different than owning the shares of a company outright. If you own shares of a company outright or are selling the shares short, the time frame of your ownership can be indefinite… not so with options.

With options, not only do you have to be right about the direction of the underlying stock, but the movement also has to take place within a specified time frame.

On a positive note, your loss with an option is limited to the amount of your investment. Because an option is a right and not an obligation to purchase or sell shares, you are never required to take action on an option you have purchased.

In this light, options investing allows you a sense of risk reduction for your investment.

For example, let’s say that in March you purchased a July $45 call option on Company XYZ with a premium cost of $2 and the stock trading at $40. If, by July, XYZ drops to $20, investors who purchased 100 shares will have lost a total of $2,000. But those who purchased the option contract will be out only $200 (the cost of the option). That’s quite a difference.

Be aware, though, that the opposite is also true.

If the XYZ shares rebound after the July expiration of your option, all you can do is watch. The investors who bought the stock outright will be rewarded for taking the added risk of paying the full price, holding on when their shares lost half their value and riding the rebound.

Options Leverage: Getting the Most “Bang for Your Buck”

Leverage is crudely defined as “using a little money to make a lot.” But we’ll use a more conventional definition: “putting down a small investment to control a large amount of stock.”

And as you’ll see, that’s exactly what an option does.

Let’s take XYZ Inc. again as an example and assume it is trading for $95 currently. A $5 premium on an XYZ call option will let you control 100 shares of a $95 stock. One option controlling 100 shares would cost you $500. However, if you bought 100 shares of the underlying stock, that would cost you $9,500. That’s a $9,000 difference.

So in reality, you are putting only 5.3% down. In terms of your profit potential, this also means that you could double or triple your investment with just a five- or 10-point move in the stock.

That’s what’s called getting the most “bang for your buck.”

The War Room Advantage

You should now have a better understanding of one of the most misunderstood investments on Wall Street.

We don’t expect you to fully grasp everything presented. But don’t worry, The War Room team will help guide you every step of the way. If you ever have any questions, please contact us.

Once you start receiving trades from us, you’ll quickly realize that you don’t have to use sophisticated trading techniques or complicated strategies in order to be highly profitable. If intricate trades are required, we’ll fully explain how to place the trade and, most importantly, when to close it out.

The truth is that options investing can be a lot more profitable than you might think.

And we’re going to provide you with – literally – hundreds of options trades, offering dozens of different ways to profitably hedge, leverage, balance and strengthen your portfolio.

You can use conservative strategies to net smaller yet very healthy returns, while at the same time swinging for the fences to make double-, triple- and even quadruple-digit gains on options.

And now that you have the knowledge and experience of The War Room working on your behalf, you’ll find that cashing winning trades has never been easier.

Click here for a glossary of terms relating to the options market. You can also find a glossary of terms in our report titled “Getting Started as a War Room Trader.”