Your Questions About Paper Trading Options

George asks…

What type of account is best for trading options?

I have been paper trading my system for over a year and now want to use real money. Should I trade out of a 401k or a Roth Ira? I don’t want the IRS breathing down my neck so trying to get educated before I jump in. What is better?

John answers:

As far as the irs is concerned, they don’t care whether you’re tading options or stocks or futures or eggs, they only care about profits.

To trade options, you will need a margin acct.

Sandy asks…

how many “paper trading” methods exist? such as share trading, option, future, currency?

I know share trading,
a little about options,
other methods I do not knows, such as “security” (?)

John answers:

Stock trading simulator

http://simulator.investopedia.com/Default.aspx?viewed=1

“share trading” equals “security” trading equals stock trading

http://www.investopedia.com/terms/s/security.asp

How many? Look up in the sky at night, as many as you can count.

William asks…

Hi i have a question on options trading?

What I need to know is, and this needs to be answered with somebody that actually trades options for a living. The other day i was watching this stock in pre market trading it was up by 5 dallars or 5 points in pre market. i wanted to catch that move using options, i have been paper trading with option express. so i purchased deep in the money calls. and the last bid and ask, the price of the option was like 8.20 – 8.50 the last trading day, i put a limit order in for 8.60 before the market opened, i was up tremendous that day because of the price discrepancy. So my anserwer is, is this a flaw with option express, or can you put in a order in using options if you see a stock up or down significantly in pre market trading. to capture the move in within the intraday.

THANK YOU

John answers:

You are asking a very important question. The fact that you are asking it shows a greater than average understanding of the markets. That said, I’m sorry to have to say that is impossible to answer for sure. Any type of paper trading does have a limitation in that a computer or person is deciding if and when an order gets filled and this might not be totally realistic. When you are ready to move on, start with real money in tiny amounts and watch what happens with real orders getting filled.

Back to your example. Please consider another theory. You didn’t capture the 5 point “discrepancy”. You might have been profitable because there was a big follow thru when the primary market opened and you caught some of that move. I have done this, and when it works, it works well, but sometimes there is no follow thru, or worse, there is a backlash, so being ready to exit promptly when the trade is not forming is crucial to success.

Michael asks…

options deep in the money profit or loss calculation?

I am new to option trading and have the following query,

Consider the following situation
1> If i bought a call option of strike price of 400 of sesagoa (deep in the money) at the premium of 66. Lot size 1500, underlying scrip value 469 and exercise it at 78 in intraday trading.
* Am i in profit or loss?
* What is the profit or loss?

I am paper trading options and would be really glad if some one can guide me.
Thanks

John answers:

What you are doing is a Long Call strategy on a bullish stock using deep in the money call options.

As deep in the money options are extremely sensitive to small movements on the underlying stock and have delta value of nearly 1, as long as the stock is higher than when you bought the call options, you would certainly be in profit as there are little to no extrinsic value erosion in the way at all.

Read the link below for all the details and calculations of the Long Call Strategy for free.

Mark asks…

Trading options example. Is this right?

I am just starting to learn about options and plan on paper trading soon. Please tell me if this is accurate…

If I buy 7 contracts of Jan. 10 at $1.10 that is $770 plus commission.

If it hits $10.00 and I decided to sell, then I take the $10.00-$5.56(price i bought) thats $4.44.

So 700 x $4.44 = $3,108 for a net profit of $2,338?

Is this right? Thanks for your answers.

John answers:

<<>>

Yes it is $770 plus commission,

“Jan. 10” is ambiguous. Obviously one other person responding assumed it is short for “Jan. 2010” but I assume it is short for a January expiration with a $10 strike price.

<<>>

No, that is not a calculation that gives any meaningful number for the option. The is the increase in the price of the stock, but the price of the option depends upon more than the price of the stock.

<<>>

That would be your net profit if you had bought the stock. It is not a meaningful number if you bought the option.

<<>>

No.

—–

To determine the price of that option you need to know

(1) The stock price
(2) The number of days until expiration
plus, if the number of days until expiration is not zero,
(3) The implied volatility of the option
(4) The risk free interest rate
(5) What dividends are expected prior to expiration.

All these variables can be pluged into a model to calculate the price of the option. Fortunately there are tools to do the math for you. You can either download the “Options Toolbox” or use the online “Options Calculator” at

http://www.cboe.com/LearnCenter/RCTools.aspx

to determine the price.

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