The Value Line Guide to Option Strategies - Page 1 THE VALUE LINE Guide to Option Strategies How to Invest Using Options (Updated September 29, 2006) If you need assistance with our service, feel free to contact us. ¾ Technical Support can be reached at 800-654-0508 or [email protected]. ¾ Value Line Options Analysts can be reached at 212-907-1597 or [email protected] ¾ For inquiries concerning your account status, call Client Relations at 800-634-3583 or [email protected]. Value Line Publishing, Inc. 220 East 42nd Street, New York, NY 10017-5891 www.valueline.com The Value Line Guide to Option Strategies - Page 2 TABLE OF CONTENTS List of Tables...................................................................................................................................... 4 List of Graphs..................................................................................................................................... 4 Preface - Options & the Value Line Daily Options Survey.............................................................. 5 Introduction - The Chapters Ahead .................................................................................................. 6 Chapter 1 – Option Basics ................................................................................................................. 7 Defining Some Terms..................................................................................................................................7 Some Sample Premiums .............................................................................................................................7 Buying a Call ...............................................................................................................................................8 Buying a Put ................................................................................................................................................8 Selling before expiration.............................................................................................................................9 Writing Uncovered or “Naked” Options ................................................................................................10 Writing Covered Calls..............................................................................................................................10 Which strategy is best?.............................................................................................................................11 Additional Information.............................................................................................................................11 Chapter 2 – Finding the Most Attractive Options........................................................................... 12 Value Line’s Common and Option Ranks..............................................................................................12 How We Rank Options.............................................................................................................................12 Using our Selected Options ......................................................................................................................13 Finding Options by Stock Ticker.............................................................................................................14 Using our Option Screener.......................................................................................................................15 Getting Started..........................................................................................................................................16 Chapter 3 – Spotlight on Buying Calls............................................................................................ 17 Paying Premium........................................................................................................................................17 An In-the-Money “Deductible”................................................................................................................17 At-the-Money: Insurance in Both Directions .........................................................................................18 Out-of-the-Money: Insurance Against Not Buying the Stock...............................................................18 Your Best Call? .........................................................................................................................................19 Chapter 4 – Spotlight in Buying ‘Naked” Puts............................................................................... 20 Varying Bearish Positions ........................................................................................................................20 Our Put Buying Picks ...............................................................................................................................21 Adding Puts to Your Portfolio .................................................................................................................22 Chapter 5 - Spotlight on Uncovered or “Naked” Option Writing.................................................. 23 The Value Line Guide to Option Strategies - Page 3 Why Write? ...............................................................................................................................................23 Capital Requirements...............................................................................................................................24 Seeking Writing Opportunities................................................................................................................24 Chapter 6 - Spotlight on Covered Call Writing............................................................................... 25 Our Covered Call Ranks ..........................................................................................................................25 The Performance of our Rank 1 Covered Calls .....................................................................................25 Our Selected Options for Covered Call Writing....................................................................................26 Further Screening .....................................................................................................................................27 Chapter 7 – How Much Should I Invest in Options....................................................................... 28 Define Objectives.......................................................................................................................................28 Using Relative Volatility...........................................................................................................................28 Using Diversification.................................................................................................................................29 How Much for Call and Put Buying........................................................................................................29 How Much for “Naked” Call and Put Writes ........................................................................................29 How Much for Covered Calls...................................................................................................................30 How Much for Market-Neutral Hedges..................................................................................................30 Testing Different Strategy Mixes.............................................................................................................30 Chapter 8 – When to Close Out an Option Position....................................................................... 31 Follow the Ranks.......................................................................................................................................31 Other Considerations................................................................................................................................31 Chapter 9 - Managing a Covered Call Portfolio............................................................................. 33 Why a Covered Call?................................................................................................................................33 Looking at Your Portfolio ........................................................................................................................33 Chapter 10 – Option Trading Tips .................................................................................................. 36 Always Diversify........................................................................................................................................36 Capital Considerations .............................................................................................................................36 Trading.......................................................................................................................................................38 Chapter 11 - Managing a Long/Short Hedge ................................................................................. 39 Why the long/short hedge works. ............................................................................................................39 Which Hedge is Best? ...............................................................................................................................39 Setting Up Your Hedge.............................................................................................................................39