Dykstra: Going Deep

Understanding the Options

Despite a heightened interest in options, most people do not take full advantage of what options have to offer. By and large, options are considered the ugly stepchild of the investment world. If more investors only did their homework and took the time to understand: This is one of the few areas, you, the retail investor, can find an edge.

If you use and truly understand options -- especially, deep-in-the-money calls -- then you can join the minority of options traders who actually make money on a regular basis. You can become a very wealthy person by just grinding away, finding deep-in-the-money calls where there is very limited downside, with a chance for a whole bunch of upside.

Unfortunately, people who "play" options as a tool for speculation usually get what they deserve. Most people will "take a flyer," and buy an option that is out of the money because they are cheap and it seems easy. They would probably be better served buying a Lotto ticket. (Out-of-the-money calls -- which give the holder the right to buy an asset at a predetermined price -- have a strike price higher than the current market value of the underlying asset. Out-of-the-money puts -- which give the holder the right to sell at a predetermined price -- have a strike price lower than the current market value. For a list of options definitions, please check out the glossary for TheStreet.com's Options Alerts newsletter.)

Therein lies the reason why most investors lose at options; the majority of volume is short-term, out-of-the-money, cheaper options. In reality, the premium is more expensive and would require almost perfect timing, which leads me to some very important information:

I will be writing only about deep in-the-money calls. If someone sends me an email about any other kind of option, I will have to pass and you should look into TheStreet.com's Options Alerts newsletter, written by Steve Smith.

In order to trade options (or futures), the Commodity Futures Trading Commission (CFTC) requires that a broker provide you with a disclosure document that describes the risks involved, according to the CFTC Web site. You will have to sign the disclosure document before the broker can accept any funds and/or make any trades. I strongly recommend you read this whole booklet, cover to cover, before you trade a single option; if you don't understand what you're doing, you will lose money!

In that same spirit, I strongly suggest you learn about deep-in-the-money calls before you put your money down. I will explain, as best I can, how a deep-in-the-money call works and would like to thank my broker, Paul Hollins of Wachovia Securities, for teaching me the power of options: the ability to control hundreds of thousands of dollars' worth of stock for minimal risk. (Paul is the brother of Dave Hollins, my best friend and former teammate with the Philadelphia Phillies.)