What are options trading strategies? Even for experienced investors, options trading can seem complicated on the surface.
But the right options trading strategies could make options trading a lot easier.
Now, if you're an options trading novice, you may not be sure what exactly options are, why you'd trade them instead of stocks, or how you'd even start. That's why we've created a guide on everything you need to begin trading options.
But today, we're going to show you a few strategies to help you see some nice returns from options trading.
And a major aspect of it involves decreasing your options trade's risk.
That's because while options can offer greater profits than traditional stocks, they can also be risky. Fortunately, there are plenty of ways to minimize risks.
Beyond that, the rewards of options trading greatly outweigh the risks. With options you could turn a 6% or 12% move in share price into 60%, 120%, or higher.
And all it requires is knowing the right actions to take. But how do you know what the appropriate decision is?
We'll show you two real-life options trading strategies in a minute. But first, we'll quickly go over what options trading is.
What Is Options Trading?
Options are contracts giving you the right to buy or sell a stock at a certain price by a certain date.
Investors use options to protect the value of their stocks, but you can also make money on options by trading them without ever buying the underlying stock.
We'll show you exactly how you can in a minute, but first, we're going to go over three key parts of options trading contracts.
First of all, options contracts are sold in groups of 100. If you buy stock options for $0.10 each, the contract will cost $1. You can purchase as many contracts as you want, but you can't go below 100 options.
The benefit of options trading is you have control over 100 shares of a stock for a fraction of the price you'd pay for 100 actual shares. In other words, you can make big gains for significantly lower up-front cost and risk.
Secondly, every option has a "strike price." A strike price is a price the stock needs to either trade above (call options) or below (put options) for options to provide returns. If a call option trades over the strike price, then it's considered "in the money" and can be exercised for cash. So, an option that's in the money allows you to purchase stock shares for less than their current value.
Finally, options trading contracts have expiration dates. The expiration date is the final day you can exercise your option to buy or sell shares of stock. If your contract isn't in the money by the expiration date, then it expires with no value.
Contracts come with expiration dates from as early as a week to over a year away. The longer your options have the chance to get in the money, the more expensive the contract.
Options that are out of the money near their expiration dates cost less since there's a limited time frame for them to be in the money.
And now that you know these three points, here's a little more information on the two types of options.
Call Options and Put Options 101
With options contracts, you can choose between call options and put options.
If you expect the share price of a stock to increase, then you purchase a call option. A call option enables you to call in stock at any time before it expires at the strike price. The more the share price increases, the more money your call option is worth.
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As for put options, it's the reverse. With put options, you have the right to sell stock at a certain price. If you think its value will dip, you'll buy a put option.
Put options enable you to potentially sell a stock for a price that's greater than its current value. The more the price dips, the more potential you have to profit.
When the stock price moves, an options contract price moves, too.
So, you can see big gains from options trading without having to buy the actual stock.
Check out our two real-life examples of options trading strategies that could help you profit from options contracts.
What Are Options Trading Strategies: Call and Put Options
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On May 22, 2017, Money Morning's options trading specialist, Tom Gentile, realized iShares Russell 2000 (NYSE: IWM) was likely to increase in share price.
At the time, it was trading for $137 per share.
And he was right. IWM jumped 3.3% to $141.46 by June 2, 2017.
If he had bought 100 shares of IWM for $1,370 on May 22, he would have profited 3.3% with a $446 gain.
But he knew he could make way more money.
That's why Tom bought a call option at a strike price of $135 at $3 per option. Since you can only buy 100 options at a time, his total contract cost $300.
That contract cost him 78.1% less than if he had bought the stock itself.
But when the stock jumped 3.3%, his options contract increased from $3 to $7.20. In return, he sold his contracts for $720, a profit of $420. That's 140% in returns in comparison to the 3.3% gain the stock saw.
And that's just one successful example of an options trade.
On April 2, 2018, Amazon.com Inc. (NASDAQ: AMZN) was trading for $1,371.99 per share. That's a crazy expensive stock as is.
But just like the previous example, Tom Gentile knew options trading was the better play.
He forecast that within the week, AMZN would either stay the same or increase in value. So, he decided to make some extra cash with a put option.
This time, he didn't buy the options contract. Instead, he wrote and sold the contract. That means he immediately collected the value of the option and just had to sit and wait.
Because AMZN's put options sold for $1.75 per share, he knew he could earn $525 by selling three contracts.
Tom wanted the contract to expire worthless. This way, he could make the $525 profit from the premium. So, in this scenario, he wanted AMZN's share price to remain above his strike price of $1,200.
With the options contract, if the buyer was right and AMZN dipped below the strike price, Tom would buy 300 AMZN shares at the strike price.
But AMZN moved just how Tom anticipated. AMZN increased 4.3%, so the contract expired worthless, and Tom was able to keep the premium profits.
He saw returns of $525.
But even if he had lost, Tom would have then owned 300 shares of one of the biggest stocks on the market.
What's absolutely wild, though, is that Tom knew the stock would move as he forecast.
With this put options trade, he used his years of knowledge, experience, and strategies that typically only the Silicon Valley and Wall Street elites had access to.
But today, Tom Gentile wants to give you access to this wealth of information. In fact, he wants to show you exactly how you can trade options like the super wealthy, all the while simplifying it.
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