It can seem intimidating to learn options trading at first, but it really is easier than you think.
All you need is a few options trading basics and a little time to get comfortable. After that, you will be ready to take the plunge. Just make sure it's consistent with your own goals and risk tolerances.
Remember, you do not have to compete with the professionals to make money trading options. Let them run their complicated strategies. You, however, will learn to make a lot of money in little time, with minimal effort.
At the very least, you can trade options simply to hedge your stocks in case the broad stock market falls.
You see, options trading gives you flexibility. It can make you money from capital gains, and it can make you money by providing an income stream. Or it can simply provide insurance against losses.
The choice is yours. We'll start with the basics, and then we'll get into how you can harness options trading to carry out your specific financial goals.
The Basics of Options Trading
Much like a stock, an options contract is defined by the underlying company for the stock on which it is based. But, unlike stocks, options have a shelf life.
Options contracts expire by a predetermined date, called the expiration date, and that is what makes them far more interesting. You know exactly how much time your options strategy has to work. But if the option you buy meets your target profit early, you can sell it and reap your reward.
Options have four important components:
Type: There are two types of options, called "calls" and "puts." Call options give the holder the right, but not the obligation, to buy the underlying stock at a specified price - the strike price - by a set expiration date. Put options give the holder the right, but not the obligation, to sell the underlying stock at a specified price by a specified date.
Strike price: This is the price at which you can exercise the option. For calls, if the strike price is above the current price of the underlying stock, then it is "out of the money." If it is below the price of the stock, then it is "in the money." For puts, it is the reverse.
Expiration date: Also called the "exercise date," this is the date at which the option becomes null and void. It will either be in the money, in which case it is automatically exercised, or out of the money, in which case it expires worthless.
Premium: This is the price the buyer pays for the option. It is not the same as the money needed to exercise the option.
Everything else is a derivative of these four components, including the "Greeks," which are measures of how options contracts behave over time.
These are labelled with Greek letters, such as delta and gamma, and tell us how fast an option price moves based on time to expiration, the amount the option is in or out of the money, interest rates, and other factors. Needless to say, they can be useful in planning your trades. But you don't need to worry about them right now.
For the most part, as you learn, you will probably trade options that are at or near the money. That means they have strike prices very close to the current price of the underlying stock. Later, you can hone your strategy to trade different strike prices.
Now, let's get into how you can achieve your financial goals by trading options...
Options Strategies That Can Work for You
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There are three main strategies used by beginners. All of them have relatively low risk, and at least one of them has a tremendous profit potential.
Trading to make money: We can call this speculation, but it is really no different than buying stocks low and hoping to sell them high. You can use options to capitalize on an expected move in the underlying stock. If you think it will go up in price, buy a call. If you think it will go down, buy a put.
Selling options to create income: The idea is to sell, or write, call options on stocks you think will not go up in price. If you are correct, you keep the premium you collect for selling them. Selling options is often risky, because you can have unlimited loss exposure. However, selling call options on stocks you already own avoids this risk. You will never have to buy a stock at inflated prices in order to satisfy the terms of the call.
Using options to hedge: This is almost the opposite of selling covered calls. Here, you buy put options on stocks you already own that can partially offset any loss you incur if the market moves against you.
Of course, there are many more strategies. But these are the best ones for beginners. After that, it's time to practice trading...
Paper trading is simply a way to take every step in the trading process without actually submitting a live trade to your broker. You use the same trading software as you will when you make real trades, but you are only trading paper, or fake, money.
When you paper trade, you can make your mistakes and learn from them before risking real money. Most online brokerages, such as ThinkorSwim, Interactive Brokers, and Ally Invest, offer the ability to practice your skills online without risk. Trading takes place during regular market hours using real bids and offers available at that time.
You can buy an option, track its progress, sell it when you wish, and record your performance. And you can do it over and over until you feel comfortable enough to try it with real money.
And now that you know the basics of options trading, Money Morning's options trading expert Tom Gentile has just provided readers with the seven best stocks to trade this December. With the tools provided above, and Tom's expert analysis, you'll be ready to hit the ground running trading stocks...
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This is an opportunity you won't want to miss out on.