Editor's Note: Options may be the market's fastest-growing moneymaker, but we understand that picking an underlying stock can be daunting. That's why we're sharing Tom's strategy with you again today. It's the easiest way to find money-doubling options trades...
Over the years, the question I've been asked most frequently is how I select which options to trade on a particular stock.
There are a lot of factors to consider with options trading - which underlying stock, which direction, which strike, and which expiration date are the big ones. But students of the markets understand that there are many considerations that can affect the price of an option.
Markets are global and so are your options. Everything - including the price of tea in China - that impacts the markets has the chance to affect your trades.
So how do I choose my options? Believe it or not, the answer is pretty simple.
Today, we're going to take a closer look at one of my favorite options strategies and how it helps me determine whether or not I'm going to take a particular trade.
I'll show you how to use it to target only those options that have the chance to double your money before you even risk your first dime...
The Easiest Way to Double Your Money with Options Trading
When someone asks me how I choose my options, the easy answer is always the one that has the lowest percent to double.
There are other strategies you can use to pinpoint which options you want to trade. But remember - we want to make the most amount of money from the smallest move in the underlying stock.
I've shared how I narrow down the list of 250 top-rated stocks and ETFs to get to my 10 "Top Movers."
From there, the two major things to assess before I take an option trade are how far I anticipate the stock moving and by what time frame I expect it to get there.
The very next thing I do is look at the "percent to double." That's the percentage the underlying stock needs to move in order for my long options to return 100%.
If you're feeling brave and want to make the calculations yourself, you can use the following formula:
This is a handy tool, but it's limited. Recall that an option's delta measures the change in the price of an option relative to the change in price of the underlying stock. But the delta is dependent on the time left until expiration. So if you're looking for a stock to make a move within a few days and you choose options that expire in a week, any move the stock makes in your direction could be negated by the loss of value in your options as they approach expiration.
The great news is, you don't even have to figure out the math on your own. You can easily obtain the "percent to double" calculation from your broker or trading platform, or from any options analysis tool.
The options analysis tool I use calculates this for me. See the image below:
The green arrow above points to the search for the "Lowest % to Double" on SPDR S&P 500 ETF Trust (NYSE Arca: SPY) call options. It can also do this for the puts as well - "percent to double" is a great strategy or analysis tool if you're looking to establish a long position in either calls or puts.
Trade Like a Pro in 3 Easy Steps
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So let's take a moment to run through my process when I sit down to make a trade.
I start with my "Top Movers" list - those are the week's best-moving stocks culled from the CBOE's Penny Pilot list. Then I use my Money Calendar and Darknet tools to find stocks that have a projected move higher or lower.
Once I have that information, I run a check on the lowest percent to double for a call or put, depending on which direction my tools tell me the stock is anticipated to go.
Here is a look at the top five results generated by a search (data originally pulled in September 2015):
See how all this is coming together? This is exactly how I determine what trades are worth my time and my money:
- Create a list of stocks, ETFs, or indices to research anticipated moves higher or lower
- Run a search on which option will double with the least amount of movement from the underlying stock; this will determine the strike price and expiration of your options
- Assess how far the move will be and by what time frame to confirm the underlying security can actually make the move
Now obviously, your stock needs to move in the anticipated direction of your original assessment. But when this happens, all the positives that usually happen with being long an option should take place. The option should go in the money before expiration, and you should be able to sell those options at a profit.
When an option goes in the money, the delta and gamma increase, minimizing the effects of theta (or time decay), which should make the value of the option greater than what you bought it for.
The Limitations of Percent to Double
Percent to double isn't much of a strategy on its own - it's really more of a criteria to help me decide which call or put option I am going to buy.
But what about the downside?
Remember, the two primary things that negatively impact a long call or long put are:
If the stock stays flat, the theta value will come out each day. It does so anyway, but at least with the underlying moving in the direction you want, the delta and gamma should help offset the theta.
If the stock goes against you, you lose theta value, and you could also be losing intrinsic value that reduces the worth of the option even faster.
Lastly, keep in mind that percent to double is not to be used for picking the stock and what direction it is going to go. You need to determine that ahead of time.
Continue to work on identifying which underlying security you wish to trade options on. That will set you apart from the average investor because you understand the value of certain tools and the power they possess in helping you get better at that part of options trading.
Once you've picked out a stock with the expected price move and expected amount of time needed, you then use percent to double to see which option trade will yield you that 100% and which one will yield you that return with the smallest amount of price move.
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About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.