Make Money With Options Trading
Friday, April 8th, 2011Options trading is a little bit, but not much, more complicated than stock trading. This is because of the time decay nature of options: They are wasting assets that lose value as time passes. However, they are also leveraged instruments and hold potential for significant gains (and losses) in a short period of time. Like most tools, if used correctly they can be your friend.
What kinds of options are there? There are two fundamental types: calls and puts. A call option gives the buyer the right to purchase stock at a known price by a known date. A put option is the opposite — the right to sell stock at a known price by a known date. The “known price” is called the “strike price”, and the “known date” is the option’s expiration date. The buyer’s right to exercise the option expires on the expiration date.
Typical uses for options include: portfolio protection (puts), speculation (calls or puts), and income (selling options to capture decaying time premium). If you own stock and purchase a put option you are guaranteed to receive at least the strike price for your stock (until the option expires); it’s kind of like insurance. By purchasing calls you can bet on a rapid rise in the stock. Or, by selling calls you capture time premium decay each day.
When trading options there is a fundamental question of whether or not you should be a buyer or a seller of options. You can make money both ways but since options are a zero-sum game and the fact that the majority of options held until expiration expire worthless, the odds are in your favor if you are a seller of options instead of a buyer.
One of the easiest and most conservative strategies to sell options is called “covered call”. It is a two part strategy where you own the underlying stock and then sell a call option against that stock. If the stock finishes above your strike price on expiration day then your stock may be called away from you (and you will receive the strike price per share). But if the stock finishes below the strike price on expiration day then you keep the option premium, the option expires, and now you can sell another option for the following month.
Selling a call option on stock you already have puts a cap on your upside. You will never receive more than the strike price per share (although you can set the strike price to whatever value you like). The plus is that you receive premium (money) the day you sell the option, and that premium can be used to offset any decline in the stock. So you get some downside protection in exchange for putting a cap on the max you can make. In many cases you can make money even if the stock declines, as long as it goes down less than the premium you received.
Investing with covered calls is not difficult. It is usually the first strategy people learn when they begin with options. It can be time consuming, though, if you don’t have a good covered call screener to help you. A good screener will scan the universe of possible trades and alert you as to where the high yield opportunities are. The alternative of using a spreadsheet to calculate possible trades is, at best, incomplete and laborious.
For additional information on stock trading please take a look at this site.