Many stock traders out there tend to overlook that profits that are available to them using stock options trading strategies. In order to operate a profitable trading portfolio, investors must constantly look for new ways to milk hidden returns from their holdings. The successful traders find these hidden opportunities and put them to work immediately.
One of these opportunities can be found in the world of stock options. It seems that many traders shy away from these for a few reasons. The first is simply a lack of knowledge about how stock options work. This roadblock can be remedies very quickly. The second reason is that they are seen to be complex. This is really not the case. Anyone who understands the stock market fairly well will have no problems grasping how the world options operate on a daily basis.
Finally, a big reason why investors do not effectively use options trading strategies and because they feel that they are too expensive to use. Buying and selling options is slightly more expensive than buying and selling stocks, but the costs can be easily offset.
Learning about Stock Options
Before we go further into talking about these options trading strategies, let us first discuss a little bit about how stock options work. This will help us describe the strategies later and help you, the reader, embrace them much easier.
When you purchase a stock option, you are obtaining the right to buy 100 shares of a certain stock at a specific price by a specific time. Let’s provide an example.
Let’s say you buy a DEC option of company ABC for $300 that has a strike price of 65. This means that between now and the third Friday of December; you have an option to buy 100 shares of ABC at the price of $65. If ABC’s stock price rises to $70, then you can exercise the option and make yourself a quick $500. If ABC’s stock price stays below $65, then your option expires worthless in December.
There are two different types of stock options. A CALL option correlates with going long and being bullish about the stock. The Call option means you have the right to buy the stock at the strike price. A PUT option is the same as going short and taking a bearish position. The Put option means you have the right to sell a stock at the strike price.
Pros and Cons of Stock Options
Before proceeding with our discussion about options trading strategies, we must address the advantages and disadvantages of trading options. This discussion would not be complete without doing this first.
The biggest advantage about buying options is that your risk is defined the moment you make the purchase. The most you can every lose form the option is the price you paid, regardless of what the stock itself does. Even if the stock crashes, your loss is the premium you paid for the option.
The second biggest advantage of buying options is the leverage and control that they provide. In the example we gave above regarding the ABC stock where we paid $300 for the Call option. If we bought the stock outright, it would have cost us $6500. Another way of looking at this transaction is that if you took the same $6500, then you could buy 21 Call options – which mean you could control 2100 shares of the ABC stock.
The biggest disadvantage of buying options is that they decay in value over time. When you buy a stock option, there is a big stopwatch that starts on your investment. A move has to be made within the required timeframe.
The option strategies that we outline below are designed to minimize the risk associated with trading them. In addition, we seek to earn income from our strategies.
Options Trading Strategies – Number One
The first of our two options trading strategies is selling covered call options. One thing about trading stock options is the fact that those who sell them make money around 90% of the time. There are two reasons why people do not sell them very often.
The first reason is that you only receive the premium that the buyer pays and nothing else, but your risk is unlimited. This is because if the option goes “in the money”, then you have to provide the stock at the strike price – even if you have to buy it at a much higher price. The second reason that people do not sell options is because their online stock brokerage will not allow them to sell options because of that unlimited risk.
However, if you have the “options covered”, then you can sell them. What this means is that you either have the actual stock or another option to cover your risks when you sell an option to someone. This way, if the option you sold goes into the money, then you already have the stock to give them. If the option you sold is not covered, then you are selling “naked options”. Only the pros are ever allowed to sell naked options.
This strategy is used when you are holding blue chip stocks that you intend to hold for a prolonged period. What you do is find call options that are within a 30-45 days of expiration. Look at the options that are a strike price above where the stock is currently trading. Wait on a bullish day and sell that option to receive extra cash in your trading account. You can sell one option for each 100 shares of the stock that you are holding.
When that option expires, then the premium you received is yours to keep regardless of what the stock does.
Options Trading Strategies – Number Two
Our second option trading strategy requires only the use of options. In this strategy, we are focusing on call options that are at least three months away from expiration. You also want to select options of companies whose stocks are in an upward trend.
The first step is waiting for a pullback day when stocks are selling off. At this point, you will want to buy a call option that is either at the money or close to the money.
The second step is to wait for a heavy bullish trading day. On this day, you will want to price the options that are a strike price above the option that you bought in the first step. Ideally if the option volatility is high, you will want to sell that option at a price that is close to what you paid for the first option.
What this does is allow you to hold a stock option vertical spread at a cheap price – depending on how much premium you received for the second option. This position has a potential profit equal to the difference between the two strike prices of the two options.
The great thing with this vertical spread is your risk is limited and totally covered. Many traders only trade these vertical spreads and set up dozens of them every month.
Conclusion
Hopefully, this article has opened your eyes to the potential of using stock options trading strategies to your advantage. When you get a grasp on the power of using options, then you will begin discovering many new way to use them.
The post 2 Stock Options Trading Strategies That Work appeared first on Investing Insight.
from Investing Insight http://investinginsight.org/stock-options-trading-strategies/
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