Options are a giant mystery to so many traders. At least they were to me, a few years back. Such incredible tools of leverage though!
1) The most important factor to know and understand about options is irrevocably that of time. All options have an expiration date. They are a lot like milk. You buy them but you are fully aware of the fact it will go bad soon. Misunderstanding time is how the majority of traders will lose money when trading options. Always buy enough time. Now your question is how much time is “enough”. Well, a swing trader, one who is simply buying at support and selling at resistance, 2-3 months is enough time. So, if you’re trading in the month of August for example, October or November are good months for your options. You can buy and sell options anytime you wish. So, you do not have to wait for option expiration to sell it, just like you don’t have to wait for your milk to expire before you can drink it. (Yuck)
2) Buy in the money options. They have intrinsic value. Intrinsic value in an option is a good thing. I know some traders who have found success trading out of the money options. They are few and far in between, especially to be consistent. I get the risk / reward reasoning behind it – but you’ll often have a low winning percentage of trades. Out of the money options are simply more risky and since they are comprised of 100% time value, if an option is out of the money at expiration, it will expire worthless. So, you could lose 100% of your investment. This is good if you’re selling, not so good if you are buying.
3) Be very careful trading options over stocks earnings. Options get inflated by the market marker with something called implied volatility. That makes options very expensive. After earnings, the implied volatility will go back to normal (which is generally anything less than 30.) Since earnings can cause a stock’s price to gap wildly overnight, it can cause a drastic change in your option price. Unless you’re working on a specific earnings strategy, before buying or selling an option on a stock, check its earnings date, always.
4) There are now something called Mini Options. Before, an option contract controlled 100 shares of a stock. Mini Options control 10. It makes trading AMZN, AAPL, GOOG, SPY, and GLD much more affordable. If longer term investors own less than 100 shares of those 5 securities, covered calls can now be completed with just 10 shares of ownership. That’s a big deal, to someone who wants to begin to own AAPL longer term. Instead of a 46,000 investment, a 4,600 invest can be procured. Receiving dividends on those 10 shares as well as selling covered calls on the 10 shares using the new leverage of mini options. These tools are brand new but quite exciting as they will offer bountiful opportunities in the future of trading. Best to understand them now.
5) Options are better than penny stocks. SO MANY beginning traders get lured by penny stock ads and the hopes of massive returns. I know the same amount of people who have made money with penny stocks, as I do know who have won the lottery, zilch, zero, nada. I also know countless of traders who have received triple digit returns trading options properly. 100, 200, 300%. It’s not the daily commonality, especially with the market like it is now with, low volatility. That will change soon, though. Rather than making any type of investment into any penny stock, learn how to trade options. They are much more liquid, safer, and more reliable, regulated and offer spectacular returns to those who properly understand them.
THE BOTTOM LINE
Options are not scary. They are great tools and were created to be insurance for those whom buy and short stock. Bottom line, if you trade stocks you should understand, learn and implement option trading. Options add incredible leverage and traders need to make sure we are using them appropriately.
