Fortunes are made and lost speculating on options. Some will tell you trading options is like gambling. However, if you understand their characteristics and how to price them… they can be a very powerful addition to your trading arsenal. Options provide leverage, and when used correctly, they could be great for speculation. That said, many traders are learning how to trade options and use that asset class to speculate on stocks.
How to Trade Options – Speculation
Defined Risk: Whenever you buy a call or put option, your risk is limited to the premium spent.
For example, Jeff Bishop does this all the time to speculate on stocks and ETFs. Kyle Dennis is also trading options and does the same. It’s cheaper to trade options and gain more leverage than buying or shorting the stock outright.
Here’s a look at one of Jeff Bishop’s emails.
Yeah, that happened. If he were to buy just 100 shares of ALRM, it would’ve cost over $35K at the time. However, because Jeff was speculating it would run higher and potentially break above $40, he was leveraging the same amount of shares by just purchasing call options at $120 a piece.
In other words, you can go to sleep peacefully knowing that you would only lose the premium you paid for an option.
Options Provide Leverage
If you were to buy 100 shares of Amazon.com (AMZN) it would cost tens of thousand of dollars. Depending on where the stock is trading and how much time is left until the expiration date, as well as the strike price, it could cost just a fraction to trade options on AMZN.
In other words, trading options give you more bang for your buck.
This is a huge benefit for those who want to trade expensive stocks or ETFs, but don’t have the capital to trade enough shares. If you have a small account, options put less capital strain on your account.
Here’s a look at one of our gurus that trades options PnL.
Don’t be Scared to Learn How to Trade Options
And here’s the thing…
… no one was born with the knowledge to trade options
With time, patience and dedication, you too can learn the ins and outs of the options market.
Kyle Dennis is even putting his knowledge to the test with options trading. He knows there’s untapped potential. His approach is simple when analyzing which stock options to choose.
How to Trade Options – Moneyness
Now, these guys know what type of options to buy. When you’re learning how to trade options, you need to understand they’re categorized into three segments. Options could be considered in the money (ITM), at the money (ATM) and out of the money (OTM). Now, the moneyness of an option depends on where the stock is trading and the strike price chosen.
For example, if a stock is trading at either $49.50 or $48.50 and you purchase a call option contract with a strike price of $49, it would be considered at the money. If the stock rise to $60, that option contract would be considered in the money, sometimes deep in the money. If the stock falls to $40, that call option would be considered out of the money.
Now, depending on the strategy, you might purchase out of the money options because they’re cheaper. This is just one of the few factors you need to understand when learning how to trade options and speculate on stocks. Another key factor is time to expiration.
We’ll keep it simple here, the more time you buy… the more you’ll have to pay for options.
As we approach expiration, at-the-money options and out-of-the-money options lose value the fastest. Options can be super cheap on expiration day, giving you incredible leverage Depending on your trading approach, if you can get away with buying less time… do it.
Using options to speculate on directional trades offers a number of benefits. For example, you can define risk, while leveraging your capital.
That said, there are a number of factors that you should consider before buying an option. This includes strike price, time to expiration, and implied volatility (this is something that requires a lot of time and dedication to learn). This may appear overwhelming at first, but no one was born with the knowledge to trade options.
Using options to speculate is great for: taking a bearish position because you can’t get shares to short; traders who have a small account; swing or position trade without having to be tied down to the computer all day.