Getting started with investing and trading options can be a bit intimidating. Learn how to trade options succesfully from the experts at RagingBull.
Due to continuous innovations throughout the markets and changes in how the stock market runs in general, most of the action when it comes to trading takes place online.
Investing was once quite a simple concept, where individuals would invest their finances in one or two small companies and stick with those investments as they grew. Today, investing is more complicated than ever before and even includes new forms of currency.
With all of these changes and the fast-paced environment of the online market, getting started with investing and trading options can be a bit intimidating.
Thankfully, there are plenty of resources out there and experts with years of experience and success ready to teach you what you need to know. The key to succeeding in the world of trading is knowledge. If you can gain a thorough understanding of what you’re doing, you will be set up for success. Here’s a start for those wondering how to make money trading options.
Let’s Get Started…What Are Trading Options?
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The First Step:
If you want to learn how to make money trading options, the first step is to develop a strategy. Don’t just leap in blind, but take some time and really think about your goals and how you plan to achieve them. Many portfolios don’t include any options trading strategies at all, but that’s a mistake. There’s a lot to gain from this aspect of the market.
Limit your downside and grow your potential for profit by approaching options without fear. Trading options doesn’t have to be a complicated process if you don’t want it to be. Purchasing options with the goal of keeping up with the price movements of future stocks allows you to lower your risks while simultaneously opening the door for unlimited earnings.
Options can also be used for hedging and giving your portfolio a little cushion. Think about it: you purchase insurance when you buy a new car or other valuable items, why not surround your portfolio with insurance, as well? Hedging can act as a last resort measure if your portfolio gets to that point.
There are a few ways that options can be approached by investors. Instead of just buying shares in stocks that you anticipate will rise in value, you can buy call options to increase your upside.
Call Options Versus Put Options
It’s important to understand the different types of options when trying to make money trading options. There are two main types of options, call options and put options. Both are a type of contract. These option contracts involve two parties, the option holder and the option issuer. The option holder is given the right to perform a certain transaction with the issuer, but the holder isn’t required to perform that transaction.
Simply stated, call options afford the right to buy, and put options afford the right to sell. The strike price is the agreed-upon price for the asset under contract. In stock trading, the asset is the share or shares. So, a call option gives the option holder the right to buy a share or shares at a strike price for a determined period of time. After that time is up, the contract has hit its expiration date and the contract is worthless. A put option gives the option holder the right to sell shares at a strike price for a set period of time.
If an investor thinks the value of shares will rise, they buy call options. If they think the value will fall, they buy put options. The ability to properly read an options chain is vital to success in buying and selling options at a profit.
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How to Buy Call Options
Want to learn how to make money trading call options? Let’s start by understanding a basic call option contract.
Assume a large company is trading at $200 per share and an investor purchases a call option contract for that company at a $200 strike price with a premium of $3. The premium amount is what the investor agrees to pay for the right to purchase 200 shares in the company at $200 apiece. In the open market, buying 200 shares at $200 apiece would cost $40,000. With a call option contract, the investor will pay 200 shares multiplied by $3 per share, which amounts to $600.
Once the investor has purchased this call option, there are a few different ways things could play out. For instance, if the company’s $200 option expires and their share price goes up to $215, the investor has the opportunity to make a profit. They can use their call option contract to buy 200 shares at the $200 per share rate and then turn around and sell those 200 shares at the new price of $215. That’s a $3,000 profit with a net profit for the investor of $2,400 ($3,000 profit minus the $600 cost of the call option contract).
As with most actions taken in stock market trading, there is some risk involved when it comes to purchasing call options. You’ll want to be sure you purchase call option contracts with companies that you anticipate will rise in value. If an investor purchases the same call option contract mentioned above, but the company’s shares only rise by $1, they could lose money if they try to trade. Here’s how that would play out.
This company’s $200 option expires, and the investor uses their contract to purchase 200 shares at $200 per share. If they then sell those shares for $201 a piece, they’ll get a return of $200. Because they paid $600 for the contract in the first place, that’s a $400 loss.
Worst case scenario, the company’s shares drop below the $200 option, and the investor’s contract becomes null or “out of the money.” This means the contract is useless, so the investor is out the full $600 they paid for the call option. When thinking over your call option strategy, consider that the potential for gain is much greater than the potential for loss, especially if you’re careful about the companies with which you purchase call options.
Basically, if you haven’t thought about adding trading options to your portfolio for a chance to grow your gains, it’s definitely worth considering. There is certainly money to be made in this practice.
Can You Make More Money Trading Options?
Understanding trading options is the only way you can make more money with this type of market play. Can more money be made trading options than traditionally trading shares? That depends on your strategy. Here’s a quick comparison of the two strategies.
Say Evercore is currently at $35 per share, but you believe the price is about to go up substantially. This is the time to get in the game. If the stock goes up to $55 per share in the following week, and you purchased 100 shares at the $35 price, you’ll be able to make a profit of $2,000 with the new $55 price. Your purchase of $3,500 for 100 shares made you $2,000, so you’ve made a 175 percent return. But, could that return be even higher?
When working the same scenario using call options, you can earn much more than $2,000. Say we jump back in time to when the stock price was at $35, but instead of purchasing 100 shares at the $35 price, you decide to purchase a call option contract for 100 shares with a $35 strike price and an expiration date of two weeks later. Let’s say the call option contract was set for $2 per share. This means that the call option contract cost you $200 for the 100 shares.
Now, following the previous scenario, the stock price rises to $55 per share one week later. Because the rise in value happened before the contract’s expiration date, you still reserve the right to purchase those 100 shares at the $35 price, even though the stock price on the open market has changed to $55.
So, now you have a call option contract that cost you $200 per contract and the right to buy the shares at a lower price. You are not, however, obligated to purchase those shares. Because the price of the shares went from $35 to $55, the contract is now worth $2,000 because it covers 100 shares at an increase of $20 per share. The contract promises a $20 return on the shares, therefore it has an intrinsic value of or is “in the money” $20.
If you decide to trade your call option contract for it’s $2,000 value, you’ve made a $1,800 profit since you paid only $200 for the original contract. That’s a 900 percent return versus the 175 percent return when trading in basic shares. So, can you make more money trading options? Yes, yes you can.
Benefits to Trading Call Options
Not only can you make more money trading options, but you can also benefit from the way they work when it comes to risks. Simply put, you can never lose more than what you originally paid for the call option contract, no matter how far the value of the stock may drop.
Most equity option and index option contracts in the United States are good for one month and expire on the third Friday of that month. As the stock market continues to adapt to changes, more exchanges are changing this rule and offering option contracts with weekly expiration dates for a quicker turn-around on bigger indices and stocks.
American call options provide quite a bit of flexibility compared to European options. A trader can enforce their call option contracts at any time before the contract expires with American style options, but European style options require the trader to wait until the expiration date to enforce the contract.
Call options also offer basically unlimited earning potential with very little risk for loss.
Pay Attention to this:
If you purchase a call option contract for $1 per share with a strike price of $10 per share and the price rises to $1000, your call options would have an intrinsic value of $900 per share, leaving you with a serious profit.
If they fall to $0 per share, you’ll only lose what you paid for the contract. Say you purchase a contract for 100 shares. That’s a loss potential of $100 with a profit potential of more than $90,000.
How Much Can You Make Trading Options?
Investors hoping to make money trading options might need a little encouragement before jumping in. Success stories from other traders can give you the boost of confidence you need to get started with trading options.
One trader was able to make a 1,300 percent return on their money in a matter of minutes in one trading scenario. One day, the trading in a company for animal health, called Zoetis, was put on hold due to a report in the Wall Street Journal that said that a Canadian pharmaceutical company might be about to buy out Zoetis. Once the stock was back in the trading game, its shares went up over 11 percent, and this trader won big.
Call volume on Zoetis shares was twice the amount of put volume. As soon as the news of the buy-out hit, this lucky trader bought 300 of the 50-strike call options for only $0.34 per share. Once Zoetis shares were back in action, they hit a huge spike in value. The shares went from $0.34 to $4.80 per share. This trader with call option contracts on 300 of Zoetis shares made over $130,000 profit.
Paying close attention to takeover reports can lead to big payouts for smart traders. Other reports include people making over $200,000 in trading options. This is a good strategy when played well. Although, you do want to be careful when it comes to buying calls through rumors.
Mistakes to Avoid When Trading Options
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The best way to make money trading options is to move carefully and try to avoid the common pitfalls traders face when starting out. Trading options offer savvy investors an opportunity to keep a good handle on their risks and leverage assets when needed. When using options skillfully, you can make a profit, no matter which way the stocks are going.
Even though trading options can seem like a smart play, you still want to move cautiously. Any mistaken opportunities can turn into a loss quite easily. When beginning your adventure in trading options, start with a basic strategy and do thorough research. Let yourself learn with experience and then branch out into more complicated strategies, as you feel ready.
While researching and formulating your strategy, you should also learn about the errors that traders frequently make when trading options. Here are some of the most common mistakes – commit these to memory, so you can help yourself avoid losses and bad decisions:
Don’t buy OTM (out-of-the-money) call options. Some experienced traders will do this to make a profit, but this is a complex and very risky strategy to start with. Keep things simple as you get your feet wet.
Many traders make the mistake of committing themselves to one strategy and are unwilling to adapt to changing markets. Consider the long spread trading approach.
Before buying a trading option, remember that it is going to expire, and be prepared. Even if everything is going well, you’ll need to be ready to make your move when the time comes. If things don’t go your way with a trading option, try to keep a cool head, and don’t risk even more by just doubling up. Take a moment and reassess the situation.
When trading in short options, you want to be careful to act on the buy back when you still can. It can be tempting to wait out your options to make the most profit, but it’s wise to act when you have a good opportunity to make a profit and not to let greed be your downfall.
How to Profit From Options Trading
Different factors can affect an option’s price, so traders can’t expect to simply start buying call options and making profits. Only certain trades will end in a profit for the buyer, others will cause a loss. A trader will only successfully make profits from trading call options when they purchase options for a stock that is expected to rise at a decent rate over the following week or month.
Consider how much you expect the stock to rise. This is where good research comes into play. Knowing a certain stock’s history and plans for their future is vital to making a profit.
Purchasing out-of-the-money call options for a $50 strike price isn’t a good move if the price is only likely to increase 5 cents per day. However, if the stock is likely to move as much as 50 cents per day, it has the potential to be a great play. A stock’s volatility also plays a huge role in whether it’s a good idea to buy its options. Some people enjoy the thrill, but a profitable trader plays the market carefully and doesn’t take many huge risks.
Even though many traders only purchase out-of-the-money options, like we said before, this isn’t actually a very solid strategy. OTM options do offer low prices, so they have the potential for some serious turn-around, but they’re risky. Some traders just like the idea of owning several options, so they’d rather buy a bunch of cheaper OTM options than a few solid ones.
Consider whether you play the lottery. If you do, maybe trading in OTM options is something you’d enjoy. If not, you probably don’t because you recognize that the odds are not in your favor. Many are so intrigued by the chance at a huge jackpot win that they ignore the odds. The stock market shouldn’t be played like the lottery. The odds don’t have to be bad. Play it smart and give yourself good odds.
You want to buy in-the-money (ITM) options that will likely continue to stay in the money before your option contract’s expiration date. Once you have good ITM options in hand, know when to sell or buy (depending on whether you purchased put or call options). We’re not trading in European Style options, so you don’t have to wait until the expiration date to make your move.
Profit By Sticking to Your Plan
Leaving money in options is a waste of your assets if the waiting isn’t going to make you a profit. The safest method is to make your trade as soon as a profit is available. Plenty of seasoned traders are tempted by the chance to make a larger profit, but waiting too long could quickly lead to you kicking yourself because you lost an opportunity.
Before buying an option, make a plan. You should decide on a target profit with your plan. As soon as your option hits that target, make the trade. Stick to your guns. Even if the target is hit early on in the contract duration, make the trade. Sometimes the target won’t be reached. In such cases, it is best to make your trade either when you’ve reached somewhere close to the target or, in the worst case, when you’re likely to incur the smallest loss.
Profit By Knowing the Factors
One of the key aspects to profiting from options trading is having a good understanding of the stock market and its current trends. Individual stocks don’t move completely out of touch with the market. Yes, some stocks do better than others, but the overall health of the market has a massive effect on individual stock values.
Knowing every factor that affects a stock before you buy its options is the best way to manage your risk. Don’t jump into any decisions blindly or ill-informed. Typically, more expensive options are less likely to make you a profit, so be careful when agreeing to your option contracts.
We want you to succeed. Most new-to-the-scene traders jump into the game without warning or much understanding. The more you know, the more successful you are likely to be. Learn more about trading by signing up for a webinar or reading an e-book on the subject. The experts at RagingBull are here to educate and help you reach your full trading potential.