More About Options Trading
Learn a trading style that can stimulate your intellect, as well as your wallet.
An option is a contract to buy (=call) or sell (=put) an agreed-upon quantity of a specific stock or other asset
at a specific price, up until a specific expiration date. Traders can write options on stocks they own, but you can
also buy and sell options in the open market with no need to own the underlying stock.
Because the value of options is tied to price movement over a given period of time, options are far more volatile
than stocks and price changes are dramatic; a $100 stock that goes to $110 has seen a 10% increase, but this might
translate to a 100% increase in an option that allows you to buy at $100 anytime in the next six months. It’s not
unreasonable that traders ask themselves, “Why should I spend $100 to buy a stock when I can control it with a $5 or $10 option?”
Two types of options traders: directional and non-directional
There are two types of stock options traders, and we teach strategies for both of
them in our Options Trader class. First is the directional trader, who uses technical analysis and market timing to predict whether
the market is headed up or down, and then magnifies their bet by trading options vs. the underlying stocks.
Traders who believe the market is headed up can buy calls which allow them to buy a stock at a specific price,
no matter how high the price may actually climb. Since this provides a no-risk opportunity to buy a stock and immediately
sell it at a higher price, the option rises sharply in value if the stock goes up. Puts are for people who think the market
is headed down; no matter how low a stock goes, they can sell it at the strike price according to the contract. Remember:
there is no need to actually buy and take delivery of the stock. And, once the expiration date passes, the option is worthless.
Non-directional traders are interested in the net premium they retain after the sale of their options, rather than
the price of individual options. A simple example is the straddle, which involves buying a put and a call on the same stock
at the price with the same expiration date. Straddles are used when a trader expects dramatic movement but is not sure whether the
movement will be up are down. If the stock goes up then the put becomes worthless, and the trader is left with the appreciation
of the profit on the call, less the loss of the premium paid for the put.
How you can trade options for risk management
The straddle, just described, is a high-risk strategy. But other options strategies are far more conservative and
can be an important part of a trader’s capital-preservation toolkit. For example, if you own a stock and think its value
might go down, you can hedge by selling a call option at today’s price. What you earn by writing the option partially
offsets your potential loss. Or, if you want to buy a stock but feel it is overvalued at today’s price, you can effectively
lower the price by selling a put which commits you to buy if it reaches your desired price. You make money from the put,
whether or not you end up owning the stock.
Advanced stock options trading tactics that produce a non-level playing field.
In an efficient market, you’d expect that the price of options would get cheaper as the clock ticks toward their expiration
date. And they do... but the process is not linear and that makes for some additional opportunities which in effect give
savvy traders a non-level playing field. At Online Trading Academy, students learn how to buy puts and calls at the exact
time that our supply and demand rules tell us they are cheap and about to become expensive.
Part of this calculation is an understanding of “The Greeks”—five different measurements of risk, each of them named after a
different letter of the Greek alphabet: Delta, Theta, Gamma, Vega (not actually a Greek letter) and Rho. Online Trading Academy
options students learn how to master these complex measurements as they build an options strategy which can meet any investment
need—from capital preservation to dramatic upside potential in good markets or bad.
Many traders who become experts at trading options say they find it intellectually
satisfying as well as profitable—like playing a great game of chess. Here is a way you can use your native intelligence
in an enjoyable way that can also be very rewarding.