Trade Options Like a Pro
Many years ago I had a friend in the IT business. These guys were building out networks for businesses. Every once and a while he’d run into a problem where some switch or router wasn’t in stock because the company who made it couldn’t keep up with demand.
Now this guy wasn’t a market guy. He didn’t work for Morgan Stanley or Vanguard. But he knew how his industry worked and so when he saw huge demand for a widget he bought call options on the company that made that widget. I don’t know how much he made exactly but I do know he bought some acreage in West Virginia in addition to his town house and was always driving the latest import.
My point is you don’t have to be a day trader to make options work for you. Many people look at options like they are trying to fix a modern car, paying taxes, or figuring out plumbing. But I’m here to tell you it’s much easier than all of those things. With some basic lingo, you too can leverage your trading and start making fast profits.
It’s a bit more complicated than simply buying a stock, but if you have confidence that a stock will move, an option is a nice tool. Say you know that Microsoft will buy out some company. This might move the stock (MSFT) three percent in a day. Great, you put down $1000 and you get $30 – big whoop. That won’t even buy you lunch.
But if you buy a call option you can make $3000 in a few days. That works, right?
What is an Option
At its core, an option is a contract. It gives you the right (but not the obligation) to buy or sell shares of a stock at a set price by a certain date.
You can trade options on regular stocks, indexes, ETFs (exchange-traded funds), and even commodities futures.
For example, let’s say you’re interested in options for a company like ExxonMobil Corp. (NYSE: XOM). In this case, XOM stock is what we call the “underlying asset.”
When we talk about options related to stocks, each contract covers 100 shares of the underlying asset, like Exxon. So, if you buy an option for $0.85, you’re essentially paying $85 for the right to control 100 shares (that’s one contract) of Exxon.
Now, let’s get familiar with some basic terms you’ll come across when you start trading.
Key Terms in Options Trading
Whether you’re buying or selling options, there are two main things you need to know:
- Strike Price: This is the price at which you can buy or sell the stock if you decide to exercise your option. It’s like your target price.
- Expiration Date: This is the deadline for using your option. If you don’t buy or sell by this date, your option becomes worthless on this date.
Remember, these terms stay the same throughout the life of your option contract.
For example, if you say, “Buy ExxonMobil January 25 calls,” you’re saying you want the option to buy ExxonMobil stock at a certain price by the third Friday in January (or whatever the specific expiration date is).
Understanding Calls and Puts
Just like when you’re deciding whether to buy or sell a stock, you have to think about whether you expect the stock’s price to go up or down. In options trading, there are two basic types:
- Call Options: You buy these when you think the stock’s price will go up. Call options give you the right to buy the stock at a set price by a certain date. Think of it as “calling” the stock to yourself.
- Put Options: You buy these when you think the stock’s price will go down. Put options give you the right to sell the stock at a set price by a certain date. Think of it as “putting” the stock to someone else.
To see all the different options available for a company, including different prices and expiration dates, you can check out options chains on financial websites like Yahoo! Finance. Just enter the company’s name or ticker symbol, click on “Options,” and you’ll see a list of available options with various prices and expiration dates.
It is important to note that the closer you get to the expiration date the faster the value of the option will decline. The best way to get started is to paper trade. See how the options react to events in real-time.
Anyway, you look at it options are a great tool to have in your investing garage.
All the best,
Christian DeHaemer
Outsider Club
