Investing in Options

Stock and ETF Options:

Most people believe that options are a lot riskier than stocks.  This is true in one sense – if the stock increases by 5% the option can increase by over 100%. Conversely, if the option declines by 5%, the option could lose all its value.  The underlying stock or ETF needs to stay even or increase in value for a call option to increase in value unless the implied volatility of the option increases dramatically.  If you understand options under the right circumstances you can lower your risk through option trading.  Options can be very complex depending on how you trade the options and it is beyond this website to explain option trading in detail.  However, I will explain covered calls, leaps (longer-term options), and hedging of your stock or ETF position using options.  I will also give you links at the end of this section to help you learn more about options.  You should also read the section on understanding graphing.

Covered Call Options:

You buy at least 100 shares of stock and then sell 1 Call option contract for every 100 shares you own.  Usually, this is done to create earnings from the selling option, which offsets your cost of purchasing the stock and lowers your net cost of the purchase, and at the same time increases your income.  This is one of the least risky option strategies.  The option length that is sold is usually a week to at most a month period of time.  If the price increases you could have the stock called away from you but you will make money through the sale of the option and usually by calling the stock from you.

Buying Longer-Term Call Options:

The option period is usually any time from 6 months to 2 1/2 years.  What happens is you buy the option at the call strike price (the price at which the call purchaser can purchase the stock or ETF when the option expires) where the delta (for example if the delta is 80 the option will increase at 80 cents for every 1 dollar of the stock price increase) the delta will generally increase as the stock increases in value or decline as the stock decreased in value.  This means you can usually buy an 80 delta option for about half or less than the price of the stock on a two-year call option. You must pay about a 10% to 16% option premium for a two-year option.  This means you could buy about twice the number of shares for the same dollar amount, which works well if the stock increases in value but you can create more losses if you buy twice the number of shares and the stock declines in value.  You could buy the same number of shares for half the price, and then invest the difference in preferred stock and probably earn more dividends than you would from the dividends of the common stock.

Hedging – Buying Put Options:

If you own a stock with a large gain and you expect it to go down you can buy a put option with a strike price that is usually close to the trading price of the stock, then if the stock goes down you gain on the option and lose on the stock. Instead of reporting the entire gain in the stock you only report the much smaller option gain which helps to offset the decline in the value of the stock.  If the stock goes up you have a loss in the option which you report and you don’t have to report the much larger gain in the stock.

There are a lot of other things you can accomplish by investing in options, but I wanted to give you some feel for three of the least risky use of options, and explain to you that option risks to a large degree are dependent on how you use them.

Learn How to Trade Options:

The first thing you need to do is find a site that will let you trade options without using any real money until you learn how to trade options.  I would recommend TD Ameritrade’s Think or Swim platform or Trade Station’s platform.  Both of these brokers have option sites and training courses available.

One of the best training sites that I have found is Option Alpha, their video course modules are outstanding.  The training is free and they also have a free membership in addition to two levels of paid memberships that provide you with the opportunity to trade live.  You should make the money you pay in membership back plus a profit.  However, it will also depend on the type of market that occurs while you’re a member.  The trades are generally intermediate term 15 to 60 days and are a combination trade of both buying and selling options at the same time.  You will learn how to trade these types of option trades while making money on the trades if you sign up for one of the paying memberships.

The next site is Market Rebellion.  This is a trading site that Jon & Pete Najarian developed that teaches you how to trade options.  You may have seen Jon and Pete on CNBC.  I was a member of the TNT options.  This is a paid membership site that teaches you to trade short-term options usually a day or two to a maximum of a week.  Each week they have a webinar and select a stock to trade and you trade it either up or down depending on the market and the individual stock or ETF they select.  They use straight lines which become support and resistance lines, see understanding graphing for more details on straight lines.  You should make money trading after a few weeks of learning how to trade with them in their plan.  They also have other paid sections that teach you how to trade other types of option set-ups.

The final site is TradeWins Publishing.  This is a site that has various members available that teach you how to trade options.  I have subscribed to the following: Chuck Hughes, Wendy Kirkland, Trade Alert 365, and Rob Abel’s Six-figure slide system.  Each of them operates a little differently, you will need to try and decide which if any are right for you. They are all good services and in a good market, you should recover much more than the membership cost.  There are many more authors with member subscription services on the site, I just haven’t used their services so I don’t know enough to comment on them.

But remember that any of these types of memberships will definitely have losing trades and you may have overall losses in certain types of markets.  Options and stocks are risky and you need to understand these risks, there are no guaranteed winners.