Tag: options trading

  • Low-risk Options Trading Strategy

    Low-risk Options Trading Strategy

    These low-risk options trading strategies are commonly used for trading stocks but they are suitable for any market you would like to trade.
    By Guy Avtalyon

    Low-risk options trading strategy should be cleverly defined. It is a whole different story from any other trading.  Options trading means a bit more security. How? Instead of estimating what price the particular asset will hit, you can enter the opposite position and speculate which price it will not hit. Sounds weird? Absolutely not. Yes, for some people this whole world of puts and calls may sound scary but low-risk options trading strategy is one of the easiest ways to make money.

    For example, you can take a position called a covered call which is one of the safest. So, instead of talking a lot, let explain this low-risk options trading strategy. 

    Covered call as low-risk options trading strategy

    This can be an excellent method to increase your profit. This strategy means to sell the right to buy a stock that you own, at a specific price, on a determined date. You’ll receive the premium when selling a contract, and you’ll receive it immediately. The best part is that you’ll profit even if the stock price doesn’t change, no matter if it stays the same or drops. The buyer, to whom you sell the contract, can make a profit only if the stock price increases within the specified time frame.

    So, you’ll have better chances than the buyer of doing well. And, don’t forget this, you’ll get the premium. You can use it to protect your trades in other positions you take if they are risky. 

    For you, that are new in this field, use the stock you already hold. In case you lose on the contract you’ll have the stock to simply give. Keep in mind that the call is only valid until the expiration. If the stock price stays below the strike price, then you’ll keep the profit or cost reduction. You can do it over and over again with the covered call. In this way, you’ll continue to reduce your cost and increase protection against unfavorable moves in the stock.

    Collared Stock

    Collared stock, or ‘collars’, are similar in approach to a covered call. In this strategy, you should start with a covered call. But the difference is that you will not take a premium to reduce the cost of your positions. Instead, you’ll take that profit to buy a put option and use it as added downside protection. By buying the put option, you’ll get the right to sell your stock at the strike price. And the best part, despite anything that could happen, you’ll have the right to sell that stock at the strike price. Frankly, this put option is the best stop-loss you can buy.

    This strategy is suitable after a large run-up in the stock. Also, when the investor assumes there is a notable downside.  You can tune Collared stock to take the remaining risk out of the stock position. How much it will be, depends on the position of the call and put options strike prices relative to the current price.
    For example, if you got $1.80 for the sale of 115 call option.

    How much put to buy?

    Let’s go further. If you have, let’s say the 110 put costs $2,75 and 105 put costs $1,15, you have a tradeoff. So, make it. The other solution is to buy the 110 strikes that will give you almost the full protection. Or you keep a bit risk on the position and purchase the 105 strikes. For the first solution, you’ll need more money, you’ll have to pay an extra amount of $0.95 for the protection. It can be a rocky path. Instead, buy the 105 strike puts. By entering this position, you’ll save $0.65 in cost reduction.

    Can you see it? This strategy means to take off as much as a possible risk from stock you can. The point with tradeoff is to take upside reward with the most risk you take off.

    In essence, it’s almost the same when you’re selling the stock. The potential risk is big, so the reasonable question is why shouldn’t you sell the stock instead? It’s simpler. Anyway, this strategy is broadly used by hedge funds to limit the market’s moving.

    Short Put or Naked Short Put

    Nothing indecent to see here. All you are performing is writing a put for the premium, or the credit from selling the put. It is alike as a covered call but without the stock.

    When you sell the put, you have an obligation to buy shares from the counterparty at the strike price if they decide to execute the contract. You’ll sell a put when you suppose the stock price will go up or stay near to the current price. But, if the stock increases, you’ll keep all the money you got from the sale.

    But there is another way also. You can use writing puts to be paid to wait for the price to pull back. And then enter the stock. In essence, you’re paid to take the risk of some other trader’s stock. Your hope is the stock will pull back and the option will be exercised by the owner of the stock. So you’ll take delivery of the shares. 

    This strategy is excellent while the markets are high. Well, what will happen if you don’t want that stock or the price suddenly drops? The premium will compensate for the drop. Same as with a covered call. If you try this with stock instead of the options, there will be no compensation. 

    With short put, you’ll have lost less than you can in stock trading.

    Generally, short puts outperform covered calls in risk-reduction trade-offs but unfortunately not in all market conditions. There is a concept in options trading known as the “volatility smile”. It points out that markets are more terrifying than greedy.  Remember, since a short put doesn’t have stock in the position, you’ll need to be very active to stay invested.

    This is a kind of leverage, so you’ll have to use it very carefully. The beginner traders should approach short put trades with the knowledge that they could be forced to buy the stock at the strike price of the put they sold. It’s very reasonable to keep aside enough money to buy the stock if you are assigned.

    Risk Reversal as low-risk options trading strategy

    With options, the focus is on implied volatility. This means, when the market falls, implied volatility increases, and vice versa. The market becomes rougher when stocks decline and more pleasant when stocks grow.

    A risk reversal copies buying stock. That means you’re selling a put and then using those profits to buy a call. But as a difference from the stocks, in this position, you’re taking advantage of the already mentioned volatility smile. It will allow you to spread out the exercise prices and take additional advantage of volatility differences. 

    This low-risk options trading strategy is a great method to employ for a big move up in stock. But, you’ll not be allowed to play in the zone between the put and call.

    Put Spread 

    So far we mentioned the low-risk options trading strategy that trades upside for downside protection. But there are other low-risk strategies for options trading.
    When you trade a position that has direction there is one obvious risk that won’t go away: the risk that you’re wrong in gauging what is the future direction of the stock. In options trading, you don’t need to trade a direction. You don’t have to determine if a stock will grow or decline. Instead, you can trade volatility and time decay. One of the lowest risk strategies is the calendar spread. The calendar spread is when you sell a near-term put and buy the same put but with the later expiry date.

    For instance, you sell the March 100 put and buy the April 110 put.  So, if we know the pricing is based on the future value of the stock, the more time the option lasts, it will lead to more value. That is the benefit of the calendar spread.

    But why would you need to do this? Simply, to benefit from the time and volatility changes. This isn’t the most exciting strategy but in trading, less is more. In other words, less excitement means less risk.

    Low-risk Options Trading Strategy

    How can you make money?

    Easy! As you go closer to the expiry date of the first put contract, its value will decline every day more than the longer-dated put. But you’ll have to stay close to the current trading range. Meaning, take advantage of the time decay of a short put. This is the way to have a steady increase in profit as long as you stay in the range. Don’t wait for the expiration date. Wait until 15-25% of the maximum return. You’ll have a nice profit.

    With these low-risk options trading strategies, you’ll have some of the tools needed to add to your portfolio. These strategies are commonly used for trading stocks but you can also buy calls and puts if you want to trade cryptocurrencies. In trading any market, it is very important to be equipped with the knowledge of how to take lower risks and maximize the profit.

    More articles on this subject:

    >>> Low-risk Options Trading Strategy

    >>> Mistakes in Options Trading – How To Avoid Them?

    >>> How Options Trading Make Money?

    >>> Greeks In Trading Options As A Risk Measure

    >>> What Is Options Trading Examples

    >>> Trading Options – Understand the World of Options (Full tutorial)

    >>> Short Call Option Strategy Explained

     

  • Mistakes in Options Trading – How To Avoid Them?

    Mistakes in Options Trading – How To Avoid Them?

    Mistakes in Options Trading - How To Avoid Them?
    Options trading isn’t difficult once you understand the basic concepts. They provide great opportunities when you use them correctly and can be dangerous when you use them wrongly. 

    By Guy Avtalyon

    You could make a profit no matter if stocks go down, up, or sideways and these great possibilities could lead you to make mistakes in options trading.  Despite the fact that this sounds great, you could also lose everything you invested in options trading. And you can do that in a short time. 

    Do you want that? Of course not. No one wants to lose money. So, what do we have to do?

    It is important to understand where mistakes in options trading can come from and how to avoid them. The truth is that even the most experienced traders can make mistakes in options trading. They can misunderstand some opportunity, have less caution, literally almost any absence of focus may cause mistakes in options trading. 

    We will examine the most frequent mistakes and how to avoid them and, also, how to overcome them.
    These mistakes are typically made by beginner options traders. So, take time to evaluate them and you can avoid making costly wrong actions.

    What mistakes can you make in options trading?

    Mistake 1: You don’t plan your entries and exits 

    Options trading is more complicated than trading stocks. When you enter the position in options trading, there are a lot more elements to watch and be aware than it is the case when trading stocks. In options trading, you cannot just enter and exit the position. You have to make a lot of adjustments if you want to profit and decrease the risks involved. 

    So the first mistake in options trading is to trade without a plan. This means you’ll enter the position and what is next? What are you going to do? Will you let your emotions to handle your trading? What if the price move against you? Will you pretend nothing is happening and like a child you’ll close your eyes until all problems go away?

    Of course, we know it’s impossible to put emotions out. But, also, we know that you can’t allow your emotions to affect your trading decisions. If you do such a thing, your portfolio could blow out and you’ll end up in losses.

    How to avoid a Mistake 1?

    Simply, trade smarter. It’s easy to say but how to avoid mistakes in options trading, particularly this one?

    Start to plan your exits. Exits are not important just to reduce the losses when things are not going in your favor. You must have an exit plan, in any case, you shouldn’t even enter the position before you have a good exit plan. Your upside exit and downside exit points must be set in advance. That means you already know the price targets. Further, a time frame for each exit is important too so you have to plan it.

    Keep in mind that options are time decaying assets. As the expiration date nears, the scope of decay grows. For example, if you are a long call or put and your expectations are more likely not to happen in the expected time frame, get out of the trade. Don’t wait, just go on to the next one.

    Time decay will not always knock your trade, of course. For example, if you sell options without having them, time decay will work for you. You’ll have a winning trade if time decay erodes the option’s price. You’ll keep the premium for the sale. Yes, that will be all you’ll earn if you are a short seller of a call or put option. The bad thing is that you may expect a great risk if the trade goes wrong.

    So, it isn’t a matter of what do you like or not, what strategy you’re running. You MUST have an exit plan for each trade. Even when you have a winning or losing trade. If your trade is winning don’t be greedy and don’t wait around for more. Exit with profit. If it is the opposite and your trade is losing, don’t wait also because you’ll need to exit the losing trade. Waiting with the hope that losing trade will turn into your favor is too risky.

    With having the plan, when you know your entry and exit points you’ll profit more consistently, you’ll reduce your losses. 

    Mistake 2: Using only the long call and long put strategies

    The important element when starting to trade options is to have a vision for what is possible to happen. In other words, you’ll have to estimate but also, your estimation must be accurate. You can use technical and fundamental analysis or a mixture of both. By using technical analysis you’ll have an interpretation of the volume and price in the charts, also you’ll look for support and resistance zones, trends because you would like to recognize opportunities for buy or sell. Fundamental analysis will show you a company’s financial audits, performance data, and current trends so you’ll be able to view the company’s value. 

    While estimating the different options strategies, you have to be sure the strategy you pick is created to take advantage of the outlook you suppose. You have to decide which is most suitable for your current situation.

    If you limit your trades to long call and long put strategies you’ll limit the probability to use some more profitable strategies. Moreover, they are unique, for options only and not implementable on stocks. 

    How to avoid mistakes in options trading?

    In trading options, you can trade an upward as well as downward move, a move in each direction, or without movement. Besides, you can trade, for example, an increase in volatility, or a decrease in volatility, etc. Is there any reason why shouldn’t you use some of these strategies and add them to your trading toolbox?

    Of course, not all options strategies will be good for every trader. There are some trading strategies that you don’t enjoy running. Maybe you didn’t have luck with them in the past. It isn’t necessary to use them but it can be useful to know them. Just try out the new strategy in a small size. That will not increase the cost per trade but new strategies might be interesting but most importantly, maybe you’ll find your next favorite strategy.

    Mistake 3: You wait too long to buy back short strategy

    This strategy can turn into a great mistake. You must be ready to buy back short strategies early. For example, if a trade is going in your favor it is easy to love the fanfare, but the trade may easily turn in a different direction. 

    We have heard numerous explanations of why traders are waiting too long to buy back options they have sold. Some were betting the contract would expire worthlessly, some didn’t want to pay the commission to get out of the positions,  or were just greedy hoping to get more profit out of the trade. The list of excuses is very long.

    How to avoid all mistakes in options trading?

    When a short option gets out-of-the-money and you want to buy it back, just do it. Don’t hesitate. 

    There’s a rule-of-thumb. If you can maintain to hold 80% or more of your original gain from the sale, think about buying it back quickly. Contrarily, a short option will come back and hurt you if you wait too long to close the position.

    Let’s say this way. For instance, you sold a short strategy for $2 and, for example, a week before the expiration date, you have an opportunity to buy it back for $1. Take it! Quite rarely it will be worth an additional week of the risk. 

    Mistake 4: You are buying out-of-the-money options

    This is common for new traders. We almost all tried this in the beginning. The reason is obvious. Out-of-the-money options are the cheapest and it looks like a great plan to start with them. Well, they are that cheap with a great reason and we understood that later. These options have very little chances of ending in the money. Most frequently they end up worthlessly. Trading these options is more a lottery game where you have to buy numerous tickets to see one that pays off and break even.

    When you buy these options, you must be accurate in timing and direction both. Even if you hold these options longer, a move in the right direction will not help you out. With approaching expiration, there is less possibility for these options to end up in the money. It’s more likely they will remain cheap.

    How to avoid this mistake?

    Try to get long calls or long puts at the money or in the money. That will increase their value since the options will be more costly than the out-of-the-money equivalent. So the probability of success will increase and it will deserve money.

    Mistake 5: Trying to overcome the past losses by doubling up

    All traders have certain absolute rules. They are playing well unless a trade turns against you. That experience is common for every single trader. Almost everyone was faced with a trade that turned against expectations. The first reaction is to break all adopted trading rules and continue trading the same option they started with. 

    Have you ever heard a saying “doubling up to catch up?” But it falls into stock trading. For example, if you bought the stock at $50 and you loved it, you’ll still love it at $30 because the lower price will give you a chance to buy more shares. This isn’t relevant in the world of options trading. It can be one of the great mistakes in options trading.

    How to avoid this mistake?

    This strategy called doubling up isn’t suitable for options trading. Don’t use it. Keep in mind that options are derivatives and that their prices don’t move the same direction as the underlying stock. 

    Yes, this strategy can lower your cost per contract for the entire position, but it can compound the risks. So when a trade goes against you, just ask yourself: “Is this a trade I would like to execute?” So, what to do in this case. Simply close the trade to cut losses and find another opportunity. To say this simply, it is smarter to take a loss now than wait and have bigger losses later.

    Everyone can make mistakes in options trading. They can be costly especially if you are trading cheap options. 

    Never think that cheap options can give you the same value as low‑priced options. Cheap options might have a bigger risk. You can lose everything you invested in them and more. the lower the likelihood is that it will reach expiration in the money. Before taking any action try to understand where the mistakes in options trading may arise.

  • How Options Trading Make Money?

    How Options Trading Make Money?

    How To Trade Options And Make The Best Returns?
    Options trading strategies include the whole range from simple trades to extremely complex. No matter simple or complex, they’re based on two fundamental option types: calls and puts.

    By Guy Avtalyon

    There are unlimited ways to learn how to trade options and make money. How to find the best options trading strategy is also very important. You have to choose and find the right time to use your options trading strategy. That will result in huge profit potential for the traders. If you never learn you’ll be stuck in the question of how to trade options and miss a chance to make the best returns.

    You may ask why trade options instead of direct assets?

    Trading options have some advantages that could benefit you more than direct assets. Before we explain to you how to trade options, we want to tell you where you can do that. 

    In the US CBOE or the Chicago Board of Options Exchange is the largest exchange for trading options, actually, it is the largest in the world. Its offer is in the range from single stocks, ETFs to indexes. 

    In Europe, the situation is a bit more complex since we have a specific type of option. More about this READ HERE
    Recently, the market maker demanded from regulators to bring the new rules about derivatives trades. But if you want to trade options CME Group or Intercontinental Exchange can be the right places.

    Anyway, whichever you choose you’ll have to create the proper options strategy, one or more. You can choose from a very simple buy or sell strategy to extremely complex that require many simultaneous option positions.

    How to trade options for income?

    Traders frequently enter the trading options with limited or lack of understanding of options trading strategies. It is quite hard to explain why because they can learn how to trade options and find plenty of strategies that could limit the risk of trading and, at the same time, give the best returns. 

    That requires a little effort but gives an opportunity to take advantage. Traders who know how to trade options can enjoy the power of options trading. And they are very powerful. Having that in mind, we are giving you the shortened version of how to trade options along with the most powerful strategies you can use to generate the best returns. These strategies will teach you how to trade options and direct you on the right path.

    Basic strategies to learn how to trade options

    Options trading strategies appear in the range from simple, for example, one-legged strategies to fascinating multi-legged that seem like they are coming from the other planet but from one more advanced than ours. Simple or complex doesn’t matter. All of them are based on primary option types: calls and puts. 

    When we say “simple” that doesn’t mean there are no risks involved but that simple strategies are a good starting point to understand how to trade options. Also, they are able to give good returns. 

    So let’s start with what traders call one-legged strategies.

    The long call

    This is a strategy when you buy a call option. In other words, you go long. This strategy means that you are betting that the underlying stock price will go up, higher than the strike price by expiry date. 

    For example, the stock you want to trade is at $40 per share and the call is accessible for $2. The expiration date will come in 6 months. As you know, you have to buy 100 shares at least which is a standard option contract, so your contract is for that amount of shares. That will cost you $200.

    $2 premium x 100 = $200

    Here are three possible scenarios with your long call option.

    The key variables in our imaginary case are:

    The strike price is $45
    Initial price in the example is $2
    Current underlying price is $40

    If the underlying price is lower than the strike price at expiration, your option will expire worthlessly. The result of your long call trade will be the loss. That loss is equal to the amount of money you paid for 100 shares, in our case study it is $200 which is the initial cost. The option’s total profit or loss depends on the underlying price. For example, if the underlying price is, let’s say, $42 why should you exercise the option? That would allow you to buy the underlying asset at, for example, at $45 which is more expensive than you buy it on the market.

    But here is the good news. In the long call trade, the loss will be always limited, you cannot lose more than your initial cost was. Even in case the underlying price drop to zero. You’ll lose the $200, the amount you paid for the call option.

    The second possible scenario is when the underlying price is equal to the strike price. That is a very rare case but still. In such a case there is no reason to exercise your option. You could simply buy it on the market since the price is the same. You’ll end up the same as in the first case scenario. Your loss will be equal to the initial cost.

    But what if the underlying price is higher than the strike price?

    Actually, you are buying the long call option for this scenario. That is the best possible case. When the underlying price is higher than the strike price that meant the option is in the money and you have to exercise it.

    For example, the underlying price rose to $50. As you already know, the options give you the right to buy the underlying asset at the strike price, in our example, it is $45. What can you do? Immediately sell it at the underlying price, meaning you have to exercise the option. That will bring you a cash flow of $5 per share, and as you have 100 shares which means $500 for that option contract.

    To calculate the profit from the trade you have to subtract the amount you initially paid.

    ($5 – $2) x 100 = $300

    That is your profit from one long call trade.

    The long put

    It is similar to the long call, but in this options trade, you’re betting on a stock’s decline because you don’t want it to rise. You are buying a put option, wagering the stock will fall under the strike price by expiration.
    For example, the stock trades at $40 per share, a long put option at $40 strike is available at a $4. The date expires in 6 months, for example.

    This long put will cost you $400 for 100 shares and you bought 10 contracts.

    $4 x 100 = $400

    The long put value is the biggest when the stock is worth $0 per share. That leads us to conclude, and we’ll be right, the stock’s maximal price is the strike price multiplied by 100 shares and multiplied by the number of contracts. 

    In our example, it is $4.000.

    $4 x 100 x 10 = $4.000

    When the stock increases, you can sell the put and save part of the premium, if there’s some time to expiration. The greatest downside is a total loss of the premium or $400 in this example.

    A long put is a way to bet on a stock’s drop if you can allow the possible loss of the whole premium. If the stock drops notably, you’ll earn significantly more if you own puts than you would by short-selling the stock. The other advantage is that you can use a long put to limit potential losses. In the case of short selling, you could take an incredible risk because the stock price could continue to rise. The stock has no expiration.

    How to trade options – The short put

    The short put is the inverse of the long put. The trader is selling a put, or in other words, going short. This strategy is best to use when you assume the stock will stay the same, meaning it will be flat or increase till the expiration. That will mean the put expires worthless and the put seller will take the whole premium. A short put is similar to a long call, but there are some differences. It is, so-to-say, a modest bet that the stock will rise so the payoff is modest too.

    If you use this strategy in the best case you can expect the maximum return same as the premium but you’ll as the seller will receive that upfront. The premium will be paid as a whole if the stock price increases above the strike price or stays the same. If the stock goes below the strike price at expiration, the seller will have great losses because such will be forced to buy the stock at the strike price.

    This strategy is useful for…

    But this strategy is suitable for traders who want to generate income by selling the premium to other traders. Particularly to traders who are betting the stock will drop. Put sellers want to sell the premium, that’s all that matters.

    Traders very often use short puts to reach a better buy price on a very expensive stock. They simply sell puts at a strike price, where they would like to buy the stock. For example, with the stock at $40, a trader will sell a put with a $30 strike price for $3.

    If the stock drops below the strike price at expiration, the trader is assigned the stock and the premium will offset the buying price. The trader pays a $27 per share, or the $50 strike price lessen for the $3 premium that he/she already got. 

    But if the stock continues above the strike at expiration, the put seller will hold the cash. So such can decide to try the strategy again.

    Is trading options a good idea?

    Yes, of course, and cheaper than trading stocks. Well, it’s obvious why trading stocks is interesting. It’s somehow simple to understand and definitely there is money that traders can make. But some other financial instruments can produce the benefits that stocks do not.
    Options trading, especially, has many advantages. Trading options is a very good idea and I’ll explain why even if it is more complex than stock trading and traders have to learn so much about it.
    First of all, in trading options, traders can make meaningful profits without having a large sum of money. So, it is perfect for beginners that want to start trading with a little money. Also, it is very profitable for those with large budgets. This potential to make a big profit with a little money comes from the leverage. The leverage is what provides your capital with much more trading power.

    A real-life example

    For example, you have $500 to invest and you want to invest it in Company ABC stock. Its stock is currently trading at $10, but you expect it to rise. If you buy this stock using your $500, then you could buy 50 shares of that stock. If you were right and the stock really rose to, for example, $15 you will make a profit of $5 per share which is $250 for the total. That’s a 25% return on your initial investment.
    Let’s see what will happen if you chose to buy call options on that stock.

    Alternatively, you could choose to buy call options on the same stock, giving you the right to purchase the stock. If call options with a strike price of $10 were trading at $1.00 each, you could buy 500 options with your budget of $500. That will give you a chance to buy 500 shares if the stock rise. So, let’s say the stock rises to $15, and you might exercise your option and buy 500 shares. If you sell them quickly your profit will be $2,500.
    Deduct your initial investment of $500 used to buy options. So, you’ll pocket $2.000. So the return of your capital invested is 200%.
    This is a simple example but tells more about trading options than everything.

    There are numerous profitable strategies for options trading. Traders-Paradise introduces you just four of the many strategies and ways how to trade options.  Of course, we will continue writing about all strategies we know or find from other traders.
    As we already said, there are countless ways to learn how to trade options and we are willing to present them. 

    Stay tuned, we are here for you. 

  • What Is Options Trading Examples

    What Is Options Trading Examples

    What Is Options Trading?
    In options trading, the underlying asset can be stocks, commodities, futures, index, currencies. The option of stock gives the right to buy or sell the stock at a definite price and specified date. 

    By Guy Avtalyon

    Before we explain deeper: what is options trading, we need to understand why we should trade options at all. If you think it something fancy, you couldn’t be more wrong. Actually, the origin of options trading came from ancient times. For example, Ancient Greeks were speculating on the price of olives before harvest and traded according to that. When someone asks you: what is options trading and argues that it belongs to modern stock brokerages just tell such one about trading olives. 

    From the first day of trade existence, people were trying to guess the price of food or some item they wanted to buy. 

    What is options trading?

    We have a simple example to answer the question: “ What is options trading.”

    Let’s say we want to buy a stock at $10.000. But the broker tells us that we can buy that stock at $20 and the time is limited so we have to make our decision in a short time frame but we don’t know “ what is options trading.” This broker’s offer means that we have to pay $20 now and get a right to buy the stock after one month. Well, our right, in this case, obligates the seller to sell us that stock at $10.000 even if the price increases in value after one month. This $200 will stay in the broker’s account forever. We will never get it back. But we got the right to buy the stock at the price we are willing to pay. 

    How does options trading work?

    We understand there is a chance that the stock price will increase much over $10.200, we want to pay our broker an extra $200 to provide us the right to buy the stock at $10.000. Moreover, we saved the rest of our $10.000 so we can keep it or invest in something else while waiting for the end of the period.

    Okay, the end is here, the one-month period is over so what is the next? Well, we have the right to buy that stock at $10.000 and we noticed the price is much over that amount. Of course, we will buy it at the agreed price. But what to do if the price is below the guessed price? Remember, we have the RIGHT to BUY not OBLIGATION. So, we can buy or not depending on the stock price. 

    This is a very simple explanation on the question: What is options trading, but this is the essence. 

    The options are derivatives. That means their prices are derived from something else, frequently from stocks. The price of an option is connected to the price of the underlying stock. Options trading is possible with the stocks, bonds market, and ETFs, and the like.

    What are the advantages of options trading?

    Some investors are avoiding options because they believe they are hard to understand. Yes, they can be if your broker has a lack of knowledge about them. Of course, you can have less than need knowledge about options trading. But the truth is, it isn’t hard to learn because this kind of trading provides a lot of advantages. Keep in mind that options are a powerful tool so use them with the necessary diligence to avoid major problems.

    Sometimes, we think that characteristics like “critical” or “unsafe” are unfairly connected to the options. But when you have all the information about options you’ll be able to make a proper decision.

    Cost less

    One of the most important advantages of options trading is it will cost you less. Let’s see how it is possible.

    Yes, we know that some people will claim that buying options are riskier than holding stocks. But we want to show you how to use options and reduce risk. Hopefully, you will understand that all depend on how you will use them.

    First of all, we don’t need as much financial assurance as equities require. Further, options are relatively immune to the possible effects of gap openings. But the most important, options are the most dependable form a hedge. Are they safer than stocks though? Yes! 

    Lower risk

    Let’s say this way. When we are trading stocks, we have to set a stop-loss order to protect our position. We are the one who has to determine the price at which we are not willing to lose more. And here is the problem. Stops are designed to be executed when stocks trade at or below the limit we set. So, what if we place a stop-loss order at, for example, $36 for the stock we bought at $40. We don’t want to lose more than 10% on that stock. Our stop-loss order will become a market order and our stock will be sold when the price reaches $36 or less. This is how this order will work during the trading day but what can happen over the night? 

    How to use options as a hedge?

    Here is where the problems arise. Let’s say we closed stock at $38. Almost immediately after the opening bell, the next morning, due to the bad morning news about the company, our stock fell under $15. So that will be the price we’ll get for our stock. We’ll be locked in a great loss. The stop-loss order did nothing for us. If we bought the options as protection instead, we wouldn’t have such a great loss since the options never shut down after the closing bell. We would have insurance 24/7. 

    Can you understand how the options are a more dependable form of hedging?

    And as an additional choice to buying the stock, we could employ the stock replacement strategy. This means we would buy an in-the-money call instead of buying the stock. We have a lot of possibilities with options trading since the options mimic almost 85% of a stock’s performance. The benefit is that they cost 25% of the price of the stock. For example, if we bought an option at $25 instead of a stock at $100, our loss will be limited on that amount, not on the stock price. 

    Do options have higher returns?

    We don’t need to be a great mathematician (well, some of us are, that’s true) to understand that if we pay less and take the same profit, we have higher returns. That is exactly what options trading provides us. 

    Let’s analyze this part and compare the returns in both cases.

    For example, we bought a stock for, let’s say $100. You bought an option of that stock at $25. This stock has a delta of 70, so the option’s price will change 70% of the stock’s price movement. (This is a made-up example, please keep that in mind.)
    So, the stock price goes up for $10, and our position on this stock will give us 10% of the return. You bought an option and your position will give you 70% of the stock change (delta is 70, remember?) which is $7. 

    Do you understand?

    We paid the same stock $100, you paid $25.
    Our return on that stock is 10% which is $10; your gain on investment of $25 is $7 which is a 28% return on investment. Who made a better job?

    Of course, when the trade goes against you, options can impose heavy losses. There is a chance to lose your entire investment.

    Benefits of options trading

    Options trading can be a great addition to your existing investing strategy. They will give you leverage in your investing. You will have cheaper exposure to the stocks, increasing profits and losses when the stock price changes. One of the benefits is that options can reduce the risk in the overall portfolio. For example, a protective put trade. That is when you combine purchasing a put option to sell stock at a specified price. That will provide you the upside when the stock price rises but also, that will protect you from losses when the stock price drops. Also, you can earn by selling the options. You will receive the money even if the stock isn’t exercised. That is compensation for giving someone else the right to buy your stock but that one never did it. You’ll keep the money anyway.

    Bottom line

    Options offer more investment options. They are highly adjustable vehicles. You can use options for positions synthetics. But it is for advanced traders.
    But there are some extreme risks to options. Firstly, options can expire worthlessly. That will be a complete loss of whatever you paid for the options. Further, options are highly volatile. Many brokerages will offer options trading, but with some added requirements before they will let you trade options. 

    Also, speaking about options strategies, they will work well when you make many trades simultaneously. You have to know that options markets aren’t constantly liquid as the stock market. The simultaneous trades don’t always go ideally. So, your strategy may not work the way you expected. Many online brokerages will give you access to options trading with low commission costs. So, we all can use this powerful tool. But, take some time to learn how to use options accurately. It is still new for individual investors. 

    We’re doing smart trading.