Getting out of the market altogether is probably one of the worst things someone could
do right now. But simply buying and holding is also not the optimum strategy either.
Picking the right stocks of course is the sure way to go. But there’s no guarantee you
have the right stocks? The stocks that have so far beaten their recovery expectations,
have been rewarded with higher prices. While many that have disappointed, have gotten
crushed.
Everything seems to be moving so much quicker these days. And the moves, both up and
down, seem so much bigger.
The answer is to be smarter.
Learn how to incorporate new trading techniques and strategies into your portfolio.
Strategies that can both help reduce your risk AND increase your returns, all at the same
time.
And those strategies I’m talking about involve the use of options.
In the following pages, we’ll discuss three of those strategies that can help you do just that.
These three option strategies are my favorite ones to use. And it’s time to get excited because
two of these strategies I’ll bet most have never even heard about, or at least explained. Until
now.
So let’s begin.
Option Strategy #1
Buying Calls
and Buying Puts
3 3 Smart Ways to Make Money with Options
Not all stocks are created equal.
Some will go up and some will go down and some will just go sideways.
And that’s perfectly alright.
With options, you can take advantage of all of
these scenarios.
Buying calls and buying puts is one of the
most common ways investors trade options.
If you believe the price of a stock will go up,
you can buy a call option on it and make
money as it goes higher.
If you believe the price of a stock will go down,
you can buy a put option on it and make money as the price goes lower.
Before I continue, let me go over some definitions.
Options Definitions
Please read the following option definitions. It will help you fully understand the strategies outlined
in this booklet.
Call Option:
A call option gives the buyer the right (but not the obligation) to buy a stock (typically 100
shares) at a certain price within a set period of time.
Put Option:
A put option givers the buyer the right but not the obligation to sell a stock (100 shares) at a
certain price within a set period of time.
Premium:
The amount paid (if buying) or collected (if writing) for the option.
Strike Price:
The price on an option contract at which you can exercise your right to buy or sell the stock.
In-the-Money:
For a call option, an in-the-money option is a strike price below the current price of the stock.
It’s said to be ‘in-the-money’ because it has intrinsic value.
If a stock was trading at $50 a share, a call option with a strike price of $45 would be in-themoney.
For a put option, it’s a strike price above the current price of the stock.
If a stock was trading at $50, a put option with a strike price of $55 would be in-the money.
(The term in-the-money is often times abbreviated as ITM.)
At-the-Money:
For both a call and a put option, it’s a strike price that’s at the same current price of the
stock.
(The term at-the-money is often times abbreviated as ATM.)
Out-of-the-Money:
For a call option, it’s a strike price above the current price of the stock.
This option has no intrinsic value and is only comprised of time value or extrinsic value.
If a stock was trading at $50, a call option with a strike price of $55 would be out of the
money.
For a put option, it’s a strike price below the current price of the stock.
If a stock was trading at $50, a put option with a strike price of $45 would be out-of-the
money.
In-the-money options have greater deltas and out-of-the-money options have smaller
deltas.
(The term out-of-the-money is often times abbreviated as OTM.)
Delta:
This is the percentage the option will increase or decrease in value in relation to the underlying
price movement of the stock.
A delta of .60 for example, means the option will move (or change in value) equal to 60% of
the underlying stock’s price change, meaning a $1.00 rise in the stock should see a 60 cent
rise in the option premium. The delta changes as the stock rises and falls.
Intrinsic Value:
The difference between a option’s strike price (that’s ‘in-the-money’) and the current price of
the stock.
For example: if a stock was trading at $50, and a $45 call option with 30 days of time left on
it was selling for $6.50 (or $650, which is $6.50 x 100 shares), that option would have $5 (or
$500) of intrinsic value.
[$50 (stock price) - $45 (strike price) = $5 (intrinsic value)]
Time Value (aka extrinsic value):
The amount of the premium that’s not comprised of intrinsic value. This part of the premium
is said to be your ‘time value’.
Using the same example as above, that same option would have $1.50 or $150 of time value
or extrinsic value.
[$6.50 (premium) – $5 (intrinsic value) = $1.50 (extrinsic value or time value)]
Expiration:
This is the last day an option contract can be traded. At expiration, an option’s only worth is
its intrinsic value. Since there’s no time left to hold your option to buy or sell, there’s no more
time value or extrinsic value left. And ‘at-the-money’ and ‘out-of-the-money’ option would
expire worthless.
Exercise:
The time in an options trade (usually at expiration) when the underlying stock is assigned to
either the buyer or the writer based on the rights and obligations of the transaction. Exercise
usually takes place for in-the-money options. Most brokerage companies will automatically
exercise in-the-money options at expiration unless notified otherwise.
The expiration date for most options is effectively the 3rd Friday, of the month of the option.
Buying Calls
Options give an investor tremendous amounts of leverage, allowing someone to speculate on
a stock without putting up a lot of money. And for the option buyer, this also comes with a
guaranteed limited risk, which is confined to your purchase price (or premium) plus any applicable
commissions and fees.
Let’s take a look at how buying a call option works.
For example: let’s say you were interested in a stock that was trading at $90 per share.
Buying $100 shares of a $90 stock would require a $9,000 investment.
But instead, you might be able to buy a $90 at-the-money call option for an $8.00 premium (which
means $8 x 100 shares or $800). That’s a significantly smaller investment with a guaranteed
limited risk.
If for example the price of the stock fell $20 to $70 a share, your stock investment would have
lost $2,000.
However, at expiration, the maximum you could lose on your option investment would be only
$800 (plus your commission and fees).
The option gives you great upside as well.
A $20 move up in the stock price to $110, would mean a $2,000 increase in your stock
investment.
However, at expiration, that $90 call option would be $20 in-the-money, meaning it has $20 of
intrinsic value, or $2,000.
$2,000 less your $800 premium is a $1,200 profit or 150% gain.
The $2,000 gain on your $9,000 investment represents a 22% gain.
Now let me say that options aren’t a panacea. Too many people use options recklessly by
loading up on cheap out-of-the-money options that ultimately expire worthless. And even though
they have a limited risk (limited to what you put in), if you put everything in there, you run the risk
of losing it all.
But smart options trading in my opinion has a respectable place in one’s portfolio.
And only invest in an option what you absolutely can afford and would be ‘willing’ to lose if your
assumptions on the market are incorrect.
Option Strategy #2
Covered Call Writing
11 3 Smart Ways to Make Money with Options
Covered call writing is an excellent strategy to use in both up, down and sideways markets.
This is a strategy used to reduce risk and generate income.
In fact, you can even execute a strategy like this in many retirement accounts.
So, let’s review: buying an option gives you the right but not the obligation to purchase 100
shares of a stock at a certain price within a certain period of time.
The price you pay, let’s say $500, is the premium. In general, if the stock goes up, the call option
will increase in value. If the stock goes down, it’ll decrease in value. But your risk is limited to
what you paid for the option. Even if the stock went to zero, you could never be on the hook for
more than you paid for the option.
If you write an option, you’re collecting that premium. Someone else is buying the right to own
100 shares of a stock at a certain price within a certain period of time. If that stock goes down
and the option expires worthless, the buyer of the option loses -$500. But the writer of the option,
makes $500.
For a covered call strategy, this is who we’re going to be -- the writer.
Let’s say you have 100 shares of stock at $110 for instance – for every dollar the stock goes up
or down, your investment will increase or decrease by $100.
Option Strategy #3
19 3 Smart Ways to Make Money with Options
If covered call writing is considered a lesser known strategy, then uncovered put option writing is
probably one of the least known strategies.
But this a great strategy and another great way to generate income.
Not to mention a way to potentially get into a stock you’d like to own at a much cheaper price.
Although, you will need full option privileges to do this in your account. So check with your brokerage
to see if you qualify.
Here’s how it works.
As you know, if you buy a put option, you’re buying the right to sell a stock at a certain price within a
certain period of time. The buyer pays a premium for this right. He has limited risk – which is limited to
the price he paid for the option.
However, the writer is taking the other side. He’s obligated to buy the stock at a certain price within
a certain period of time. As in the call example we went thru earlier, the option writer collects a
premium.
We’re, going to be the option writer.
So, the benefits are: if you write an out-of-the-money option on a stock you wouldn’t mind owning if it
went down, you might just get the chance to own it at a cheaper price than it’s currently trading at if it
does go down.
If however, it never gets to that level, you’ve collected the premium for writing the option and taking the
risk that the stock would be put to you at that price.
But again, if you wouldn’t mind owning it if it did go lower, you’ve still won because now you’ve got that.!!!
Summary
27 3 Smart Ways to Make Money with Options
As you can see, there are many different ways to make money in options.
And the ones in the preceding chapters are just some of the many different options strategies
that you can use to make money in the market no matter what.
And there are many, many more:
• Straddles
• Strangles
• Debit spreads
• Credit spreads
• Ratio spreads
• Iron Butterflies
• Condor spreads
• Calendar spreads
• and more
Take the appropriate amount of time to research each one of these before you attempt to place
one on your own.
But my three favorite options strategies are the ones I just described: Buying Calls and Puts,
Writing Covered Calls and Put Option Writing.
But start slow.
After you’ve put on any of the above options trades and see it in your account, it’ll make even
more sense to you and you’ll be able to feel what it feels like to have one of these positions on
and see how it fits with your trading style.
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Thanx :)
Ivy