Option Trading Strategies

If You Ever Wanted To Trade Options, Then You Need To Read This...

Have you ever suggested to your stockbroker that you were interested in trading options? More than likely he (your broker) tried to talk you out of investing in options. Quite possibly, he insisted that options were high risk and only professional traders should use options in their investments.

Well, let me let you in on a little secret. The reason why your broker doesn’t want you to trade options is because your broker does not know how to trade option properly. Understand, most stockbrokers are sales people, not investors. They offer what is hot in the market and usually push you towards managed money. The reason being is because your stockbroker gets paid to direct your capital into funds where portfolio managers manage stocks and bonds in anticipation of beating the market indices.

A true investor and some very well trained stockbrokers (hard to find these brokers, but there are some out there somewhere) will tell you that option trading is a very lucrative investment and less risky than what your broker is suggesting. Option trading strategies can increase your return on your overall portfolio by leveraging and insuring the stocks in your portfolio.

Option trading strategies, range from creating income into your portfolio on a monthly basis, insuring any downside in a particular stock you may be holding in your portfolio and a way to leverage both the upside of the market and the downside, all at the same time.

Now, if you are like me and want to see your portfolio increase in value overtime, while having the opportunity for income, (which everyone reading this is probably saying no $#!t) then you need to learn all the option trading strategies that are available to you.

To give you an example of a great option trading strategy that you can implement right now is the selling of covered calls. This simple option trading strategy will allow you to take an underperforming stock in your portfolio and create a monthly income. How this option trading strategy works is as follows:

Step 1. You own a stock in your portfolio that is either stagnant in your portfolio (meaning not moving up or down), or the stock has dropped way below your purchase price.

Step 2. You sell a call option on this stock. Basically, for every 100 shares of the stock you own, you can sell 1 call option related to that stock. (Example is you own 500 shares of ABC stock, you can sell 5 ABC call option contract). This scenario is selling a covered call.

Step 3. You collect a premium from the sell of the call option. (These premiums vary depending on the volatility of the stock and the amount of time left on the option contract.

Step 4. Now you sit back and see what the market will do for you. For example, the stock may move down in value and the call option will expire worthless, meaning you keep the premium and sell new call options next month, or the stock stays stagnant and does not move during the month. Again you would keep the premium and write another call option against your stock. The last scenario is the stock starts to increase in value and you have to sell the stock for the strike price of the call option. Typically, if the stock you have has a high volatility, you probably would not use this option trading strategy. But, it is your decision.

Now, here are a few items I left out of the above scenario. You can sell your call options in the money, out of the money or at the money. We will discuss the terminology of these positions in a later article. But for now, I hope you see the value of option trading strategies in your stock portfolio.

Please come back soon to learn more about different option trading strategies to increase your overall return in your portfolio. You can also subscribe to this page and get future updates sent directly to your email box. Just click the rss feed at the right.

Alan Manns
Profession Option Trader

I can’t believe my stockbroker told me to do this...

My phone rang this morning and it was my stockbroker. He started to regurgitate everything I heard on the news the previous night. He was telling me how he believes that the market is overbought and that more than likely we are going to see a sell off in equities in the coming months. My stockbroker continued by saying how the financial markets are still seeing stress and more than likely we are going to see additional banks shuttering in the near future.

Now, I really don’t care that he is summarizing what he and I both heard the night before. What really irks me was what he suggested I do after he regurgitated the financial news. He suggested that I sell my equities and go into cash and wait out the market. I almost fired him for that comment. However, he and I are very close and I know he means well. Anyway, I had to back him up and explain that I would prefer to use the option trading strategies that are available to me.

He continued to express his position with what he was advising. I told him that there was no way I was selling any of my stock positions based on his fear of what the market may do in the future.

After much debate, I explained to my stockbroker that I was going to use an insurance policy to secure any downward movement in the market over the next 3 months.

How does this option trading strategy works:

Anytime you are concerned about any downward movement in the market or an individual stock, you should purchase put options.

Let’s say you have a position in a great stock, but there is pressure on the upside, which in turn may drive owners into taking money off the table (sell their position and go into cash, kind of like what my stockbroker suggested). What you should consider is buying a put option for every one hundred shares of the underlying stock you own. This option trading strategy is like buying an insurance policy.

Purchasing put options allow the owner of the contract (the buyer) to actually put the stock to the seller of that contract at the strike price (or the predetermined price you are willing to put the stock to the seller of the put contract).

For example: Let’s say you own 1000 shares of ABC stock at $50.00 and there is news coming out about the company’s revenues and earnings. Now you are feeling a little unsure about the strength of the company, but think in the long term with the current management team and the superior product, you see the stock increasing in the future.

But, why risk a chance of bad numbers coming out of the company and dropping the value of the stock or why risk good numbers coming out and the stock increases and gets away because you sold your position too early. Why not purchase, in the case of this scenario, ten (10) put option contracts at $50.00. And let’s say those contracts cost you $3 per contract or $3000.00.

What this means is if the stock drops in value, you can put the stock to another investor (the one that sold the put option) at $50 and salvage most of your money.

The most you will lose is $3000.00 whether you sell the stock or keep the stock and let the option expire worthless.

The benefit of this option trading strategy is that the stock can drop to 0 and you will only lose the $3000.00 you spend to insure your position. But, if the stock increases to $53 you will be back at your breakeven point.

Not too bad of a risk position to secure your investment in your stock. Just imagine if you would have listened to my stockbroker and sold out your position and the next morning the stock opens up $5 higher.

This stock option strategy is great for insuring your stock position when you are not willing to sell or not wanting to sell.

Sure, there is a cost to buying your put options, but would you buy a home and not pay for home owner insurance? Or would you buy a car and drive around with no auto insurance? These are just some great reason and analogies when deciding next time whether or not to sell your position in a good or great company.

Alan Manns
Profession Option Trader

I had to fire my stockbroker today. Wait till you find out why…

The other day my stockbroker made a comment that was so hysterically outrageous that I had to fire him. He called me up and offered to me what he thought would be the perfect strategy out of all the option trading strategies for my portfolio.

Initially, I thought he was joking. But, after fifteen minutes on the phone with him, listening to his insistence that what he was offering was so apparently beneficial to me, I had to make a very harsh decision.

So what was this apparent deal killer strategy he was offering, you ask. Well, my stockbroker insisted that based on what he believed was a sure winner for bringing income into my account was for me to… sell naked calls.

Let me explain this option trading strategy and the risk you are going to inherit by using this strategy. Selling naked calls is a strategy where you are obligated to sell an underlying stock sometime in the future. For that obligation the buyer will pay you a small premium that you will receive into your account immediately.

Sounds good so far, huh? Well imagine this, let’s say you decide to obligate yourself to sell a specific underlying stock that you do not own and you take the small premium. Then, some amazing news comes out on the company stock and the stock value skyrockets. You now must go into the open market and buy this stock (you better have the money to buy it too) and then you turn around and give it away at a price way below what you bought it for because the buyer of your call wants the stock you just bought, so he can sell it back into the market and make a huge profit with your money.

Do you see the uncertainty of this strategy? The uncertainty is you will not know what price you will have to buy the underlying stock for until you have to buy it from the market. That is way too risky for anyone’s portfolio.

So, if you decide to sell calls, I would suggest that you own the stock in your portfolio already, just in case the buyer of the calls requests your stock if and when the stock increases in value.

Alan Manns
Profession Option Trader