Let’s talk about Options. What are they? How do I use them? Are they for me?
I first discovered Options following the Global Financial Crisis in late 2008. It was then that I discovered the downside of using Stop Loss orders when stocks gap down in price. They don't always reduce your losses. Reeling from the emotional pain of large losses, I was determined to bounce back and not suffer again.
That's when I discovered Options.
Learning about Options has changed the way I trade and invest in the Stockmarket. It has allowed me to protect my stocks against market falls in the same way I insure my house and car. More importantly, I no longer worry about losing money. And that's not all. I’ve also learned how to use them to legally buy my stocks for less and generate a regular monthly income selling options to other investors.
So if you're interested in learning more, great....
Let's explore how they work.
An option is simply an agreement between a buyer and seller to exchange something in the future at an agreed price. There are always two people in every option transaction. A BUYER and a SELLER.
The seller may be obligated to fulfill the terms of the contract if instructed (exercised) by the buyer. Whereas the BUYER has a right, but not an obligation, to exercise the terms of the contract.
There are two types of Options
A Call Option gives the buyer the right to purchase stock at a specified strike price, on or before the contract expiration date.
Put Options give the buyer the right to sell stock at an agreed price on, or before the contract expiration date. Buying a Put option allows you to insure your stock at the Strike Price in the contract. They are purchased when traders anticipate the stock’s price to fall. They are also suitable for investors looking to protect their stocks against falls in price.
A Few Key Options Characteristics
The Strike Price is the price at which you would buy or sell the stock.
All contracts have an Expiration Date. This is the day the options contract expires and ceases trading
A standard options contract represents 100 shares of stock. So remember to multiply the broker quotes by 100. This will make more sense in the examples below.
Here are Some Options Examples
NFLX Mar 15, 2019, $300 Call – if you owned one Netflix Call Option, you would have the right to buy 100 shares of Netflix at $300 per share, on or before the option expiry on March 15, 2019.
FB Mar 15, 2019, $160 Put – owning one Facebook Put Option, would give you the right to sell 100 shares of Facebook at $160 per share, on or before the expiration date. If Facebook falls to $150, you would still be able to sell your stock for $160 per share to the seller of the Put option.
3 Reasons Options Might Be For You
Options are suitable for you if you are looking to:
Generate a regular income
Insuring your Stocks against losses
Speculate on Stock Price Moves
Generating a Regular Monthly Income
A great way to collect a regular monthly income is by selling options to other investors. It is one of my favourite strategies because the cash is immediately deposited into my trading account. The money can then be used to buy more stocks or options.
Two options strategies that new traders can easily learn to generate a regular income are:
Covered Call- think of this strategy in the same way you would rent out a property you own. You collect money each month from selling call options to other investors. The stock you own is used as collateral should the option be exercised by the buyer. That's because you will have to sell the stock to the buyer of the option if they decide to exercise it. By selling options on stock you own, you can also use the income to reduce the purchase price of your stock. This will also allow you to increase your returns.
Selling Puts- is a simple way to generate an immediate income each month by selling options to other investors
For new investors, both of these options strategies are ones that anyone can master with a little time and effort.
Insuring Your Stocks Against Price Falls
Are you an investor who believes stock investing is risky? Are you afraid of losing all of your money? If so, buying Put Options is a perfect way to reduce your risk.
You already insure your house or car. So why wouldn't you also insure your investments?
Say you own Facebook stock in your retirement account and are worried that the stock price could fall in the future. By purchasing a Put Option, you can protect against falls in the market price of the Facebook stock. You will also benefit if the stock price rises. The most you can ever lose would be the cost of the Put option. But don't you also lose the premium if you don't make a claim on your home or car insurance policy? What you are buying is peace of mind in the event the stock falls in price.
As you become more experienced with options, you can take advantage of more advanced strategies. They will allow you to make a consistent income in only a few hours each month.
Speculating on Price Movements
Options can be used to gain exposure to stock price movements. This is particularly useful if you're trading a small dollar account, say less than $5k. Using options will allow you to trade expensive stocks like Amazon, Netflix, or Apple, rather than buying the stock outright.
Speculate on Price Rises- Microsoft stock is currently trading at $100 and your view is the price will continue to rise. You purchase one MSFT Mar 15 2019 $100 Call option for $3.75 or $375 per contract. Your maximum risk on this trade would be the cost of the option contract, or $375. If Microsoft rises to $110 before the option expiration date, you could sell your Call option and collect $10 or $1000 per contract.
An advantage of using Call Options rather than buying the stock outright is that you benefit from leverage. In the example above, the Call option contract only costs you $375.
Buying 100 shares of Microsoft stock at $100 per share would have set you back $10,000 to get the same exposure.
Speculate on Price Falls- Now if you thought a stock was going to fall in value, you could purchase a Put Option. The Apple stock you own has recently been falling in price and is currently trading at $150 per share. Worried about losing money, you decide to take out insurance by buying one AAPL Mar 15, 2019, $150 Put for $6.45, or $645 per contract.
If the stock falls to $140 before expiration, the Put Option would be worth at least $10. In this example, you could sell your position at $10 or $1,000 per contract and lock in a 55% return!
The good news is stocks usually fall faster than they rise, so you will likely make money sooner.
If you're interested in exploring options in more detail....
Here's What to Do Next
I’ve created some free stockmarket training for you and I’d like you to have it.
This will allow you to learn more about investing in the Stockmarket and our online Learn to Trade Programme. This is designed for people who want to take charge of their finances, invest for the long-term, earn more, and become financially secure.
Here’s what you will learn in this training:
How to reduce risk and invest in Stocks in a safe and steady way
How using options will allow you to create an additional monthly income and boost your returns in only a few hours per month
How you can protect yourself from the Next Stock Market Crash, so you can worry less and focus on the things you enjoy