Options trading is one of the most lucrative strategies for investors looking to maximize their profits in the stock market. It can be a great addition to your stock portfolio and a way to generate monthly cash flow for your portfolio. In this article we will discuss options trading for beginners and our favorite option trading strategies.
Online trading for beginners can be divided into two main branches: stocks and options. An investor usually starts by building a portfolio of stocks. After the initial phase and the respective knowledge curve, one can then delve into the world of options trading. Opening an account with a reputable broker that offers options trading is the first step for online trading for beginners. One can decide later if one wishes to enter options trading, but in this manner, one has the choice when the moment arises.
Options trading are simply put another way of investing into stocks without actually owning them. When one buys options, he is committing capital to the respective stock without owing the asset. This is a great way to minimize costs and be able to participate in the underlying’s stocks future rise. Options represent the commitment of the investor to buy the respective asset at a pre-defined price and date. As a result, options have a value and time component.
One of the best options trading strategies for beginners is buying call options.
Let’s take a quick example to simplify the above definition. If an investor wants to participate in a potential rally of the stock XYZ in the next month he has 2 options: either to buy the underlying stock or to buy call options for XYZ for next month. Let’s assume that XYZ trades at $100 in the present. The stock has a strong fundamental basis and looks good from a technical perspective. If the investor wishes to buy the 100 shares of XYZ, he needs $10.000, which might be a considerable sum for a young investor. By buying options, the money allocated to XYZ is considerably lower and the potential percentage gain much higher in case the stock moves in his favor. In this example, if the investor buys $110 calls for XYZ one month out for $1 per contract, he is participating with just $100 (each options contract is equivalent to 100 shares).
Now, let’s look at 3 possible outcomes and how options trading compares to stock investment. Let’s assume that XYZ closes at a price of $120 in 1 month time. By buying the underlying at $100, the gain after 1 month would be $20 for each share. This translates into 20% gain for the portfolio. With this options trading strategy for beginners, the result would be much better. At the close of $120, each contract bought for $1 ($100) would be worth $10 (underlying price $120- options underlying price $110). Therefore, by investing $100 for the next month, the overall result with options trading would be $1000, a gain of $900. This is a percentage gain of 900%.
In the second scenario, let’s assume that the underlying closes at $109. This is a gain of 9% for stock investors in one month, while for the options investors, it will be a loss of the investment, since the underlying closed below its target price of $110. The total loss for the options trader is equal to the sum invested at the beginning. This is a great way of limiting your risk in case your thesis did not work out.
In the third scenario, we assume that the underlying dropped to $80. For stock investors this would be a drop of 20% in their portfolio. For options traders, the loss is the same as in the second scenario.
From this quick example we can draw the following conclusions. Online trading for beginners poses several risks of losing capital. By trading options, the risk is limited to the amount invested and in all cases considerably lower than owning an asset through a downtrend period. Options trading offers investors flexibility in their trading account, as they can exit their options positions whenever the asset is moving in their direction, booking profits along the way. In addition, by trading options, investors can be involved in several underlying stocks without needing to have a big portfolio to cover the purchase of all these assets. Options trading is especially useful when dealing with very expensive stocks such as Amazon and Google which trade above $2000 per share and are therefore not for everyone’s portfolio.
Another good options trading strategy is selling calls versus the stocks that you own in your portfolio in order to generate weekly income. Let’s assume that the investor has a large portfolio and has several stocks within it. Selling covered calls offers such investors the chance to generate cash each week. If an investor owns 100 shares of XYZ currently trading at $100 he can sell weekly $105 calls for 2$ (200$). If XYZ stays below $105 each week, we continue to collect $200 weekly. If the underlying gets above $105, we still collect the 200$ and has to sell the underlying at $105, therefore not participating in the future rise of this particular stock. Therefore, selling calls can be considered a way of hedging against a possible sideways/ downtrend market, while still generating constant cashflow for your portfolio without having to sell shares.
There are plenty of complicated options trading strategies out there. In our experience the best ones are those highlighted above which work great for all types of investors irrespective of their portfolio size.
Online trading for beginners needs to be a responsible way of generating extra income. Beginners need to understand the risk involved in trading stocks and options. With options trading the risk is known from before and as a result risk is premium paid. By buying call options, beginners know exactly the sums they are risking, while the potential gain is infinite. From our example, if XYZ trades at $150 by the expiration period, the gain will be $4900 per contract, a gain of 4900% in just 1 month, compared to 50% by just owning the stock. For explosive potential gains and limited risk, options trading is a great way to diversify your portfolio.
Options trading for beginners can be daunting at first as they need to grasp the concept to time and value and how time decay influences the price of the option. The closer one gets to the expiration period, the lower the time component is, and the option begins to move solely with the value of the stock. As a result, we recommend following our options trading strategies presented in our Morning Game Plan for best results. If you want to find out more, please visit our plans here.