Hello Stock Traders!
One question might’ve been plaguing your mind: How to Trade Options for Income?
There’s a few steps you will need to take in order to get started with stock options. I’ve found some other information on the web that explained how to do this, but none of them explained how to do the research for yourself or where you can find it if you are a beginner. I took it upon myself to include some basics here today.
Find an Online Platform and Apply
There are many online stock trading platforms out there and not all of them deal with options. Make sure the platforms allows for trading options and that it fits your needs. Some platforms provide more guidance than others, and some trading brokers charge a commission. Find which one suits your needs.
Online stock trading brokers will assess and choose which level of option trading is available to you. There may be a few bumps in the road to achieving access to options when you first apply to trade options.
A few key areas they will ask about:
- Investment Goals or Financial Objectives. Are you looking for income, growth, capital preservation or speculation? Are you investing in options for retirement?
- Financial Wealth. What is your total net worth, liquid net worth, annual income, and employment? Do you have the means to pay for your losses?
- Experience. Do you have experience owning and trading stocks? Stock options? How many trades? How large were the trades? What is your knowledge on stock options?
- Type of Options. Are you interested in Puts, Calls, Buying/Selling, Covered or Naked options?
Create a Game Plan
After you apply for stock options, they will place you at a specific trading level. The types of options are you allowed to trade will be determined by the broker. Once you know which types of options you can trade, you should set up a plan for your next moves.
Research a Stock
Here is a quick way to do some research before you are even approved by your online stock broker platform.
1. Go to https://finance.yahoo.com/.
2. Type in a stock name or ticker symbol that you are interested in trading.
3. Click the Options tab to check to see if they have options available for trading as not all companies offer options; this can save you some research time if they do not. While you are on this page, you can also click the tab at the top to view the different expiration dates available for their stock options.
4. Click the Profile tab to view more information about the company. It is beneficial to know where your company is located, their industry sector, what they do, and more because many factors can influence the market price of the stock. Most professionals would recommend only investing in companies that you understand or are familiar with already.
5. Explore and click around on all the other tabs to learn more about the company including their current earnings, projected earnings, debt, and so on. The more familiar you are with a company, the more you can make an educated decision with your investment.
Pick a Direction
6. Click back to the Summary tab in Yahoo Finance. There you will see a chart, typically set to the default of 1 day which presents you with the changes in market price for the stock for that day only. Toggle to different time frames such as 5 day, 1 month, and so on to view the past trends of this stock.
You can base which direction you think the stock will go from that information, any company news, advice from economists or stock analysts; you’re the driver so it’s completely your own decision.
Do you think the market price will increase? It may be a good idea to buy a call option or to sell a put option. Do you think the market will decrease? It might be a good idea to sell a call option or to buy a put option.
There are many strategies a person can use, but you will need to choose which direction – up or down – you think the stock will go.
Find Your Target Price
The next step is to figure out which strike price or target price you would want to buy or sell the option.
Let’s say a stock trader, Brian is looking at Cable X company stock. Brian notices a trend that Cable X’s market price has gone up ~$6 every month for the last 3 months. The company has had a growth in earnings each quarter in the last 1-year time frame, and the company has very little debt.
The current price of Cable X is $51.25 so Brian decides to look at buying a call option. Brian may buy a call option with a strike price of $55 or $60 although he can choose any strike price that is available.
Choose a Time Frame
There are many factors that could influence the growth rate for any company so you want to make sure to choose an expiration date that aligns with your market predictions. The longer the time frame before the option expires, the greater the risk that the option could turn in a less favorable direction.
Due to Brian’s previous research on Cable X, Brian decides to buy a $55 call option for a $3.20 premium that expires in 6 weeks as he predicts the stock price will go up $9 in that time period. This means in order to break even on the $320 he paid to buy the call (1 contract underlies 100 shares), the market price of Cable X will need to increase to $58.20 or $6.95 more than the current price of $51.25.
If the stock goes above $58.20, the rest of that money would be your profit. If the stock does not hit $58.20 in 6 weeks, the call option expires worthless.
In case Brian had chosen the $60 strike for a $1.60 premium, the stock would need to increase to $61.60 to break even or $10.35. Based on Brian’s $9 prediction, this scenario would be unlikely to generate a profit in this time frame.
A good rule of thumb is to not risk more than the reward. Which type of option you choose, whether you choose to buy or sell the call or put, the strike price, and the expiration date are all really important in determining your success with stock options. Choose your platform, do your research, and create your game plan.
Grab your copy of Real Money: Sane Investing in an Insane World by my personal favorite stock professional from CNBC’s Mad Money James Cramer here.
Side Note: I love to hear from you as your questions fuel my fire to continue to provide useful information in upcoming posts. Please drop a comment below if you like.