If you are looking for ways to make money in the stock market, options can help you not only increase your income but also limit your risk.
Unlike passive investors in the stock market who rely on stock market gains and dividends to make money, options traders have many more ways to make money.
Options can generate cash flow similar to dividends. And options can protect investments much like insurance policies do.
Here are 5 options tips to help you with your goal to make money trading.
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Table of Contents
- Option Trading Tips #1: Make Money Trading Covered Calls
- Option Trading Tips #2: Make Money Trading Weekly Options
- Option Trading Tips #3: Pick A Good Options Trading Platform
- Option Trading Tips #4: Lower Your Risk
- Option Trading Tips #5: Capitalize On Volatility
- Tip #6: Simulate Stock Ownership Buying LEAPS Options
- Option Tips #7: Hedge Event Risk
Option Trading Tips #1: Make Money Trading Covered Calls
If you already own a portfolio of stocks, you probably make money in two ways: when stocks rise, and when companies issue dividends.
But did you know that you can proactively generate income on your terms? You don’t have to rely solely on the company issuing dividends to earn income from your shareholding.
The covered call strategy is among the most powerful options trading strategies because it lets you sell options against your stock position.
When you sell calls against your stock, you receive money into your brokerage account.
It’s not free money though. It comes with an obligation, which is to sell your stock if it rises above a certain price.
For example, in the options chain below a shareholder who decides to sell a strike 126 call option would receive $1.86 per share or $186 per contract.
|Strike||Bid||Ask||Volume||Open Interest||Implied Volatility|
Generally, one contract corresponds to 100 shares so if you owned 1,000 shares you could pocket $1,860 (less commissions costs and fees) by agreeing to sell 10 call contracts at strike 126 for a bid price of $1.86.
What’s the catch? If the stock goes above $126 by expiration, you have to sell it at $126 per share.
You still get to keep your $1,860 – nobody can take that away from you if you hold the call option through expiration, at which point it will be assigned and your stock sold.
So if you don’t think the stock will rise above $126 by the option’s expiration date, then selling calls against your shareholding makes economic sense.
What makes options trading attractive compared to dividend paying stocks is you get to control when you generate income. You don’t have to wait for a quarterly dividend payment, you can sell call options weekly.
>> Related: Learn Options Trading Basics
Option Trading Tips #2: Make Money Trading Weekly Options
How nice would it be to click a few buttons and money gets deposited into your account when you want it?
Now you know covered calls allow you to do that but how often can you do it?
For a few decades after options were introduced you were limited to generating cash flow from selling call options no faster than monthly.
But greater demand from options traders has resulted in greater choices, and these days you can trade options as frequently as weekly if you wish.
The amount you can make on any given week tends not to be large when compared to the share price of the company, but the value of trading weekly options is not only what you can pocket on any given week but more so the compounded sum total of the income you can earn from selling calls each and every week.
>> Caution: When trading weekly options, beware of upcoming news announcements for the company. If a company is due to report quarterly earnings, volatility may be higher than normal causing options prices to be temporarily higher than usual. If traders react negatively to earnings and the share price falls, the premiums you receive from selling calls may not offset the losses in share price.
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Option Trading Tips #3: Pick A Good Options Trading Platform
When you trade options to earn extra money, you will want to use an options trading platform that has a good understanding of options trading strategies to make sure your order execution is seamless and any hiccups or queries are resolved quickly.
Good options trading platforms offer fast and accurate order execution, knowledgeable staff who understand how to guide you when executing orders, competitive commissions and fees, tools and screeners to help you select trades, and mobile access when you are on the go.
Both platforms were built by similar teams so you can expect a top notch experience from each of them.
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The nice thing about TastyWorks is no commissions costs are charged when closing trades.
While at thinkorswim, the tools and screeners are virtually unparalleled and will please the most avid options trader.
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>> Related: What Are The Best Online Options Trading Brokers?
Option Trading Tips #4: Lower Your Risk
Emotions play a big part in trading the stock market. It is difficult to remain rational when everyone else seems to be panicking and selling or fearlessly buying.
When you own a portfolio of stocks, it can be easier to panic and sell at the wrong time than when your risk is limited.
After all, when you own a stock, the most you can lose is the entire amount you paid for it if the stock were to fall all the way to zero.
In practice, the likelihood of that happening is really low. It is rare for companies to go bankrupt and share prices to get entirely wiped out.
But tell that to your inner self when fear takes over and, if you are like most people, you will find it is not so easy to stay calm.
So how do you hold on to the shares of good companies when fear is gripping the markets and still keep your risk contained to a fixed amount?
The answer comes in the form of the married put options trading strategy, which involves buying put options against shares you own.
MARRIED PUTS → STOCK MARKET INSURANCE
Married puts are about as close as you can get in the stock market to buying insurance.
Just like you might pay an insurance premium monthly to protect your car, home or even your health, so too can you pay a premium to buy protection on stocks you own in the form of put options.
The difference is that you cannot buy insurance on your car after a crash, but you can buy insurance on your stock even after it has fallen lower.
If you think a stock will continue declining you can buy protection to limit risk and contain further losses.
For example, assume the options chain below displayed put option prices.
|Strike||Bid||Ask||Volume||Open Interest||Implied Volatility|
If you were concerned the share price would decline, you could buy the strike 124 option to limit your risk if the stock falls below $124 per share.
The insurance is not free and will cost you $2.80 per share in this case. But much better to pay $2.80 than lose a lot more in the event the stock fell a good bit lower or worse if there were a stock market crash.
Above all, the married put offers peace of mind to help you make rational decisions.
The time may come where you want to sell your stock for fundamental reasons. But if nothing fundamentally has changed with the company yet market sentiment is causing a selloff, then married puts can be an ally to save your portfolio from short term dips that would otherwise occur.
>> MORE: Options Trading For Dummies
Option Trading Tips #5: Capitalize On Volatility
Generally spikes in volatility accompany stock market declines so the fear is not without some merit.
But with options, you can take advantage of, rather than suffer from, volatility.
The options strategy that can make money when volatility spikes is called the straddle and involves buying call and put options.
When you buy call options you are betting on the underlying stock or index going higher. And when you buy put options you are placing a bet that the underlying stock will fall.
So when you buy calls and puts, you don’t necessarily care whether the stock goes up or down, as long as it goes up or down by a large amount.
The reason the stock needs to move a lot is the share price must generally move by a greater amount than the cost of both options in order to make money. If it hasn’t by expiration, the straddle will be under water.
So, if you think a stock could move a lot before an expiration date, the straddle can make money from the volatility in share price if it occurs.
But keep in mind the straddle is generally a speculative options trading strategy. Where the covered call strategy can be applied as part of a core investment approach, the straddle is more akin to a gamble that may payoff big but equally may fall flat.
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Tip #6: Simulate Stock Ownership Buying LEAPS Options
Stocks don’t always perform the way you predict they will. Instead of directly investing in a company, you can purchase LEAPS options that give you an opportunity to earn money when a share prices increase.
LEAPS, which stands for “long-term equity anticipation security,” options are significantly cheaper than the cost of buying stocks. In fact, you get to decide what price you want to purchase stocks. For example, if a stock trades at $50 today, you could use LEAPS options to purchase the stock when it falls to $30.
Typically, you want to purchase LEAPS options that are about 20% lower than the stock’s current trading price. When the stock’s price recovers, you can sell them to make money.
Keep in mind, though, that you must pay a premium for LEAPS options. You can expect to spend about $8 per share.
If the stock’s value recovers to $50, you can share your share to earn $20 minus your $8 premium. You end up with a profit of $12 per share.
As with all investments, LEAPS options come with risk. If the share prices fall, then you won’t make any money from your purchase. You could even lose money, especially since you still have to pay the premium.
Option Tips #7: Hedge Event Risk
Hedging acts like an insurance policy against falling index values. A hedge event risk doesn’t prevent you from losing money, but it does limit the amount of money that you can lose.
When major economic events are announced, indexes can respond by increasing or decreasing in value. If the report offers good news, then your portfolio’s value could rally and earn you money. Bad news, however, could wipe out your portfolio.
Hedge event risk prevents you from losing an excessive amount of money by limiting the decline that your portfolio can experience. When you buy index puts, you earn the right to sell assets when they reach a certain price.
For example, you could use index puts to sell assets that fall below 10% of their current value. If the market plunges, you will lose at most 10% (plus the cost of the puts).
What Options Tips Have Paid Off For You? Share Your Options Trading Stories Below, We Would Love To Hear From You.
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