REVEALED: My Top 2 Options Trading Rules
When used properly, options have many benefits over buying or selling stock shares. Less capital is required, and potentially greater returns make option purchases the choice for smart-money traders.
A long option can provide the staying power for a market upswing. More importantly, the maximum risk is the premium paid. Plus, a deep in-the-money call or put will act like the underlying at a lower cost than trading the stock.
One major advantage of using long options instead of buying or selling shares is putting up much less money to control 100 shares. That’s the power of leverage.
Choosing an option can sometimes be a daunting task with all of the expiration months and strikes. Simply put, traders want to buy a high-probability option that has enough time to be right.
The option strike price is the level at which you have the right to buy without any obligation to do so. In reality, you rarely convert the option into shares. Instead, most traders sell the option exit the trade for gain or loss.
There are two rules options traders need to follow to be successful:
Rule One: Choose an option with 70%+ probability.
The Delta is a measurement of how well the option reacts to movement in the underlying security.
It is important to buy options that pay off from only a modest price move. There is no need to ONLY make money on the massive price explosion.
Any trade has a fifty-fifty chance of success. Buying in-the-money options increase that probability.
That Delta also approximates the odds that the option will be in-the-money at expiration.
Buying better options are more expensive, but they are worth it — the chances of success are mathematically superior to buying cheap, long-shot, out-of-the-money lottery tickets that rarely ever pay off.
With a stock trading at $15.00, for example, an in-the-money $13.00 strike trading at $2.50 option currently has $2.00 in real or intrinsic value. The difference is the time value of the option.
Rule Two: Buy more time until expiration than you may need.
Time is an investor’s greatest asset when you have completely limited the exposure risks.
Traders often buy too little time for the trade to develop. Nothing’s more frustrating than being right but only after the option has expired prematurely to the market move.
The power of the payoff sees the option position gain 50% with just a 5% to 10% move in the underlying stock.
The combination of a high-probability play, and buying enough time to be right, make the stock substitution strategy a favorite trading tactic.
Keep it In the Money,
Chart of the Day: Can these stocks challenge tech?
The tech-heavy Nasdaq Composite is once again pushing to new highs this week as it tries to extend its seven-day winning streak into the weekend.
Everyone is talking about tech. Stories of some of the hottest tech names doubling in a matter of months are even starting to migrate from the financial section to the front page. Everyone wants in on these stocks that just can’t seem to lose.
But as you’re probably aware, there are other stocks and sectors that haven’t performed well in this new world of pandemic shutdowns.
We’ve highlighted the downright awful performance of airlines, cruise stocks, and brick and mortar retail names many times this year. Barring a few rare exceptions, many of these stocks continue to struggle this year.
But we are beginning to see some forgotten stocks and sectors attempt to get off the mat as we get into the final weeks of summer.
Just check out this chart of the small-cap iShares Russell 2000 ETF (NYSE:IWM):
Yes, IWM has to climb almost 10% before reaching its pre-pandemic highs. But it looks as if small-caps are setting up for a potential breakout here as they sneak above their June highs.
Remember, bulls want to see broadening participation in this rally. If small-caps join the fun, it would be a healthy development for the market.
— Greg Guenthner