Options trading may seem intimidating to beginners because of the numerous strategies.
While traditional stock investing follows a simple principle – buy shares in stocks you think will go up in value – there are dozens (or maybe hundreds) of options trading strategies to make money.
Today we’re going to demonstrate that you don’t have to be a Wall Street whiz to be a successful options trader. We’ll focus on three popular strategies for beginners: long-term options (LEAPS), short-term options, and covered calls.
With these techniques, you can turn modest stock gains of 5% or 10% into 50% or 100%. Or you can take a stock you own that isn’t going anywhere and collect an instant, low-risk premium.
If this doesn’t make sense to you right now, don’t worry. It will all become clear soon, and you’ll be trading and making big bucks in no time.
Trading Options for Beginners, Strategy No. 3: LEAPS
Most option contracts have a lifetime of six months or less. But for those looking to trade options over a longer time period, “LEAPS” are the perfect answer.
LEAPS stands for long-term equity anticipation security. That S on the end makes for some confusion, because a single long-term options contract would be called a LEAPS contract – not a LEAP.
7-Day Cash Course: With the secrets in this video series, you could potentially start collecting anywhere from $1,190, $1,313, and even $2,830 in consistent income – each and every week. And it can be yours for only $1…
LEAPS contracts can stretch for as long as three years. Other than that extended time frame, they operate very much like shorter-term options. Buying a LEAPS contract gives you the right to purchase a stock for a certain price on a certain date.
This isn’t the kind of option you would use if you’re expecting a quick movement in a stock’s share price. And it’s important to keep in mind that, unlike when you buy shares outright, a LEAPS contract doesn’t let you collect dividends or participate as a shareholder in the company – unless, of course, you exercise the option to buy shares at the end of the contract.
But if you’re expecting a significant long-term movement in stock price, LEAPS give you a way to boost your potential earnings.
Because, just like with other options, a LEAPS contract gives you access to many more shares than you would be able to buy for the same price.
LEAPS can also limit your losses if the trade goes against you. When you buy LEAPS, you can only lose as much as you put up in the first place. That will be significantly less per share than you would have spent buying the stock outright.
LEAPS tend to be more expensive than shorter-term options, because the longer time frame means it’s more likely for the stock price to move by large amounts. But if you’re expecting a particularly big move in a stock’s price – and you expect that to play out over more than six months – LEAPS offer a way to maximize your profits.
If you’re expecting a stock to rise 50% over the next two years, for example, you could just buy the stock outright and enjoy your 50% gains. But if you bought LEAPS, you could invest the same amount and triple or quadruple that gain to up to 200%, depending on market factors. And unlike trading on margin, you don’t run the risk of being forced to sell early, and you don’t owe interest on any borrowed shares.
One thing to keep in mind with long-term options is that they are more sensitive to the underlying stock’s volatility than shorter-term options. More time plus more volatility means a lot of opportunity for the share price to move in a favorable direction.
Therefore, when you’re shopping for LEAPS, you might want to look for stocks that currently have low implied volatility. If that implied volatility rises while you hold the LEAPS contract, the premium should move in your favor – even if the share price of the stock doesn’t.
Like regular options, LEAPS can be bought as both call options and put options. So in addition to betting on a stock going up over time with a LEAPS call contract, you can use a put contract to bet on a downturn.
If you see a possible market downturn in the near future, for example, or a downturn in a particular sector, you can use a LEAPS put contract to protect yourself and even profit when that time comes.
You may want to use LEAPS put contracts as a hedge against the rest of your portfolio. If you are mostly long on the market, as most investors are, LEAPS can provide a way to protect against a crash for relatively little risk. If the market keeps going strong, the gains from the rest of your portfolio should cover the cost of your LEAPS. And if the market does turn downward, your short-positioned LEAPS will rise significantly and make up for some or all of your losses.
If you’re looking for some quick profits, of course, you’ll want a shorter-term strategy…
Best Options Trading Strategies for Beginners, No. 2: Short-Dated Options
The duration of standard options contracts can range from one week to several months. But since you’re buying options on the open market, you only have to pay attention to the expiration date. It doesn’t really matter how long ago the option was written.
There are a few advantages that short-dated options provide. To begin with, they’re cheaper. The window of time for share price movements is shorter. That lowers the odds – and the price along with it.
The real advantage, though, is that as the price goes down, the potential profit goes up. Short-term options are extremely sensitive to share price movements in the underlying stock. So as the share price moves in your favor, you can expect an exponential gain in the value of your option.
We’ll show you in a minute how you could multiply your gains more than nine times over with short-term options during earnings season.
Earnings season, the period when companies report their performance for the last quarter, is ideal for options traders because rapid price movements are common. Many investors are trying to guess whether companies will meet, beat, or miss earnings expectations. And prices swing up and down accordingly.
You don’t need a crystal ball to make quick money in this scenario. In fact, your best bet is to buy a short-term option and get in and out before the earnings come out.
The stock market tends to “buy the rumor and sell the news.” So a stock’s share price might rise in the days or weeks before an earnings call as investors anticipate an earnings beat. But even if that earnings beat happens, enthusiasm often wanes, and the share price falls back down near previous levels.
So the strategy is simple. Find a stock that has a history of price swings ahead of its earnings call. Then buy a short-term option – call if you’re betting on a rise, put if you’re betting on a fall – a few weeks ahead of the call.
Now the important part: Sell the option a day before the earnings call. You’re not betting on the company’s performance. You’re only taking advantage of traders’ tendency to push the stock price up or down ahead of earnings. So set your exit date and stick to it, no matter what.
You don’t have to be successful every time you make this trade in order to reap big profits in the long term. You’ll only be putting up small amounts of money for each option. And one big winner can more than make up for a few unsuccessful trades.
Take the case of Yelp Inc. (NYSE: YELP), which was coming off a series of earnings beats heading into its May 2018 earnings call. As had often been the case, its stock price rose in the weeks leading to that report. Shares went from $44.83 to $47.92 between April 18 and May 9, the day before the announcement.
Learn How to Trade Like the Pros: Tom Gentile just recorded all of his most potentially lucrative trading secrets in America’s No. 1 Pattern Trader Cash Course. This could set you up for life – and it’ll only cost you $1…
That’s a 6.9% gain, which isn’t bad for less than three weeks.
But if you had bought a short-term in-the-money option for $3 per share, you could have sold it on May 9 for $4.92 per share.
That’s a 64% gain. If you had put $900 into that trade, you would have collected $576 in profit in just 20 days. And that’s from a share price movement of less than 7%.
That gives you an idea of the kind of money you can make from simple, modest option trades – much more than simple stock investing can offer.
We’ve already discussed how options can be used not just to score quick profits but also to protect your portfolio from losses. Another way to use options as crash insurance is through covered calls.
Best Options Trading Strategies for Beginners, No. 1: Covered Calls
A covered call involves selling call options rather than buying them. That means you collect a premium from the option buyer, who then has the right to buy the underlying stock from you at the strike price when the option expires.
The danger, of course, is that the share price might rise. And you might be forced to buy shares at a higher price than you anticipated only to sell them at the (lower) strike price.
That’s no fun. But you can mitigate that risk by “covering” the call option you sell: that is, buying the shares up front. Or, more likely, you would sell a call option for stock you already own – and have probably already earned a decent profit from.
To make money off a covered call, you employ it when you don’t expect significant movement in share price. If the price goes up a little bit, you might have to sell your shares for less than current market rate. But the premium you collected when you sold the option will more than cover that loss. And if the share price stays the same or goes down a little bit, the buyer won’t exercise the option and you’ll keep both the premium and your shares.
Covered calls are best used when you already own the stock and planning on holding onto it for a long time. This strategy lets you capitalize on a lull in the stock’s otherwise strong long-term trajectory.
Even in the worst-case scenario, a covered call is less risky than many other trading strategies. You get to keep the premium no matter what. And even if you have to give up your shares, you’ll get paid for them at the option’s strike price – which should be somewhere near what the share price was when you first sold the option.
So for the investor who wants to take a conservative approach to options trading, covered calls can be a great way to get started.
These three strategies should be enough to get you started making money with options. But there’s a lot more where that came from. And if you’d rather not have to do the heavy lifting, Money Morning‘s options trading specialist, Tom Gentile, has got you covered…
You Can Learn How to Trade Like the Pros – for Just $1
America’s No. 1 Pattern Trader, Tom Gentile, is giving you a rare opportunity to learn how to amass a constant stream of extra cash – year in and year out.
And he’s going to teach you how to do it entirely on your own.
People have paid up to $30,000 to access his secrets… but it can all be yours for only $1.
Join the conversation. Click here to jump to comments…