Options trading and stocks
Please read about the Greeks before reading further.
Options trading is another way of earning income. This is a similar strategy to just buying and selling stocks which you could also do. If you are risk averse I would avoid options and individual stock trading. Only play with 10% or less of your money.
Stock trading you buy a stock at what should be a lower value and sell at a higher price later making income. For example you buy apple stock at $140 per share and sell at $150 a share. Say you buy 10 shares. That cost you $1400. You then sell that 6 months later at $150 a share. You get $1500 or a net profit of $100. Now that is only a 7% yield for that time frame. If you had similar success this could be 14% yearly. If the stock drops you lose profits and possibly your investment. I would urge you not to panic in that situation and you should just ride this out in most instances with strong companies. The stock will usually rebound and go up.
Option trading is similar to this but you are placing bets on the value of the stock. An opinion has a defined end date. One option is 100 shares of a stock. You have the choice of buying or selling options. If you buy an option you have the choice of taking the stock, selling the option, or letting it expire on the end date. If you are selling an option you have the ability to collect a premium for the sale, buy to close the option, and wait for expiration. This is complicated so feel free to watch YouTube and read other articles to educate yourself.
For example:
The stock market is the casino. The stock market has to be open for this and you may need to qualify for a margin account and show you have financial means to do this. You will need a brokerage account.
Apple stock is valued at $140 per share. So 100 shares is $14000. The strike price is the limit in which the option starts to increase or decrease in value. The buyer and the seller are able to choose a strike price that fits their strategy. A call and a put depend on the strategy and if you are the seller or buyer (explained more below). Factors that come into play include time decay, intrinsic value of stock, and volatility. A highly volatile stock that changes price quickly will have more risk but also more money to be made. Time decay is about how much time does the option have left before expiration. Time decay drops quickly at the last day or so of trading.
Option buyer:
The gambler
The call
If buying a call you are betting the stock goes up above strike price. Premium paid to the seller is lost unless you profit. Say you buy a call of apple at a strike price of $138. At the time apple stock was worth $137. The premium for this was $0.48 per share($48 for 100 shares) you paid this to the seller of the option plus a small transaction fee to the brokerage. The option expires in a week but can be months to years long if chosen. Usually the longer the option the more expensive the premium to the seller. The apple stock went up to $140. You would now call the option in the money. You sell to close the option for the profit before expiration which is usually a Friday. Option value is now $300.
Example: paid $48 for the option, option is now $300. If sold you make $252 minus brokerage fee. If you can make that every week of the year that is 27300% yield per year(252 profit/48 investments multiplied by 100 for percentage then multiplied by 52 weeks a year). Example: paid $48, took stock ownership at $138 price. You pay $13800 for 100 shares you now own. You can sell whenever or trade options on it. If you just sell the stock you make $152 minus brokerage fee. Example: you let the option expire. Loss of fees paid $48 plus brokerage fee.
Alternatively if the stock goes down or stays the same price you lose the $48 premium. The option will be worthless. So statistically you have a 33% chance of winning or 1/3 chance.
The put
You are betting the stock goes down. You paid a $50 premium that apple will go down this month. Currently it is at $138. The strike price is $130. So you are betting sometime this month the price will go below $130. The price goes to $150 and never hits the strike price. You lose $50 plus brokerage fee. Again you have a 1/3 chance at winning in general. You can just let the option expire or close it out early, maybe saving some of the $50. This could happen if the stock went to $135 but didn’t hit the strike price. The option could be worth more than $50 now it is closer to $130.
Alternatively say the stock goes down to $120. The put is now in the money. The put is now worth $1100. Profit is $1050 if you sell the put minus brokerage fee (1050/50x100percentx12months=25200% yield) or you buy shares at $120 and sell the shares at $130 to the put seller. If you sell the shares then you net $1000 minus brokerage fee (100 shares is $13000-$12000=$1000). Again if the stock does not change it is worthless. It is usually better to sell the option than own the stock unless you anticipate a stock jump coming or dividend is that week.
As you can see these yields are high. I cannot stress it enough that you are unlikely to win in these trades probably less than 1/3 of the time. If you do, the reward is high. You will have loss days and you will have win days. Practice a strategy before using real money. People will buy these as hedges for stock changes in price. They will buy a put to protect them from a price drop or a call to protect them from a price increase.
Option seller:
The insurance agent
The goal is to keep premium. Win 2/3 or 66% of the time. You keep the premium when the stock does not hit the strike price or does not move. Never do this with a stock you want to keep forever or a stock that you are not happy buying.
The call
You are betting that the stock will go down or stay the same. Goal is to keep the premium.
You open to sell a call. So you have 100 shares of apple. You bought apple at $130 at a cost of $13000. This is a covered call meaning you have the stock. A naked call is when you do not have the stock already which is risky as prices change. I would not recommend doing this. It is an easy way to lose money. You sell or write an option call at a strike price of $140 and expires in 1 week. Current price of stock is $138. The premium you get immediately as a credit to your account and pay a brokerage fee. Premium is $200.
Example: Sold option for profit of $200, stock price didn’t hit the strike price (stock went down to $135). You keep $200 and stock minus brokerage fee ($200 profit/13000 investment x100 percent x52 weeks=80% yield per year).
The buyer loses $200.
Example: Sold option for $200. Strike was hit at the money $140. Probably the buyer will not assign you at the money as it is not profitable. Same result as it never hitting strike price.
The buyer loses $200.
Example: Sold option for $200. Stock went up to $142. You are assigned and your stock is taken from you. You get the $200 premium plus $140 per share or $14000. Profit of $200 plus $1000 of stock value increase minus brokerage fee paid. (yield of 9% just for that week, yearly that would be 480%)
Buyer breaks even.
Example: Stock price drops to $120. Call option you sold is almost if not worthless. You can buy to close the position for $3 maybe or just wait for it to expire. You keep the premium and repeat. If the stock does drop below what you paid for it I would not sell it for that price. You should wait for it to go back up. The premiums will now be less so keep that in mind. You may only get $1 per week if that, selling the same option. If you bought at $130, I would not sell for less than $131 per share (strike price).
The buyer loses $200.
Example: Stock increases to $150. This is past the strike price of $140. Buyer assigns you and takes the stock. You get the $200 premium plus $140 per share or $14000. Profit of $200 plus $1000 of stock value increase minus brokerage fee paid. (yield of 9% just for that week, yearly that would be 480%). In this scenario you miss out on the additional increase in value (you are capped).
Buyer nets $800. ($1000 stock increase minus premium $200). That is a 400% yield in this transaction for just that one week (yearly 20000%).
Example: Apple drops to $0. You keep the $200 but now the stock is worthless and you have to wait for it to increase in value. Lost $13000 but have 100 shares.
Buyer loses $200.
The put
For the put writing or selling you have cash. With the cash you can sell a cash secured put. This is that you have enough cash to buy the stock if it drops to the strike price. You are betting that the stock goes up or stays the same. If it drops then the option can be assigned and you will be forced to buy the stock. Goal is to keep the premium. You still pay taxes and pay broker fee.
You write a put for apple at a strike price of $120. The current price of apple is $123. You need $12000 cash to do this (100 shares of apple at $120). Expires in one week. Premium you get is $200.
Example: Apple increases and the put expires worthless. You get to keep all your cash plus the $200. (yield yearly of 86%).
The buyer loses $200.
Example: Apple stays the same put expires worthless. Same result as above.
The buyer loses $200.
Example: Apple drops to $118. This is below the strike price and you are assigned. You have to buy the stock at $120. The option holder or buyer gets to pocket the difference ($200). You now own 100 shares purchased at $120 per share. You can now sell calls if you like.
The buyer breaks even.
Example: Apple drops to $100. You are assigned and have to buy at $120. Buyer pockets ($2000). This is where the buyer of the option wins. You now own 100 shares purchased at $120 per share. You can now sell calls if you like.
The buyer gets a wild yield of %1000 for that transaction.
Example: Apple goes to $0. You lose $12000 but have 100 shares.
Buyer wins. Makes $11800.
As you can see this can be highly profitable but also dangerous. So many different things can happen to stocks and the prices change for emotional reasons not logical ones. Bottom line is that selling wins more but you are capped. Buying has no cap other than the losses (premium) but you lose more often. In order to make money as the buyer the stock has to change drastically. There are many other strategies you can read about but the more complicated the plan should yield you more money you would think but they don’t.
Complicated example:
Current price of apple is $120.
You buy a far off call (years) of apple for $4000 at a strike price of $120. You then sell call options that have more short term expirations a week at a time. AKA the poor man’s call.
- The premium you get is $150 at a strike of $122. The price goes to $125. You are assigned and lose the call option you had but keep the $150 and $500 change in value. You lose $3350.
- The premium you get is $20 at a strike of $150. The price goes to $150. You are assigned. You get $20 and $3000 change in value. You lose $980.
- The premium you get is $20 at a strike of $150. You get premium each week for 2 years and the stock never hit $150 ($2080). You lose $1920.
- The premium you get is $20 at a strike of $150. The price goes to $155. You are assigned. You get $20 let’s say for 1 year each week. That is $1040 plus the increase value of $3000. You are up net $40.
- The premium you get is $20 at a strike of $150. The stock goes to $100. You are not able to make any premium. The stock does not recover to the $120 strike. You lose $3980.
- The premium you get is $150 each week. You sell the strike at $150 each week.The stock sits around $147. You do this for 1 and ½ years. That is $11700. Then the stock increases to $152. You are assigned. You make the $11700 plus $3000 the change in value for a total of $14700. Subtracting $4000. You net $10700. Yield is about 300%.
As you can see in this version you limit the amount of losses but need a high increase in value to make up the initial cost or much higher premium returns each week. Out of these 6 possible outcomes you only made money in 2 of them.
Don’t get greedy and do not make the mistake that you think you will always win. If you feel this way you should pause and take a break because you are going to get burned.
The brokerage:
The house always gets the fee.
The Government:
You will be paying taxes. They have a hand in your pocket.
If you enjoyed this please check out my other articles.