The Final Step in Your “Optucation”
Dear Penny Stock Millionaire,
Over the last two days, I’ve taken a deep dive into the inner workings of options. Yesterday, I explained how to buy and profit from options, after covering exactly how put options work on Tuesday. Today, I’m going to finish up with some tips that can help you enter the complicated world of options trading if you so choose.
Much like penny stock trading, if you are looking to start trading options, you gotta find a plan that works for you. There’s no magic formula that works for everyone.
Options traders love to make bets on earnings. You can bet on the long side by buying calls, and at the same time bet on the short side by buying puts. If the swing is big enough in either direction, it can turn a hefty profit.
Another big indicator is implied volatility, which can give you clues about a stock that’s about to make a big move.
The key point to remember here is that no indicator is right 100% of the time. You must learn to manage your risk.
If you’re just getting started and trying to figure out where to start with trading, I think it’s smart to start small. Options aren’t the best place to start. If you have been trading for a while and you are ready to try your hand at options, you need to consider a few key factors:
Duration of Time
One of the reasons that earnings are so popular with options traders is because options contracts have set expiration dates.
Options traders often like to trade during different time frames.
That said, the duration of time can vary greatly. It depends on your trading style and your unique, customized trading plan.
Amount You Can Afford
How much you can afford to trade is a highly personal decision. The answer varies for every trader. First, consider your risk tolerance … Can you stomach losing $500 on a single trade? That’s what the TSLA trade we looked at over the last two days would cost. If you purchased the $355 strike.
With penny stocks, you can trade using a small account, but options require more capital. For an options account, it’s not wise to risk more than 5% of your account on a single trade.
Options trading can vary in price from around $100 to well over $1,000. For that reason, I wouldn’t consider trading options with an account below $20,000.
That’s one more reason trading options isn’t a beginner’s game.
Length of Move
The move always ends on the expiration date of the contract. You can buy it in advance up to 100 days. Remember, option prices typically go down over time, so they start out high.
You don’t want to buy too close to the expiration date, either. That can greatly limit the amount of time you have for a move to play out.
The longer you hold an option contract, the more likely it is to move in the direction you want. But the further out you buy, the more expensive the premium is.
I’m talking in circles a bit here… In short, it’s complicated. As a general starting point, you can buy and sell between 30 to 60 days away from expiration. That can provide some balance between premiums and allow enough time for the stock to move.
Put Option Strategies
From a married put to an iron condor, there are dozens of different strategies you can use to trade options. And they can vary greatly in cost and complexity.
For our purposes today, I’ll review three different strategies to show the level of complexity that can come with options trading. Let’s start with the most basic.
Put Option Strategy #1: Long Put
This most basic strategy is what we’ve been discussing with TSLA. If you think a stock will decrease in price, you can buy a put contract and profit from its fall.
Put Option Strategy #2: Protective
Check out the following TSLA chart:
This is essentially an insurance policy for a long position. Here’s how it works…
- You buy 100 shares of TSLA for $358 (near the closing price on December 13).
- You buy a single put option with a strike price of $365 for a $20 premium — your total cost is $2,000.
Now you’re protected from a big loss. If the price drops more than $20, the put will increase in value at the same rate your long position will decrease in value. This strategy essentially limits your total loss up to a certain date. This example protects you through January 17.
But if the price goes up as expected since you had a long position, you need the price to increase $20 per share to cover the cost of the put option premium.
If the price stays flat or increases less than $20, you lose money, albeit a capped amount.
Put Option Strategy #3: Butterfly
This is by far the most complex strategy we’ll look at. Look at the chart for The Walt Disney Company (NYSE: DIS).
This strategy requires three transactions, and using more than one option is known as a put spread option.
- Sell one put for $5.25
- Buy two puts for $9.25
- Sell one put for $13.50
If executed at this price, you’ll receive $1,875 for the premiums you sell. And you’ll spend $1,850 for the options you buy. You keep the $25 difference.
The positions essentially cancel each other out, so you keep the $25 no matter what.
Options traders try to actively trade these positions to maximize their winnings. This comes with increased risk and can potentially cancel out any small profit you managed to make if you don’t manage the trade perfectly.
I hope you have a better understanding of the option market now. Next time you hear “how do you write a put position?” … you’ll have a better idea.
Always remember that over 90% of traders lose. Options can give you a sense of security — but remember that big rewards come with big risks. And taking large risks can make it tough to be consistently profitable.
Most stocks don’t make 10%+ moves, and you can try to predict 30–60 days out … But bottom line, it can be extremely difficult to be consistently profitable trading options.
I’ll stick to trading and teaching penny stocks. Options are too complex for me, and I think they’re too complex for beginners.
Editor, Penny Stock Millionaires