Source: financialpicks.com
Pros: Going into options trading gives you tremendous opportunity for huge gains. 500%+ gains are not unheard of at all. Also, the worst that can happen is your option goes to zero. It’s not like other leveraged products like S&P 500 futures where you can lose more than what’s in your account.
Cons: Options decay in price over time. That’s why so many pros want to sell them to ignorant investors looking for a quick buck. You better have one heck of an edge in trading if you want to overcome this roadblock.
Option Trading Tutorial
Watch me in this quick video as I explain my most profitable trading method and how to trade options.
Smart Money Over-view
Watch as I go over all the Smart Money trade signals since 1995.
What are options? [Click here to skip ahead]
Contracts and Strike price:
Options are basically contracts that allow a person to buy a stock at a certain price (called the Strike Price) at a certain date (expiration date).
You pay money up front for the option because you think the stock is going to either go up or down. When the stock goes up, a CALL option will go up. When the stock goes down, the CALL option goes down. Simple right?
When you buy call options, you will buy in lots of 100 (One contract=the option to buy 100 shares of stock XYZ). That means that if you see the price of the option at $1, it will cost you $100 for one contract. You now have the right (but not the obligation) to buy 100 shares of stock XYZ for whatever Strike Price you bought the options.
A strike price for a call is the price at which you could buy the actual stock. So if you bought an option on SPY with a strike of 125, for every dollar over 125, you would usually add a dollar to your option price, plus whatever premium is figured into the option pricing.
This premium goes into the pocket of the person that sold you the option. This is their reward for the risk they take in selling you the option. The longer an option is from it’s expiration date, the more premium you pay.
Example:
You buy a long-term SPY call option for $6.10. The strike is 125, and SPY is currently trading at 125. You’re basically paying $6.10 in premium (since we’re buying an option that doesn’t expire for 18 months).
If SPY just stays at 125 until expiration, the option will expire worthless.
However, if SPY should happen to go to 150, you would be up $25 per option plus whatever premium is left.
So the contract you bought for $610 turns into $2800 ($25 * 100 + $300 in premium left). That’s how you start making 500%+ gains.
By the way, the example was a real option that coincides with the Smart Money buy signal from June, 2006 to May, 2007. OPRA: SPYLU SPY December 2007 call.
Expiration:
The main problem that occurs with options is the fact that they expire. If you buy an option with an expiration date of October, the option will expire on the third Friday of October.
If you bought that option back in August, the option will become less and less valuable as you approach the expiration date. It’s just like buying milk at the grocery store– as the date gets closer and closer to expiration, not too many people want to buy it, and if they do, they want to get a better price.
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