I'm not a newb to stocks or the market in general, just a 100% newb to options. So let's say i think i'm pretty savvy and with 10k i want to take advantage of short term trends with options. The strategy calls for catching up or down trends that can range from 1-3 months. For example, i'll pretend i had a crystal ball and predicted the sharp decline of Google around $660 or so in January and my target for this down move was to last at least 1.5-2 months and move at least to $600. With my limited education of options i am asking what would be the most appropriate expiration and strike price to consider when trying to undertake a 1-3 month swing strategy with options. (How far out of the money vs in the money...etc) Please note i am beginning my option education and any books that come recommended are appreciated.
I read about an analogy in a blog that may be of help. Imagine climbing a ladder. The steps are: 1. Find an up ladder (up could be turned to down). 2. Put your feet and your hands on certain steps (steps are strikes). 3. The stock is between your hands and feet (facing your... you know what I mean). 4. If the stock gets closer to your hands, touch them or pass them, then move your feet up, and your hands up to the next steps (strikes) as per step 3. 5. Never move your feets and hands up if stock fall below your feet. Feet= long call (put), hands= short call (put). I will find the link to the blog and post it here.
You could have bought a put "at the money" or a couple strikes "out of the money." You could buy them in the money but it gets pricey. The further out of the money the cheaper. Time decay (where the value of the option depreciates) is the worst the last 30 days before it expires. So look at the timeframe you expect it to go down in and leave room for the worst 30 days of time decay. Also, if you were really expecting a huge move down, you could buy puts way out of the money (lower strikes than the current price). They will be really cheap and will give you some huge percentage returns if you guess right, but also carry a fair amount of risk of losing all your invested capital. Thats how I would do it, im sure you will get different answers from everyone.
You are essentially recommending to him to be a net buyer of premium. The price he will pay is that his prob of winning will be lower. If he climbs the ladder as I told him (with the stock facing his part organs), he will pay NO time premium, only the instrinsic value (distance from his feet to his private organs). There is an assumption that the stock and his private parts are point to the same direction--up that is.