I am an extreme newbie to trading. I am trying to learn as much as possible before investing. One of the things that I came across are options. From what I have read this is what I have gathered. Please correct if i am wrong... I can do a put or a call option on stock A and if I have a call and the stock goes up I can execute my call and make money (minus the contract). If this does not happen in a designated time then the option expires and I lose the contract money. If I do a put to sell then if the stock drops and I exercise my option to put then I purchase at the current price and can resell at my option price. Do I have it correct so far? If so then I could do what I used to do when gambling on football. I would find 2 people to bet with and bet on the same game. With person A I would bet straight (without a spread) and bet person b with the spread but I would bet on the opposite team. That way if the score came out in the middle of the spread I would get paid from both bets and if it fell outside of the spread then basically person A would pay person B. Now with options I should be able to do the same thing (only opposite). If I buy 2 options (1 put/ 1 get) on the same stock and watch it for the 3 months. If it goes up I can exercise my call and just let the put expire or vise versa if it goes down exercise my put and let the call expire. With Scottrade each contract is 1.25 so on a 100 share block I would have to make sure that it either went up or went down more than 264 bucks to cover the contract and trade fee. The only way that I could lose is if the stock that I chose did not climb or fall more than $2.64 in a 3 month period. And if it ends up rocketing in either direction I have the potential at a huge return. Please correct my thinking if this is not possible. Thanks in advance, JV
What you are talking about is called a straddle. You can Google that term along with stock options and find a lot of info. Volatility and time premiums are priced into options, so that is the flaw in your thinking. The pricing models take all of this stuff into account, so it's not necessarily easy money. However, of course, the stocks don't always conform to the pricing models in their movements, so there is money to be made. But, it's not just like picking up a dollar bill from the sidewalk. I tend to go the other way with options, bet against the stock moving as much as is priced into the option, taking advantage of the decaying time premium in the option. There are several ways to do this, the most pure plays being to sell a call or sell a put, but you usually want to hedge yourself in some way, making a spread out of it (or owning or shorting the underlying stock).
So owning outright is better? I have read that short sales carry a lot of risk. Sort of putting a built in dump and that if you (pardon the pun) short the short then you potentially will accidently sell in a bearish market before the stock gets a chance to return a profit. BTW thanks for the detailed reply. Your help is appreciated. JV
When you say "short sales" do you mean selling (writing) option contracts? It just depends on how you do it how risky it is. If you do credit spreads (so, you sell and option and buy an option to limit your downside), it mitigates risk. You can also do covered calls or covered puts (calls are covered with a long position in the underlying stock, puts are covered with a short position in the underlying stock). The risk profile for covered calls is the same as selling a put and having the cash to cover having to buy the stock if you are put the stock (forced to buy it when the option you wrote expires). I don't really like to do covered calls and puts very often, credit spreads are more appealing to me. Just keep asking questions if you have them and I'll try to answer to the best of my knowledge. Options get a little confusing with all of the terminology and the graphs when you read about them. The easiest way I've found to learn about a strategy is to actually trade it. There are plenty of paper-trading accounts you can sign up for that do options.
How do you find stocks to use for credit spreads? Do you just follow certain stocks and then put on a credit spread based on the action of the underlying stock? What kind of R:R are you looking for before you would put on a credit spread? Do you generally use options that have less than 30 days or more? If you use a put credit spread, how close to the price of the underlying is your strike price? Can you give me an example of how you might put on a put credit spread using Apple if you thought the outlook was bullish right now? Thanks
I would first like to welcome you to trading and to the site. However, since you are completely new to trading I feel I should point out that options are both easier and harder to make money with than with stocks. The reason options are easier is b/c you can mitigate risk easier and there are techniques to make money even when the stock is moving sideways. However with a stock you only have to be right about direction but with options you have to be right about direction AND TIME. For instance if you buy a stock and it goes against you and hangs there for 2 years then skyrockets you can still make money b/c you were right about the direction....eventually....but the time didn't matter. If you bought a Call option 3 months out and the market moved against you then skyrocketed the DAY AFTER expiration you still lost money. The same goes for the neutral trades. If you think the stock will stay in it's sideways channel for 2 more months and setup a trade that way and it only stays in it's channel for 1 month then breaks out before you close the position you lose money. Finally time erodes the value of options so it is VERY important to understand how this will help or hurt your trade. Before you trade any options I suggest learning everything you can about the Greeks and how they affect options (Delta, Theta, Vega, Gamma, and Ro), everything you can about Implied Volatility, Open Interest, and how to predict where a stock will be and when it will be there.