If you have been trading stocks, you really need to look at trading options as a strategic investment - using strategies that will boost your profits, decrease your costs and give breadth and depth to your trading approach. Although many people are scared of using options, it is important to realise that they are no more or less dangerous than any other form of trading. The only danger lies in not having defined strategies, and in allowing greed to be the controlling factor in making decisions. Options are simply strategic tools that, used safely, can be incredibly beneficial to a portfolio. Many people don't realise that options are short term trading instruments, and therefore in some cases require less technical analysis than straight stock trading. What is more important is to have the right technical analysis linked to any given strategy - in other words, a very focussed rifle approach as opposed to a shotgun analysis of everything that can be graphed.
How you can use options as a strategic investment
1. Reduce the cost of your investment - if you own some stock, you can greatly reduce the cost of the stock by selling calls against the stock every month. This called the "covered call" strategy. It is a great strategy for a stock that has stagnated for a while, or is even going through a cyclical dip. Over a year, it is even possible to sell covered calls enough times that you can eventually pay off everything that you initially invested in the stock, freeing you up to buy more or to buy a different stock. Technical analysis is not very complex - you need to know how to do Trend Analysis,
and you need to know how to find support and resistance points.
2. Get paid to buy stocks - if you have stock in mind that you would like to own, but don't want to buy too high, the "selling naked puts" strategy is very useful. Every month, you sell puts against a stock, but at a lower strike price than the stock is currently trading. If the stock goes up in price, your put expires worthless, and you keep the money (and do it again next month); if the stock drops to your chosen price, then you can buy it and wait for the profit to roll in as the stock bounces back up. After you have bought the stock, you can then sell covered calls to even further reduce the price you paid for it. What do you need to know? How to find a trend, support and resistance points, and how to pick a swing trade.
3. Buy stocks for half price - buying DITM (Deep-in-the-Money) options for shorter term momentum trading is a great way of buying into a stock for half the price (or doubling the bang for your buck). You don't particularly have a great interest in owning the company long term, but you do see a potential growth probability in the next two months. The important thing is that the price of the option moves at exactly the same rate as the stock, but is usually half the price. So, if the stock moves up a dollar, the option gains the same value. The technical analysis is not too complex - you need to be able to identify a trend in a stock. Knowing the fundamentals of a company is more important in this stratgey than in other options strategies.
4. Profit from volatile markets - stock traders often hide their heads in volatile markets, or go into cash for a while. However, options traders delight in the opportunities presented. Selling credit spreads, buying straddles orstrangles, dealing in iron condors or butterflies - these are all excellent strategies to profit from a volatile market, especially when you are not sure which way the chips will fall.
5. Selling the future - options deal with promises in the future. Selling a call or a put takes advantage of this, but the risk and the potential loss are offset by buying another option as insurance. This is a great way to make a steady, compounding profit of about 10% per month, and it is referred to as the credit spread strategy. Identify a trend, see where points of support and resistance are floating, look ahead to news events - and that is all you need to know to sell credit spreads.
Fire in a fireplace is useful and beneficial, but outside the fireplace, is dangerous and destructive. Options are the same - in the context of a solid trading plan, with the right amount and the right kind of technical analysis, they are incredibly useful tools to any serious investor. The range of strategies presented by options allows a trader to take advantage of almost any market condition, and to turn a steady and reliable return on investment. Click on any of the links in this page to get to free (Yes, Free!) tutorials on any of the strategies I have listed.
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