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Michael Michaud is the founder of Invest2Success.com (http://www.invest2success.com/) and the Invest2Success Blog (http://invest2success.blogspot.com/). He has been investing and trading in the financial markets since 1989. He founded Invest2Success.com to empower individual institutional... More
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  • Options Trading Strategies 0 comments
    Sep 26, 2013 7:29 PM

    Options Trading Strategies

    Two Bullish Strategies to Make Money With Options by - By Zacks Investment Research

    Bullish on stocks?

    Here are two ways to play it with options:

    1. Buy a Call.

    2. Write a Put.

    How bullish you are will help determine which strategy is right for you.

    1) Buy a Call

    Buying Calls is one of the easiest and probably most well know option strategies.

    If you believe the price of a stock will go up, you can buy a call option on it and make money as it does.

    But unlike a stock, it needs to move within a certain period of time.

    And based on the strike price you've got, it'll need to move a certain minimum amount to overcome your purchase price.

    Knowing this, there are a few things to consider when you're selecting your option.

    The first thing you'll want to consider is time.

    As a rule of thumb, unless I'm speculating on a date-specific event, I'll normally buy a little extra time than I might need.

    This gives me a little extra leeway and time in case the move I was looking for takes a bit longer than expected.

    For example, if I'm expecting a move within two months - there's no harm in picking up an extra month or two to be on the safe side - especially if that extra month could mean the difference between a profit and a loss.

    The next decision to make is if you'll pick up an in-the-money option (NYSEARCA:ITM) or an out-of-the-money option (OTM).

    Just remember: an in-the-money option will have a greater likelihood of making money than an out-of-the-money option.

    Why?

    Because at expiration, your profit is the difference between the stock price and the strike price less your premium.

    For example: let's say a stock was trading at $50 and you had two options:

    1, $45 call (ITM) for $6.50 and 1, $55 call (OTM) for $3.75

    If at expiration, the stock was trading at $60, that's a 20% move in the stock.

    At expiration, the $45 call would be worth $15 or $1,500. Remove your premium of $6.50 and that's an $850 gain.

    The $55 call on the other hand would be worth only $5 or $500. Subtract your premium of $3.75, and instead you'd only have a gain of $125.

    Same stock move, but vastly different profit outcomes. Sure you saved a few hundred dollars on the way in, but look what it cost you on the backend.

    Of course, if you're wildly bullish, you could really get a lot of leverage on the cheaper out-of-the-money options. But usually, the out-of-the-money options are best only if you're expecting some pretty big things to happen.

    For your regular moves - good moves - but not astronomical moves, consider staying closer to the money as it'll increase your chances for success.

    2) Write a Put

    This strategy, unlike buying calls, is probably one of the least known option strategies.

    And also, probably one of my favorites.

    It's a bullish strategy.

    But you have more ways to profit with this one.

    When Writing Puts, the stock can go up, sideways or even down (albeit only a certain amount) and you can still make all of the money you expected to make when you put the trade on in the first place.

    Essentially, writing a put means you might be obligated to buy the underlying stock at a certain price if the stock goes down to your strike price. This is called 'having the stock put to you'. But you'll get paid for taking that risk.

    But the benefits are great.

    First, when writing a put option, I don't favor getting more time than needed. Instead, try and get only as much time as necessary to ensure a big enough premium to make the trade worth your while. This strategy will benefit from time decay.

    Moreover, I recommend writing out-of-the-money options too. Not too far out, but close enough to maximize the premium you'll collect. But far enough away so your chances of keeping the entire premium remains high.

    Continuing with the same example, let's say the stock was at $50 and you thought it was going to go higher or maybe even a little lower at first, but you liked the stock and were essentially bullish on it.

    If you wrote a put option, let's say the $45 put for $400:

    At expiration, as long as the price of the stock was above your strike price of $45, you'd keep the entire premium you collected. (It doesn't even have to be above $50, just your strike price of $45.)

    If the stock is at or below $45, the stock will likely be put to you, meaning you'll have to buy that stock at $45. But not only did you now get to own that stock at a cheaper price ($45 rather than $50), but you also got paid $400 while you waited and got in at a lower price.

    The stock would have to go below $41 to even begin losing money on the trade.

    This is a great strategy if you have a neutral-to-bullish bias on a stock and would like a strategy to profit under a wide range of scenarios.

    But if you're super-duper bullish on a stock, this would be the wrong strategy because you'll always be limited with what you can make.

    But your chances are good that you'll get what you expected if you correctly determined what you broadly thought the stock would do (or at least wouldn't do).

    But these two strategies, buying calls or writing puts, should be considered based on how bullish you are.

    The Biggest Mistake Covered Call Traders Make by - By Zacks Investment Research

    I'm asked this same question time and time again! If the majority of my covered call trades are profitable, why am I unable to outperform the major market index?

    The answer is quite simple: risk management. I've spent over 16 years speaking with covered call traders. I'm fascinated at how willing they are to voice their results. I recently had an experienced trader state: "Over 65% of my covered call trades are profitable." My response was "Wonderful!" And I then proceeded to ask him, "How much did you earn last year trading covered calls?" Let's just say he was less anxious and less forthcoming.

    Without auditing his trading journal, I could foretell the problem. He overlooked risk management. A covered call trader is faced with two types of risks: the risk of experiencing a large loss and the risk of running across a losing streak. While neither one is completely avoidable, following a few simple steps can help minimize losses and reduce equity drawdowns.

    Large losses should be managed with stop-loss orders. Yes, a stop-loss order on the entire covered call position! Many covered call traders fall in love with their stocks and plan to hold their positions into perpetuity. They fail to understand the true risk-to-reward relationship of the trade. If an upside profit is limited, then a downside loss should be limited too. For instance, let's take a look at the following trade:

    Options Trade

    Is it logical to risk $28.75 in order to make $3.75? That's a (28.75:3.75) risk-to-reward ratio. I'm not sure about you, but that's too much risk for my blood. If, however, I enter a stop-loss order at $25.00, then I can reduce the risk to $3.75 and improve my ratio to (1:1). This is a very simple remedy; nonetheless, it yields a more acceptable and more manageable number.

    Losing streaks are another issue - one trade after another triggers for a small loss. Streaks tend to occur during major market corrections and can ravage a covered call portfolio. One way to neutralize this risk is through portfolio diversification. A properly diversified portfolio of stocks from different industry groups will reduce risk; however, you cannot stop there. One should also trade a few uncorrelated trading strategies. For instance, covered calls are a neutral to bullish trading strategy, so one should also trade a second strategy that is perhaps neutral to bearish, e.g., bear-call spreads or naked calls.

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