So if you've read this far you're probably interested in trading options and making good money doing it. Just like anything else, you need to be well informed about what you're doing if you want to succeed. The concept of options has already been explained. Now it's time to learn how to actually trade them.
As previously mentioned, we will concentrate on only the long call and the long put, avoiding all the unnecessary calculus along the way.
Trading stocks is rather simple. You simply buy in at whatever they're currently valued, decide how many shares you want, and your return depends on how much the stock gains or loses. If it gains 5%, then you gain 5%. If it loses 5%, then you lose 5%. Simple as that.
With options, it's a little bit different. In order to trade options, you first need to select options associated with an underlying stock. As previously mentioned, an option gives the buyer the choice, but not the obligation, to buy or sell a stock at a given price within a set period of time. Since the investor is not obliged to execute whatever action is in the terms of the contract, you can simply sell that option for whatever it may be worth when you want to sell it. For many options, this return can be worth far more than if you invested in the underlying stock. In some cases this may be as high as 100% or 200% within just a matter of days, sometimes even higher.
When selecting options, you should keep in mind that there are 3,000 to 4,000 stocks with associated options. There are about 40,000 publicly traded stocks in the United States. So by doing the math, only about 10 percent of stocks have options. This may not sound like much initially, but rest assured that being able to pick between 4,000 or so choices is plenty enough. In the end it's all about returns, not necessarily the number of choices available to you.
An important point should be made here. Many options traders choose to concentrate on only a handful of associated options with underlying stocks when executing their trading, sometimes as low as 4 or 5 companies. They believe that they can make solid and consistent returns by simply concentrating on the oscillations of only a few stocks and tracing their movement patterns. And many of them actually do. You can make money on any stock and their underlying options whether they are going up or down, so long as your investment is targeted in the right direction. So by focusing attention on only a select group, many investors can make more informed decisions. Again, it's about the quality of your analysis and information available that's more important. Too many choices can sometimes be a diversion from making the best decisions and investing in the options that can make you good returns. Try not to focus too much on "playing new games." It's important to find out where your "bread and butter" is and to turn to it consistently if it's making you money.
The Long Call
The long call is the simplest type of option there is. If you learn how to execute it, however, you are probably better educated than most investors out there who only trade stocks. You should read other sections of this site to better understand some of the terminology explained.
If you take a "long" call position on a particular stock, it means that you are invested in an option that will increase in value if the underlying stock increases in value as well. It gives you the right, but not the obligation, to buy a stock at a particular strike price (which is discussed below). For our purposes, we are not focused on following through with such rights. We are only concerned with trading the options themselves.
If you buy option .XYZKL for $4.00 and the underlying stock XYZ is valued at $50.00, the value of the option will increase so long as stock XYZ is bullish. As discussed on this site, a delta is associated with every option. The option will increase by delta for every dollar that XYZ goes up. Deltas for long calls max out at .99. If the delta for option .XYZKL is .99, then option .XYZKL will go from $4.00 to $4.99 if XYZ goes from $50.00 to $51.00. The option has increased by about 25% in value, whereas the stock increased by only 2%. Time value will devalue the option as it approaches its expiration date, so it's important to consider all factors that affect what an option is worth.
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