Options trading is one of the major trading niches that traders specialize in. Lately it’s become more popular than ever. Even if you don’t trade options, your knowledge account will be lacking if you don’t understand the discipline.
I don’t trade options, but my former student and current Challenge mentor Mark Croock does. He’s implemented my penny stock strategies into options trading. That’s how he’s made most of his $3.9 million in career earnings.
Options trading is very different from penny stock trading. There’s an entirely new learning curve, and it can be overwhelming if you don’t know what you’re doing.
Still on the fence about getting into options trading as a beginner? Read on to learn more!
Table of Contents
How Does Options Trading Work?
Options trading works by speculating whether an asset’s price will rise or fall by a certain amount, after a specified amount of time. Essentially, you’re “betting” on the movements of a stock — and profiting if you get it right.
Options are derivatives of actual stocks, meaning an option doesn’t have any value of its own. Instead of holding its own value, an options contract gives you “the right to buy or sell a stock at a predetermined price within a certain period of time.” Like stocks, you get access to options trading through your broker and various trading platforms.
Options trading involves two parties: the holder/option trader and the writer/option seller. When you trade options, you pay the option seller for the right to trade a stock for a certain price by a certain date.
The money you pay to get an options contract is called a premium. If you don’t do anything with your contract, the only money you’ll lose is the premium.
The price where the option becomes executable is called a strike price.
Why do traders love options trading? Here are some common reasons:
Provides Trading Flexibility
When you trade penny stocks, you need to own the underlying asset at some point. With options trading, you can decide whether or not to go through with the stock trade based on the current price information. If the contract’s expiration date passes without you doing anything, the option simply becomes null and void.
Options exist for a range of investment vehicles, from stocks and indices to commodities and foreign currencies.
Has Built-In Risk Limitations
If you don’t cut losses quickly when you buy a stock, you might have to sell at a significant loss. When trading options, there’s less of a risk — you can choose not to go through with the trade.
The only thing you’ll lose is your premium and nothing else, in contrast to the much larger losses you can incur when trading actual stocks.
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Rewards Good Speculation
I teach my Trading Challenge students to never try to predict the market, react to it instead. I don’t want my students believing in a stock — I want them to trade good setups with a high degree of confirmation, and cut their losses if a trade goes against them.
The exception is in options trading. Options trading rewards good hunches about a stock’s future moves. Smart options traders like Mark can trade on speculation because an incorrect options idea doesn’t penalize them as much as a dumb stock bet.
If your prediction is right, you can safely buy or sell the stock. If you get your trade wrong, you’ll lose a fraction of the money you would if you actually traded the stock.
Call Options
When you buy a call option, you’re essentially getting the right to buy a stock at the specified price.
For instance, let’s say you think a $3 stock in Company Y will rise by 20% some time in the next two months. You’d buy a call option to purchase 100 shares of Company Y’s stock at $3.60 per share.
When you buy a call option, you pay a premium to the seller. If Company Y’s stock price jumps to $6 per share before your contract is up, you can buy shares at the $3.60 strike price and sell them for the difference.
If Company Y’s stock price drops, you can ignore the option and only lose your premium.
Use Cases of Call Options
You’ll benefit the most from a call options contract when you expect a stock to rise in price — you can lock in a lower purchase price and sell it for a profit.
Put Options
A put option is the opposite of a call option. It gives you the right to sell stock at a certain strike price.
For instance, you can get a put option to sell 100 shares of a $3 stock in Company Y two months from now if you think it will trend down. The strike price would be under $3 on a put. You would be able to sell (or short sell) your optioned shares for $3 each — then immediately buy them back at the lower price.
Use Cases of Put Options
Since put options require you to own the underlying stock when they execute, they are more complicated than calls. If you already own shares in the optioned stock, you can use your own shares to exercise the option. If the stock price goes up, you can just sell your shares at a profit without exercising the option. This strategy is called “hedging.”
If you don’t own shares in the underlying stock, it’s often more profitable to just sell the put. This is because the remaining time value can also be monetized.
How to Trade Options Effectively
While options trading differs from penny stocks, the same basic framework applies:
- Don’t follow anybody else’s picks
- Study successful traders’ options strategies
- Create your own watchlists and trading plans
- Track your trades
Becoming a great options trader is a marathon, not a sprint. Winning or losing your trades isn’t the only point. You want to make sure that your trading technique is improving everyday.
Not willing to sacrifice money on mistakes? Paper trading is a great way to get your feet wet. It won’t teach you how to deal with your emotions when real money is at stake though…
I think the best way to learn any trading strategy is to learn from those who have more experience than you. Find a trading community on Discord or elsewhere to share experiences and learn from like-minded options traders.
Want to learn options trading from the best? Sign up for Mark Croock’s Evolved Trader program now and learn from one of the only options traders I trust!
American vs European Options
American and European options are just trading terms for different types of options contracts (there are also Bermuda options if you want to get really technical).
The most important difference between American and European-style options is that European options can only be exercised on the expiration date. American options can be exercised anytime within the expiration time frame, which makes them more valuable.
American and European options are both available on stocks traded in the U.S. But you won’t get a choice between them when you’re taking an options contract…
American options are the dominant options contracts for stocks and ETFs. European options are more common in index-based options contracts.
Short-Term Options vs Long-Term Options
Depending on your trading style and risk appetite, you can choose between short-term options and long-term options contracts.
Short-term options expire within days or weeks. You might buy these in advance of forthcoming news, like an earnings call or product announcement. They’re typically riskier but cheaper.
Conversely, long-term options can last six months or more. They’re usually more expensive, as they give the underlying stock more time to hit its strike price.
Key Takeaways
Options trading involves some degree of speculation, but it also has some risk limitations built into the concept. My former student Mark Croock bases his entire trading strategy in options trading, and he’s one of my most profitable students ever.
If you’re interested in getting into options trading, make sure it fits your general trading strategy and can help you reach your goals. As with penny stock trading, never copy another trader — learn from them so you can develop your own strategy.
Trading Options on the Stock Market FAQs
This article is just the tip of the iceberg. Here’s a bit more…
Is options trading better than stock trading?
I don’t think options trading is better than stock trading. I believe in keeping trading simple, and options trading can get really complicated… Ultimately, you need to look at how either style fits your trading strategy and will help you reach your goals.
Is stock options trading worth it?
Stock options trading can be worth it — just ask Mark Croock. Any trading strategy can help you reach your goals. Just make sure you’re tracking your trades and keeping your risk tight.
What type of option is the most profitable?
Any kind of options strategy can be profitable as long as you understand it and have put in the study time. If you don’t know where to start, learn from experienced options traders like Mark as you develop your own trading strategy.
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