This is a personal take on option trading.
After years of trading FOREX and stocks I decided to at least explore option trading. As usual, I fell into the trap of always looking for new and shiny things. This personal trait has, to be honest, restricted making the most out of trading. “There has got to be a better way” has always plagued me. Anyway…
What is option trading?
- An option is a contract giving the buyer the right—but not the obligation—to buy (in the case of a call) or sell (in the case of a put) the underlying asset at a specific price on or before a certain date.
- People use options for income, to speculate, and to hedge risk.
- Options are known as derivatives because they derive their value from an underlying asset.
- A stock option contract typically represents 100 shares of the underlying stock, but options may be written on any sort of underlying asset from bonds to currencies to commodities.
- Read more: https://www.investopedia.com/options-basics-tutorial-4583012
The practical, simple view:
For example, after some analysis you think AAPL will go from $156 to at least $160 within a month. You buy 10 shares of AAPL at the cost of $1,560. AAPL does rise and you sell at $160. You have made $40 which is 0.26% of your investment (risk) of $1,500. Suppose the stock tanks and you decide enough is enough at $150 and sell at a loss of $60. OR WORSE. You could see the stock tank and lose a lot more. Just look at the 20% drop in FB recently. You would have been down $31 per share. You do the math.
Buying and selling stocks is fine, it is considered “investing”. Buy to hold. And most years you can see a 6-8% gain or better. To buy 100 shares outright you need to tie up $15,600 of capital. An option contract represents 100 shares.
You buy a CALL option contract at a strike price of $180 a month in the future. For say a premium of $450. (Just an example, prices swing wildly). The upside is endless and the most you can lose is $450. Trading options is considered risky for several reasons. One, there is a time limit. If you buy a contract March 1 for expiry April 1, and the stock doesn’t go up at all it will expire worthless. If it goes up some, more than the premium the contract has value and can be sold.
Options are a very leveraged instrument. Imagine, you control $15,600 worth of AAPL for a risk of $450. Leaving $15,150 for other contracts.
My experience in a nutshell
I started buying call options on my RBC RRSP account. At a commission rate of $20 round trip. It worked ok. But the commission cost ate up most of the profits. Then I discovered a education website called “Trade with me now” and signed up for the course. I spent a lot of time and learned what I needed to learn. During that time I changed to Interactive Brokers which is a pro trading platform with commissions $1-6. Better. After making some spectacular, costly and frequent mistakes, I finally started to “get it”. These are the take-away points:
- Frequent trading of options is considered Day Trading in Canada. You will tax on 100% of profits, but you can deduct expenses and losses. Check with your accountant.
- You need at least $5,000 to do this comfortable.
- Most brokers will need proof or experience or knowledge of options.
- > KEY: The main strategy is to buy contracts and sell them at a 40-50% profit or loss. NOT to let them expire. The win/loss ratio is currently over 66% which is profitable.
- Only buy contracts up to say 60% of capital.
- After some experimenting I now subscribe to Mad Options which I find incredible valuable. They provide all day analysis and share what they trade. So far I am profitable taking their trade advice with my own decisions sometimes to close the trade.
- Done right and conservatively you could expect a return of an average 2-3% month. When the market cooperates, more.
I have to admit, this was quite a learning curve. But so interesting!
Bottom line is this: you have to be fascinated about trading in general and especially options to do this. If you are not, and just look to make money you will have issues. You need to constantly learn.
To learn more, see the Investopedia link above.
P.S. There are a LOT of hype and scams on options. Be careful. Only learn from reputable sources.