Over the last few weeks, we’ve discussed most of the major ins-and-outs of options trading, the benefits, the leverage, as well as how to choose an options broker.
We’ve also dispelled quite a few myths along the way, too.
Now, we want to touch base on placing your first options trade, and the top four things to understand as you roll through the process.
No.1 – Know the difference between a put option and a call option
If you believe a stock will move higher, you want to buy a call option.
For example, if I believed that shares of Netflix (NFLX) could run from $202 to $210 a share, I could buy a call option, which would move higher as the stock ran higher.
Or, if you believe that a stock will move lower, you would want to buy a put option.
For example, if I believed that Apple (AAPL) could fall from $159 a share to $152, I could buy a put option, which would move higher as the stock moved lower.
No. 2 – Know your Strikes
Beginners are often confused by the word “strike.”
Essentially a “strike” is your target. For example, when choosing a call option, I believe that by November 2017 expiration, shares of Disney (DIS) could run from $100 to $105 a share, for example. The November expiration is my strike month.
The “strike price” is my target price. For example, if I chose to buy the DIS November 17, 2017 100 call option, my strike price is 100. That means that I believe DIS will move to or above that price by my expiration date of November 17, 2017.
No. 3 – Know that one contract carries 100 shares
Let’s say that I believe shares of Disney (DIS) could from $100 a share to $105. Let’s also say I wanted to buy the DIS November 2017 100 call. It last traded at $1.80. To find my price for that particular option (excluding commissions), I would multiply $1.80 x 100 to find my price of $180 per single contract.
That’s because there are 100 shares in each contract.
What’s interesting is I never have to take ownership of those shares. All I’m doing is trading the value of the contract. That’s it. Plus, I can still control 100 shares of DIS for a price tag of just $180 instead of paying $9,800 to buy and hold 100 actual shares of DIS.
No. 4 – Know Buy to Open / Sell to Close
This is one of the biggest hang-ups for new options traders.
When starting out, we’re not concerned about Selling to Open, or Buy to Close. All we want to focus on right now is Buy to Open and Sell to Close.
When you buy to open, you are initiating action to buy an option.
When you’re then ready to close that same trade, you would sell to close the trade.
At first, options trading can seem difficult to master. But give it time. It could add much more to your bottom line over time. Plus, remember the benefits. Earlier, we spoke about DIS possibly running from $100 to $105.
That’s a massive 5% gain.
However, if I bought the DIS November 2017 100 call at a price of $1.80, or $180 a contract, and DIS ran higher by $5, I could make a potential return of nearly 100%.
Which sounds better? 5% or 100%...? That’s why we use options.