Basic Primer on Options Trading
With this tutorial we need to assume you have a fundamental understanding of the two basic types of option contracts, put options and call options. If you are not comfortable with your understanding of either of these investments click the links above for a quick refresher on each. As you should be already aware, call options represent a right to buy an underlying security, and put options represent the right to sell a security.Using Buying Leverage to Make Big Money on Options
Ok so if you've done your homework your know how call options and put options function in the market. Now it's time to leverage that knowledge into an understanding of how to turn modest amounts of capital invested into big money returns.The simplest way to think of how to use and manage the leverage when going long options contracts is to compare the call or put premium of the contract with the actual price of the underlying security. While this isn't perfect in mathematical terms, it is good enough for the fast thinking needed to make trades in the market.
A Quick and Dirty Leverage Example
If a call option is priced at a dollar, and the underlying stock is at $100, purchasing a call option near the money will give you approximately 100:1 leverage on your investment. If you invest $100 (1 contract) and the call premium jumps to $2 (from $1 initially - representing approximately a $1 move in the stock from $101 to $102 for example) - your investment is now worth $200 - a 100% gain! Think this can't work for you? It happens ALL*DAY*LONG for online traders. A 100% gain isn't typical of every investment, double digit short term returns are not unusual - particularly in today's highly volatile markets.Bear in mind that multiple variables impact options pricing, and jumps in the underlying stock price DO NOT translate 1 for 1 in jumps in contract premiums (though they do approximate it). Also bear in mind that the higher the leverage, the further you typically are from having an "in the money" position. "Out of the money" contracts behave quite differently from in the money (instantly convertable into cash) contracts, and while price jumps on out of the money contracts are how to make big money on options - they are also more likely to expire worthless - a loss of your entire investment.
For that reason I tend to stick to in the money positions with modest leverage. That doesn't mean you have to.
Using Covered Contract Writing to Make Money on Options
A second way to make money on options is to use them similar to the way some people use jewelry or musical instruments at pawn shops. You're probably thinking to yourself, "Seriously? You must be joking."No really - in the investment world one of the most profitable ways to cash in on assets you already own is to write call options (giving someone the right to buy your stocks) at strike prices just out of the money. Given that it typically is prohibitively expensive to actually execute options, 99% of contracts don't get executed. Traders either buy them back near expiration at a deep discount (due to premium decay), or they simply expire worthless.
Incidentally, this is also a great way to buy stocks you want in the market at a steep discount from today's prices. "How?" you ask? Simple: write a naked out of the money put option on a stock. You pocket the cash (the put premium) and heaven forbid the stock is ever put (executed) to you then you just bought the stock at a steep discount to the market at the time you entered the contract. Did I mention you also pocketed the cash of the put premium? Juuuust sayin'.
Word to the wise tho': Make sure you keep enough cash in your account to cover the cost of the stocks (strike price times number of contracts times 100 plus commission and fees) in case they ARE put to you. Don't want any margin calls do we?
These strategies for how to make money on options are great if you have plenty of capital to throw around (minimum $10K, preferably $25K and up), but what if you're a recent college finance grad and are flat broke? Fear not, I have just the solution for you: Binary options.
Using Binary Options to Make Money on Micro Investments
I cover binary options trading extensively elsewhere (see link above), but suffice to say if you have $100 in an electronic bank account somewhere or access to a credit card, you can be trading in a couple of days to learn how to make money on options with less than a thousand dollars. Don't know a thing about binary options? Take a free no obligation course on binary options trading.I'm sure you're asking youself how to make money on options movements if I'm not sure which direction the market is moving. Fear not, we have some ideas on that as well.
Consider reading:
Trading the VIX - Understanding the relationship between the fear index and stock prices
Forex Trading Signals - How forex market movements dictate price movements in equities markets
