Options trading is a great way to supplement your income or create a flexible source of income.
While some people equate options trading with playing the stock market, there are options trading strategies to help minimize risk and maximize profits.
David Jaffee of BestStockStrategy.com has taught options trading basics, and advanced options trading strategies, to more than 1,500 students.
By understanding the foundational terminology and strategies involved in options trading, beginners can hone their skills and make informed trades to earn a profit.
Keep reading for more valuable information about options trading basics, including how to learn the best options trading strategies.
Options Trading for Beginners
Starting any new venture can be daunting, and trading options is no different.
When it comes to options trading for beginners there is a lot of information available online, which can quickly become overwhelming.
David Jaffee teaches his beginner options trading students and advanced options traders to block out the excess noise and focus on making effective trades to win up to 98% of their trades.
In order to make successful trades, you must first understand what options are and how they are traded.
What is an option?
An option is known as a derivative because the price of the option is derived from the price of an underlying asset.
Underlying assets for options can include stocks, commodities, indices (such as SPY, QQQ and SPX), and currencies.
Options are traded as contracts, which involve a buyer and a seller.
When trading stock options, each option contract represents 100 shares of a stock.
Options contracts include an underlying asset (a specific stock or index), a strike price, an expiration date and a market price.
Put Options Defined
Put options enable the option buyer to sell 100 shares of the underlying stock at the strike price on or before the expiration date.
The option buyer pays an option premium, which is collected by the option seller.
Investors often use put options as part of their strategy as insurance for their portfolio to minimize losses and reduce portfolio volatility.
If an investor thinks that the market value of one of their stocks will decrease in the future, they can purchase a put option, which allows them to sell their shares for a higher price than the market value (assuming the stock ends up falling).
Sellers of options will also sell puts if they believe a stock is not likely to fall below the strike price, or if they want to own the underlying stock at the strike price.
Option sellers collect premium and if the underlying stock is not trading below the strike price once the option expires, then the option seller’s profit is equal to the entire premium collected when selling the option.
Call Options Defined
Call options enable the option buyer to purchase 100 shares of the underlying stock at the strike price on or before the expiration date.
As with put options, the buyer pays an option premium to the option seller.
Call options are often used by investors for speculative purposes.
If an investor believes the market value of a stock will increase in the near future, they may purchase a call option, which enables them to control more of the stock, with greater leverage and capital efficiency, than by buying the stock outright (buying call options also has lower black swan tail risk since the maximum loss for the call option buyer is the premium paid for the option).
Sellers of options can sell calls if they believe a stock is not likely to rise above the strike price, or if they wouldn’t mind shorting the underlying stock at the strike price.
What is an option writer?
Option sellers are sometimes referred to as writers.
When an investor purchases a call or put option, they must pay an option premium for the right to enter into the contract and own the option contract.
An option writer collects this premium, and they keep the premium regardless of whether the option contract is exercised.
David Jaffee recommends selling option premium as the best way to make money trading options, although buying options, at specific times is also very important to reduce portfolio volatility.
Options Trading Example
If Amazon is trading at $120, an option writer can sell a $100 strike put option.
The put option stipulates that the seller will purchase 100 shares of Amazon at $100 if the option is exercised.
The option buyer pays a premium of $2 per share, or $200 total, to purchase the option.
The seller collects and keeps the $200 option premium.
If the buyer exercises the option at or before the expiration date, the option seller is able to purchase Amazon stock at a significantly lower price.
If the buyer does not exercise the option, the seller still keeps the $200 premium.
What is the best options trading strategy?
Buying options often gets the attention of beginner options traders because there is a higher potential payoff.
However, buying options comes with a lower probability of profit than selling options.
As one of the best options trading coaches, David Jaffee recommends selling options, and many students have found success with this options trading strategy.
Although it's best to also buy options during periods of market extremes, this helps smooth portfolio volatility.
By selling options, traders can better manage their risk and win up to 98% of their trades.
The best options trading strategy also involves learning how to become disciplined when trading and limiting your risk on the few trades you might lose.
David Jaffee considers selling options to be the best options trading strategy because traders can be more consistently profitable when compared to buying options.
How do you learn options trading strategies?
It is easy to learn how to sell options and refine your strategy over time.
David Jaffee offers an online options trading course through BestStockStrategy.com, which provides everything traders need to know to successfully sell options.
Start learning how to trade options today by visiting BestStockStrategy.com, and receive $400 worth of free training materials.
Frequently Asked Questions (FAQs)
What are some options trading basics key takeaways?
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.
Is it better to buy or sell options?
It's important to do both because, at certain times in the market cycle, options can be both underpriced and overpriced.
During periods of euphoria, it's important to buy puts to hedge against market pullbacks and also, because options are cheap, then there's an asymmetric opportunity to profit.
During normal periods, it's usually best to sell options.
Should I day trade options?
No, it's best to not day trade options.