Call option trading rules

Investors using the covered call option trading method own the underlying stock and sell one call option for every 100 shares held. In either scenario, covered calls are not the best method to take advantage of that kind of volatility. Stocks are extra volatile just before and after an earnings release date. Better to stick with highly liquid stocks, or at least avoid the illiquid ones. Leveraged ETFs, which use two or three times leverage to magnify the results of an unleveraged ETF, are mostly day trading instruments not designed to be held over night. This article is by Mike Scanlin, CEO of Born To Sell, www. Large volume in the underlying stock makes for small spreads. Or a short squeeze? If you ever need to exit early you are unlikely to get a fair price in a series with low open interest. The method has proven to be a smart way to profit income on your stock positions.

Note: these tips are mostly aimed at people who buy stock for the purpose of writing call options. ITM options with the expectation that they will be called away, realize that they may not be called away. Why are those options priced so high? You may end up owning the stock after expiration. These large spreads will hurt you if you need to exit your position early or make an adjustment to your position. Or is the stock a momentum play?

Is there some pending news announcement? The series should have at least 2000 open interest, but as little as 1000 may be okay. When there is an FDA announcement these stocks tend to get cut in half or double overnight. The option premium garnered can be a nice addition to any gains realized in the stock. Not appropriate for covered calls. You can always look to the future if you have enough capital. For our purposes though, you just need to understand the concept. By and large, the more time you give a stock to move, the further it can travel up or down a chart.

Just like stocks, options can be overvalued or fairly valued. Minimize your time decay right off the bat. Invest in options that move well with the underlying stock. This story originally ran in BigTrends. All options have risk, but the risk has to make sense compared to the reward. The more I do this, the more attracted I become to simple ideas and strategies.

To read more option analysis and trading ideas visit Trading Strategies. Getting a handle on delta, theta, and time can help you do just that. That would be a relatively low delta. Here are four cornerstones of sound options trading that I believe new, intermediate, and even veteran investors can use to better profit in the market. Any investments recommended by Investment U should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company. To name just a few. Of course, test results are just one possible driver of gains. Needless to say, grouper sandwiches were on him that night.

That is, sell half of your contracts and let the other half ride. This takes that idea one step further. For many, their contracts expired worthless, causing them to lose their entire investment. And if not, they certainly should. You still have several months before your calls expire, so you have a choice to make. You could take advantage of the situation by selling calls. Investment U Bookstore and check out our Essential Options Manual.

Just one word of warning. OPEC, the Fed, the FDA, etc. Options befuddle many investors. Properly diversified and allocated, your stock portfolio should serve as the solid foundation upon which you build your wealth. You may find yourself investing much more aggressively while paper trading than you would with actual money. No communication by our employees to you should be deemed as personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. We expressly forbid our writers from having a financial interest in their own securities recommendations to readers. This is something that comes up often in the biotech space.

Find a strong catalyst. Leave a comment below. Instead, consider splitting your position. Have thoughts on this article? The information you uncover could be instrumental in determining an ideal expiration date or strike price. Investment U Disclaimer: Nothing published by Investment U should be considered personalized investment advice.

There are other factors to consider as well. One example is buying calls ahead of a big news release. But those who understand them love them. Fortunately, there are ways to greatly improve your odds of success. All it takes is a little due diligence. As we covered in Rule No. The real secret is in being proficient with the underlying asset. There are options on all sorts of securities and assets, so make sure you specialize. To practice option strategies before you risk real money, consider doing some simulated trading.

Consider different options on different securities; have some bullish strategies and some bearish strategies as well. Stagger your option purchases if possible. Just make sure you know the difference between bull and bear markets, or you may end up buying lots of call options that expire worthless. Get closer to the money, and you increase your chances of success. When choosing which call option to buy, get the longest time frame that you can afford. Be a contrarian where possible. This approach increases your chances of having winning positions in your portfolio.

After you master a particular asset class, become proficient in a few basic option strategies. The longer the time frame, the greater your chances of success. Use this golden rule to augment the preceding rule. For some folks, just mastering covered calls makes a huge difference in their overall success. The most successful practitioners focus on a particular asset class and know it inside and out. Use technical analysis where applicable. You can buy puts or calls with the cash in your account, and no extra money is required in case of an exercise, primarily because you decide whether to exercise. It can be more difficult to get a grasp on the function of puts, because most new traders think about investments going up in value.

The higher levels allow traders to use advanced and riskier option trading strategies. Your broker will charge a commission when you buy, sell or exercise an option contract. Prices and expiration dates function exactly the same as with call options. One option contract covers 100 shares of the underlying stock, and the putting cost of the option is 100 times the quoted price. In this case it is important to have either the cash or shares already in your account. With calls you would buy the shares, and with puts you must have the shares to deliver if you choose to exercise. However, the value of your options will track the changes in the share price, so in most cases you will just sell your options to realize any gains. To buy options you need level 2 authorization, which brokers will give to almost any account. All options have an expiration date, which is the close of business on the third Friday of the listed expiration month.

With a put, the put value goes up only if the underlying stock price goes down. The value of a call comes from the relationship between the strike price and the stock price. Options that are out of the money at expiration expire without value, and the money you paid for them will be a 100 percent loss of money. The first step toward buying stock options is to apply for options trading authorization for your brokerage account. The broker will require you to complete forms that provide information about your investment and trading experience. As the buyer of call or put contracts, you decide whether to exercise the contracts.

Meaning divide the price of the stock by the actual option price. These events or catalysts can be anything from: Earnings Announcements, Fed Meetings, Economic Releases, an Activist Hedge Fund buying a stock to any type of corporate change, CEO, sale of a business unit, merger or acquisition. Meaning do not buy an option unless it meets each and every one of the 5 rules. To make it not difficult for yourself print out these rules and then before you trade an option make sure that you can check off each rule before you buy the option. Simply stated only buy an option when you have at least a 2 to 1 reward to risk scenario. This means you only buy an option when there is an event that will dramatically move the price of the stock up or down.

This is very important, too many people buy options with no exit plan or profit target. The Option must be Cheap. Now I will give you a real life example of an options trade I just made, where I only followed 2 of the 5 steps and it cost me dearly on my trade. So my lesson to you is not only are these 5 Rules for Trading Options important, but even more important is that you make sure before you buy an option that you have followed each and every one of the 5 rules I stated above. This Catalyst or Event must occur before the option expires. An not difficult example of this is Earnings, you only want to buy an option that expires more than a week after the earnings date. Also if you have options software, you can compare the stock and its options implied volatility and underlying volatility to its historical implied and underlying volatility.

This may sound confusing but its the same premise value investors use, they buy stocks when they are cheap in comparison to what they historically sold for, so you want to buy options when the volatility is low or lower than what it historically has sold for. He had a 5 Step system for trading options that I use for my all my options trading today. So in summary only buy an option when there is catalyst or event that will dramatically alter the price of the stock. If you do this I promise that not only will you greatly improve the success of your options trading but you will make a lot of money in the process as well. But if its a high priced stock, I will only buy the option it gives me at least 25 times leverage or more on the stock. This means you want to buy options on stocks that have moved sideways of flat for months at a time. Only buy options in stocks that have low volatility. Job Numbers that were released 2 weeks ago would be strong and therefore would cause Silver to sell off. You have to set a goal or sell point when you buy an option and to make it worthwhile from a risk reward standpoint.

But there is one Billionaire I met during my hedge fund days that I will never forget, because he was one of the best options traders I have ever seen. So I learned first hand how much it can cost you by not following each and every one of the 5 rules above. Again this means when you buy an option make sure you leave yourself enough time so that your option does not expire before the catalyst or event occurs. Trading Rules for Options, I missed out a huge trade. The key is to buy the option before this event occurs, you never ever want to buy an option after the catalyst or event. Look at a chart if there has not been a significant uptrend or downtrend in the last 3 to 4 months, there is a good chance that the volatility in the stock is low and the options are cheap. These guidelines are not the path to not difficult riches, or some such hype, but following these guidelines will generally keep you out of trouble, increase your efficiency of capital, and hopefully improve your chances of making money with options. In our feature articles, many useful general strategies have been given, but not assembled all in one place. This is the first and last rule and, ultimately, the most important one.

One way to counter this is to concentrate the option selling in index options. Similarly, buying a put and selling a call with the same terms is equivalent to being short the underlying instrument. This is related to the previous rule. Naked put selling is equivalent to covered call writing, but is generally a better method. The prices of the options provide a price discovery mechanism, in that one can see where the futures would be trading were they not locked at the limit. They are not presented in any particular order. The equivalent option method may be better than owning the underlying stock itself. No one method is right for all traders due to their individual risk and reward characteristics, and accompanying psychological demands. There cannot be a takeover attempt on an index nor can an individual earnings report, for example, cause the index to move a great distance as it can for a stock.

For these reasons, naked put selling is the better method of the two. Thus, the profit potential is very similar to that of the underlying instrument. However, the naked put sale involves less of an investment in terms of collateral required, has a lower commission cost, and allows one to earn interest on his collateral while the position is in place. The next two rules deal with these equivalences. Naked combo selling in indices is usually less trouble than selling combos in individual futures or equity options. The Option Strategist Newsletter, yet the guidelines still hold true today.

The purchase of the call will only cost a fraction of the amount needed to purchase the put and the underlying stock, for example. The equivalent option method is mandatory knowledge for futures traders, for it allows one to extricate himself from a position that is locked limit against him. Unfortunately, large or sudden moves by the underlying instrument can create some nasty surprises for the option writer. Finally, the risk is limited by the fact that one cannot lose more than the price he paid for the option, while one has much larger risk when owning or shorting the underlying instrument. The same principles of option evaluation needed to construct a statistically attractive method apply equally well to all three markets. Selling both puts and calls is an attractive method to many option traders, since the benefits of the wasting asset are on your side. Always use a model. Over a short time period, an overpriced option may significantly underperform the movement by the underlying instrument.

The biggest mistake that option traders make is failing to check the fair value of the option before it is bought or sold. Know what strategies are equivalent and use the optimum one at all times. When futures are locked limit, the options will generally still be trading. Equivalent strategies have the same profit potential. For example, owning a call is equivalent to owning both a put and the underlying instrument. The broader the index, the less likely it is to experience a gap opening.