In 2012 as a recent example I was able to trade the price action in Apple stock from an all time breakout over $390 to $700 and return over 51% on my total trading capital in one quarter. The strange thing was that in 2012 when I was heavily trading the price of the stock I never owned a single share of Apple stock. How in the world did I catch the majority of the Apple move from $390 to $605 while never owning a single share of stock? I also controlled hundreds of shares of stock for minimal capital and caught the majority of the move dollar for dollar while managing risk by limiting my trading capital to risk. Now this is a special circumstance that was presented to me in 2012. I did buy and trade Apple stock in other years with it was priced in the $100s like in 2007 and 2015. However when I traded the stock both before and after it split it was in the $100s so a round lot was only about $10,000. When the share price got to $400 a round lot was $40,000 and at $700 a round lot was $70,000. I prefer to always trade in increments of 100 shares, it is just how my brain works. Option contracts come in round lots of 100 shares per contract. One option contract gives you control of 100 shares of stock in almost every case. (The only exception was the introduction of mini-contracts that controlled 10 shares and if a stock splits or reverse splits the open option contract share count is adjusted to reflect the split.)
With Apple stock becoming so high and price without a split I starting using in-the-money stock options in place of stock. It was much better for my risk to return ratio to buy an Apple option contract for $1,000 – $1,500 than to put down $40,000 for a hundred shares. Apple met all my criteria for a monster stock and I wanted to trade it aggressively while managing risk closely. With the lower amount of capital needed I could easily trade 1 contract, 5 contracts, and even 10 contracts with minimal outlay of capital. I could still capture a big part of the move a stock’s price because I controlled the rights to buy Apple stock at a predetermined price by a set date. The value of my options changed as the probability of my options expiring in the money changed with each price move. My call options would go up as the odds of them expiring in-the-money also went up and they would drop as the price of them expiring in-the-money went down.
How was I able to make such a large return on my capital in such a short amount of time? The leverage provided to me with front month in-the-money call options and weekly call options. While this is a specific stock and time period options provide the ability to maximize your leverage during trends.
Stock options truly give you more options in your trading. While stock trading is like checkers, options more resemble three dimensional chess. Option trades can be structured to bet on trends, a lack of volatility, time limits for moves, magnitude of a move, and the trend of volatility itself.
With options you can:
- Control large blocks of stocks with call options that are going up with a small amount of capital.
- You can short stocks with put options so you do not have to find shares to borrow or use margin for selling short.
- You can sell options short to other traders getting paid for allowing option traders to place very low probability bets on a price move in a short amount of time.
- You can buy a hedge using put options to protect your long term stock holdings from a downtrend instead of selling your stock holdings.
- Manage your risk with predefined maximum capital at risk limited to the price of the option contract.
- Both buy or sell time value.
- Both buy and sell volatility.
- Bet on a stronger trend than the market is pricing in, but bet on both directions at the same time. (straddles and strangles)
- Create synthetic stock positions using options with little capital out lay. (Selling a put and buying a call option or the reverse)
- You can both sell an option and hedge it with a cheaper option so your short option does not have unlimited risk.
Here are the underlying risks you have to manage while trading stock options:
- Lack of liquidity. Watch Bid/Ask spreads carefully do not trade options that are 10% apart, you will lose 20% of your capital at risk both entering and exiting the trade. Only trade high volume options with tight spreads, examples Google, SPY, Apple, QQQ, and IWM
- Expiration. If you bet on a strike price that the stock does not make it to you could lose your entire bet and end up at zero.
- Options are a bet- not an asset. They are only worth the intrinsic value of the underlying at the time of expiration nothing else.
- Options are more difficult trading vehicles to let winners run. Your time to be profitable with options is limited, you have to take profits at the right time.
- You can trade a longer term trend with options by rolling them to a farther out strike.
This book is focused on teaching readers the right way to use options as tools for profits in the stock market.