Contracts and Strike price:
 Options are basically contracts that allow a person to buy a stock
at a certain price (Strike price. Make sure to check out our FAQs
page for more key terms). You pay money up front for the option because
you think the stock is going to either go up or down. When the stock
goes up, a CALL option will go up. When the stock goes down, the CALL
option goes down. Simple right? When you buy calls, you will buy in
lots of 100 (One contract=100 options). That means that if you see
the price of the option at $1, it will cost you $100 for one contract.
The next piece of information you must know is the STRIKE PRICE. If
you ever decided to buy the stock (Exercise the option), the strike
price will be the price you buy the stock at. To give an example,
if you buy one call contract of INTC, and the strike price is $80,
you could buy 100 shares of INTC for $80, even if INTC was at $100!
Expiration:
The main problem that occurs with options is the fact that they expire.
If you buy an option with an expiration date of October, the option
will expire on the third Friday of October. If you bought that option
back in August, the option will become less and less valuable as you
approach the expiration date. It's just like buying milk at the grocery
store-- as the date gets closer and closer to expiration, not too
many people want to buy it, and if they do, they want to get a better
price.
Pricing:
The price of an option is based on five different pieces of data.
The price of the stock. A call will be more expensive to buy as
the stock rises. One of the less know reasons for price fluctuation in an option
is volatility. If the stock has wild price swings, the option will
be more expensive to buy. For example, if a stock's price moved 10%
every day between its high and low, you can bet that the volatility
is extremely high, thus raising the price of the option. The strike price of an option will also be included in an option's
price. If a call's strike price is increased, the price of the option
will decrease. Expiration is a key factor because people will pay less for something
that will expire soon. Who would want to buy the right to buy an option
with a strike price of $50 when there is only 5 days before expiration,
and the stock is at $40? The odds of the stock going up past $50 by
the expiration date could be very bad. However, if the option was
purchased with several months before expiration, you can bet that
people will pay more. Therefore, the price of the option will be more
expensive. Finally, one aspect that none of the standard equations can equate
for is supply and demand. Just like a stock, an option can be effected
by how many people are buying or selling at any one time. Sometimes
a bunch of people will buy options at the same time. This tends to
raise the price even if the stock is going nowhere. The opposite is
also true-- if a bunch of people are selling at the same time, the
price of the option will down down even if there was no movement in
the stock. This is why everyone who trades options should look at
not only a real-time graph of the stock, but also of the option itself.
There's nothing worse than paying too much for an option because you
happen to be buying at the wrong time. However, it takes a great deal
of buying or selling to move an option's price in this manner.
Making money:
Our approach to option trading is not to exercise them-- it is to
trade them. Our goal is to buy an option in a stock we think is going
to have explosive movement up or down, then sell them. We are in and
out of an option within a couple days. That way, expiration is not
a big factor. Trading options is more complicated than trading stocks,
but the rewards are well worth it.
Common mistakes:
One of the most common mistakes for losing money on options is holding
on to them for too long. Never hold on to an option in the hopes that
it will go back up. When we give our picks, we will reassess the situation
any time the stock goes the wrong way. Losing 40% is better than losing
100%. We have seen this happen time and time again on stock such as
DELL. People will buy calls with the assumption that any pullback
will be short lived and the stock will go right back up. Even performers
like DELL can have sideways and downtrends, so just buying options
based solely on fundamentals is a sure way to lose.
Another mistake we have seen in option trading is the idea that
every option should go up 100%. While many of our picks have done
this, the majority have been sold after rising 30-50%. We are more
conservative because we are confident that we will get more winners
than losers.
Index options:
We trade many options based on the S&P 100 index. This index is
made up of 100 different stocks so it can show the overall trend of
the market. The volume of options on the OEX is the highest out there,
so the price between the bid and ask is usually around 1/8 of a point.
Trading the OEX is probably our biggest money maker out of ALL the
options we trade.
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