What the heck is an option and why do we want to sell these things?
I like to think of an option as a coupon. Let’s say you are thinking of buying a watermelon in the not too distant future. And you think that the price of watermelons is going to increase. So you want to lock in today’s price.
In this case, I agree to sell you a coupon (option) to buy a watermelon from me for $1.00 which is today’s price. But I will charge you 10 cents for this coupon and it expires in 90 days.
Let’s say 89 days go by. Your coupon expires tomorrow. If the price of watermelons is more than $1.00 and you still want your watermelon you should use the coupon. If the price of watermelons is below $1, you should forget the coupon and just buy a watermelon at the market price. This will allow the coupon to expire worthless and I would make a nice profit of 10 cents.
But what if you didn’t want the watermelon but the price went up to $2. You could either buy the watermelon yourself using the coupon and sell it to someone else for $2, making you a nice 90 cents profit. (Remember you paid 10 cents for the coupon.) Or you can sell the coupon to someone else, for $1, also making you 90 cents. Either way you win, and I lose.
It’s the same with stocks. Thousands of stocks, indexes, and ETFs have options available to trade. Options are gaining in popularity because of the immense leverage. In our example, all you have to invest was 10 cents to control $1 worth of watermelon.
Let’s look at our example above again. You buy an option for 10 cents, and you later can sell that option for $1 making you 90 cents. That’s a 900% return on your money. If instead you had bought a watermelon at $1 and sold it later at $2, you would have made $1, or 100% return. 100% is great, but not compared to 900%.
What about me, the option seller?
In this scenario I would have to sell you a watermelon at $1. If I had one, you could have it. But if I did not have one, I would have to buy one in the market at $2 and sell it to you for $1.
Let’s look at the other side. What if prices went down? Imagine prices went down to 50 cents. Your option that you bought for 10 cents would be worthless and you would have a loss of 10 cents. But what if instead, you had bought the watermelon at $1? You would have a 50 cent loss!
As the option seller, I keep the entire 10 cents you paid me.
As you can see, options are cheaper to invest in, they limit your loss, and they also provide leverage for higher percentage of profits.
Sounds like the perfect investment right? Let’s go out and buy a bunch of these suckers.
In our example prices went way up to $2 and way down to 50 cents. But what if prices didn’t move much at all? What if the price stayed at $1? Then your option would expire and you would lose your 10 cents.
That would be the perfect scenario for the option seller. And guess what? This is what happens most of the time. In the news, you hear about the wild fluctuations of the markets. You hear about the stock that went from $10 to $100 or the ones that went the other way from $100 to $0. But these are the few exceptions amongst the thousands of stocks that trade everyday. The majority of stocks move very little at all. Sure they move up, but then they also move down. Overall the move is measured in small percentages. If a stock moves 10% in a year it’s a big deal.
Options need big moves to make money. That’s why according to industry sources, 80% of all options expire worthless!
In the following lessons, we will cover
Lesson 2 – How options are a decaying asset. As an option gets closer to expiration, it losses value. So by selling options, everyday that goes by, works in your favor. I call it Selling Time.
Lesson 3 – Trades that work if the stock goes up, down or sideways. If we sell a call option (I’ll explain what a call option is in this lesson), we make money if the stock goes down or sideways, but we can also position our trade to make money if the stock goes up only a little. Making money three ways is much better than buying a stock and praying it goes up.
Lesson 4– Your Own Casino. Casinos have the odds stacked in their favor. Some people get lucky and win more than they lose, but casinos know that over the long term they will make money. That’s their edge. Our edge is the same. As option sellers we can stack the odds in our favor. How does 80% probability of success sound to you? I’ll show you how.
Lesson 5 – Not being glued to the screen all day. This is not daytrading. I don’t have to watch my monitor all day. You can put on my trades and spend about 15 minutes monitoring them a day.
Lesson 6 – No guesswork. You don’t need to guess which way a stock will move, or use fancy technical or fundamental analysis. Don’t need to know how to read the MACD or Stochastic or other indicators. I use simple statistics to figure my probabilities and can manage my positions using concrete math, not voodoo or guesswork.
Lesson 7 – Limiting your risk. In this lesson I will show you how to limit the risk on every option trade you do. I hate losing money. So every trade I put on has limited risk. I know what my maximum loss can be on every trade, and if the trade goes against me, I make adjustments to my position to protect myself. Even with an 80% probability of success, you will still have 2 out of 10 trades go against you. I do not believe in putting on a trade and not protecting it.
Lesson 8– Sure, steady, reliable results. In this lesson I will give you examples of trades that make 10% in a month. It’s possible and there are people, like me, doing it each and every month. You can either leave your gains in the account and let it grow or withdraw it to live on.
Lesson 9 – We couldn’t do this a couple years ago. Up until recently only market makers and very large traders could do these trades. The reason: commissions. As soon as three to four years ago you would have to pay $30-$40 to buy or sell a single option. Now you can to the same trade for less than $1. Online trading and lower commissions have allowed regular people like you and me the same opportunities as money managers.