Options Trading On Wall Street

To continue the post on How To Trade Options, let’s first recap what has been discussed in Part 1. There are two types of options that you can trade: Call Option and Put Option. A call option, when bought, gives the holder the right but not the obligation to buy the underlying stock at an agreed price (strike price) on or before the expiry date. A put option, on the other hand, gives the holder the right but not the obligation to sell the underlying stock at an agreed price (strike price) on or before the expiry date. The seller of each one of them naturally has the opposite option (i.e., Call Option seller will be able to sell the stocks, and Put option sellers will be able to buy the stock).

Options Trading Strategies

Having explained what call and put options do, let’s explore further on how to trade options by explaining what we can then do to these fantastic financial instruments. Here are some point you might want to remember when trading options:

• Buying Options (Call or Put) – The buyer has to pay a premium for holding on to the option. The price of a premium is dictated by the market, and is based on a formula, which will be discussed at a later post. For now, let’s just take that there is a formula that the market calculates to come up with the premium price.
• Selling Options (Call or Put) – The seller of the option receives a premium for exposing himself to the potential risk of either losing his stocks or having to buy the stocks at the strike price on or before the expiry date.

There are a number of ways on how to trade options. You can trade options:

• singularly on their own without owning the underlying stocks, or
• a combination of options without owning the underlying stocks
• you can trade it with owning the underlying stocks themselves.

“Naked” Options

Trading options singularly without owning the underlying stocks are called “naked options”. This strategy means that you only buy a put option or sell a call option on its own without owning the stock. It is called “naked” because you are exposed to the possibility of getting exercised on the option without any backing of the actual stocks to sell. This is a very risky strategy when looking at how to trade options, and one that should be taken with extreme caution. While this can be one of the most profitable ways to trade options, this strategy is not advisable for beginners. You need to be able to monitor this type of strategy closely, and to learn your options pricing model very well to be successful at this.

Credit Spreads

Trading options in combination without owning the underlying stocks are called “credit spreads”. Generally, this strategy uses either a combination of a buy and sell of a call option, OR a buy and sell of a put option. Essentially, the idea is that the premium you receive from selling the option will be much greater than the premium you have to pay for the buy option, and thus giving you what is called a credit or the difference between the 2 premiums. This credit is what you earn if the options expire worthless (i.e., you are not exercised by expiry date of the options). I will delve into more detail on this on succeeding posts, so look out for it. This can be a great strategy for both bullish and bearish markets, and also when you can’t afford to buy the underlying stocks to trade. The other leg of this combination of options minimizes your risk when getting exercised. However, there is still risk involved, and further knowledge needs to be acquired to trade this strategy.

Covered Calls And Puts

The best way to trade options is to trade it with the possession of the underlying stocks. This strategy is called covered options (more commonly referred individually as covered calls and covered puts). This is because owning the stock guarantees you that you are able to fulfill your commitments to the options trade, should you get exercised on or before expiry date. This is a great income generation strategy for your stocks when used properly. You can buy the stocks and then sell a call option with a strike price that is at a higher level than your purchase price, and then receive a premium for it. More details will be covered in the succeeding posts.

Options Trading Education

All these options trading strategies give you a rough idea on how to trade options and make money from it. Further learning should be undertaken to fully understand the nature of these trading strategies. It is important to have the right education in options trading in order to become a successful options trader. The educational materials and resources at Planet Wealth are awesome for both beginner and advanced options traders, as it covers a wide range of topics on how to trade options and it goes into depth on each topic. The great thing about Planet Wealth is that they are very helpful if you have any questions on options trading, and they also have experts who can hold your hand while you first start with your options trading journey. They also only recommend trades that they themselves are getting involved in with their own money, so it’s very reassuring that they have the best interest at heart when it comes to your success in options trading. Moving forward, I’d recommend taking Planet Wealth’s educational package to take those steps in becoming a successful options trader.