Start Here If You’re New To Options Trading!
Options Trading 101: A Beginner’s Guide
Ask any professional investor and they’ll tell you the same thing…
Options are a very powerful investing tool.
As you may know, we use options in our premium trading service, the Options Profit Pipeline. This service focuses on call and put buying in commodities and the companies producing them.
Today we’re going to discuss the basics of options. This report will allow new Options Profit Pipeline subscribers, or any other beginning option trader, to shorten the options learning curve, and get on their way to profits sooner.
But before we get into the intricate details of options trading, let me explain why investors trade them in the first place.
There are two main reasons for using options- hedging and speculating.
While individual investors can benefit from hedging via options, it’s mostly large institutions that do it. If someone holds a large stock position in a particular company, they may want to insure that position against a downturn with put options.
The other function of options in speculating…
This is where the big money can be made- or lost. Using options to speculate on price movements allows you to profit, without having to plunk down thousands of dollars to actually buy a stock and/or commodity ETF.
What’s more, it’s a great way to trade while keeping your downside risk controlled.
We’ll get into more on this later, but the most you can ever lose on an option is the premium you pay to purchase it. Nothing more!
With that out of the way, let’s discover a few options essentials…
The Basics Of An Option Quote
First of all, what are options?
An option is basically a right to buy or sell one hundred shares of an individual stock, before a specific date, at an agreed upon price.
If that’s confusing to you, let me explain…
Look at the following option quote-
XOM April 2015, $95 Call for $3.00
This option gives you the right to by 100 shares of Exxon Mobil (XOM), anytime before the 3rd Friday of April, at $95 a share.
To get this right to buy XOM stock at a future date, you have to pay a premium. In this case, the premium is $3.00 per contract. That’s the price you pay to buy the option.
Since all option contracts are for 100 shares of stock, you take the $3.00 and multiply it buy 100. That leaves you with the actual cost of the option- $300.
Now let’s take a step back…
The option quote above has 5 components. Let’s break them down one by one.
XOM – This is the stock that the option is based on. While some stocks don’t have options available, most of them do. There are literally hundreds of thousands of options available in the marketplace at any given moment.
April 2015 – This is the expiration date of the option. Expiration normally occurs on the 3rd Friday of every month. In the case above, the option expires on the 3rd Friday of April.
In many large, highly liquid stocks and commodity ETFs, you’ll find weekly options. It’s important to note the difference between weekly and monthly option contracts.
$95 – This is the strike price. The strike price is where you get to buy XOM upon expiration of the option contract. For example, if XOM is trading at $98 upon expiration, you still get to buy it for $95.
On the other hand, if XOM is trading below $95 at expiration, the option will expire worthless.
Call – There are two types of options- call and puts. If you’re buying calls, you expect an asset to trade higher in the period of time before expiration. If you’re buying puts, you expect the asset to trade lower before expiration.
To make it simple, if you’re buying calls, you want a stock to trade higher. If you’re buying puts, you want a stock to trade lower.
$300 – As I mentioned earlier, this is the premium you pay for the option. The farther the expiration date is in the future, the higher the premium you’ll have to pay to own the option.
Now this is important…
In the option example above, the $300 you pay in premium for the XOM calls gives you the RIGHT, but not the obligation to buy XOM at $95. If you exercise the option, you’d have to come up with $9,500 to actually buy the shares ($95 x 100 = $9,500).
With the Options Profit Pipeline, we suggest selling the option back to the market before the expiration date arrives. If you don’t sell the option before expiration, and the option is in-the-money, most online brokerages will automatically exercise the option for you.
Options Trading: Limited Risk, Unlimited Gain!
One of the biggest benefits of options is the fact you have the potential for unlimited profits. But at the same time, your risk is limited.
Let me explain…
In the XOM example above, the premium you have to pay to own the option is $300 (plus any commissions).
That $300 is the maximum amount you can lose on that contract.
XOM could go bankrupt and you’d still only lose $300. Compare that to owning 100 shares of XOM at $95. If the stock dropped to $0- you’d lose $9,500.
But here’s the deal…
You still get to profit from upside in XOM by owning the call option. If XOM keeps trading higher and higher, the value of the option will keep going up and up.
This is why you see option trades returning 100%, 200%, 300%, and much more.
In fact, we achieved gains of over 300%, 400%, and 700% in the Options Profit Pipeline in 2014!
If done properly, options trading is a fantastic way to limit your investment risk while reaping outsized gains.
Options Trading- There’s A Lot To It!
While the information above will get you started on your way to options profits, what we covered today is just the basics. In reality, there’s a lot more information you’ll need to know before you’ll feel confident in your ability to trade options.
Some additional concepts you’ll need to understand are…
- In-the-money vs. out-of-the-money
- Option spreads
- Leverage
- Option Greeks: Delta, Gamma, Vega, and Theta
- Money management techniques
While I don’t have the time to cover these concepts today, I’ll be providing additional, easy-to-use information in coming weeks. You can get a jumpstart on your options education by visiting the Chicago Board Options Exchange’s education link.
But keep in mind…
A subscription to the Options Profit Pipeline will give you everything you need to know to start profiting from options quickly. With your subscription, you’ll receive a Quick Start Guide along with an in-depth report on options trading in commodity ETFs and natural resource companies.
Stay tuned to Commodity Trading Research!
Until Next Time,
Justin Bennett
Commodity Trading Research
BIO: Justin Bennett is the head commodity research analyst at Commoditytradingresearch.com. With over a decade of real world trading experience, he finds ways for you to consistently profit from movements in commodities and the companies producing them. Sign up for our free reports and commodity newsletter at https://commoditytradingresearch.com/free-sign-up.
Category: Commodity Options Trading
