A lot of people think options is much more riskier than stocks but here I’m going to share with you some insight on how you can make it safer or customize it based on your own personal need.
As you dig deeper into options you probably recognize that there’s a lot of learning that you need to do to be able to understand them
Although many things out there talk about buying calls and buying puts and how to kind of trade those kinds of things but it’s not really the most effective and wisest approach to trading options.
In this case, people might try it out for a bit and then they lose consecutively, then they say options just don’t work.
What I want to share with you is:
- How you can customize some strategies when it comes to trading options.
- How you can be a little more safe or safer as you trade the option contracts.
I’ll share with you kind of two to three levels of it of being safer and that way you get a little insight on what it’s all about.
So if I’m looking to purchase a stock and let’s just say, for example, Tesla.
You’re thinking this stock has been running up the last couple days. Look at that explosion. It’s just been moving higher.
Typically, the approach that people would say is just buy a call.
The problem with the call contract, let’s say you’re going in and you want to buy and purchase a call.
Here’s kind of the downside, when you purchase that call you have a theta decay problem.
Which means that hey you’re losing 47 bucks a day (560 call). That’s quite a bit to lose from just the time value. So you have this curve, which means if that stock goes up you make money.
But if it stands still a few days later, you’re losing 50 a day and you’ll be down much more.
So that white line continues to get closer to the green line.
Green lines = expiration
White line = today
So not only does it have to kind of move up but it has to move off up enough to offset the theta problem or the time value loss.
Short is not the wisest approach — what’s the better approach?
Well let’s say you sell a put instead. Also a kind of a bullish strategy if you’re assuming that stock will go up.
But now here’s the cool kicker part, you’re getting 44 dollars of theta positive. So every day that white line now gets closer and closer to the green line.
So if you look at your profit and loss right here
You can see that white line continues to get closer and closer. So that’s really what you’re doing and that’s the better approach to kind of trading options.
What’s the downside to this?
The downside is if this thing does go against you.
Let’s say the stock pulls back, you could get assigned 100 shares.
If you’re dealing with one contract, you can get assigned 100 shares. One contract controls 100 shares.
So that’s kind of the problem when you’re dealing with options.
Here’s the awesome part, stock stands still, you make money.
Stock goes up, you make money
Stock pulls back a bit, you still make money.
On the flip side, if you’re trying to do a bullish strategy.
In this case stocks stand still, you lose money.
Stock moves up a little bit, you lose money.
Because of the time value, it has to move up quite a bit. When it comes to selling it’s typically a better approach.
But the issue is that, if it pulls back you know you have to actually put up the stock or you’ll get the stock put to you at the strike you sell — which is in this case 440.
So if the stock is at zero, somebody can give you that stock at 440, meaning you’d have to buy it back at 440.
That’s where the significant losses come in. Here when you look at it 440 compared to the stock chart that’s not that far.
That’s only right down here. That’s not a big movement.
When you start evaluating this
So here we’ve got 440
So that’s pretty close.
But what if we can get under at around let’s say 360.
You might feel a little bit safer, right?
So in that case somebody puts the stock to me at 360, I’d be much more comfortable because it’d be much lower than where it is.
So what I could do is in fact move this to maybe about a 360.
Can I go ahead and sell something at 360? Sure I can.
However, the problem is, look at the difference.
So you can see so here’s kind of our breakeven zero line at the 360.
Then our breaker mark on the other one the 440. You break even at 409 in this case. That’s why it’s not 440 because by the time you break even with the time value.
So the question is is do you want to be at breaker mark or at zero line?
What’s the trade-off?
You can go wider and be safer. The trade-off is that you’ll make less money.
This one you’re making 31 and 55 cents. This one you’re making ten dollars per contract. So in this case you’re making a thousand dollars at expiration and in this case you’re making three thousand dollars at expiration.
But the risk is greater, right? You’re closer.
So what’s great about options is that you can kind of control your risk.
You can get wider and be safer. So that’s the smarter approach to trading options is that you can just go wider.
Here’s the other thing, depending on what you want to do, the problem is still here.
You still could get that assignment even if you do go wider.
Let’s say you went wider right here.
How do you protect yourself?
Well, you buy a put further down. So I sell something for 10 and I get something at 340. I buy some protection at 340.
Now what that does is it sets up a little bit of a strategy.
The contracts look a little funky but that’s just because the way I’m splitting it up.
Basically think of it, you buy something for nine dollars and you sell it for ten.
That’s the way it works.
So you’re selling something that’s worth more than what you bought it for. That creates this spread.
So that way stocks stand still, you make money.
Stock goes up, you make money
Stock pulled back a bit, you make money
If it really tanks to zero, at least you’ve bought some protection there down below. Now let me show you what this kind of looks like at maybe as a single spread.
You can see there’s the zero line. If it pulls back you make money up to this point, you can still make your full amount.
If it stands still, you make money.
If it goes up, you make money.
So that’s a smarter approach.
Let’s just say that this was too close. So that’s that’s kind of the difference is.
You can spread them out as wide as you kind of want. Obviously the trade-off though is the that you make less money.
So from the closer one you make 2.27 cents. From the other one, you make 1.67 dollars.
So what does that mean?
In this case I make 2.27 dollars if I decide to go wider. I make less. I make 1.67 but at least I’m making 1.67 dollars. But I’m safer.
So it’s kind of like hey how close or why do I want to be. The closer you are the more you can make.
But it just shows you that you can control your risk. Safe to you is different than safe to other people.