Exercising the Option to Buy or Sell

What Options Can Do

Options trading on the stock market is an additional way to diversify your investment portfolio. This differs from trading options and futures on commodities.

Stock market options trading involves contracts which give an owner the opportunity to buy or sell a security at a fixed price either before, or on, the date the contract becomes due. Investors can either trade the security itself, or trade the option. Some investors choose to use options trading as a hedge against losses in other segments of their portfolios.

Let’s take a look at exercising the option to buy or sell a particular stock for which you have a contract. You have any time up until the contract’s expiration date to decide what you want to do. You can either take the stock or sell them at the price fixed on the contract no matter what their current value on the market might be.

Consider this example in options trading. There is a stock you have had your eye on and because of your research and analysis of historical trending reports, you believe the price of these stocks will rise. Should you be concerned that the price may not rise as you expected, you would probably wish to buy a call option that is close to the price on the current market.

Before that option expires, the stock price may increase quite a bit. In that instance, you would exercise the option to buy at the lower contract price.

Conversely a put option gives you the right to sell at a fixed price. You would buy a put option if your research indicated the stock price would likely fall.

Now your options trading choice is whether to keep the stock and its built-in gains, or sell it and take your profit. Of course, there will be fees due out of this profit which pay for the cost of the option itself, taxes, and brokerage commission.

Options trading is not as straightforward as you might believe. The beginning investor would do best to use a good deal of caution and the benefit of a mentor’s experience before attempting to profit from options trading. Mentors can help save you all the pain of making unnecessary losses, so I suggest you find one, and grab a book to learn from.

The Importance of Risk Management

Risk Management - what is it and why do we need to consider it? Risk Management is the ability to handle or manage the risk that you are exposed to in a particular trade. Risk Management is important in trading in order to protect your money or your capital because no one exactly knows for certain what the market will do once you are in a trade. We can only try and tell based on certain analysis and trends what we think will happen to a particular stock, but no one out there (not even the market makers) is certain that a stock will go to the direction that you would trade as or told to trade. Thus, it is only fair that we need to look after our cash and make sure that if things don't go on our favour, we will not have lost everything in our trading account.

Risk Management also involves identifying how much you are willing to risk for a particular trade. For example, if you have $10,000 in your bank account, you might only want to risk 20% of this amount at a time. Thus, when you trade, you may only get into a trading position that will only let you lose a maximum of $2,000. In other words, you are comfortable enough to lose this amount, should the trade go against you.

Another aspect of risk management involves looking at a risk-reward ratio for a particular trade. This basically means that you look at how much you are risking in proportion to the reward or potential profit that you will make out of a trade. For example, if a trade is only able to generate $1,000 in profit, and you are risking $10,000, this may not necessarily be a good risk-reward ratio as compared to a trade with $1,000 potential profit and a risk of $4,000.

Prudent risk management is part and parcel of trading, whether it be stocks, options, futures contracts or indices. When I trade using Planet Wealth's recommendations, I always work out how much I'm willing to put into the trade. I never put all of my money into one trade, and before I enter on a trade, I also think if I'm prepared to lose x amount of dollars, should it go against me. More importantly, I also look at the risk-reward ratio that is not less than 20%, and this means that my trades will only let me risk less for more profit.

One good thing about the range of strategies that Planet Wealth offers is the various levels of risk that each strategy entails. This helps their clients decide if it meets their risk management criteria, and if they are also feasible for certain market conditions. This is especially crucial for times like what are experiencing now, where the market is very volatile and tends to go on a downward trend. Planet Wealth has strategies to cater for a downward trend, and also ensures that the level of risk is minimised as much as possible.

In summary, risk management is a very important factor for trading in order to protect your money and allow you to profit in the markets in the long term. Whether you trade stocks/shares, options, futures contracts, currencies or indices, make sure that this is at the top of your list.

Another sharemarket secret unveiled. To the many trading successes.

"Share Renting" strategy - a great income earner for Bull Markets

What is "Share Renting"?

Share Renting is a term coined by Jamie McIntyre of 21st Century Academy to simplify an options strategy that can be used to generate extra income when you hold physical stocks or shares. Share renting is being used to form an analogy with owning a property and renting it out to a tenant, and making an income from rental. This is one of the strategies that are being taught in more depth by Planet Wealth. Basically, the strategy is this:

1.) Own the physical shares or stocks. If you're investing in the Australian market, you must hold at least 1,000 shares (or multiples of 1,000). In the US markets, you can go for at least 100 shares (or multiples of 100). This is so you can apply the options strategy on top of the stock or share that you purchased.

2.) Sell a Call Option - When selling a call option, you get a premium or "rental income" for agreeing to sell your stock at a certain date for a specified price. Choosing an option to sell will depend on the price level that you purchased the shares, and the expectations/views/predictions that you or the market have on the particular stock or share at a certain date.

The trick is, you should choose a call option at a higher price and with a price that you think it will not reach or hit at the expiry date. Each option has an expiry date, and you also need to look into this to work out if your view is for within the month or within the next 2 months, etc. This is one of the factors that will determine how much income you will make out of the premium.

For example:

You purchased 1,000 shares of Company XYZ @ $2.00
You foresee that this stock, based on existing market conditions, and based on previous movements, will not go up to $2.50 in the next month.

The $2.50 Call Options strike price for next month is paying 15 cents premium.
You can sell 1 call options contract for Company XYZ and earn $150.

If Company XYZ doesn't reach $2.50 at the expiry date, then you get to keep your shares, and you also get to keep the $150 premium! If you continue to have a bullish view of the stock or share in the long run, you might want to keep it. Hence, the strategy is to find a strike price that is more likely not to be hit or reached.

If it does hit the $2.50 strike price, then you would have to sell the shares for $2.50, which then means that you still made money on the stock or share ($500 in this instance, plus the $150 premium). Either way, you win!

Not a bad strategy for a Bull Market! You can still do this on a bear market, but you have to be bullish on the stock that you own and not make a loss on it if the call options are exercised.

I've learned all of this in more detail through Planet Wealth, and more details are on their e-book, so check them out! I hope you've learned another options strategy today.

Another Sharemarket Secret unveiled! Til the next post!