How to Pick Stock Options
Choosing stock options to trade involves quantifying many variables. Investors must consider the likelihood of the stock moving in the direction of the option, how expensive the premium value is, and how much time there is before expiration. Carefully done options trading is very lucrative. However, investors are warned to consider that of several options traded fewer than half will result in profits. Hence, a diversified portfolio of options is necessary to regularly achieve success.
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Instructions
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Know that the strike price is the stock price at which the option holder must pay in order to exercise the option and exchange it for stock. A call option gives the option holder the right to buy stock at a specified stock. A put option gives the holder the right but to sell stock at a price set at the time the option was bought. Option traders must first pick the direction of the stock under consideration.
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Options contain time value known as premium. The premium is the difference between the strike price and the value of the option. If a stock is at 55 and the exercise price is 50, the intrinsic value of the option is 5. If the option is at 7, the premium is 2 points. The 2 points represents the fact that the option does not expire until some time in the future. The longer the time before expiration, the higher the premium. Look to buy options with as much time to expiration with as little premium as possible.
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Compute an expected value that you expect the stock to reach. Compute the possible value of the option if the stock reaches your estimated value. Choose the option to buy by computing the option with the highest percentage gain. Understand that any premium will decline in value even if the stock price remains the same as the option approaches expiration.
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Understand that stock option premiums are also a function of the daily fluctuations, or volatility, of the market. If the market or the individual stock is subject to a large daily range between its high and low values each day the opportunity to trade between the fluctuations is also high. The result is an increase in the value of the premium. Remember that options are not investments. They have finite time values and must be traded as profits arise.
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Learn other facets of picking options. Covered call writing is an option picking technique that affords the investor additional income by selling options against a stock already owned. Learn to buy options and exercise them if there are large capital gains. This will turn short term capital gains into the reduced tax rate of long term capital gains.
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Before trading any investment, especially stock options, have a plan. Trade options knowing your setup (when to recognize an option is ready to move), a reasonable amount to buy, a reasonable sell signal and the ability to stick to the plan. While individual hunches may pay off, discipline is a much better technique to use when buying options.
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Tips & Warnings
Practice paper trading before investing any real money.
Never trade off rumors or hunches. Neither provides the investor will enough information to complete successful trades on a regular bais.
References
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