The Best Options Strategies
One way to invest in the stock market is through the use of options. Options are contracts based on underlying stocks. They give the holder great leverage, as a small amount of money can control a large amount of stock. Option strategies range from simple to complex, and they can be used either to produce income or to protect money invested in stocks.
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Use Options To Diversity
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Owning shares in only one or two stocks increases risk. You should diversify your portfolio by owning stock in a variety of companies in a variety of market sectors, such as technology, medicine, real estate and energy. However, some of these stocks are expensive, and you may not have a large sum of money to invest in all of these at once. You can buy call options on stocks rather than buying the actual stocks. This gives you great leverage and doesn't expose as much of your investment capital to risk. For example, suppose you want to buy a stock whose price is $30 per share. It would cost $3,000 to buy 100 shares. Instead, you can buy a call option for 75 cents a share ($75 for 100 shares) with a "strike price" of $30, which is the cost at which you can purchase the stock anytime before the option's expiration date. If the stock goes up in price, say to $35 per share, you can "exercise" your call option and buy the stock at $30 per share. You can immediately turn around and sell those shares for a nice profit.
Use Options To Generate Income On Stocks You Own
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Owning a stock only gives you a profit if it goes up in price. While you are waiting for that to occur, you can make additional money by "writing covered call options." With this strategy, you write (that is, "sell") a call option. It's called a "covered" call, which means you own the underlying stock. You are giving someone the right to buy the stock from you at a specific price on or before a specified date. The "strike price" of the option -- that is, the price set for someone to buy the stock from you -- should be slightly higher than the stock's current price. For example, suppose you purchased 100 shares of company XYZ at $19 per share for a total of $1,900. One call option covers 100 shares of stock. Write a covered call option with a strike price of $20. You receive a premium for selling the option. No matter which direction, if any, the stock goes, you keep the premium, which might be $50 to $100 per contract. If the stock goes up in price and someone "exercises" your option, you will give up your shares of stock, but you'll also make money from that sale.
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Use Put Options To Secure Stock Gains
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Consider a scenario in which you own shares of stock, and the price has risen considerably since you bought them. You believe there is still potential for the price to rise, so you don't want to sell it. However, you don't want to risk losing money should the price drop. You can use a "protective put" strategy by buying an "in the money" put option -- that is, the current price of the stock must be below the put's strike price (the price per share for which the underlying stock may be sold). Should the price of the stock drop, the value of the put option will go up, offsetting any loss in the stock.
Combine Strategies
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Advanced options traders often incorporate more than one strategy in a play. Writing a covered call option and buying a protective put on the same stock is commonly called a "collar" strategy. When you write a covered call, you cannot sell your shares of the underlying stock should it drop in price. You can use a put option to offset any loss should the stock price go down.
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