Options 101 - Another Leveraged Tool to Make Big Profits

Interest in options trading has grown considerably in popularity in recent years. If done properly, options trading can put the trader in a position to make some massive gains without the risks that are present in other markets. For too long, investors associated options with risk and danger, and while some options strategies are accurately described by those two adjectives, the more basic options trades that beginners should focus on are not. In fact, options trading is the most cost-efficient way to control large amounts of stocks or other underlying assets without lots of risk. We're going to show you some of the basic strategies that you can use to do just that.

Puts, Calls And More

For rookie options traders, it's best to keep your focus limited to the most basic options strategies and that includes buying puts and calls. When we buy puts, we are bearish and we want the underlying asset to decline in value. Calls are the opposite. When we buy calls we are bearish and want the underlying asset to appreciate. Either way, our risk is limited to the premium we pay for each contact. An equity options contract is equal to 100 shares of stock and quote in prices such as $1, 2.50, $5, etc. So if you buy one call contract on Microsoft when the contract is trading at $2, your total is $200. ($2 x 100 shares = $200)

Here's the beauty of options. Let's say Microsoft shares were trading at $25 when you purchased that call. To buy 100 shares of Microsoft, you'd have to risk $2,500, more than 12 times more than the cost of the call contract. Best of all, the returns with options are usually far greater than with just owning stocks. Price action for options contracts is measured by delta, that is, the measure of how much an options contract moves in relation to the underlying security. A contract with a delta of 0.5 means that the contract moves 50 cents for every dollar the underlying asset does. That puts you in a position to gain 50% on a $2 options contract. If you buy a $30 stock, it needs to go up $15 to net you a 50% return. See how powerful options can be?

Other Conservative Options Strategies

There are a couple of other conservative options strategies that beginners should explore. They are covered calls and married puts. Covered calls and married puts are both income-generating strategies that allow us to collect premiums on stocks we own that either aren't very volatile or are going through a period of choppy, range-bound trading. A good rule of thumb with both strategies is to write one contract for every 100 shares of stock you own.

Here's how they work: Let's say you own 1,000 shares of Pepsi and want to write (or sell) 10 covered calls at 50 cents each when Pespi is trading at $60. You will collect $500 in income for writing these calls (50 cents x 100 shares x 10 contracts = $500). Sounds good, but what's the risk? The risk is that if Pepsi soars above $60 before the contract's expiration date, the buyer of the calls is going to call away your Pepsi shares at $60 and sell them for a profit at whatever the market price is.

Married puts function in the same fashion. We can collect premiums, but we want our shares to stay ABOVE the strike price before the option expires. On the other hand, if we own married puts and the stock falls below the strike price, we exercise the option and sell the shares at the strike price. This is a nice option to have, so consider married puts to be an insurance policy against your stock position.

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