More Sophisticated Stuff

There is much more to an options education, but there is no urgency. First, learn the basics. When that is accomplished, interested investors can learn to use options with more sophisticated strategies. Options are versatile and may be used to accomplish many investing objectives.

When you own stock (or sell it short), you earn money when the stock price rises (or falls). That’s about all you can do when using stock. With options, you can make good money by owning positions that prosper when the following happens:

• If you predict that a given stock will trade in a narrow range for a given period of time (perhaps six months or one year) and then rise sharply, you can use options to cash in on that situation—if it comes true. In simple terms, you sell one call option (that expires in five or six months) and buy a different call option (that expires at a later time). That second option may explode in value if the stock price increases after the first option expires worthless (per your prediction).

• The trader correctly anticipates that the stock is about to undergo a significant price change, but the direction of that change is unknown. This can occur when news is pending and it is uncertain how the news will affect the future business prospects for the company. Straddles or strangles (one call plus one put) can be bought by investors who anticipate such a move in the underlying stock. This is a high risk/high reward play.

Straddles can be sold by investors who want to bet against such a large move. Because it is an especially risky play to sell call and/or put options, the strategy can be modified (iron condor) to limit both risk and reward.

• Traders can earn money by correctly predicting that the stock will soon become more volatile. Or, they earn a profit by correctly predicting that the stock will soon be less volatile.

Bottom line: You can cash in on a variety of market expectations. There is no need to be a one-trick pony (always bullish). None of these plays can be made when trading stock.