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Friday, June 2, 2017

Stock Option Trading



The first time I heard of stock option was when I opened an account with a discount broker, however, I kept away from it because of the high risk stated in the disclosure form more than ten years ago.

I decided to learn more about stock options within the last six months, reading articles, watching YouTube videos and also listening to podcast on the subject. I was surprised to see the amount of information and sources on this topic. The trading strategies such as Iron Condor, Iron Butterfly, Butterfly Spread seems too complicated for me.

After reading through all the material, I decided to focus on the following basics:
  1. Options can be bought and sold.
  2. Options have a strike price, premium and expiration.
  3. Selling a call option means we may have an obligation to sell shares at the strike price (even when the market price is higher that the strike price).
  4. Buying a call option will allow us to get the shares at the strike price if the price of the underlying share reaches or goes above the strike price.
  5. Selling a put option means we may be obligated to buy shares at the strike price (even if the market price is lower than the strike price).
  6. Options represent 100 shares of the underlying security.

At the moment, I prefer to do the following:
  1. Sell calls when I already own the underlying shares and the strike price and premium is high enough that I would not mind giving up the underlying shares.
  2. Sell put for shares I plan to buy anyway if the premium is high enough (provided I have enough funds to cover the price of the shares should the option be exercised).

Using the above approach, I stand to collect the premium with very little risk. To further reduce the risk, I look at the following:
  1. Only trade options that expire after known major events such as earnings.
  2. Trade only if the premium is high enough (more than 50 cents but I prefer premiums that are closer to $1). This is because anything less is not worthwhile (after taking into account the fees and risk in the trade).

In terms of investment, the focus of my returns are: dividend followed by capital gain. Option trading provide additional income but only when the opportunity presents itself; I do not plan to chase after it.
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