Simple Options Trading System

This Section describes how to calculate the profit or loss on an option trade. This would be the case should you take possession of a stock as a result of an option assignment and is shown graphically in this lesson.

If you buy a call, when the option comes ITM, it trades essentially just like the stock and the value goes up about $1 for every $1 the stock goes up.

If you buy a put, when the option comes ITM, it trades essentially just like the stock and the value goes up about $1 for every $1 the stock goes down, just like a short position.

In this example, you would have to put up $3875 to get 100 shares of MSFT, whereas with the call options, you only need $25 to control 100 shares of MSFT stock until expiration date or closing out the option contract.

The basic formula for calculating profit/loss on an option trade and the implications of the 3 possible outcomes explained.

You do not have to hold the option to expiration. You can close it out in an offsetting action anytime during an active trading day. You would get the cash value deposited or debited from your account.

An option that is ITM will be automatically exercised by your broker if held to the closing on expiration Friday.

Having a reliable broker with low commission rate is essential. I present a list of the best options brokers, choose one that fits your needs.

Try to get the highest trading level possible in our account either 2 or 4, whereby you will be able to sell naked puts. Level 4 requires a margin account which is not allowed in retirement accounts but it is beneficial to get you can for a non-retirment account. Just remember you do have obligations so don't overuse margin. if you can only get level 1 to start out with that is fine. Once you start doing a few trades you can request an upgrade later.

Commissions can severely cut into your profits as I show in this lesson. Be sure to use a discount broker or one that does not charge an advisory fee per trade. The more contracts you do, the less the commissions matter. But if you have a small account, commissions can eat away at your profit.

This module illustrates the 2 main strategies I do and how they put the odds in your favor. When you sell an option, time is on your side. The time value of an option decreases as time goes on and falls to "0" at expiration day. I like to sell OTM options with 4-7 weeks of life.

If you buy an option you have to be correct about the direction of the stock, the duration of the trade, and the magnitude of the move. Get any one of these 3 wrong and you lose. You could be right about the direction the stock moved, but many times it doesn't move enough to overcome the cost. As a seller that does not matter. You win.

Of course, you don't get big winners by selling options but you get MORE winners. Kind of like a home run power hitter vs a singles hitter in baseball. The singles hitters have a better batting average. I like to win more.

I walk through and explain a trade I did in IBM in early 2014. This is a typical trade on a typical stock that I use in my system. You will learn all the nuances and implications as the trade matured. I do my main trade which is sell the put. In this case I "lost" by getting assigned IBM stock, then turned around and sold a call against the stock. I collected premium and was out of the trade by expiration. So I made double digit returns on a stock that went nowhere.

Choosing between a covered call and selling a put. They are essentially equivalent positions, except selling the put is less risky because you would get a lower cost basis should you wind up owning the stock. Use the covered call if you are not yet approved for selling puts or if you want to collect the dividend. You cannot collect a dividend when selling a put because you do not actually own the stock yet.

Support lines and moving averages are used by many traders to establish important buying information and investor psychology. Here I explain what they are and how I use them for options trading. Basically you'd want to sell a put below or near one of these lines.

A support line stays a support line until it is violated. In this case if IBM fell below 170, you'd have to wait until a new price floor was established to get the news support price.

When a stock cannot go higher then a certain price, this is called resistance, and is usually a former support line. So IBM would theoretically have trouble breaking through the 170 barrier if it fell below that level.

When Stochastics get <20 and thus in oversold area, I like to enter a trade to sell a put. Looking at many charts and patterns, this one indicator seem to increase odds of success more than others. Look to enter a trade at or near a support price to increase your odds of success even more.

The typical stocks I do these trades on are big name stocks also called "blue chips". Most investors ignore them cause of their commonality. But by selling options against these types of companies you can get better returns and maintain a margin of safety due to the reputation and financial clout of the Market blue chips.

I like to use a trailing stop to protect my profits. You will always sell at profit and not worry about losing everything should a stock return to the price you bought it at after a big run. Had investors used this one technique during the big corrections in 2001 and 2008, they would have kept much of their gains.

By cutting losses, you can be wrong more times than right and still come out ahead, as the portfolio slide shows. Use a stop price you feel comfortable with, but never more than 25%.

When determining a stop loss, use the underlying stock to calculate your sell price, do not use the option price. The option is tied to the actual asset, therefore the price of the asset is what determines the value of the trade, should you be assigned.

A minimal portfolio of about $15000 is required to take advantage of these trades.

The list of stocks presented are the main ones I've been trading because they are industry stalwarts and great long term investments. So the worst that can happen is you will own one of these. That said, even though they are great companies, you still don't want to pay too much for them. I read several newsletters to keep informed. You should consider a subscription to some of the better ones I use listed here:

Motley Fool

Investor's Business Daily

Stansberry & Associates

I also have some syndicated articles from Motley Fool here and here,

Here I show you live exactly how I found a trading opportunity in EXC using technical analysis and then explain in detail how to fill out an option trade order form during open market hours. Watch my account get immediately credited for putting on this position by selling a put. I always sell OTM puts as exemplified here.