Options trading is the future of the stock market thanks to its low cost to start and high potential gains. But there are more complex strategies to investing other than picking a stock you think might do well. Sometimes you are even betting against the stock doing well to make money.
The process of trading an options contract is to say you are going to buy 100 shares of a company at x amount of money. It is then set in stone for a period of time, usually around a month. In that month, you can then decide whether to exercise your right to buy those shares or let the contract fall through and lose the money.
Learning options trading is complex, so here are seven questions you should ask before jumping in.
1. Do You Have a Strategy Already?
If you are like most people investing in options trading, then you have been in the stock market game for at least some amount of time. Your time in the stock market will also influence your investing strategy.
There is a purpose for the stock market and that is to make your money make money. Don’t let the thrill of huge returns cloud your vision of investing.
A person looking to live off of this income now will enjoy options trading thanks to its quick turnaround times. If you’re looking to retire on this method of money-making, then always keep your portfolio diverse.
2. Ask Yourself “What If?”
‘What if’ questions refer to the string of questions that follow the purchasing of a contract. It is the process of understanding there are always multiple outcomes for any contract and that every option should be considered.
Staying on top of these questions ensures you will have a steady hand when it comes to choosing trading strategies. Preparing for each scenario will ensure you make the best trade option possible. This is why research is key when it comes to options trading.
Being prepared for different outcomes allows you to adjust as needed as the stock market changes.
3. What Is the Volatility of the Stock and Stock Market?
The stock market goes through different periods of volatility. A “bull” market refers to steady or high growth year-over-year. A “bear” market is used to refer to slow growth or even negative growth year-over-year.
This can then be broken down by individual stock volatility. If it is a newer stock that has a higher volume, chances are it will be a higher volatility stock. If it is an older stock that has not historically fluctuated much and has a higher volume, chances are this stock will continue to remain steady in the coming months.
You also will need to establish the “break-even-price.” This is the price target of the stock where you’ll break-even when you buy or sell a contract. Anything above that price means you profit and anything below means you are out the money.
4. How Much Are You Willing to Risk?
You can answer this question in two different ways. Either by pulling from pre-existing investing accounts or by setting up a separate fund, thus increasing the amount you are investing.
If you’re getting into the stock market for the first time and want to risk it all on options trading, then you need to have an options trading strategy. Without a proper risk management strategy, you are almost guaranteed to set yourself up for failure.
A good risk management strategy will include a diverse portfolio. A diverse portfolio should include individual stock investments, options trading, and bonds. This diversity allows for a mixture of safe investments and risky ones.
Options trading allows you to start trading your contracts with lesser amounts of money. So if you want to buy a single contract (a contract consists of 100 shares) of Company 123 at $10 a share, then you only need to put down $10.
If you decide to go through with the contract at the said price, then you pay the $1000 dollars regardless of what the stock price is. If you decide to pull out of the contract and not exercise your right to buy those shares, then you are only out $10.
5. Are You in for the Long-Term or Short-Term?
Options are versatile, which is why they are a favorite among investors. You can put up a contract that will only last a week, or go long and take six months to see how the stock is going to perform.
Long term contracts mean you have faith in the company doing well in the long run. Six months down the road you expect them to be turning over profits and performing well for the shareholders.
Short term contracts mean that you may be “riding the wave” of the stock. If you’re betting on this company getting bought out or beating expectations on their quarterly earnings for just this quarter then dipping, short term is the better option for you.
6. Does Options Trading Fit Your Type of Investing?
Your investing style will determine your style of choosing trading strategies. Your trading style will also depend on your definition of safe and risky. One person will see a week’s investment as risky, while the other will see it as a safe bet.
Your investment style indicates how comfortable you are with trading and can come down to experience in the stock market and age. A person may be comfortable day trading and having multiple brokerage accounts. On the opposite end, a person may only be comfortable in one brokerage with someone else providing the best way to invest.
Those in their younger years will be more likely to take on an aggressive trading style. Those in their older years will want to play it safer in case of emergencies.
7. Are You Watching Your Contract or Is Your Broker?
This is realistically the most important question. A broker is someone that has experience in the stock market. They will do their best to produce the most favorable outcome, based on their research.
But if you’re watching them yourself, then you can make the call to exercise your contract immediately. No middle man. The downside to this would be that you have to have the time on your hands to do so.
The Right Time to Get Into Options Trading Is Now
The best time to get into options trading is always going to be sooner rather than later. The earlier you get in, the more your money will start to work for you.
When it comes to trading options, don’t look any further than our Options Income Course. This course will show you how to make an income off of options trading and can ensure you will be living comfortably.