After Tuesday’s issue, our inbox was flooded with some amazing reader questions that I couldn’t wait to answer. While some asked about last week’s Fossil Group (NasdaqGS:FOSL) trade, most people asked questions about trading strategy basics that I’m more than happy to cover.
I’m always excited to get your feedback, and always ready to answer your questions. If you didn’t get a chance to ask something before this issue, you can send me a message here.
You’ve Got Questions, I’ve Got Answers
Here are your most-asked questions.
- If a share price falls, how can I make money from an option? – Mike B.
The easiest, and I think best, way to make money from a stock whose price is declining is simply to buy “put” options.
When you buy a put option, you are buying the contractual right (options are actually “contracts”) to “put” stock onto the person who sold you the put option.
To “put a stock on” someone means you get to sell it to them, like forcing them to buy it from you. If you buy a put whose strike price is $50, $40, $30, whatever the strike is, it means you have the right to sell someone stock at that strike price.
Let’s say you think XYZ stock is going down and it’s now at $50. Maybe you think it could go down to $30. If you buy a $50 strike price put, that gives you the right to sell someone XYZ at $50, as long as your contract doesn’t expire. If the stock drops to $30, and your option hasn’t expired, you can put stock on them at $50, meaning you force them to buy stock from you and pay you $50. Then you’d be “short” XYZ, having sold stock you didn’t actually own. You can then go into the market and buy the stock at $30 and use that stock to cover (it’s done automatically) the stock you are short. By doing that, you made $20 a share.
However, the easier way to make the same $20 (or more) is by simply selling the put option you bought. Whatever you paid for it, it is now worth at least $20, because someone else would want the right to sell XYZ at $50 when it’s only trading at $30.
So, you sell the put for at least $20 and profit that way. That’s a simple example, but you get the picture.
Buying put options is a way to profit on betting an underlying stock is going down in price. In contrast, buying call options can bring profit by betting that the stock will go up in price.
To help you remember what a call option is, it gives the buyer the right to “call” the stock to you. Like if you “called” the person who sold you the option to say, “I’m buying it at the strike price you are contracted to sell it to me.” And when you buy a call option you have the right to call stock to you at the strike price.
Hope that helps you remember the difference between different options contracts!
- Do I have to be glued to my computer to get into these trades? – Moira A.
No. Making these trades is easy.
You can use limit orders to buy options and use stop-orders and limit orders to get out of your positions while you’re at work, or at the beach. I use them even when I’m watching the market like a hawk.
- Why should we sell half of our position when it hits 100%? – Allen B.
An age-old Wall Street adage, and one of my absolute favorites is, “Bulls make money, bears make money, pigs get slaughtered.”
A 100% gain is always a thing of beauty, so taking off half of a winning position when you’ve locked in a 100% gain is about not being a pig.
Then, there are the mechanics of options. When you’re on the right side of an options trade and you have a handsome gain, it’s because the underlying stock did what you expected and wanted it to do, and the gain in your option position reflects that.
The first thing to recognize is that if the stock already moved in the direction anticipated, it may have exhausted its move. By taking half the position off, then the stock could subsequently move against you, your option position starts to lose profitability, and you can make sure you get out of the remainder of the position profitably.
I’ll typically put down a stop-loss order on the remainder of the position. I’ll get out on that leg with around a 75% gain, or at worst, I’ll get a 50% gain on that remaining half. Again, the option is profitable, and the stock has moved in the desired direction. The thing that’s left for you to consider is how much time there is left on the option (the expiration date). If there’s not a lot of time, maybe a matter of days or a week, I prefer taking all my gains and will close out the position.
If I have a couple of weeks or more, and I believe the stock “could” continue to move the option further into profitability, I’ll let the other half of the position run. Other considerations on letting the remainder of your position run are what the market is doing, and how investors are reacting to what the stock’s already done.
The market, moving in the wrong direction, can crush any good position. And after a stock has made a good or bad move, investors adjust their expectations. This is especially true of short-term traders who might be looking to buy a dip, short-sell if some support is broken, or otherwise play the stock based on the move it just made.
Taking half of a winning position off with a 100% gain is always smart.
- I move fast with alerts, but sometimes your prices are already out of reach. What should I do to make sure that I get into these trades? – John U.
Getting into option positions I recommend can be a bit tricky, I’ll admit.
I’ll almost always recommend a price I think subscribers can get into the trade at, based on where the option is trading and what the underlying stock is doing. That’s why I suggest a price to “pay up to.” Sometimes the trade takes off because the stock starts doing exactly what we expect it to do, and there’s opportunity to buy in near where I’ve recommended.
Sometimes, if the price goes up, the option comes back down and patient investors waiting to buy at more favorable prices get filled where they are waiting with their limit orders. Generally, if you can’t get into a trade at 10% to maybe 15% higher than where I recommend, it’s best to let it go and wait for the next trade.
Trades are like busses, there’s always another one coming along. And in Zenith Trading Circle, I send out alerts every week with new information and opportunities.
I’ve spent the last 35 years as a student of the markets and trading every opportunity I can. And I started by learning some of the information that I’ve covered just now…
Anyone can do this kind of trading, and everyone is encouraged to learn how to find profits and accelerate them. That’s why I joined Zenith Trading Circle, and if you have any desire to learn how to make gains like the quadruple-digit profits we scored last week, you should too.