If you’re looking to hedge risks and earn a good income, then options trading may be something to consider. Of course, there are a lot of different strategies that come along with this path, and the trick of the game is to figure out the right asset to invest in to yield the best return.
Not only do options allow you to hedge risks, but they also give you a great opportunity to pacify your portfolio, which is why so many people are jumping into options trading. But when you’re new to something, there is a big learning curve, especially when you’re dealing with money and an ever-fluctuating market.
So today, we’re going to look at some tips our team at Capital Exploits has on how to pick stocks for options trading that are going to be the right fit for your portfolio and allow you to improve the odds of a successful investment.
What is Options Trading?
First off, what exactly is options trading? This is the trading of option contracts that are tied to assets such as stocks or other securities that are designated for a set time frame. There are two different types of options – call option and put option.
A call option allows you to buy a certain asset at a price within a defined time frame. This is called the strike price. The final date that you have in that time frame is called the expiration date. When it comes to a put option, this is the exact opposite of what a call option is.
Basically, option tracing is when you look to buy or sell these assets, and this can be done through an online brokerage account.
Pros & Cons of Option Trading
The trick to looking into option trading, especially with stocks, is having access to resources that could really help you determine what stocks are right for you. Even so, we thought it would be helpful if we looked at some of the pros and cons of options trading before we got into the process of picking stocks for options trading.
Pros:
- Options trading offers cost-efficiency with a huge leveraging power
- You can see a higher return on your investment than buying shares
- They can be used to hedge positions which make them a lower risk than some equities
- A wide range of strategies are available when it comes to option markets and trading
Cons:
- Options trading of stocks often come with less liquidity
- Trading in this way is more expensive than doing so with things like futures or stocks
- Premium values will decrease faster than other options
- Not all stocks are available for option trading
How to Pick Stocks for Options Trading?
Now you understand the advantages and disadvantages of options trading when it comes to any type of asset and exactly what options trading is. The next step is to take a look at a few steps that might help you form a strategy for picking stocks for options trading.
Research
Everything when it comes to investing should start with research. You first need to look at the markets and industries that offer stocks for options trading. Then find a few that you want to really dive deep into and look at things like earning reports, industry-related research, upcoming events that specifically have to do with that industry, and other ones that might impact the stock market.
When you narrow down the companies that you want to choose, you then want to dive deeper into the company itself and look at the management team, their website, the products themselves, as well as press releases. You want to choose stocks that are proven to be successful.
Liquidity
When looking at these stocks regarding options trading, you want to find extremely liquid options. By doing this, you’re going to allow yourself an easy entry and exit without having to worry about extreme slippages. So looking at liquid stocks with high volumes of stock already being traded is important.
On top of this, if you can find stocks that look like there are no upcoming events that could potentially affect them, they would be a great option. The key, though, is to look at the stocks and their options to make sure that both are liquid. Because sometimes, a stock may be liquid, but the option is not.
Track Them
Next, when looking at these stocks, you want to look at implied volatility. This is a key factor when you’re looking to decide whether options prices are going to be moving either up or down. Higher volatility comes with higher premiums. This might cause the option to get exercised. On the other hand, if you’re looking at lower volatility, this is more favorable to the buyer of options.
For traders looking at stocks for options trading, you should look at the stock’s historical volatility along with the implied volatility. This means you need to track them for a little bit before you jump into the investment.
Look at Stock-Specific Events
For those considering options trading, you have to be able to really keep an eye on events that will affect the stock itself. This means looking at economic data, election results, earning reports, and even new product launches. These can all be events that will impact the stock.
In essence, you are looking for indicators that are going to help you predict when there will be a price movement of a significant amount. When you’re looking at stocks for options trading, this will allow you to know when to buy and when to sell.
Create a Watchlist
As you’re doing all this research and tracking of these stocks, you’re going to notice that you have a list of stocks you’re monitoring. This can be made into your watch list. By having this list, you’ll be able to become even more familiar with the ebbs and flows of that particular company as well as the market.
Our team of experts highly suggests that you stick with specific industries and companies when you are first starting out. Especially if, through your research and tracking of the market itself, you’ve had success with them regarding these investments.
Eventually, once you have become more knowledgeable, you can expand this watch list. Still, in the beginning, you should definitely keep an eye on these and only these stocks.
Investment Objective
Another great thing to do when you’re looking at stocks and are trying to decide what you’re going to choose as an options trader is to really look at your objectives. What are your goals, and what are you looking to achieve by investing in these options?
This will also help you create your investment strategies which is the next important factor when it comes to choosing stocks for options trading. Are you looking to make this a career? Or are you simply doing it to help diversify your portfolio? Maybe you’re just doing it to make a little extra cash for your next vacation. Whatever the reason is, this is your objective, and it will inform your decisions in the future.
Strategize
Now that you have all of that, you can sit down and look at the available strategies when it comes to trading options, particularly stocks. Several different strategies can be useful.
For instance, if you’re a more conservative trader with a pretty good stock portfolio, you might want to go for a writing strategy. This basically has you writing calls on some of the stocks in your portfolio.
For a more aggressive trader, you may choose to be a little bit riskier. This might mean you look at more longshot stocks and opt to buy puts on these stocks indices. No matter what your strategy is, and these are just two of the options, the fact that you went through all the steps above and understood why you’re doing what you’re doing will help you choose the right one for you.
Build Parameters
If you have the strategy in place and all your research, you can then look at building parameters such as expiration dates, option deltas (the ratio that compares fluctuation in a price of an asset), and strike prices. This will be the final step in deciding what strategies you want to use and how to choose the stocks for your option trading investments.
Final Thoughts
Options trading has a lot of great benefits, such as being able to hedge risks. There are some challenges and things you have to look at before deciding to invest in the stock market. So if you take the information we’ve given you above and walk it through each of the stocks you’re looking to invest in, you should be able to find the right ones for you.
Of course, having access to a vast number of resources to keep up to date on all that information is essential, so we highly suggest you check out our newsletter Insider Newsletter.